passive investing

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pages: 345 words: 87,745

The Power of Passive Investing: More Wealth With Less Work by Richard A. Ferri

asset allocation, backtesting, Bernie Madoff, buy and hold, capital asset pricing model, cognitive dissonance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, endowment effect, estate planning, Eugene Fama: efficient market hypothesis, fixed income, implied volatility, index fund, intangible asset, Long Term Capital Management, money market fund, passive investing, Paul Samuelson, Ponzi scheme, prediction markets, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, survivorship bias, too big to fail, transaction costs, Vanguard fund, yield curve, zero-sum game

—Jim Wiandt, President and CEO, IndexUniverse “Few people understand indexing better than Rick Ferri. In The Power of Passive Investing, Rick clearly explains the sophistication of passive investing and how it will enhance account performance. If you haven’t yet incorporated passive investing into your portfolio, this book will convince you.” —Taylor Larimore, co-author of The Bogleheads’ Guide to Investing and The Bogleheads’ Guide to Retirement Planning “Rick Ferri has brilliantly assembled hordes of unbiased, highly technical investment research so that the average investor can understand and benefit from what the smart money has known for decades. If you care about how much you’ll retire with, you’ll read The Power of Passive Investing.” —Mitch Tuchman, CEO, MarketRiders, Inc. “Rick Ferri has gathered a wealth of research. A passive investment strategy is a great approach because it allows a person to focus on more important things in life.”

The numerous studies he reviews provide powerful support for passive investing and guide trustees and other fiduciaries toward this ideal solution.” —W. Scott Simon, principal, Prudent Investor Advisors, LLC “Passive investments deserve a place in almost all investors’ portfolios, but the range of choices has never been so complex or treacherous. There are now every bit as many flawed, gimmicky, or overpriced index funds as there are those from active managers. If you want to navigate this new terrain successfully, you’ll find Rick Ferri’s The Power of Passive Investing an essential text.” —Don Phillips, Managing Director, Morningstar, Inc. “Powerful! The extensive research behind this book makes a compelling case for a passive investing strategy. Ignore the information in this book at your own peril.”

These facts are well documented in the studies covered throughout this book. So why doesn’t every investor embrace passive investment strategies? The purpose of this chapter is to offer a few general thoughts about why more people don’t go passive when the evidence is so clearly in favor of this way to invest. Three Non-Indexers Non-index investors can be divided into three categories: the uninformed, the naysayers, and the procrastinators. More specifically: 1. The Uniformed: investors who don’t know about passive investing or don’t understand it. 2. The Naysayers: investors who know about passive investing but think they know better. 3. The Procrastinators: investors who understand and accept passive investing but don’t implement the strategy. Not everyone takes the path or knows it exists. There are those who are never enlightened, those who refuse to be enlightened, and those who believe in the strategy but never finish the job.


pages: 317 words: 106,130

The New Science of Asset Allocation: Risk Management in a Multi-Asset World by Thomas Schneeweis, Garry B. Crowder, Hossein Kazemi

asset allocation, backtesting, Bernie Madoff, Black Swan, business cycle, buy and hold, capital asset pricing model, collateralized debt obligation, commodity trading advisor, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, fixed income, high net worth, implied volatility, index fund, interest rate swap, invisible hand, market microstructure, merger arbitrage, moral hazard, Myron Scholes, passive investing, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, risk-adjusted returns, risk/return, selection bias, Sharpe ratio, short selling, statistical model, stocks for the long run, survivorship bias, systematic trading, technology bubble, the market place, Thomas Kuhn: the structure of scientific revolutions, transaction costs, value at risk, yield curve, zero-sum game

As indicated in the previous chapter, increasing the number of potential asset classes increases both the potential for greater risk management as well as increased return for a predetermined level of risk. As shown in Exhibit 6.2, while the underlying strategic asset allocation may be based on noninvestable benchmarks, an investor’s core portfolio should contain investable passive investments which capture the underlying returns of the noninvestable benchmarks. If an investor desires to increase their potential return without dramatically changing one’s asset class exposure, then, as shown in Exhibit 6.2, adding additional manager based investments (Satellite I and Satellite II) which track the passive investable assets but also may contain potential manager alpha should be considered. 114 THE NEW SCIENCE OF ASSET ALLOCATION Satellite II: Less Liquid Alpha Alternative to Satellite I Investments (Private Equity, Long-Term Lock Up) Satellite I: Investable Alternatives to Core Investables (Mutual Funds, Manager Based Alternatives) Core Investables (ETFs, Replication Products) Strategic Asset Allocation Benchmark Determined EXHIBIT 6.2 Strategic Benchmark, Core, and Satellite Groupings In Exhibit 6.3, the core investment classes have been broken down into equity, fixed income, traditional alternatives, and modern alternatives.

Moreover, global and domestic regulatory forces as well as market forces have created a new list of investable products (exchange traded and over the counter). These products include more liquid and readily available forms of traditional stock and bond investment (e.g., ETFs, OTC forward and options contracts) as well as more liquid and readily investable alternative investment forms (e.g., passive investable benchmark products). The addition of new investment forms has permitted individuals to more readily access previously illiquid or less transparent asset classes (e.g., private equity or real estate) and has increased the number of assets that provide the potential for risk diversification in various states of the world. In fact, risk itself has become a more tradable asset. While options had always provided a means for individuals to directly manage risk, previous attempts to directly trade risk had not met with success.

To the extent that returns to those risk factors can be predicted, then that knowledge can be used to determine asset weighting between various asset classes.2 Unfortunately, academic research has generally concluded that it is not possible to obtain accurate estimates of future returns to macroeconomic factors such that, as a result, future expected returns are often based on subjective estimates related to long term historical returns to risk factors. In the investment area one of the primary, if not the essential, questions is the value of active management relative to manager based or security/ market factor passive investable indices. Most investors are aware of the number of articles as well as books that attempt to address the value of active versus passive management. For years, this discussion was primarily limited to the traditional stock and bond area as informational and trading costs limited its use in the traditional alternative investments (commodities and private equity) area as well as in the area of modern alternatives (hedge funds and CTAs).


pages: 249 words: 77,342

The Behavioral Investor by Daniel Crosby

affirmative action, Asian financial crisis, asset allocation, availability heuristic, backtesting, bank run, Black Swan, buy and hold, cognitive dissonance, colonial rule, compound rate of return, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, endowment effect, feminist movement, Flash crash, haute cuisine, hedonic treadmill, housing crisis, IKEA effect, impulse control, index fund, Isaac Newton, job automation, longitudinal study, loss aversion, market bubble, market fundamentalism, mental accounting, meta analysis, meta-analysis, Milgram experiment, moral panic, Murray Gell-Mann, Nate Silver, neurotypical, passive investing, pattern recognition, Ponzi scheme, prediction markets, random walk, Richard Feynman, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, science of happiness, Shai Danziger, short selling, South Sea Bubble, Stanford prison experiment, Stephen Hawking, Steve Jobs, stocks for the long run, Thales of Miletus, The Signal and the Noise by Nate Silver, tulip mania, Vanguard fund

The very process of trying to define a gold standard can result in its bastardization. It has been said that “what gets measured gets done,” but it is equally true that “what gets measured gets dumb.” Passive management, which makes the yardstick the investment vehicle, falls prey to some of the shortcomings of the Cobra Effect as a result. But before I render a nuanced behavioral critique of passive investing (and anger an army of Bogleheads with pitchforks), let me speak to some of its considerable strengths. To be as direct as possible, passive investing should be the de facto choice of those uninterested in the art and science of investment management. By buying a diversified basket of index funds that covers a variety of asset classes, know nothing investors (who often know a great deal) are likely to beat more than 90% of active managers and have time to focus on pursuits more meaningful than compounding wealth.

This causes valuations to rise, and expected forward returns to fall, on what can only be considered inconsequential information. The rise of passive investing also means that stocks included in large indices tend to be less informationally efficient than those not in such company. Michael Mauboussin and company report that, “in mid-2016, passive index funds and ETFs owned 10 percent or more of 458 of the 500 companies in the S&P 500. In 2005, that was true for only 2 of the 500.” Increasingly, large swaths of a corporation are being bought and sold out of habit and not conviction, meaning that prices are less and less reflective of true value. Speaking to this phenomenon Jesse Felder has said, “‘passive investing’ will ultimately become a victim of its own success. The massive shift to index funds over the past 15 years or so drove the valuations of the largest index components to levels which guarantee poor returns going forward.

But if “this time is different” is the most expensive phrase in investing, I would like to nominate “I don’t know” as the most overlooked phrase in investing, with “I was wrong” as a close second. As is so often the case, the usefulness of these beliefs in an investment context is directly proportional to their behavioral difficulty. Acceptance of uncertainty and a belief in personal fallibility are remunerative precisely because they come so hard to humankind. It is strange to consider that many of the most effective tactics in investing have “I don’t know” at their core. Passive investing is the embodiment of “I don’t know” investing; if you’re not sure what’s good and what’s not, just buy the market. In large part due to this attitude of humility, passive vehicles have spanked active funds over just about any timeframe you’d care to consider. Just look at the results of the SPIVA Scorecard, a comparison of how active managers have done relative to their passive counterparts.


The Permanent Portfolio by Craig Rowland, J. M. Lawson

Andrei Shleifer, asset allocation, automated trading system, backtesting, bank run, banking crisis, Bernie Madoff, buy and hold, capital controls, correlation does not imply causation, Credit Default Swap, diversification, diversified portfolio, en.wikipedia.org, fixed income, Flash crash, high net worth, High speed trading, index fund, inflation targeting, margin call, market bubble, money market fund, new economy, passive investing, Ponzi scheme, prediction markets, risk tolerance, stocks for the long run, survivorship bias, technology bubble, transaction costs, Vanguard fund

(An index fund is a mutual fund that tracks the broad movements of a stock-market index, such as the S&P 500.) Over the long term, this passive investing approach has been shown to produce above-average returns for patient investors. Why? There are many reasons, but primarily because investing in index funds costs much less than nearly any other method. In fact, Stanford University professor William Sharpe famously demonstrated that passive investing with low-cost index funds must produce better results than traditional investing. The average return of both methods is the average return of the market. But because traditional investing costs so much, investors taking that path necessarily see smaller returns on their investments. (To read more, see http://tinyurl.com/sharpe-rocks.) But there are other ways to explore passive investing besides index funds. Three years ago, I read a book called Fail-Safe Investing by Harry Browne.

Since long-term investment success is related to the ability to stay the course and not try to outguess the markets, a stable portfolio will help you emotionally to stick with the plan. Making the Most of Your Investments A portfolio that is simple, safe, and stable can be achieved by doing the following: Using passive investing only. Keep costs low. Use volatile individual assets to reduce overall portfolio volatility. Expect the unexpected and embrace the idea of market uncertainty. Passive Investing Passive investing is the opposite of the active asset management that is typically offered on Wall Street. The Permanent Portfolio is a passive strategy, which means that it does not engage in market timing, actively trading stocks, moving in or out of the market on chart signals, or other similar tactics.

Three years ago, I read a book called Fail-Safe Investing by Harry Browne. This tiny volume, first published in 1999, champions a method of passive investing that Browne called the Permanent Portfolio. And while it's a little more complicated than simply investing in index funds, the ideas are still fairly simple. According to Browne, the Permanent Portfolio should provide three key features: safety, stability, and simplicity. He argues that your permanent portfolio should protect you against all economic futures while also providing steady returns. It should also be easy to implement. There are many ways to approach safe, steady investing, but Browne has some specific recommendations: Hold 25% of your portfolio in U.S. stocks, to provide a strong return during times of prosperity. Hold 25% in long-term U.S.


The Smartest Investment Book You'll Ever Read: The Simple, Stress-Free Way to Reach Your Investment Goals by Daniel R. Solin

asset allocation, buy and hold, corporate governance, diversification, diversified portfolio, index fund, market fundamentalism, money market fund, Myron Scholes, passive investing, prediction markets, random walk, risk tolerance, risk-adjusted returns, risk/return, transaction costs, Vanguard fund, zero-sum game

Those of us who advise clients on how to invest for market returns find ourselves burdened with names that have negative connotations. The current terminology is a snore; it makes our readers' and our clients' eyes glaze over. 18 8eaJme a Smart Investor The current terminology fo r investi ng for market returns is "passive investing." What could be more boring? Do you want to be an active investor or a passive investor? No one wantS to be passive; it implies you have no abi li ty to have any influence on an outcome. Anomer term historically used for market~return investment is "index-based investing"-anomer less-than-scintiUating bit of verbiage. Over the years. index-based or passive investing has come to be equated with being "average." And no one wants ( 0 be average. We al1 want to believe in the utopian Shangri-La described in James Hi lton's novel Lost Horizon, where everything is perfec t and no one is average.

Ifyour advisor says anything other than "You would, » he or she either does not understand the data or is not being candid with you. u.s. Then walk our the door, dose your account and become a Smart Investor. Chapter40 Where Are the Pension Plans for Smart Investors? [A}ctive investment management is a source ofpension fund losses, not profits. Individual fonds can have profitable strategies, but aggregate profits are negative because of manager foes and transactions costs. The recent growth in passive investment products and increased interest in performance-linked fees are evidence that Canada's pension community recognizes how difficult it is to earn above-market returns. -John I1kiw, "Pension Fund Financing: A Plan Sponsor's Guide to Fiduciary D uty.'" Reponed at: http://www.benefits canada.com/conrcnt/lcgacy/Content/1997103-97/fl. html For many Canadian investors, their registered pension plans (RPPs) and their Registered Reti rement Savi ngs Plans (RRSPs) represent an important part of thei r retirement plann ing.

If you find that there are no (or few) ETFs or index fund investments in your pension plan, complain to the person responsible for selecting the investment managers of the plan. If there are enough complaints, you will start to see investment options for these plans that will permit the beneficiaries to become Smarr Investors. Chapter 41 Have the Inmates Taken Over the Asylum? Of course. I favour passive investing for most investors, buause markets are amazingly sucussful devices for incorporating information into stock prices. I beliroe. along with Friedrich Hayek fa Nobel laureate, and a contemporary ofJohn Maynard KeymsJ and others, that information is not some big thing that's locked in a iafo somewhere. It exists in bits and pieces scattered all over the world. -Merton Miller, Nobel laureate in economics.


pages: 353 words: 88,376

The Investopedia Guide to Wall Speak: The Terms You Need to Know to Talk Like Cramer, Think Like Soros, and Buy Like Buffett by Jack (edited By) Guinan

Albert Einstein, asset allocation, asset-backed security, Brownian motion, business cycle, business process, buy and hold, capital asset pricing model, clean water, collateralized debt obligation, computerized markets, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, fixed income, implied volatility, index fund, intangible asset, interest rate swap, inventory management, London Interbank Offered Rate, margin call, money market fund, mortgage debt, Myron Scholes, passive investing, performance metric, risk tolerance, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, statistical model, time value of money, transaction costs, yield curve, zero-coupon bond

This winning bid typically is awarded by means of a random drawing. Related Terms: • Bond • Market Maker • Stock Market • Broker-Dealer • Par Value The Investopedia Guide to Wall Speak 221 Passive Investing What Does Passive Investing Mean? An investment strategy that does not include active buying and selling of securities. Passive investors purchase investments with the intention of long-term appreciation and thus have limited portfolio turnover. Index fund investing, in which shares in the fund simply mirror an index, is a form of passive investing. Investopedia explains Passive Investing Also known as a buy-and-hold or couch potato strategy, passive investing requires good initial research, patience, and a well-diversified portfolio. Unlike active investors, passive investors buy a security and typically do not actively attempt to profit from short-term price fluctuations.

Investopedia explains Index Fund Indexing is a passive form of fund management that some argue outperforms most actively managed mutual funds. The most popular index funds track the S&P 500, but a number of other indexes, including the Russell 2000 (small companies), the DJ Wilshire 5000 (total stock market), the MSCI EAFE (foreign stocks in Europe, Australasia, and the Far East), and the Lehman Aggregate Bond Index (total bond market), are followed widely by investors. Investing in an index fund is a form of passive investing. The primary advantage is the lower management expense ratio. Many actively managed mutual funds fail to beat broad market indexes because their returns are reduced by higher expense ratios. The Investopedia Guide to Wall Speak 137 Related Terms: • Benchmark • Expense Ratio • MSCI—Emerging Markets Index • Mutual Fund • Standard & Poor’s 500 Index—S&P 500 Index Futures What Does Index Futures Mean?

Investopedia explains Spiders (SPDR) Spiders are listed on the American Stock Exchange (AMEX) under the ticker symbol SPY. SPDRs trade like stocks, are liquid, can be sold short and bought on margin, and are a good source for dividend income. As with a stock, investors pay a brokerage commission when trading SPDRs. Investors buy SPDRs to replicate the performance of the overall stock market. SPDRs are not actively managed and are thus passive investments (index investing). Related Terms: • American Stock Exchange—AMEX • Benchmark • Diversification • Exchange-Traded Fund—ETF • Standard & Poor’s 500 Index—S&P 500 Spinoff What Does Spinoff Mean? The creation of an independent company through the sale or distribution of new shares of an existing business or a division of a parent company. A spinoff is a type of divestiture. Investopedia explains Spinoff Businesses that want to “streamline” their operations often sell less productive or unrelated subsidiary businesses as spinoffs.


pages: 733 words: 179,391

Adaptive Markets: Financial Evolution at the Speed of Thought by Andrew W. Lo

"Robert Solow", Albert Einstein, Alfred Russel Wallace, algorithmic trading, Andrei Shleifer, Arthur Eddington, Asian financial crisis, asset allocation, asset-backed security, backtesting, bank run, barriers to entry, Berlin Wall, Bernie Madoff, bitcoin, Bonfire of the Vanities, bonus culture, break the buck, Brownian motion, business cycle, business process, butterfly effect, buy and hold, capital asset pricing model, Captain Sullenberger Hudson, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, corporate governance, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, Daniel Kahneman / Amos Tversky, delayed gratification, Diane Coyle, diversification, diversified portfolio, double helix, easy for humans, difficult for computers, Ernest Rutherford, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, Fractional reserve banking, framing effect, Gordon Gekko, greed is good, Hans Rosling, Henri Poincaré, high net worth, housing crisis, incomplete markets, index fund, interest rate derivative, invention of the telegraph, Isaac Newton, James Watt: steam engine, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, longitudinal study, loss aversion, Louis Pasteur, mandelbrot fractal, margin call, Mark Zuckerberg, market fundamentalism, martingale, merger arbitrage, meta analysis, meta-analysis, Milgram experiment, money market fund, moral hazard, Myron Scholes, Nick Leeson, old-boy network, out of africa, p-value, paper trading, passive investing, Paul Lévy, Paul Samuelson, Ponzi scheme, predatory finance, prediction markets, price discovery process, profit maximization, profit motive, quantitative hedge fund, quantitative trading / quantitative finance, RAND corporation, random walk, randomized controlled trial, Renaissance Technologies, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, Robert Shiller, Robert Shiller, Sam Peltzman, Shai Danziger, short selling, sovereign wealth fund, Stanford marshmallow experiment, Stanford prison experiment, statistical arbitrage, Steven Pinker, stochastic process, stocks for the long run, survivorship bias, Thales and the olive presses, The Great Moderation, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Triangle Shirtwaist Factory, ultimatum game, Upton Sinclair, US Airways Flight 1549, Walter Mischel, Watson beat the top human players on Jeopardy!, WikiLeaks, Yogi Berra, zero-sum game

John Maynard Keynes famously said, “In the long run, we are all dead,” but it was a hedge fund manager who added the important coda, “Make sure the short run doesn’t kill you first.” THE DEMOCRATIZATION OF INVESTING Passive investing—the idea that you can’t beat the market and should invest in index funds—is now such an important part of the traditional investment paradigm, it’s hard to appreciate just how revolutionary the idea of an index fund once was. These days, however, there seem to be nearly as many indexes as there are stocks. Where did the idea of the index come from, and where is it going? The Adaptive Markets Hypothesis can also explain the evolving nature of passive investing and indexation. As with many financial innovations, the genealogy of passive investing can be traced to academic research, in this case two different programs. We already described one of them: the CAPM, developed by Bill Sharpe (and simultaneously by John Lintner, Jan Mossin, and Jack Treynor).

And it’s cold comfort to the investor that the rest of the market had the same experience. Must passive investing always accept risk passively, and never have the benefits of active risk management? The answer is no. One of the most mind-numbing aspects of professional portfolio management is monitoring the portfolio in real time, and deciding when to act in response to rapidly deteriorating market conditions. However, much of this monitoring can be automated with preset rules that alert the investor—text messaging, smartphone notification, and social media make this simple—to pay attention and make a decision when the need arises. This is particularly straightforward for passive strategies that are dedicated to achieving the returns of an index. Existing technology can easily integrate active risk management with passive investing through algorithmic trading, derivatives, securities exchange design, telecommunications, and back-office infrastructure.

The CAPM and related linear factor models are useful inputs for portfolio management, but they rely on several key economic and statistical assumptions that may be poor approximations in certain market environments. Knowing the environment and population dynamics of market participants may be more important than any single factor model. Principle 3A: Portfolio Optimization and Passive Investing. Portfolio optimization tools are only useful if the assumptions of stationarity and rationality are good approximations to reality. The notion of passive investing is changing due to technological advances, and risk management should be a higher priority, even for passive index funds. Principle 4A: Asset Allocation. The boundaries between asset classes are becoming blurred, as macro factors and new financial institutions create links and contagion across previously unrelated assets.


pages: 363 words: 28,546

Portfolio Design: A Modern Approach to Asset Allocation by R. Marston

asset allocation, Bretton Woods, business cycle, capital asset pricing model, capital controls, carried interest, commodity trading advisor, correlation coefficient, diversification, diversified portfolio, equity premium, Eugene Fama: efficient market hypothesis, family office, financial innovation, fixed income, German hyperinflation, high net worth, hiring and firing, housing crisis, income per capita, index fund, inventory management, Long Term Capital Management, mortgage debt, passive investing, purchasing power parity, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Sharpe ratio, Silicon Valley, stocks for the long run, superstar cities, survivorship bias, transaction costs, Vanguard fund

Consider a study by Gorton and Rouwenhorst (2006) of the stocks of commodity firms over the period from 1962 to 2003. Gorton and Rouwenhorst compared passive investment in commodity future contracts with the stocks of commodity firms producing the same commodities. They found that the correlation between the two investments was only 0.40. At the same time, the correlation between the stocks of these firms and the S&P 500 was 0.57. So the stocks of the commodity producers were more highly correlated with stocks than the commodities that they produced. Commodity futures provide a pure play on commodity investment. But passive investment is very different from active investment. Passive investment involves buying a futures contract at the beginning of the period, then closing the position automatically at the end of the period.

In a sense, managed futures are a form of hedge fund. You are investing in the manager’s expertise. That expertise will guide the manager on when to be long or short in the commodity, whether to overweight one commodity relative to another, or whether to take positions more aggressively in currencies rather than commodities. Passive investments in commodity futures represent a much purer play on the commodities themselves. For this reason, most of the chapter will be devoted to passive investment. SOURCES OF RETURN ON COMMODITY FUTURES Before considering actual returns on commodity contracts, it’s important to understand the sources of return on commodity futures. There are two main sources of return, risk premiums and forecast errors. John Maynard Keynes wrote extensively about futures contracts in his Treatise on Money (1930).

P1: a/b c12 P2: c/d QC: e/f JWBT412-Marston T1: g December 10, 2010 15:49 Printer: Courier Westford 249 Real Assets—Commodities Thus in the recent period, in particular, there is only a weak case for diversifying a portfolio with a passive investment in commodities. Despite having a very low beta, it’s not a miracle drug for the portfolio. DOES GOLD BELONG IN THE PORTFOLIO? For millennia, gold has been considered the ultimate store of value. So does it deserve a place in a modern portfolio? To answer that question, consider the return on the GSCI Gold index, a sub-component of the Goldman Sachs commodity futures index. Like the overall GSCI index, the return on the GSCI Gold index is derived from passive investment in futures contracts, in this case the futures contract tied to the London gold price (which is quoted in dollars).10 This gold index is available beginning in 1979.


pages: 417 words: 97,577

The Myth of Capitalism: Monopolies and the Death of Competition by Jonathan Tepper

Affordable Care Act / Obamacare, air freight, Airbnb, airline deregulation, bank run, barriers to entry, Berlin Wall, Bernie Sanders, big-box store, Bob Noyce, business cycle, Capital in the Twenty-First Century by Thomas Piketty, citizen journalism, Clayton Christensen, collapse of Lehman Brothers, collective bargaining, computer age, corporate raider, creative destruction, Credit Default Swap, crony capitalism, diversification, don't be evil, Donald Trump, Double Irish / Dutch Sandwich, Edward Snowden, Elon Musk, en.wikipedia.org, eurozone crisis, Fall of the Berlin Wall, family office, financial innovation, full employment, German hyperinflation, gig economy, Gini coefficient, Goldman Sachs: Vampire Squid, Google bus, Google Chrome, Gordon Gekko, income inequality, index fund, Innovator's Dilemma, intangible asset, invisible hand, Jeff Bezos, John Nash: game theory, John von Neumann, Joseph Schumpeter, Kenneth Rogoff, late capitalism, London Interbank Offered Rate, low skilled workers, Mark Zuckerberg, Martin Wolf, means of production, merger arbitrage, Metcalfe's law, multi-sided market, mutually assured destruction, Nash equilibrium, Network effects, new economy, Northern Rock, offshore financial centre, passive investing, patent troll, Peter Thiel, plutocrats, Plutocrats, prediction markets, prisoner's dilemma, race to the bottom, rent-seeking, road to serfdom, Robert Bork, Ronald Reagan, Sam Peltzman, secular stagnation, shareholder value, Silicon Valley, Skype, Snapchat, Social Responsibility of Business Is to Increase Its Profits, Steve Jobs, The Chicago School, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, too big to fail, undersea cable, Vanguard fund, very high income, wikimedia commons, William Shockley: the traitorous eight, zero-sum game

One of the major reasons for the enormous swelling of these institutional holdings is the history-making transition into “passive investing.” In previous years, financial managers would actively direct investments. They felt that they could beat the market by researching, employing smart mathematicians and economists, and by spending a lot of time noodling about market trends. This is known as active investing – and in recent years it has come under fire for being ineffective and expensive. Warren Buffett claims that investors have “wasted” upwards of $100 billion paying useless wealth managers high management fees.14 He is a proponent of what's known as passive investing, or investing in index funds. These funds do not try to beat the market, but mimic a performance of a particular index like the S&P, Russell 500, and so forth.

These funds do not try to beat the market, but mimic a performance of a particular index like the S&P, Russell 500, and so forth. They do not have to be managed, so they are much less expensive than active funds, and they help investors lessen risk through diversification. Passive investing has brought great benefits for average, middle-class investors. It has been somewhat of a Robin Hood story in finance. Small investors who had been paying absurdly high fees to Wall Street investment managers suddenly got access to a low-cost product that democratized investing. For the last decade, passive investing has outperformed active management, and it has involved a lot less effort or skill. The index does all the work. The highest paid investment managers in the world lost out to a simple index in which anyone could invest. Jack Bogle is the godfather of index funds. He created the world's first retail index fund at Vanguard in 1974.

Figure 9.3 S&P 500 Ownership by “Big 3” SOURCE: Lazard, FactSet. Despite their popularity and outperformance, passive investments are starting to become more hotly contested. What began as a financial innovation to democratize access to investment products has morphed into a situation where a few huge players dominate access to these products. Exchange traded funds (ETFs) are super cheap for investors, but the Big 3 have more than 80% of the market between them. Not since the gilded age has so much power been highly concentrated.17 Asset management has, itself, become “Morganized.” Control has, once again, concentrated in relatively few hands. Paul Singer, a billionaire hedge fund manager, has called passive investing “a blob which is destructive to the growth-creating and consensus-building prospects of free market capitalism.”


pages: 236 words: 77,735

Rigged Money: Beating Wall Street at Its Own Game by Lee Munson

affirmative action, asset allocation, backtesting, barriers to entry, Bernie Madoff, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, call centre, Credit Default Swap, diversification, diversified portfolio, estate planning, fiat currency, financial innovation, fixed income, Flash crash, follow your passion, German hyperinflation, High speed trading, housing crisis, index fund, joint-stock company, money market fund, moral hazard, Myron Scholes, passive investing, Ponzi scheme, price discovery process, random walk, risk tolerance, risk-adjusted returns, risk/return, stocks for the long run, stocks for the long term, too big to fail, trade route, Vanguard fund, walking around money

While most active investors fail in beating the market, it is human nature to try and defeat most other people. Notable winners include Warren Buffet and Peter Lynch. Losers include most active mutual fund managers. passive investing An investing strategy that buys and holds low-cost index funds to closely match the market returns. By admitting you don’t want to go for the gold, a passive investor wins by choosing to be mediocre. Most American passive investors fail, though, by not being able to stick with the strategy during exceptionally good or bad periods in market performance due to the inherent manifest destiny gene. Notable winners include active investors that write books on the virtues of passive investing. What are the assumptions? 1. That asset classes will not move in tandem with each other. 2. That each class has a unique thing called expected return, and somehow smart people know what this number is and it is expected to happen. 3.

None of this was wrong, but up until that time everyday people didn’t own ETFs, nor understand them in general. What was about to happen was a resurgence in indexing, or passive investing. ETFs were supposed to allow long-term investors a cheap and easy way to grow their money with less expense than mutual funds and more diversification than buying a few stocks. The plan worked too well, and then the baskets kept increasing. You see, Wall Street will lure people in with ideas of a better mousetrap, which ETFs were to a large extent. Once in the system, you will be fed more and more options until you slowly forget what your plan was in the first place. Let’s look at the most basic example of how things got out of hand quickly. We are told by those that sell ETFs that passive investing is cheaper, better performing, and tax-efficient. This only occurs if you buy and hold an index ETF forever.

Simple: Stock exchanges wanted to compete for speculators who traded indexes all day. That’s right, the sole purpose was to capture business from the futures exchange. Now they are quickly becoming a staple in many portfolios because they are cheap, tax-efficient, and tradable during market hours. However, just because something is an ETF doesn’t mean it will have those attributes. Now they are sold to the public as a cure-all, ranging from the ultimate in long-term passive investing to high-octane leveraged bets on specific commodities like gold and oil, creating access to markets not previously open to most individual investors. Breaking down boundaries can have unintended consequences. You can expand your mind to the point of losing it. There has been an explosion of ETFs that short the market with double or triple leverage. Listen to me now: Professional traders don’t use these tools.


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Reset: How to Restart Your Life and Get F.U. Money: The Unconventional Early Retirement Plan for Midlife Careerists Who Want to Be Happy by David Sawyer

Airbnb, Albert Einstein, asset allocation, beat the dealer, bitcoin, Cal Newport, cloud computing, cognitive dissonance, crowdsourcing, cryptocurrency, David Attenborough, David Heinemeier Hansson, Desert Island Discs, diversification, diversified portfolio, Edward Thorp, Elon Musk, financial independence, follow your passion, gig economy, hiring and firing, index card, index fund, invention of the wheel, knowledge worker, loadsamoney, low skilled workers, Mahatma Gandhi, Mark Zuckerberg, meta analysis, meta-analysis, mortgage debt, passive income, passive investing, Paul Samuelson, pension reform, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, Silicon Valley, Skype, smart meter, Snapchat, stakhanovite, Steve Jobs, Tim Cook: Apple, Vanguard fund, Y Combinator

For many years, his fund – derided at first as “Bogle’s Folly” – made him the laughing stock of the industry he’d worked in for 25 years since graduating from Princeton University in 1951. Now the 89-year-old is having the last laugh with that fund alone having $403bn[360] in assets and passive, index-tracking funds accounting for 29% of the entire US market[361]. In summary, a MIT professor’s peer-reviewed research then a huge step into the unknown by one of the world’s true visionaries sparked a passive investing snowball that has gathered momentum in the past five years. What did Samuelson make of it all? Way before index investing took off, seven years before Mr. Money Mustache put finger to keyboard, and four years before his death in 2009, he had this to say: “I rank this Bogle invention along with the invention of the wheel, the alphabet, Gutenberg printing, and wine and cheese: a mutual fund that never made Bogle rich but elevated the long-term returns of the mutual-fund owners.

Both have excellent UK-based enthusiastic experts, based in Edinburgh and London, able to answer your queries by phone. Both have good fund choice for the suggested RESET portfolio. Fidelity shades it here with its access to funds from other providers whereas with Vanguard you can only buy Vanguard funds. Both have an excellent ethos. One is a co-operative[374], owned by its members (you), and set up by Jack Bogle; one a family firm that has embraced passive investing[375]. At time of going to press (late August 2018), if you’re in the UK and using the RESET portfolio, choose Fidelity for your Sipps and Vanguard for your Isas. Here’s why: Vanguard doesn’t yet offer Sipps. Vanguard does offer Isas and is 0.16% cheaper under the suggested RESET portfolio[376]. If you want to go with one provider to keep it simple, choose Fidelity for now.

A difference of 0.16% a year in charges may be small beer when investing £10k in an Isa, but if we’re talking ten or 20 or 30 times that amount in a Sipp, the difference in charges and lost compounding will soon add up. Vanguard is a co-operative. Owned by its members it has no incentive to, and cannot, turn a profit. Safe in that knowledge, you don’t need to keep an eye on costs; you can set and forget. I feel I owe it to the mellifluous tones of Jack Bogle, founder of Vanguard, whose passive investing ethos runs through Vanguard like tree rings. Action As a UK investor, if you want a simple home for your money now, pick Fidelity[378]. Then transfer it over to Vanguard when Vanguard starts doing Sipps. It’s easy to sign up to either provider, and transferring your existing investments is a mere online form, telephone conversation and two-to-three-week Fidelity-or-Vanguard-managed process away.


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Smarter Investing by Tim Hale

Albert Einstein, asset allocation, buy and hold, buy low sell high, capital asset pricing model, collapse of Lehman Brothers, corporate governance, credit crunch, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, equity premium, Eugene Fama: efficient market hypothesis, eurozone crisis, fiat currency, financial independence, financial innovation, fixed income, full employment, implied volatility, index fund, information asymmetry, Isaac Newton, John Meriwether, Long Term Capital Management, Northern Rock, passive investing, Ponzi scheme, purchasing power parity, quantitative easing, random walk, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, South Sea Bubble, technology bubble, the rule of 72, time value of money, transaction costs, Vanguard fund, women in the workforce, zero-sum game

I know it is tempting to get swayed by the supposed evidence of short-term performance of markets and managers but you will not be being rational if you are. Play the highest probability game. The rationale for adopting a passive approach to investing is made succinctly by Professor Keane (2000): ‘The significance of the empirical evidence is not that passive investment will always outperform active investment, but that, at the time of decision-making, the balance of probabilities is always in favour of passive investment.’ Active fund management employees invest in passive funds In a recent survery by Ignites1, it interviewed 1,001 active management employees in the UK and discovered that two thirds of them have sizeable amounts invested in passive funds and 45 per cent who hold a ‘significant’ amount in them. 4.8 Your investment philosophy rules 1 Set an appropriate investment policy mix of assets and stick to it at all times. 2 Remember at all times the wise words of Charles Ellis: ‘The ultimate outcome is determined by who can lose the fewest points not win them.’ 3 A penny saved is a penny earned.

No more gullible than those professionals who ‘approved’ and invested in Madoff’s $50 billion Ponzi scheme, uncovered at the back end of 2008 – that list is long and undistinguished. The time has come for transparency, value for money and the fulfilment of the fiduciary responsibility of all in the industry including fund managers, product development and marketing teams, and advisers. The outlook for impartial fee-based advice and evidence-based, transparent passive investing has never been so promising, or important to us. DIY investing The ability to buy, and in many cases trade, funds and other securities online has grown dramatically in the past decade. A growing band of DIY investors are seeking to use the information and technology to manage their own investments. While this may be a sensible route for an experienced and rational investor, it is likely to be a very expensive option for many investors who do not have a sensible investment philosophy and approach.

Some are omitted, not by implication but for the sake of simplicity. The onus is on you to work out which is most suitable for you. Passive index fund providers For UK investors the choice of passive providers and they product ranges that they offer have risen rapidly since the second edition of this book. The most notable new entrant into the market has been Vanguard (www.vanguard.co.uk) who are the pioneers of low-cost, passive investing. They immediately forced a step change in the pricing of passive funds offering a UK FTSE All-Share Index fund at 0.15% (15 basis points) per annum. They are also highly skilled at capturing market returns. Take a look at Table 9.3 on page 172. Their highly efficient trading and low cost approach is highly beneficial to investors. It is interesting to note that Vanguard is a mutual company.


Deep Value by Tobias E. Carlisle

activist fund / activist shareholder / activist investor, Andrei Shleifer, availability heuristic, backtesting, business cycle, buy and hold, corporate governance, corporate raider, creative destruction, Daniel Kahneman / Amos Tversky, discounted cash flows, fixed income, intangible asset, joint-stock company, margin call, passive investing, principal–agent problem, Richard Thaler, riskless arbitrage, Robert Shiller, Robert Shiller, Rory Sutherland, shareholder value, Sharpe ratio, South Sea Bubble, statistical model, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, Tim Cook: Apple

Benjamin Solarz at Yale University considered this question in 2009.63 He examined the portfolios of activists and tracked the performance of “activist” campaigns, and “passive” investments—those investments that did not result in activism. Solarz concluded that activist holdings earn 3.8 percent greater returns than comparable passive investments over the first two months, and an astonishing 18.4 percent greater return over two years. Figure 9.2 shows the returns to activist and passive holdings over the short term (a 61-day window). 180 DEEP VALUE 20% Board 15% Active NoBoard 10% 5% Passive 0% –5% 0 –3 s s ay D 5 –2 s ay D 0 –2 s ay D 5 –1 s s ay D 0 –1 ay D –5 ay D 13 Fi s g lin D 5 ay D s 10 ay D s 15 ay D s 20 ay D s 25 ay D s 30 ay D FIGURE 9.2â•… In the Short Run, Activist Investments Outperform Passive Investments Source: Benjamin S. Solarz. “Stock Picking in Disguise?

The valuation of businesses using Buffett’s method is a subjective process, falling somewhere between an art and an inexact science. We can, however, extract some rough guidelines. There are two considerations when valuing a business—the quantitative and the qualitative—and each informs the other. The quantitative leg of a theoretical valuation employing Buffett’s insight is relatively simple:37 The economic case justifying equity investment is that, in aggregate, additional earnings above passive investment returns—interest on fixed-income securities—will be derived through the employment of managerial and entrepreneurial skills in conjunction with that equity capital. Furthermore, the case says that since the equity capital position is associated with greater risk than passive forms of investment, it is “entitled” to higher returns. A “value-added” bonus from equity capital seems natural and certain.

By September 1983 Mesa had spent $350 million buying 8.5 million shares, representing 4.9 percent of Gulf Oil, and just below the 5 percent threshold that would require it to file with the SEC and disclose its holding to the market.20 By the time Mesa filed with the SEC in October, it held 14.5 million shares, representing almost 9 percent of Gulf, acquired at a cost of $638 million. Mesa filed a 13G notice indicating a passive investment, but its reputation as a hostile bidder caused Gulf’s management to panic. The board announced a special shareholders’ meeting for December. Their plan was to have Gulf change its charter and bylaws to remove several shareholder rights and to move the state of incorporation from Pennsylvania to Delaware, which The Art of the Corporate Raid 159 was friendlier to incumbent management teams.


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Stocks for the Long Run 5/E: the Definitive Guide to Financial Market Returns & Long-Term Investment Strategies by Jeremy Siegel

Asian financial crisis, asset allocation, backtesting, banking crisis, Black-Scholes formula, break the buck, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, capital asset pricing model, carried interest, central bank independence, cognitive dissonance, compound rate of return, computer age, computerized trading, corporate governance, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, Deng Xiaoping, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, Financial Instability Hypothesis, fixed income, Flash crash, forward guidance, fundamental attribution error, housing crisis, Hyman Minsky, implied volatility, income inequality, index arbitrage, index fund, indoor plumbing, inflation targeting, invention of the printing press, Isaac Newton, joint-stock company, London Interbank Offered Rate, Long Term Capital Management, loss aversion, market bubble, mental accounting, money market fund, mortgage debt, Myron Scholes, new economy, Northern Rock, oil shock, passive investing, Paul Samuelson, Peter Thiel, Ponzi scheme, prediction markets, price anchoring, price stability, purchasing power parity, quantitative easing, random walk, Richard Thaler, risk tolerance, risk/return, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, stocks for the long run, survivorship bias, technology bubble, The Great Moderation, the payments system, The Wisdom of Crowds, transaction costs, tulip mania, Tyler Cowen: Great Stagnation, Vanguard fund

With a 3 percent annual fee, the accumulation amounts to just over $10,000, less than half the market return. Every extra percentage point of annual costs requires investors aged 25 to retire 2 years later than they would have in the absence of such costs. THE INCREASED POPULARITY OF PASSIVE INVESTING Many investors have realized that the poor performance of actively managed funds relative to benchmark indexes strongly implies that they would do very well to just equal the market return of one of the broad-based indexes. Thus, the 1990s witnessed an enormous increase in passive investing, the placement of funds whose sole purpose was to match the performance of an index. The oldest and most popular of the index funds is the Vanguard 500 Index Fund.13 The fund, started by visionary John Bogle, raised only $11.4 million when it debuted in 1976, and few thought the concept would survive.

Chapter 22 Behavioral Finance and the Psychology of Investing The Technology Bubble, 1999 to 2001 Behavioral Finance Fads, Social Dynamics, and Stock Bubbles Excessive Trading, Overconfidence, and the Representative Bias Prospect Theory, Loss Aversion, and the Decision to Hold on to Losing Trades Rules for Avoiding Behavioral Traps Myopic Loss Aversion, Portfolio Monitoring, and the Equity Risk Premium Contrarian Investing and Investor Sentiment: Strategies to Enhance Portfolio Returns Out-of-Favor Stocks and the Dow 10 Strategy PART V BUILDING WEALTH THROUGH STOCKS Chapter 23 Fund Performance, Indexing, and Beating the Market The Performance of Equity Mutual Funds Finding Skilled Money Managers Persistence of Superior Returns Reasons for Underperformance of Managed Money A Little Learning Is a Dangerous Thing Profiting from Informed Trading How Costs Affect Returns The Increased Popularity of Passive Investing The Pitfalls of Capitalization-Weighted Indexing Fundamentally Weighted Versus Capitalization-Weighted Indexation The History of Fundamentally Weighted Indexation Conclusion Chapter 24 Structuring a Portfolio for Long-Term Growth Practical Aspects of Investing Guides to Successful Investing Implementing the Plan and the Role of an Investment Advisor Concluding Comment Notes Index FOREWORD In July 1997 I called Peter Bernstein and said I was going to be in New York and would love to lunch with him.

., New York: Norton, 2003, pp. 372-274. 11. John C. Bogle, The Little Book of Common Sense Investing, Hoboken, NJ: Wiley, 2007, Chap. 9. 12. Ellis, “The Loser’s Game,” Financial Analysts Journal, p. 19. 13. Five years before the Vanguard 500 Index Fund, Wells Fargo created an equally weighted index fund called “Samsonite,” but its assets remained relatively small. 14. Heather Bell, “Vanguard 500 Turns 25, Legacy in Passive Investing,” Journal of Index Issues, Fourth Quarter 2001, pp. 8-10. 15. The Vanguard Institutional Index Fund Plus shares, with a minimum investment of $200 million, have outperformed the S&P 500 Index by 3 basis points over the 10 years ending June 30, 2013. 16. Roger J. Bos, Event Study: Quantifying the Effect of Being Added to an S&P Index, New York: McGraw-Hill, Standard & Poor’s, September 2000. 17.


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DIY Investor: How to Take Control of Your Investments & Plan for a Financially Secure Future by Andy Bell

asset allocation, bank run, buy and hold, collapse of Lehman Brothers, credit crunch, diversification, diversified portfolio, estate planning, eurozone crisis, fixed income, high net worth, hiring and firing, Isaac Newton, Kickstarter, lateral thinking, money market fund, Northern Rock, passive investing, place-making, quantitative easing, selection bias, short selling, South Sea Bubble, technology bubble, transaction costs, Vanguard fund

If this is an argument that chimes with you, then you are in the company of a growing band of financial advisers and other investment experts. There have been loads of surveys that have ‘proved’ this point, though I still believe that certain managers will deliver the goods more often than not. Central to the theory of passive investing is the efficient market hypothesis, which is essentially the effect of what we all know as ‘market forces’ – namely that stock prices always settle at their true value, so there is nothing that can be done to find extra value. The real trick in passive investing is choosing the right index to track. Once you have done this, if you stick with a mainstream tracker fund provider you won’t go far wrong. The decision as to which index to track is all about asset allocation, as covered in the previous chapter. The momentum investor In its simplest form, a momentum investor buys investments that are on the rise and sells investments that are falling in value.

The introduction of ETFs has not only seen cost pressure on active fund managers, but also on the early entrants to passive fund management. A 10 basis points annual management charge for a mainstream index is, if not the average, where the market seems to be heading. The UK was relatively late to the party with ETFs, but with investors on the other side of the Atlantic getting access to passive investments so much more cheaply it was only a matter of time before they hit these shores. The first launch on the LSE did not happen until April 2000, when iShares brought its FTSE 100 ETF to market. ETFs soon picked up momentum in the UK and 2002 saw the creation of a dedicated ETF trading segment on the LSE, while Chinese, Japanese and European ETFs were launched in London in 2004 and energy, metals and agricultural sectors were added the following year.

However, a beleaguered chief executive may buy shares to try and help swing market sentiment back in the company’s favour. In the main, though, directors buying or selling shares in their own companies is a good indicator, and one that many investors will follow. Two websites that allow you to follow directors’ share purchases and sales are www.directorsholdings.com and www.directorsdeals.com. The long-term buy and hold investor This self-explanatory way of investing, combined with passive investing, explained below, is arguably the strategy that gives the DIY investor the best chance of good returns over a long period of time. Buy and hold investing is founded on the idea that markets will give a good rate of return in the long term, in the way that they have done over long periods for most of the last 100 or so years. Buy and hold investors believe it is not possible to beat the market by making short-term bets on swings in valuations because the increased costs of dealing, including broker costs, stamp duty and bid/offer spreads, will more often than not wipe out whatever gains, if any, the investor trying to time the market might make.


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Take the Money and Run: Sovereign Wealth Funds and the Demise of American Prosperity by Eric C. Anderson

asset allocation, banking crisis, Bretton Woods, business continuity plan, business process, buy and hold, collective bargaining, corporate governance, credit crunch, currency manipulation / currency intervention, currency peg, diversified portfolio, fixed income, floating exchange rates, housing crisis, index fund, Kenneth Rogoff, open economy, passive investing, profit maximization, profit motive, random walk, reserve currency, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, sovereign wealth fund, the market place, The Wealth of Nations by Adam Smith, too big to fail, Vanguard fund

The Democratic Senator from Indiana offered the following two proposals in mid-February 2008: 1. At a minimum the U.S. ought to require passive investment by sovereign wealth funds 2. CFIUS reviews are only triggered when an investment exceeds 10% of total ownership . . . a more realistic standard is required115 Allow me to comment on these proposals in reverse order. As we have seen above, proposed regulations for implementing FINSA 2007 do indeed end the perceived 10% ownership “rule.” It increasingly appears as though CFIUS is going to be tasked with conducting a review and/or investigation any time a sovereign wealth fund invests in the United States. As for the argument concerning passive investment, the Norwegian Government Pension Fund-Global, for one, has made it quite clear such rules will drive their investments elsewhere.

Now, back to our previous discussion of the CIC’s intended purpose. Western observers were aware of a debate over the China Investment Corporation’s mandate before the institution even opened its doors for business. In an article published in September 2007, The Wall Street Journal reported, the “fund’s mandate has been the subject of contention among Chinese officials.” According to the Journal, “many involved in the [CIC] planning favor passive investments, by turning money over to professional money managers, with the single goal of improving returns on China’s $1.53 trillion foreign exchange reserves . . . Other officials are viewing [the CIC] as a more strategic vehicle, such as to back Chinese state-owned companies as they invest overseas.”49 At the moment, the truth seems to lie somewhere between these two extremes. CIC officials used the first tranche of $67 billion to acquire Central Huijin and thereby win control of the Chinese government’s holdings in the largest three recapitalized, publicly listed commercial banks: the Industrial and Commercial Bank of China, the Construction Bank of China, and the Bank of China.

“Therefore,” he continued, “we must have a certain level of income from our investments and [they] must have a certain liquidity.”96 How to accomplish this objective? Lou contended his fund would seek to primarily invest in financial instruments like indexed listings. Lou, however, seems to have slipped on the “benign intent” message, as he told the assembled financial analysts that CIC hoped to help improve corporate governance at firms receiving Chinese funding.97 So much for the promise of passive investment. In the meantime, U.S. and international demands for Chinese investment transparency had come under attack. In a publication issued by the Jamestown Foundation—a nonpartisan think tank with the self-declared mission of informing and educating policy makers—Wenran Jiang, acting director of the China Institute at the University of Alberta, wrote: If Washington is comfortable having Beijing buy up $400 billion of its treasury bonds to subsidize President Bush’s deficit spending economic policy, it needs to answer the question of why it should be so alarmed about Chinese investments in the form of sovereign wealth funds—both are in the nature to seek returns for the money.98 A comparable message was issued by the Heritage Foundation.


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The Bogleheads' Guide to Investing by Taylor Larimore, Michael Leboeuf, Mel Lindauer

asset allocation, buy and hold, buy low sell high, corporate governance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, endowment effect, estate planning, financial independence, financial innovation, high net worth, index fund, late fees, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, market bubble, mental accounting, money market fund, passive investing, Paul Samuelson, random walk, risk tolerance, risk/return, Sharpe ratio, statistical model, stocks for the long run, survivorship bias, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

In fact, most of them build substantial wealth at their clients' expense. More than one broker has been heard to remark, "We make millionaires-out of multimillionaires." What's that? You say your money guy is making you a fortune? We sincerely hope that's the case. However, with a very simple, no-brainer investment strategy called passive investing you have, at the very least, a 70 percent chance of outperforming any given financial pro over an extended period of time. And over some 20-year periods, passive investing outperforms as many as 90 percent of actively managed funds. The reason is because this system allows you to keep more of your money working for you, which means less money for the brokers, investment houses, mutual fund managers, money managers, and the government. It may sound too good to be true, but this time it really is true, and it's backed up with a preponderance of empirical evidence.

Style Drift and Tracking Errors Not a Problem With active funds, there is always a possibility of some of the stocks in a fund moving from one classification to another. Inasmuch as index funds are designed to replicate a particular segment of the market, such as largecap growth, or small-cap value, there is no possibility of the funds drifting into another category. READ WHAT OTHERS SAY Most of the world's leading investment researchers, scholars, authors, and almost anyone who isn't trying to sell you their investment products, agree that low-cost, passive investing is an excellent strategy for most or all of your portfolio. Following are what many of them have to say on the subject of passive vs. active investing: Frank Armstrong, author of The Informed Investor: "Do the right thing: In every asset class where they are available, index!-Four of five funds will fail to meet or beat an appropriate index." Gregory A. Baer and Gary Gensler, authors of The Great Mutual Fund Trap: "With returns corrected for survivorship bias, the average actively managed funds trail the market by about 3 percentage points a year."

And in the past 25 years, a portfolio of Vanguard's actively managed funds outperformed the Wilshire 5000 (the total U.S. stock market index) by an average of 0.9 percent per year. This portfolio's excellent performance has been largely due to a combination of good management coupled with low costs. Vanguard's actively managed funds, like all Vanguard funds, carry no sales charge and have an average annual expense ratio of just 0.47 percent. Does this mean one should abandon passive investing and opt for low-cost, actively managed funds? Not at all! At the same time Vanguard Health Care was doing phenomenally well, Vanguard U.S. Growth was a disaster, turning in a shameful performance during the great bull market of the 1990s. It's also important to keep in mind that investing in a health care fund is placing a sector bet. What if the government enacts new regulations or some unforeseen event happens, depressing the market for health care stocks?


Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies by Jeremy J. Siegel

addicted to oil, asset allocation, backtesting, Black-Scholes formula, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, capital asset pricing model, cognitive dissonance, compound rate of return, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, fixed income, German hyperinflation, implied volatility, index arbitrage, index fund, Isaac Newton, joint-stock company, Long Term Capital Management, loss aversion, market bubble, mental accounting, Myron Scholes, new economy, oil shock, passive investing, Paul Samuelson, popular capitalism, prediction markets, price anchoring, price stability, purchasing power parity, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, stocks for the long run, survivorship bias, technology bubble, The Great Moderation, The Wisdom of Crowds, transaction costs, tulip mania, Vanguard fund

Every extra percentage point of annual costs requires investors aged 25 to retire two years later than they would have in the absence of such costs. 11 Charles D. Ellis, “The Loser’s Game,” Financial Analysts Journal, July/August 1975, p. 19. CHAPTER 20 Fund Performance, Indexing, and Beating the Market 351 THE INCREASED POPULARITY OF PASSIVE INVESTING Many investors have realized that the poor performance of actively managed funds relative to benchmark indexes strongly implies that they would do very well to just equal the market return of one of the broadbased indexes. Thus, the 1990s witnessed an enormous increase in passive investing, the placement of funds whose sole purpose was to match the performance of an index. The oldest and most popular of the index funds is the Vanguard 500 Index Fund.12 The fund, started by visionary John Bogle, raised only $11.4 million when it debuted in 1976, and few thought the concept would survive.

318 Chapter 19 Behavioral Finance and the Psychology of Investing 319 The Technology Bubble, 1999 to 2001 320 Behavioral Finance 322 Fads, Social Dynamics, and Stock Bubbles 323 Excessive Trading, Overconfidence, and the Representative Bias 325 Prospect Theory, Loss Aversion, and Holding On to Losing Trades 328 Rules for Avoiding Behavioral Traps 331 Myopic Loss Aversion, Portfolio Monitoring, and the Equity Risk Premium 332 Contrarian Investing and Investor Sentiment: Strategies to Enhance Portfolio Returns 333 Out-of-Favor Stocks and the Dow 10 Strategy 335 PART 5 BUILDING WEALTH THROUGH STOCKS Chapter 20 Fund Performance, Indexing, and Beating the Market 341 The Performance of Equity Mutual Funds 342 Finding Skilled Money Managers 346 xiv Persistence of Superior Returns 348 Reasons for Underperformance of Managed Money 348 A Little Learning Is a Dangerous Thing 349 Profiting from Informed Trading 349 How Costs Affect Returns 350 The Increased Popularity of Passive Investing 351 The Pitfalls of Capitalization-Weighted Indexing 351 Fundamentally Weighted versus Capitalization-Weighted Indexation 353 The History of Fundamentally Weighted Indexation 356 Conclusion 357 Chapter 21 Structuring a Portfolio for Long-Term Growth 359 Practical Aspects of Investing 360 Guides to Successful Investing 360 Implementing the Plan and the Role of an Investment Advisor 363 Concluding Comment 364 Index 367 CONTENTS F O R E W O R D Some people find the process of assembling data to be a deadly bore.

Because of proprietary trading techniques and interest income from loaning securities, Vanguard S&P 500 Index funds for individual investors have fallen only 9 basis points behind the index over the last 10 years, and its institutional index funds have actually outperformed the index.15 THE PITFALLS OF CAPITALIZATION-WEIGHTED INDEXING Despite their past success, the popularity of indexing, especially those funds linked to the S&P 500 Index, may cause problems for index 12 Five years before the Vanguard 500 Index Fund, Wells Fargo created an equally weighted index fund called “Samsonite,” but its assets remained relatively small. 13 Heather Bell, “Vanguard 500 Turns 25, Legacy in Passive Investing,” Journal of Index Issues, Fourth Quarter 2001, pp. 8–10. 14 Vanguard’s number includes assets of its 500 Index Fund open to both individuals and institutions. 15 The Vanguard Institutional Index Fund Plus shares, with a minimum investment of $200 million, have outperformed the S&P 500 Index by 7 basis points in the 10 years following the fund’s inception on July 7, 1997. 352 PART 5 Building Wealth through Stocks investors in the future.


pages: 402 words: 110,972

Nerds on Wall Street: Math, Machines and Wired Markets by David J. Leinweber

AI winter, algorithmic trading, asset allocation, banking crisis, barriers to entry, Big bang: deregulation of the City of London, business cycle, butter production in bangladesh, butterfly effect, buttonwood tree, buy and hold, buy low sell high, capital asset pricing model, citizen journalism, collateralized debt obligation, corporate governance, Craig Reynolds: boids flock, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Danny Hillis, demand response, disintermediation, distributed generation, diversification, diversified portfolio, Emanuel Derman, en.wikipedia.org, experimental economics, financial innovation, fixed income, Gordon Gekko, implied volatility, index arbitrage, index fund, information retrieval, intangible asset, Internet Archive, John Nash: game theory, Kenneth Arrow, load shedding, Long Term Capital Management, Machine translation of "The spirit is willing, but the flesh is weak." to Russian and back, market fragmentation, market microstructure, Mars Rover, Metcalfe’s law, moral hazard, mutually assured destruction, Myron Scholes, natural language processing, negative equity, Network effects, optical character recognition, paper trading, passive investing, pez dispenser, phenotype, prediction markets, quantitative hedge fund, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Renaissance Technologies, risk tolerance, risk-adjusted returns, risk/return, Robert Metcalfe, Ronald Reagan, Rubik’s Cube, semantic web, Sharpe ratio, short selling, Silicon Valley, Small Order Execution System, smart grid, smart meter, social web, South Sea Bubble, statistical arbitrage, statistical model, Steve Jobs, Steven Levy, Tacoma Narrows Bridge, the scientific method, The Wisdom of Crowds, time value of money, too big to fail, transaction costs, Turing machine, Upton Sinclair, value at risk, Vernor Vinge, yield curve, Yogi Berra, your tax dollars at work

Part Two Alpha as Life 90 Nerds on Wall Str eet I ndex funds are passive investments; their goal is to deliver a return that matches a benchmark index. The Old Testament of indexing is Burton Malkiel’s classic A Random Walk Down Wall Street, first published in 1973 by W.W. Norton and now in its ninth edition. For typical individual investors, without special access to information, it offers what is likely the best financial advice they will ever get: It is hard to consistently beat the market, especially after fees. A passive strategy will do better in the long run. Of course, no one thinks of oneself as a typical individual investor. That might be your brother-in-law or the guy across the hall. And index funds are just not as much fun as picking stocks. It’s called passive investing for a reason. Alpha, outperforming a passive benchmark, is the goal of active investing.

Looking at stocks just by price and ignoring dividends tends to favor stocks that don’t pay dividends. Simply listing acquisition price and current price ignores the aspect of time, and not comparing it to any well-defined benchmark (like the S&P 500 index) leaves the meaning of even a well-studied report unclear. A.G. Becker was the first firm to compare the total return of a stock portfolio to an index. Since an S&P 500 index fund is just a passive investment consisting of a capitalization-weighted portfolio of the 500 stocks in the index, it will do no better than the index—and if managed effectively, no worse. An index fund can’t just be started up and left alone to run itself forever. The stocks in the index change; dividends need to be reinvested, and most significantly, there are cash flows in and out of the portfolio from new funding or payment requirements.

This increases effective housing demand, which would help absorb the nation’s excess housing supply, thereby stabilizing prices at a higher equilibrium price than would otherwise be possible. Structural Ideas for the Economic Rescue 309 A Capital Market for Home Equity Fractional Interest Securities The HEFI security represents a passive investor interest in a home— just as a share of stock represents a passive investment in a company. Institutional investors such as pension and endowment funds would be interested in HEFIs to achieve diversification beyond stocks and bonds. The single-family, owner-occupied (SFOO) equity asset class is as large as the entire U.S. stock market, around $10 trillion. To be properly diversified, institutional investors should hold about as much in the SFOO equity asset class as they do in stocks.


pages: 130 words: 11,880

Optimization Methods in Finance by Gerard Cornuejols, Reha Tutuncu

asset allocation, call centre, constrained optimization, correlation coefficient, diversification, finite state, fixed income, frictionless, frictionless market, index fund, linear programming, Long Term Capital Management, passive investing, Sharpe ratio, transaction costs, value at risk

(5.8) In this equation, wit quantities represent the sensitivities of Rt to each one of the n fach iT tors, and t represents the non-factor return. We use the notation wt = w1t , . . . , wnt h i and Ft = F1t , . . . , Fnt . The linear factor model (5.8) has the following convenient interpretation when the factor returns Fit correspond to the returns of passive investments, such as those in an index fund for an asset class: One can form a benchmark portfolio of the passive investments (with weights wit ) and the difference between the fund return Rt and the return of the benchmark portfolio Ft wt is the non-factor return contributed by the fund manager using stock selection, market timing, etc. In other words, t represents the additional return resulting from active management of the fund. Of course, this additional return can be negative.


pages: 304 words: 80,965

What They Do With Your Money: How the Financial System Fails Us, and How to Fix It by Stephen Davis, Jon Lukomnik, David Pitt-Watson

activist fund / activist shareholder / activist investor, Admiral Zheng, banking crisis, Basel III, Bernie Madoff, Black Swan, buy and hold, centralized clearinghouse, clean water, computerized trading, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crowdsourcing, David Brooks, Dissolution of the Soviet Union, diversification, diversified portfolio, en.wikipedia.org, financial innovation, financial intermediation, fixed income, Flash crash, income inequality, index fund, information asymmetry, invisible hand, Kenneth Arrow, Kickstarter, light touch regulation, London Whale, Long Term Capital Management, moral hazard, Myron Scholes, Northern Rock, passive investing, performance metric, Ponzi scheme, post-work, principal–agent problem, rent-seeking, Ronald Coase, shareholder value, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, Steve Jobs, the market place, The Wealth of Nations by Adam Smith, transaction costs, Upton Sinclair, value at risk, WikiLeaks

Yet many more people, probably including you and definitely including the authors of this book, don’t invest like Buffett. Instead, they invest through index funds—pools of money that buy shares of many companies listed in an index. The S&P 500 or the FTSE 100 are two such indices, comprising, respectively, the 500 largest companies listed in the United States and the 100 largest in the United Kingdom. Because the investments match an index, this is sometimes called “passive” investing, since it involves no “active” stock picking. But few people stop to think how the indices themselves are determined: how much of stock A is included and how much of stock B. The most common method is to use the market capitalization of the stocks being considered, that is, how much the market values each stock. The amount of each stock within that index will vary with its market capitalization.

There are issues created by the widespread adoption of cheap beta strategies. As we’ve seen, mass adoption of diversification can allow risks to build up in the system, even while decreasing the risk to an investor of something going wrong with any one investment. Thankfully, thought leaders like the Royal Society of the Arts are trying to mitigate those risks and accentuate the positives. We discuss how in chapter 5. 58. “Passive Investing Has Room to Grow,” Financial Times, September 23, 2012. 59. “Investors Shift to Low-Cost ‘Tracker’ Funds,” The Telegraph, February 12, 2013. 60. www.unpri.org, accessed September 21, 2014. 61. “Public Funds Take Control of Assets, Dodging Wall Street,” New York Times, August 19, 2013. 62. Ibid. 63. US Department of Labor, “Fact Sheet: Final Rule to Improve Transparency of Fees and Expenses to Workers in 401(k)–Type Retirement Plans” (US Department of Labor, February 2012). 64.

See National Employment Savings Trust (NEST) Nestor, Stilpon, 43 Netherlands, 90, 111, 113 collective pension system in, 60, 197, 199, 209, 264n6 fund governance regulation in, 108–9 pension beneficiaries and investment returns, 265n20 New York Stock Exchange: average holding period of traded stock, 63 financial services as percent of, 16 high-frequency trading and, 88 New York Times (newspaper), 77, 88 Nippon, 18 Normal curve, 161–63, 260n18, 261n38 real world phenomena and, 172–73 Northern Rock, 245n31 Nusseibeh, Saker, 140 One-way market for financial assets, 240n31 Ontario Teachers’ Pension Plan, 59, 111 Opportunities, fiduciary duty and, 140 Organisation for Economic Co-operation and Development, 109 Outcomes, measuring success using, 132 Oversight: regulation and, 150–51 trust in government and, 141 Owner, use of term, 235n25 Ownership: agency capitalism and, 74–80 capitalism and, 62, 83–93, 243n2 changing conception of, 62–63 corporate governance and, 22 derivatives and, 80–83, 93 economic attention deficit hyperactivity disorder and loss of, 63–68 election of directors and, 78–79 exercised by financial agents, 230 for long-term investors, 87 individual investor’s use of technology and, 90–92 institutional investors and, 3–4, 249n3 portfolio management function and, 246n36 promoting culture of, in investment, 222–24 tax policy and, 92 Oxford University, 122 Passive investing, 45 Pax World, 77 Pay for performance, institutional investors and, 112–13 Payments system, banks and, 16–17, 20, 22, 211–12 Pension funds: collective, 197, 199, 209, 263n1, 264n3, 264n6, 266n28 commonsense, 194–96, 199–202 fees, 97–98, 195–96, 233n5 governance of, 100–101, 104–6, 107–9 investment strategy, 195, 196 People’s Pension, 202–11 portability of, 196 purpose of, 194 regulation of, 107–9, 251n22 shift from defined benefit to defined contribution plans, 99–100, 104–5 time frame and, 207 Webster and Wallace’s, 14, 199–202, 209.


pages: 478 words: 126,416

Other People's Money: Masters of the Universe or Servants of the People? by John Kay

Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, buy and hold, call centre, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, cognitive dissonance, corporate governance, Credit Default Swap, cross-subsidies, dematerialisation, disruptive innovation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, Elon Musk, Eugene Fama: efficient market hypothesis, eurozone crisis, financial innovation, financial intermediation, financial thriller, fixed income, Flash crash, forward guidance, Fractional reserve banking, full employment, George Akerlof, German hyperinflation, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, income inequality, index fund, inflation targeting, information asymmetry, intangible asset, interest rate derivative, interest rate swap, invention of the wheel, Irish property bubble, Isaac Newton, John Meriwether, light touch regulation, London Whale, Long Term Capital Management, loose coupling, low cost airline, low cost carrier, M-Pesa, market design, millennium bug, mittelstand, money market fund, moral hazard, mortgage debt, Myron Scholes, NetJets, new economy, Nick Leeson, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shock, passive investing, Paul Samuelson, peer-to-peer lending, performance metric, Peter Thiel, Piper Alpha, Ponzi scheme, price mechanism, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, railway mania, Ralph Waldo Emerson, random walk, regulatory arbitrage, Renaissance Technologies, rent control, risk tolerance, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, Schrödinger's Cat, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, sovereign wealth fund, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, Steve Wozniak, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Tobin tax, too big to fail, transaction costs, tulip mania, Upton Sinclair, Vanguard fund, Washington Consensus, We are the 99%, Yom Kippur War

The strength and ethical integrity of a chain are as strong as its weakest link. The rise of passive investment management has been a response to excessive costs and conflicting objectives in this investment chain. Vanguard – the largest asset management firm after Black-Rock and Allianz – was established in 1975 by Jack Bogle, an evangelical promoter of passive investment.7 Bogle’s thesis was that, since the chances of out-performing a stock market index on a sustained basis were slight, replicating that index was a simple and inexpensive investment strategy. Passive investment has steadily grown in scale, and much of the activity of BlackRock, Vanguard and State Street is in the management of indexed funds, an activity that can now be entrusted to a computer. There are significant economies of scale in passive investment, and these large incumbents derive competitive advantage from their size.


pages: 504 words: 139,137

Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined by Lasse Heje Pedersen

activist fund / activist shareholder / activist investor, algorithmic trading, Andrei Shleifer, asset allocation, backtesting, bank run, banking crisis, barriers to entry, Black-Scholes formula, Brownian motion, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, conceptual framework, corporate governance, credit crunch, Credit Default Swap, currency peg, David Ricardo: comparative advantage, declining real wages, discounted cash flows, diversification, diversified portfolio, Emanuel Derman, equity premium, Eugene Fama: efficient market hypothesis, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, Gordon Gekko, implied volatility, index arbitrage, index fund, interest rate swap, late capitalism, law of one price, Long Term Capital Management, margin call, market clearing, market design, market friction, merger arbitrage, money market fund, mortgage debt, Myron Scholes, New Journalism, paper trading, passive investing, price discovery process, price stability, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, selection bias, shareholder value, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stocks for the long run, stocks for the long term, survivorship bias, systematic trading, technology bubble, time value of money, total factor productivity, transaction costs, value at risk, Vanguard fund, yield curve, zero-coupon bond

Ainslie III of Maverick Capital 108 Chapter 8 Dedicated Short Bias 115 Interview with James Chanos of Kynikos Associates 127 Chapter 9 Quantitative Equity Investing 133 Interview with Cliff Asness of AQR Capital Management 158 Part III Asset Allocation and Macro Strategies 165 Chapter 10 Introduction to Asset Allocation: The Returns to the Major Asset Classes 167 Chapter 11 Global Macro Investing 184 Interview with George Soros of Soros Fund Management 204 Chapter 12 Managed Futures: Trend-Following Investing 208 Interview with David Harding of Winton Capital Management 225 Part IV Arbitrage Strategies 231 Chapter 13 Introduction to Arbitrage Pricing and Trading 233 Chapter 14 Fixed-Income Arbitrage 241 Interview with Nobel Laureate Myron Scholes 262 Chapter 15 Convertible Bond Arbitrage 269 Interview with Ken Griffin of Citadel 286 Chapter 16 Event-Driven Investments 291 Interview with John A. Paulson of Paulson & Co. 313 References 323 Index 331 The Main Themes in Three Simple Tables OVERVIEW TABLE I. EFFICIENTLY INEFFICIENT MARKETS Market Efficiency Investment Implications Efficient Market Hypothesis: Passive investing: The idea that all prices reflect all relevant information at all times. If prices reflect all information, efforts to beat the market are in vain. Investors paying fees for active management can expect to underperform by the amount of the fee. However, if no one tried to beat the market, who would make the market efficient? Inefficient Market: Active investing: The idea that market prices are significantly influenced by investor irrationality and behavioral biases.

The alpha is the intercept from a regression on the MCSI World stock index, Barclays Bond Index, and the GSCI commodities index. The t-statistic of the alpha is shown in parentheses. Source: Hurst, Ooi, and Pedersen (2013). In addition to reporting the expected return, volatility, and Sharpe ratio, table 12.1 also shows the alpha from the following regression: We regress the TSMOM strategies on the returns of a passive investment in the MSCI World stock market index, the Barclays U.S. aggregate government bond index, and the S&P GSCI commodity index. The alpha measures the excess return, controlling for the risk premiums associated with simply being long in these traditional asset classes. The alphas are almost as large as the excess returns since the TSMOM strategies are long–short and therefore have small average loadings on these passive factors.

Such struggling firms are sometimes defined as those with a credit spread over comparable-duration Treasuries of more than 1,000 basis points (bps). This credit spread means that the price of the firm’s debt is so low that its yield to maturity is more than 10 percentage points higher than the yield on Treasuries. While this credit spread is large, so is the risk of not getting paid. In fact, a passive investment to distressed debt has historically not been well compensated according to some indices, surprisingly. Hence, distressed managers must be active to add value. Indeed, companies in distress often present significant opportunities and risks as the underlying business is in flux and the various stakeholders may attempt to extract the remaining value. An event manager can approach a distressed investment in many different ways.


How to Form Your Own California Corporation by Anthony Mancuso

business cycle, corporate governance, corporate raider, distributed generation, estate planning, information retrieval, intangible asset, passive income, passive investing, Silicon Valley

How business profits are taxed General Partnership Ease of conversion to another business form Sole Proprietorship generally not, if all members are active in the business owners who want limited liability, a less formal legal structure, and automatic passthrough of profit individual tax rates of members, unless LLC files IRS Form 8832 and elects corporate taxation; $800 minimum tax each year plus additional fees if gross income is $250,000 or more same as C corporation owners who want limited liability, the built-in formality of the corporate form with the pass-through of corporate profits to individual owners individual tax rates of shareholders; $800 minimum tax for second and subsequent tax years issuance or transfer of stock subject to state and federal securities laws owners who want limited liability, the built-in formality and capital incentives of the corporate form, and the ability to split business income to lower overall taxes split up and taxed at corporate rates and individual tax rates of shareholders; $800 minimum state tax for second and subsequent tax years joint owners who partnership tax treatment and some nonmanaging investors; general partners must be willing to assume personal liability for business debts individual tax rates of general and limited partners, unless partners file IRS Form 8832 to elect corporate tax treatment may change to corporation or LLC; legal paperwork involved issuance or transfer of limited partnership interests is subject to state and federal laws LLC may change to general or limited partnership or corporation; legal paper involved S Corporation generally same as C corporation—may terminate S tax status to become C corporation but cannot reelect S status for five years after C Corporation may change to S corporation by filing simple tax election; change to LLC can involve tax cost and legal complexity Limited Partnership Business Entity Comparison Tables—Legal, Financial, and Tax Characteristics (cont’d.) chapter 1 | choosing the right legal structure for your business | 27 yes partners may use losses to deduct other income on individual tax returns if at risk for loss or debt yes Automatic tax status Tax level when business is sold personal tax level of owner income on individual tax returns (subject to active-passive investment loss rules that apply to all businesses) personal tax level of individual general partners general partners and other employees may set up IRA or Keogh plans; can make corporate tax election to obtain corporate benefits sole proprietor may set up IRA or Keogh retirement plan Tax-deductible fringe benefits available to owners who work in business Deductibility of owner may use losses business losses to deduct other General Partnership Sole Proprietorship follows sole proprietor­ ship, partnership, or corporate tax rules depending on tax status of LLC follows sole proprietor­ ship, partnership or corporate tax rules depending on tax status of LLC shareholders may deduct share of corporate losses on individual tax returns, but must comply with special limitations normally taxed at personal tax levels of individual shareholders, but corporate level tax sometimes due if S corporation was formerly a C corporation corporation may deduct business losses (shareholders may not deduct losses) two levels: shareholders and corporation are subject to tax on liquidation same as general partners­hip, but limited partners may only deduct nonrecourse debts (for which general partners are not specifically liable) personal tax level of individual general and limited partners yes, one-owner LLC treated as sole proprietorship; coowned LLC treated as partnership; one-owner and co-owned LLCs can elect corporate tax treatment no; must meet require­ ments and file tax election form with IRS; revoked or terminated tax status cannot be re-elected for five years same as general partnership yes, upon filing certificate of limited partnership with state filing office can get benefits associated with sole proprietorship, partnership, or corporation, depending on tax treatment of LLC LLC yes, upon filing certificate of limited partnership with state filing office S Corporation employee-shareholders owning 2% or more of stock are restricted to partnership rules C Corporation employee-shareholders eligible for medical reimbursement, term life insurance, and equity-sharing plans Limited Partnership Business Entity Comparison Tables—Legal, Financial, and Tax Characteristics (cont’d.) 28 | how to form your own california corporation ● 2 C H A P T E R How California Corporations Work Types of California Corporations .................................................................................................... 30 The Privately Held California Profit Corporation ............................................................. 30 Nonprofit Corporations ................................................................................................................. 31 Professional Corporations ............................................................................................................. 31 The Close Corporation...................................................................................................................... 32 Corporate Powers .................................................................................................................................... 34 Corporate People ..................................................................................................................................... 35 Incorporators......................................................................................................................................... 35 Directors................................................................................................................................................... 36 Officers...................................................................................................................................................... 40 Shareholders........................................................................................................................................... 41 How Many People May Organize the Corporation?..............................................................

A bank that makes a loan to a new business will often demand that the personal assets of the incorporators be pledged as security for the loan. A standard note, however, unlike a stock certificate, doesn’t carry with it the attractive possibility of providing the lender with a percentage of the profits or the liquidation assets of a successful enterprise. The situation is altered somewhat for a closely held corporation. The share­holders of the corporation are not normally passively investing in an enterprise but are simply incorporating their own business, which will pay them a salary in return for their efforts and provide them with favorable corporate tax advantages. Nonetheless, if the incorporators lend money to the corporation, they, too, will be able to look to the specific terms of a promissory note in seeking a guaranteed rate of return on their investment, rather than relying solely on the profits of the corporation to pay them money by way of salary.

An accredited investor includes persons who come within, or whom the corporation reasonably believes come within, any of chapter 3 | issuing and selling stock | 59 the following categories at the time of the sale of shares to the person (we don’t list categories unlikely to apply to small corporations or those already included in another suitability category under the California limited offering exemption): • a person whose individual net worth, or joint net worth with the person’s spouse, exceeds $1,000,000 at the time of the purchase of shares, or • a person who had an individual income in excess of $200,000 in each of the two most recent years, or joint income with the person’s spouse in excess of $300,000 in each of those years, and has a reasonable expectation of reaching the same income level in the current year We won’t dwell on these requirements here. In the unusual event that you do need to use one of these major shareholder tests, it will usually be to qualify an outside shareholder (one who is passively investing in your corporation). Because these shareholders are outsiders and should have financial resources, your best bet is to ask them to check with their lawyer to make sure they meet the technical requirements of this suitability category. Or you can ask them to designate a professional advisor who will protect their interests in connection with their purchase of shares in your corporation (as explained in Category 5, just below).


pages: 337 words: 89,075

Understanding Asset Allocation: An Intuitive Approach to Maximizing Your Portfolio by Victor A. Canto

accounting loophole / creative accounting, airline deregulation, Andrei Shleifer, asset allocation, Bretton Woods, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, corporate governance, discounted cash flows, diversification, diversified portfolio, fixed income, frictionless, high net worth, index fund, inflation targeting, invisible hand, John Meriwether, law of one price, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low cost airline, market bubble, merger arbitrage, money market fund, new economy, passive investing, Paul Samuelson, price mechanism, purchasing power parity, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, selection bias, shareholder value, Sharpe ratio, short selling, statistical arbitrage, stocks for the long run, survivorship bias, the market place, transaction costs, Y2K, yield curve, zero-sum game

Some time ago, Rex Sinquefield made the case that the efficient market theory—which, in brief, states consistently “beating the market” is improbable because existing stock prices are the result of all current information—is simply an application of Adam Smith’s invisible-hand theory to financial markets. I share this efficient market world view. More, although it is true market inefficiency is a sufficient condition for justifying active management, it is not a necessary condition. In this sense, I again part ways with Sinquefield’s passive-investing-only mandate. A broad market can be defined as a majority of stocks outperforming a benchmark index. This is a good way for an active manager to envision market breadth. To illustrate why, let’s borrow an analogy from the efficient market theory: Assume a number of people are throwing darts at a blackboard containing the names of all the stocks in the S&P 500. The chance of one dart thrower picking a winning stock is equal to the number of stocks outperforming the benchmark index at any point in time.

Our Midwest hedge fund from Chapter 8, “The Cyclical Asset Allocation Strategy’s Versatility,” came to understand this. The long–short hedge-fund strategy captures the value-added the CAA produces. Chapter 12 Keeping the Wheels on the Hedge-Fund ATV 239 This page intentionally left blank 13 MARKET TIMING OR VALUE TIMING? 241 O ne of the central themes of this book is the size effect and the relative performance between active and passive investing are directly related. As stated, these are two sides of the same coin. The interaction between the indices’ weighting schemes and the size effect tells active investors and managers when to build index-like portfolios and when to pursue an active strategy. The newer, equal-weighted S&P 500 index is tailor-made for empirically testing the desirability of a pure-passive strategy, a pure-active strategy, and a strategic asset allocation (SAA) and tactical asset allocation (TAA) to passive and active strategies.

They are also exempt from many of the rules and regulations governing other mutual funds. high-yield bonds A debt instrument issued for a period of more than one year with high rates of return because there is a higher default risk. hurdle rate-of-return The required rate of return in a discounted cash flow analysis, above which an investment makes sense and below which it does not. index In economics and finance, an index (for example, a price or stockmarket index) is a benchmark of activity, performance, or evolution in general. Consumer price indexes (an inflation measurement), or a country’s gross domestic product (GDP) index (an economic growth measurement) can be used to adjust salaries, Treasury bond (T-bond) interest rates, and tax thresholds. Index funds manage their portfolio so their evolution always mirrors a stock-market index’s evolution. A passive investment strategy in which the portfolio is designed to mirror a stock-market index’s performance. 304 UNDERSTANDING ASSET ALLOCATION inflation hedging An investment designed to protect against inflation risk. Such an investment’s value typically increases with inflation. information ratio The expected return-to-risk ratio as measured by standard deviation. This statistical technique is usually used to measure a manager’s performance against a benchmark. interest rate parity Relationship that must hold between the spot rate currencies’ interest rate if there are to be no arbitrage opportunities. interest rate spread The difference in yield between two distinct securities, such as corporate bonds and government securities. investor’s horizon The time length a sum of money is expected to be invested. law of one price The economic rule that states that, in an efficient market and absent transaction or transportation costs, a security and/or a commodity must have a single price, no matter how that security is created. leverage buyouts (LBOs) A transaction used to privatize a public corporation financed through debt, such as bank loans and Treasury bonds (T-bonds).


pages: 330 words: 99,044

Reimagining Capitalism in a World on Fire by Rebecca Henderson

Airbnb, asset allocation, Berlin Wall, Bernie Sanders, business climate, Capital in the Twenty-First Century by Thomas Piketty, carbon footprint, collaborative economy, collective bargaining, commoditize, corporate governance, corporate social responsibility, crony capitalism, dark matter, decarbonisation, disruptive innovation, double entry bookkeeping, Elon Musk, Erik Brynjolfsson, Exxon Valdez, Fall of the Berlin Wall, family office, fixed income, George Akerlof, Gini coefficient, global supply chain, greed is good, Hans Rosling, Howard Zinn, Hyman Minsky, income inequality, index fund, Intergovernmental Panel on Climate Change (IPCC), joint-stock company, Kickstarter, Lyft, Mark Zuckerberg, means of production, meta analysis, meta-analysis, microcredit, mittelstand, Mont Pelerin Society, Nelson Mandela, passive investing, Paul Samuelson, Philip Mirowski, profit maximization, race to the bottom, ride hailing / ride sharing, Ronald Reagan, Rosa Parks, Second Machine Age, shareholder value, sharing economy, Silicon Valley, Snapchat, sovereign wealth fund, Steven Pinker, stocks for the long run, Tim Cook: Apple, total factor productivity, Toyota Production System, uber lyft, urban planning, Washington Consensus, working-age population, Zipcar

“The Global Gender Gap Report 2013,” World Economic Forum, 236, http://www3.weforum.org/docs/WEF_GenderGap_Report_2013.pdf; “The Global Gender Gap Report 2017,” World Economic Forum, 90, http://www3.weforum.org/docs/WEF_GGGR_2017.pdf. 43. GPIF was allowed to directly invest in bonds and mutual funds; 15 percent of GPIF’s fixed-income assets were managed internally. 44. “The Benefits and Risks of Passive Investing,” Barclays, www.barclays.co.uk/smart-investor/investments-explained/funds-etfs-and-investment-trusts/the-benefits-and-risks-of-passive-investing/. 45. See GPIF’s 2018 Annual Report. 46. The Nikkei Telecon Database, accessed December 2018. 47. Size is classified based on market capitalization. 48. “2018 Global Sustainable Investment Review,” Global Sustainable Investment Alliance (2018), www.gsi-alliance.org/wp-content/uploads/2017/03/GSIR_Review2016.F.pdf. 49.

Nearly two-thirds of this money is in pension funds, while the remaining third is in sovereign wealth funds.69 The fifteen largest asset managers collectively handle nearly half of the world’s invested capital. They include BlackRock, which currently manages just under $7.0 trillion; the Vanguard Group, which controls $4.5 trillion; and State Street, which has $2.5 trillion under management.70 A very high proportion of this money, as we saw earlier in the chapter on rewiring finance, is in passive investments. In the United States, for example, 65–70 percent of all equities are held by index and quasi-index funds.71 These investments are completely exposed to system-wide risk. Their owners cannot diversify away from the risks that accelerating rates of environmental degradation and inequality present to the entire economy. The best way to improve their performance is to improve the performance of the economy as a whole.


pages: 202 words: 62,901

The People's Republic of Walmart: How the World's Biggest Corporations Are Laying the Foundation for Socialism by Leigh Phillips, Michal Rozworski

Berlin Wall, Bernie Sanders, call centre, carbon footprint, central bank independence, Colonization of Mars, combinatorial explosion, complexity theory, computer age, corporate raider, decarbonisation, discovery of penicillin, Elon Musk, G4S, Georg Cantor, germ theory of disease, Gordon Gekko, greed is good, hiring and firing, index fund, Intergovernmental Panel on Climate Change (IPCC), Internet of things, inventory management, invisible hand, Jeff Bezos, Joseph Schumpeter, linear programming, liquidity trap, mass immigration, Mont Pelerin Society, new economy, Norbert Wiener, oil shock, passive investing, Paul Samuelson, post scarcity, profit maximization, profit motive, purchasing power parity, recommendation engine, Ronald Coase, Ronald Reagan, sharing economy, Silicon Valley, Skype, sovereign wealth fund, strikebreaker, supply-chain management, technoutopianism, The Nature of the Firm, The Wealth of Nations by Adam Smith, theory of mind, transaction costs, Turing machine, union organizing

Passive management is increasingly dominant, not just within equity markets, but among other investment types, and it is displacing the historic but more expensive norm of active management strategies, which use fund managers and brokers to buy and sell stocks and other investment vehicles, deploying their research and knowledge to attempt to outperform the market. This shift in recent years from active to passive investing is not news. But the implications are systemic and profound for the very notion of a competitive market. An investor who has holdings in one airline or telecom wants it to outperform the others: to increase its profits, even if only temporarily, at others’ expense. But an investor who owns a piece of every airline or telecom, as occurs in a passively managed index fund, has drastically different goals.

Competition no longer matters; the overriding interest now is squeezing the most out of customers and workers across an entire industry—no matter which firm does it. In principle, capitalist competition should unremittingly steer the total profits across a sector down, ultimately to zero. This is because even though every firm individually aims for the highest possible profit, doing so means finding ways to undercut competitors and thus reduce profit opportunities sector-wide. Big institutional investors and passive investment funds, on the other hand, move entire sectors toward concentration that looks much more like monopoly—with handy profits, as firms have less reason to undercut one another. The result is a very capitalist sort of planning. This unseemly situation led Bloomberg business columnist Matt Levine to ask, in the title of a remarkable 2016 article, “Are Index Funds Communist?” Levine imagines a slow transition from today’s index funds, which use simple investing strategies, through a future where investing algorithms become better and better, until “in the long run, financial markets will tend toward perfect knowledge, a sort of central planning—by the Best Capital Allocating Robot.”


Early Retirement Guide: 40 is the new 65 by Manish Thakur

"side hustle", Airbnb, diversified portfolio, financial independence, hedonic treadmill, index fund, Lyft, passive income, passive investing, risk tolerance, Robert Shiller, Robert Shiller, time value of money, uber lyft, Vanguard fund, Zipcar

There's no hard and fast answer for this since some individuals are very entrepreneurial and want to actively manage where their dollars are put to work, and some individuals are already booked solid and want a more passive approach. The key to this is to simply get started. This section will give you 90% of the knowledge and resources to get started investing today. Invest in an adequately diversified portfolio of low cost passive investments and hold for the long term. That sentence holds all the secrets and techniques needed to invest and thrive. Don't spend a dime on finance gurus and conferences that will teach you "the 5 key techniques to earning millions on stocks" or "the secret to how I made $65,000 in a month." When first starting out in investing, it's understandable to look for a secret to consistently making money with investments.


pages: 263 words: 75,455

Quantitative Value: A Practitioner's Guide to Automating Intelligent Investment and Eliminating Behavioral Errors by Wesley R. Gray, Tobias E. Carlisle

activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, asset allocation, Atul Gawande, backtesting, beat the dealer, Black Swan, business cycle, butter production in bangladesh, buy and hold, capital asset pricing model, Checklist Manifesto, cognitive bias, compound rate of return, corporate governance, correlation coefficient, credit crunch, Daniel Kahneman / Amos Tversky, discounted cash flows, Edward Thorp, Eugene Fama: efficient market hypothesis, forensic accounting, hindsight bias, intangible asset, Louis Bachelier, p-value, passive investing, performance metric, quantitative hedge fund, random walk, Richard Thaler, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, statistical model, survivorship bias, systematic trading, The Myth of the Rational Market, time value of money, transaction costs

Analysis Legend Word/Symbol Description Quantitative Value or QV The quantitative value strategy described in the book. MF The Magic Formula strategy. S&P 500 TR Standard & Poor's 500 Total Return Index, the free-float, market capitalization–weighted index including the effects of dividend reinvestment. MW Index A total-return, market capitalization–weighted index that we construct from the universe of stocks included in the analysis. The MW Index's returns represent a passive investment in the universe of all stocks we analyze. CAGR Compound annual growth rate. Standard Deviation Sample standard deviation (annualized by square root of 12). Downside Deviation Sample standard deviation of all negative observations (annualized by square root of 12). Sharpe Ratio Monthly return minus risk-free rate divided by standard deviation (annualized by square root of 12). Sortino Ratio (MAR = 5%) Monthly return minus minimum acceptable return (MAR/12) divided by downside deviation (annualized by square root of 12).

Word/Symbol Description QV Our quantitative value strategy. MF The Magic Formula strategy. S&P 500 TR Standard & Poor's 500 Total Return Index, the free-float, market capitalization–weighted index including the effects of dividend reinvestment. MW Index A total-return, market capitalization–weighted index that we construct from the universe of stocks included in our analysis. The index's returns represent a passive investment in the universe of all stocks we analyze. CAGR Compound annual growth rate. Standard Deviation Sample standard deviation (annualized by square root of 12). Downside Deviation Sample standard deviation of all negative observations (annualized by square root of 12). Sharpe Ratio Monthly return minus risk free rate divided by standard deviation (annualized by square root of 12). Sortino Ratio (MAR=5%) Monthly return minus minimum acceptable return (MAR/12) divided by downside deviation (annualized by square root of 12).


pages: 301 words: 77,626

Home: Why Public Housing Is the Answer by Eoin Ó Broin

Airbnb, carbon footprint, Celtic Tiger, financial deregulation, housing crisis, Kickstarter, land reform, mortgage debt, negative equity, open economy, passive investing, quantitative easing, Right to Buy, Ronald Reagan, the built environment

One of the unusual features of the Southern Irish rental market is the large volume of semi-professional or accidental landlords. Almost 80 percent of the 172,820 landlords operating in the State own just one property. Many of these are people who availed of Celtic Tiger lending to buy a second home primarily as a passive investment. Others took advantage of generous Section 23 tax reliefs when purchasing buy-to-let mortgages. However, a lack of appreciation that being a landlord is an active investment requiring a significant allocation of time rather than passive investment, had meant that many landlords did not fully understand the scale of the undertaking they were engaging in. In addition to the large number of semi-professional landlords there are those for whom renting emerged from necessity as negative equity prevented them from selling their initial family home when up-sizing.


pages: 505 words: 142,118

A Man for All Markets by Edward O. Thorp

3Com Palm IPO, Albert Einstein, asset allocation, beat the dealer, Bernie Madoff, Black Swan, Black-Scholes formula, Brownian motion, buy and hold, buy low sell high, carried interest, Chuck Templeton: OpenTable:, Claude Shannon: information theory, cognitive dissonance, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Edward Thorp, Erdős number, Eugene Fama: efficient market hypothesis, financial innovation, George Santayana, German hyperinflation, Henri Poincaré, high net worth, High speed trading, index arbitrage, index fund, interest rate swap, invisible hand, Jarndyce and Jarndyce, Jeff Bezos, John Meriwether, John Nash: game theory, Kenneth Arrow, Livingstone, I presume, Long Term Capital Management, Louis Bachelier, margin call, Mason jar, merger arbitrage, Murray Gell-Mann, Myron Scholes, NetJets, Norbert Wiener, passive investing, Paul Erdős, Paul Samuelson, Pluto: dwarf planet, Ponzi scheme, price anchoring, publish or perish, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, RFID, Richard Feynman, risk-adjusted returns, Robert Shiller, Robert Shiller, rolodex, Sharpe ratio, short selling, Silicon Valley, Stanford marshmallow experiment, statistical arbitrage, stem cell, stocks for the long run, survivorship bias, The Myth of the Rational Market, The Predators' Ball, the rule of 72, The Wisdom of Crowds, too big to fail, Upton Sinclair, value at risk, Vanguard fund, Vilfredo Pareto, Works Progress Administration

Partners would get a payout consisting of at least 56 percent cash, possibly some scraps of stock in assorted companies, and an estimated 30 to 35 percent, for those who chose not to have them sold for cash, in two companies—Diversified Retailing and a New England textile company called Berkshire Hathaway. He added the discouraging, “For the first time in my investment lifetime, I now believe there is little choice for the average investor between professionally managed money in stocks and passive investment in bonds.” As I reread Buffett’s letter today I see no clue now, nor did I then, that Berkshire Hathaway would become the successor to Warren’s partnership. Ralph Gerard, a longtime investor with Buffett and the man who introduced us, never did, either. Of the $100 million distributed to partners, about $25 million was Buffett’s. He eventually ended up with nearly half of Berkshire’s stock.

As the $65 billion Ponzi scheme perpetrated by Bernard Madoff showed, thirteen thousand investors and their advisers didn’t do elementary due diligence because they thought the other investors must have done it. The issue here is the same as for those buying stocks, bonds, or mutual funds. You need to know enough to make a convincing, reasoned case for why your proposed investment is better than standard passive investments such as stock or bond index funds. Using this test, it is likely you will rarely find investments that qualify as superior to the indexes. Another issue is taxes. US domestic hedge funds, like most active investment programs, are tax-inefficient. Their high turnover tends to produce short-term capital gains and losses taxed at a higher rate than securities owned for more than one year. For tax-exempt investors, US hedge funds that borrow money (but not their clones based outside the United States) trigger taxes for the otherwise tax-exempt entity to the extent the realized gains, losses, and income are generated by the loans.

This means if the oil giant Exxon has a market value, computed as share price times number of shares outstanding, of $400 billion and the total market value of all stocks is $10 trillion, then the index fund puts 4 percent of its net worth in Exxon, and so on for all the other stocks. A mutual fund like this that replicates the composition and investment results of a specified pool of securities is called an index fund, and investors who buy such funds are known as indexers. Call any investment that mimics the whole market of listed US securities “passive” and notice that since each of these passive investments acts just like the market, so does a pool of all of them. If these passive investors together own, say, 15 percent of every stock, then “everybody else” owns 85 percent and, taken as a group, their investments also are like one giant index fund. But “everybody else” means all the active investors, each of whom has his own recipe for how much to own of each stock and none of whom has indexed.


pages: 321

Finding Alphas: A Quantitative Approach to Building Trading Strategies by Igor Tulchinsky

algorithmic trading, asset allocation, automated trading system, backtesting, barriers to entry, business cycle, buy and hold, capital asset pricing model, constrained optimization, corporate governance, correlation coefficient, credit crunch, Credit Default Swap, discounted cash flows, discrete time, diversification, diversified portfolio, Eugene Fama: efficient market hypothesis, financial intermediation, Flash crash, implied volatility, index arbitrage, index fund, intangible asset, iterative process, Long Term Capital Management, loss aversion, market design, market microstructure, merger arbitrage, natural language processing, passive investing, pattern recognition, performance metric, popular capitalism, prediction markets, price discovery process, profit motive, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk-adjusted returns, risk/return, selection bias, sentiment analysis, shareholder value, Sharpe ratio, short selling, Silicon Valley, speech recognition, statistical arbitrage, statistical model, stochastic process, survivorship bias, systematic trading, text mining, transaction costs, Vanguard fund, yield curve

But the limited trading-book size is compensated for by the higher potential returns generated in intraday trading. Intraday alphas can be of different types, varying from pure intraday alphas that hold no overnight positions to hybrid daily-­intraday alphas that hold overnight positions but boost returns with an intraday overlay. 28 Finding an Index Alpha By Glenn DeSouza Alpha discovery is not limited to single-company equity instruments. With the dramatic rise of passive investing in the past two decades, exchange-traded funds (ETFs) and related index products have fostered the growth of various index-based alpha strategies. Historically based in large investment banks because of their reliance on technology investment, balance sheet usage, and cheap funding, these strategies have become more popular among buy-side firms in recent years, including large quant- and arbitrage-focused hedge funds and market-­ making firms.

Whereas Russell 2000 candidates include rising microcaps as well as declining large caps, the S&P 500 index already is at the top of the market capitalization range and can only add either new large- or megacap IPOs or rising small- and midcap names that have outperformed recently, thus exposing the index to long momentum factor risk. CONCLUSION The rise of index products has created not only a new benefit for the average investor in the form of inexpensive portfolio management, but also new inefficiencies and arbitrage opportunities for many active managers. An extended period of low interest rates has allowed the proliferation of cheaply financed strategies, while the rise of passive investing has created market microstructure distortions, in part as a result of rising ownership concentration. Fortunately, new index constructions (and associated funds) also have proliferated in recent years, allowing investors to slice and dice passive portfolios in myriad ways that avoid several index drawbacks, including market impact and valuation distortions. But with legacy index products continuing to reap liquidity and some market inefficiencies persisting, both passive products and the active ones that arbitrage them may prosper for a while longer, implying that perhaps the investment allocation debate is not simply a choice between active and passive but rather the creation of a combined model of active overlays to passive core portfolios to take advantage of the best aspects of both worlds. 29 ETFs and Alpha Research By Mark YikChun Chan 6,000 7,000 5,000 6,000 5,000 4,000 4,000 3,000 3,000 2,000 # ETFs Assets (US $ bn) Exchange-traded funds (ETFs) are investment funds that are traded on stock exchanges.


pages: 868 words: 147,152

How Asia Works by Joe Studwell

affirmative action, anti-communist, Asian financial crisis, bank run, banking crisis, barriers to entry, borderless world, Bretton Woods, British Empire, call centre, capital controls, central bank independence, collective bargaining, crony capitalism, cross-subsidies, currency manipulation / currency intervention, David Ricardo: comparative advantage, deindustrialization, demographic dividend, Deng Xiaoping, failed state, financial deregulation, financial repression, Gini coefficient, glass ceiling, income inequality, income per capita, industrial robot, Joseph Schumpeter, Kenneth Arrow, land reform, land tenure, large denomination, liberal capitalism, market fragmentation, non-tariff barriers, offshore financial centre, oil shock, open economy, passive investing, purchasing power parity, rent control, rent-seeking, Right to Buy, Ronald Coase, South China Sea, The Wealth of Nations by Adam Smith, urban sprawl, Washington Consensus, working-age population

Syed Mokhtar became Mahathir’s pet entrepreneur in the wake of the financial crisis. In the final years of his premiership, before he resigned in 2003, Mahathir lavished Syed Mokhtar with electricity generation deals and state financing to build a new container port at Tanjung Pelepas. But once again it was without any export or manufacturing quid pro quo. In time-honoured fashion, the grateful billionaire took the cash flow and poured it into relatively passive investments in mining, plantations, hotels and real estate – a small part of which I am looking at now from my car window.168 A little further north, on the west side of the Jalan P. Ramlee intersection, is Menara Hap Seng, formerly MUI Plaza, which for decades was the headquarters of fallen billionaire Khoo Kay Peng. Khoo got on the wrong side of Mahathir in the 1980s, and stopped receiving state concessions.

Infant industry policy required that funds be directed to industrial projects that were less immediately profitable than either other potential manufacturing investments or consumer lending. Banks were therefore kept under close control. International inflows and outflows of capital were also strictly limited so that domestic capital remained under state control and unregulated flows of foreign funds did not disrupt developmental planning. And the returns that citizens could earn on bank deposits and other passive investments were frequently crimped, increasing the surplus left at the financial system’s disposal, which could then be used to pay for development policy and infrastructure. This amounted to a hidden taxation, which was tolerated by people in these societies because they could see the economic transformation taking place all around them. South Koreans, for instance, put up with negative real interest rates on bank deposits because they saw their economy overtake first North Korea, then the south-east Asian states, then even Taiwan in only three decades.

Mahathir began discussions with Daihatsu on another trip to Japan in 1991. The trading house Mitsui, then managed in Malaysia by Mahathir’s long-time confidant Kazumasa Suzuki, handles much of Daihatsu’s international trading activity. 200. In 1982, long after the original MMC technology transfer deal had been agreed, Hyundai did sell a 10 per cent stake to the Japanese to raise cash; this subsequently rose to 12.6 per cent, but remained a purely passive investment. 201. Written response to questions put to Mahathir, 7 March 2011. 202. For Mahathir’s personal forays into businesses in real estate, taxis and trading, and his home workshop where – among other things – he invented a new Islamic toilet, see Wain, Malaysian Maverick, pp. 15–16 and p. 55 respectively. 203. For a more detailed discussion, see K. S. Jomo, ‘The Proton Saga: Malaysian Car, Mitsubishi Gain’ and Kit G.


pages: 463 words: 105,197

Radical Markets: Uprooting Capitalism and Democracy for a Just Society by Eric Posner, E. Weyl

3D printing, activist fund / activist shareholder / activist investor, Affordable Care Act / Obamacare, Airbnb, Amazon Mechanical Turk, anti-communist, augmented reality, basic income, Berlin Wall, Bernie Sanders, Branko Milanovic, business process, buy and hold, carbon footprint, Cass Sunstein, Clayton Christensen, cloud computing, collective bargaining, commoditize, Corn Laws, corporate governance, crowdsourcing, cryptocurrency, Donald Trump, Elon Musk, endowment effect, Erik Brynjolfsson, Ethereum, feminist movement, financial deregulation, Francis Fukuyama: the end of history, full employment, George Akerlof, global supply chain, guest worker program, hydraulic fracturing, Hyperloop, illegal immigration, immigration reform, income inequality, income per capita, index fund, informal economy, information asymmetry, invisible hand, Jane Jacobs, Jaron Lanier, Jean Tirole, Joseph Schumpeter, Kenneth Arrow, labor-force participation, laissez-faire capitalism, Landlord’s Game, liberal capitalism, low skilled workers, Lyft, market bubble, market design, market friction, market fundamentalism, mass immigration, negative equity, Network effects, obamacare, offshore financial centre, open borders, Pareto efficiency, passive investing, patent troll, Paul Samuelson, performance metric, plutocrats, Plutocrats, pre–internet, random walk, randomized controlled trial, Ray Kurzweil, recommendation engine, rent-seeking, Richard Thaler, ride hailing / ride sharing, risk tolerance, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Rory Sutherland, Second Machine Age, second-price auction, self-driving car, shareholder value, sharing economy, Silicon Valley, Skype, special economic zone, spectrum auction, speech recognition, statistical model, stem cell, telepresence, Thales and the olive presses, Thales of Miletus, The Death and Life of Great American Cities, The Future of Employment, The Market for Lemons, The Nature of the Firm, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, Thorstein Veblen, trade route, transaction costs, trickle-down economics, Uber and Lyft, uber lyft, universal basic income, urban planning, Vanguard fund, women in the workforce, Zipcar

The relevant portion of the law reads: No person … shall acquire, directly or indirectly, the whole or any part of the stock or … assets of another person …, where … the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly.43 A corporation counts as a “person,” so a corporation cannot buy the assets or stock of another corporation where the effect is to concentrate the market to a sufficient degree. But the statute includes an exception: This section shall not apply to persons purchasing such stock solely for investment and not using the same by voting or otherwise to bring about, or in attempting to bring about, the substantial lessening of competition.44 This provision came to be known as the passive investment defense. Thus, a corporation cannot obtain shares when doing so reduces competition; but it may obtain shares for “investment purposes.” How are these provisions reconciled? In United States v. E.I. du Pont de Nemours & Co., the US Supreme Court ruled that du Pont’s purchase of a substantial stake in General Motors could violate Section 7.45 “Even when the purchase is solely for investment, the plain language of Section 7 contemplates an action at any time the stock is used to bring about, or in attempting to bring about, a substantial lessening of competition.”46 So, in the end, the only question is whether the acquisition of stock does or does not reduce competition.

Section 7 has been used to block numerous mergers and other asset acquisitions over the years. It has not been used against institutional investors. Yet as the legal scholar Elhauge notes, the legal argument for applying Section 7 to institutional investors seems clear.47 As in the case of merger-related antitrust enforcement, the plaintiff need not prove that the defendant “intended” to reduce competition; effects are what matter.48 Moreover, the so-called passive investment defense in the statute does not apply to institutional investors because, regardless of how they choose stocks, they vote and communicate with corporations in an effort to influence their behavior, and are likely to be liable even if they only have the capacity to influence a corporation, whether or not they use it.49 Regulators and private antitrust plaintiffs could sue the institutional investors whenever investors’ stock purchases tend to lessen competition in particular industries.


pages: 117 words: 31,221

Fred Schwed's Where Are the Customers' Yachts?: A Modern-Day Interpretation of an Investment Classic by Leo Gough

Albert Einstein, banking crisis, Bernie Madoff, corporate governance, discounted cash flows, diversification, fixed income, index fund, Long Term Capital Management, Northern Rock, passive investing, Ralph Waldo Emerson, random walk, short selling, South Sea Bubble, The Nature of the Firm, the rule of 72, The Wealth of Nations by Adam Smith, transaction costs, young professional

L. 44 mergers and acquisitions (M&As) 88–9 middle age 99 Milken, Michael 73 millionaires, behaviour of 46 Minogue, Kenneth 24 misinformation 72–3, 90, 91 Modern Portfolio Theory 49 modernity and globalisation 78–9 momentum 38–9 mutual funds 86 average returns 105 N Nabisco 89 ‘Names’ 45 new issues 56–7 newsletters 96–7 O Ogilvy, David 88 online brokers 71 ‘open-end’ funds 86 optimism 42–3 ‘options’ 32 OTC (Over The Counter) market 70 overseas markets and diversification 49 P passive investment 111 patterns, identifying 40–1 Patton, George 80 pension schemes 99 Pope, John 104 popular investments 30–1 positive news about companies 42–3 predicting by analysts 97 the market 40–1 returns 80–1 small changes 38–9 ‘present value’ 94 price/book ratio 92 price/earnings (P/E) ratio 55 price/equity to growth (PEG) ratio 93 price/sales ratio 93 probability 26–7 professional stock-pickers 20–1 professionals 96, 98 commissions 72 and investment skills 47, 54–5 risk aversion 58 profit and company size 105 hiding 91 prospectuses 35, 56–7, 87 public overspending 28–9 R Random Walk theory 27 ratio price/book 92 price/earnings (P/E) 55 price/equity to growth (PEG) 93 price/sales 93 reading about stock markets 112–13 ‘regression to the mean’ 105 regulators 84–5 retirement 99 planning for 60–1 returns and diversification 49 estimating 80–1 inflation-adjusted 103 on investments 58–9 long term 64–5 risk adjustment 80–1 and hedge funds 100–1 in large investments 44–5 perception of 108 relative 50–2 in short selling 82–3 in speculation 12–13 and variance 81 Rogers, Jim 36, 77 Rogers, Will 58 Rowe, David 38 Royal Mail 66–7 ‘rule of 72’ 103 rumours, affecting the market 83 Russia, government bonds 51 S Sarbanes-Oxley Act (2002) 85 Schwed, Fred, background 8–9 SEC (Securities and Exchange Commission) 14, 84 Seneca 46 Seven (bank) 41 Shakespeare, William 86 share analysts 37 shares popular 30–1 prices 14–15 releasing 25 short sellers 82–3 short-term fluctuations in share prices 38–9 short-term investing 63 size of company and profit 105 Soros, George 77, 101 South Sea Bubble 56, 109 speculation 12–13 spread betting companies 83 stages of life, planning for 98–9 start-up businesses 106–7 Steinherr, Alfred 20, 33 stock indices 34–5 stock markets share prices 14–15 speculation in 12–13 stock-picking 20–1 stockbrokers 71 T Taiwan 87 takeovers 88–9 tax on trust funds 58–9 technical analysis (TA) 40–1, 112 telecoms companies 108 Thinc Group 84 timing of investments 64–5 tracker funds 21, 62–3 tracking error 63 ‘traction’ 38–9 traders, investment skills 47 see also professionals transaction costs 70–1 trusts 35, 48–9 low returns 58–9 turnarounds 66–7 Twain, Mark 12, 14 U ‘unit trusts’ 86 US, government bonds 80 V Vanderbilt family 16 variance 81 volatility in the Far East 76–7 and risk 51–2, 58 W Wall Street crash 82, 104 Walsh, David 73 wealth passing down through generations 16–17 and relative risk 44–5 and skill in investment 46–7 Wells, H.


Stock Market Wizards: Interviews With America's Top Stock Traders by Jack D. Schwager

Asian financial crisis, banking crisis, barriers to entry, beat the dealer, Black-Scholes formula, commodity trading advisor, computer vision, East Village, Edward Thorp, financial independence, fixed income, implied volatility, index fund, Jeff Bezos, John Meriwether, John von Neumann, locking in a profit, Long Term Capital Management, margin call, money market fund, Myron Scholes, paper trading, passive investing, pattern recognition, random walk, risk tolerance, risk-adjusted returns, short selling, Silicon Valley, statistical arbitrage, the scientific method, transaction costs, Y2K

Only about 25 mutual fund institutions control almost one-third of total equity assets in this country, and every one of those guys knows what the others are doing. It may become quite uncivil if they all run for the exits at the same time. So you're saying that many individual investors who believe they have placed their money into the most conservative stock funds are unwittingly holding high-risk investments. Absolutely. What started out as a conservative, passive investment strategy has metamorphosed into a "greater fool" investment pyramid. When this situation begins to unravel, the losses will be horrific. People talk in terms of a bear market being a 20 percent or 30 percent decline. I can make a case why a stock such as Microsoft—which is by far the largest component of the S&P 500, and not surprisingly the biggest holding in Magellan (and most other mutual funds)—could decline by as much as 80 or 90 percent.

The point is that a short-selling approach is normally not intended as a stand-alone investment; rather, it is intended to be combined with long investments (to which it is inversely correlated) to yield a total portfolio with a better return/risk performance. Most, if not all, of Galante's investors use her fund to balance their long stock investments. Apparently, enough investors have recognized the value of Galante's relative performance so that her fund, Miramar Asset Management, is closed to new investment. Most people don't realize that a short-selling strategy that earns more than borrowing costs can be combined with a passive investment, such as an index fund or long index futures, to create a net investment that has both a higher return than the index and much lower risk. This is true even if the returns of the short-selling strategy are much lower than the returns of the index alone. For example, an investor who balanced a Nasdaq index-based investment with an equal commitment in Galante's fund (borrowing the extra money required tor the dual investment) would have both beaten the index return (after deducting borrowing costs) and cut risk dramatically.


pages: 482 words: 121,672

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing (Eleventh Edition) by Burton G. Malkiel

accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, beat the dealer, Bernie Madoff, bitcoin, butter production in bangladesh, buttonwood tree, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, Detroit bankruptcy, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, financial repression, fixed income, framing effect, George Santayana, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, money market fund, mortgage tax deduction, new economy, Own Your Own Home, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, stocks for the long run, survivorship bias, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond, zero-sum game

The chapter concludes that “smart beta” is not a smart way to go for the individual investor, and it argues that the tried-and-true approach—investing in low-cost, broad-based, capitalization-weighted index funds—is still the best way to build an investment portfolio. WHAT IS “SMART BETA”? There is no universally accepted definition of “smart beta” investment strategies. What most people who use the term have in mind is that it may be possible to gain excess (greater than market) returns by using a variety of relatively passive investment strategies that involve no more risk than would be assumed by investing in a low-cost Total Stock Market index fund. I have argued in earlier chapters that the core of every investment portfolio should consist of low-cost, tax-efficient, broad-based index funds. Indeed, from the first edition of this book in 1973—even before index funds existed—I urged that they be created because such funds would serve investors far better than expensive, tax-inefficient, actively managed funds.

A Broader Definition of Indexing The indexing strategy is one that I have recommended since the first edition in 1973—even before index funds existed. It was clearly an idea whose time had come. By far the most popular index used is the Standard & Poor’s 500-Stock Index, an index that well represents the major corporations in the U.S. market. But now, although I still recommend indexing, or so-called passive investing, there are valid criticisms of too narrow a definition of indexing. Many people incorrectly equate indexing with a strategy of simply buying the S&P 500 Index. That is no longer the only game in town. The S&P 500 omits the thousands of small companies that are among the most dynamic in the economy. Thus, I believe that if an investor is to buy only one U.S. index fund, the best general U.S. index to emulate is one of the broader indexes such as the Russell 3000, the Wilshire 5000 Total Market Index, the CRSP Index, or the MSCI U.S.


pages: 515 words: 132,295

Makers and Takers: The Rise of Finance and the Fall of American Business by Rana Foroohar

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, additive manufacturing, Airbnb, algorithmic trading, Alvin Roth, Asian financial crisis, asset allocation, bank run, Basel III, bonus culture, Bretton Woods, British Empire, business cycle, buy and hold, call centre, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, centralized clearinghouse, clean water, collateralized debt obligation, commoditize, computerized trading, corporate governance, corporate raider, corporate social responsibility, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, crowdsourcing, David Graeber, deskilling, Detroit bankruptcy, diversification, Double Irish / Dutch Sandwich, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial deregulation, financial intermediation, Frederick Winslow Taylor, George Akerlof, gig economy, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, High speed trading, Home mortgage interest deduction, housing crisis, Howard Rheingold, Hyman Minsky, income inequality, index fund, information asymmetry, interest rate derivative, interest rate swap, Internet of things, invisible hand, John Markoff, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, Kickstarter, knowledge economy, labor-force participation, London Whale, Long Term Capital Management, manufacturing employment, market design, Martin Wolf, money market fund, moral hazard, mortgage debt, mortgage tax deduction, new economy, non-tariff barriers, offshore financial centre, oil shock, passive investing, Paul Samuelson, pensions crisis, Ponzi scheme, principal–agent problem, quantitative easing, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, Rana Plaza, RAND corporation, random walk, rent control, Robert Shiller, Robert Shiller, Ronald Reagan, Satyajit Das, Second Machine Age, shareholder value, sharing economy, Silicon Valley, Silicon Valley startup, Snapchat, Social Responsibility of Business Is to Increase Its Profits, sovereign wealth fund, Steve Jobs, technology bubble, The Chicago School, the new new thing, The Spirit Level, The Wealth of Nations by Adam Smith, Tim Cook: Apple, Tobin tax, too big to fail, trickle-down economics, Tyler Cowen: Great Stagnation, Vanguard fund, zero-sum game

By the end of this period, around a third of the largest firms in the United States had ceased to exist as independent companies.38 Yet even as their laws were helping to create a climate ripe for financialization, Reagan and his advisers had begun to worry about the results, which included the eroding market share of US manufacturing firms vis-à-vis their Asian and European competitors. One report released by Reagan’s Commission on Industrial Competitiveness in 1985 sounds, amazingly enough, like something that could have been written by President Obama’s Council on Jobs and Competitiveness today: “In the 1960s, the real rates of return earned by manufacturing assets were substantially above those available on financial assets. Today, the situation is reversed. Passive investment in financial assets has pretax returns higher than the rates of return on manufacturing assets….As a result, the relative attractiveness of investing in our vital manufacturing core has been compromised.” 39 A little-known and truly stupefying fact is that Reagan was so worried about the financialization of the US economy and its impact on competitiveness that he actually launched a secret project to develop a US industrial policy—a term that is still so strongly associated in the public consciousness with Soviet Russia that it has become (wrongly) a third-rail topic even among most American liberals, not to mention conservatives.

He published an article about his idea in the Harvard Business Review and began raising it within his firm. Not surprisingly, the notion met with a chilly reception amongst Scudder principals, who could see the handwriting on the wall—index funds, and passively managed products in general, might eventually put them out of business. Sedgwick didn’t get rich, never made partner, and died a rather frustrated man, upholding his ideas about passive investing to the end.16 His article about how the “20 largest” had beaten all actively managed funds between 1948 and 1972, published in the Financial Analysts Journal in 1973, three years before his death, had the plaintive title “The Record of Conventional Investment Management: Is There Not a Better Way?”17 The answer, of course, was yes. But that way wouldn’t enrich the financial industry. By the 1970s, the die was basically cast.


pages: 168 words: 50,647

The End of Jobs: Money, Meaning and Freedom Without the 9-To-5 by Taylor Pearson

"side hustle", Airbnb, barriers to entry, Ben Horowitz, Black Swan, call centre, cloud computing, commoditize, creative destruction, David Heinemeier Hansson, Elon Musk, en.wikipedia.org, Frederick Winslow Taylor, future of work, Google Hangouts, Kevin Kelly, Kickstarter, knowledge economy, knowledge worker, loss aversion, low skilled workers, Lyft, Marc Andreessen, Mark Zuckerberg, market fragmentation, means of production, Oculus Rift, passive income, passive investing, Peter Thiel, remote working, Ronald Reagan: Tear down this wall, sharing economy, side project, Silicon Valley, Skype, software as a service, software is eating the world, Startup school, Steve Jobs, Steve Wozniak, Stewart Brand, telemarketer, Thomas Malthus, Uber and Lyft, uber lyft, unpaid internship, Watson beat the top human players on Jeopardy!, web application, Whole Earth Catalog

We lose control to react to market forces outside the scope of the job. Entrepreneurship: The Fast Lane The alternative to jobs, entrepreneurship, is based on Fast Lane math. At its core is a focus on rapidly building assets that grow without perpetually requiring direct intervention. According to research and marketing firm The Harrison Group (HarrisonGroupInc.com), only 10% of penta-millionaires (net worth $5 million) report that their wealth came from passive investments.49 They accumulated their wealth actively through building businesses, assets that grew without them. I spoke with a business owner who had a similar experience to MJ. He’d always loved cars and spent time at the race track growing up. He had a moment of realization when he saw that the only way he could ever race consistently was if he became an entrepreneur. In order to race cars, you need lots of money and lots of time.


pages: 356 words: 51,419

The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns by John C. Bogle

asset allocation, backtesting, buy and hold, creative destruction, diversification, diversified portfolio, financial intermediation, fixed income, index fund, invention of the wheel, Isaac Newton, new economy, passive investing, Paul Samuelson, random walk, risk tolerance, risk-adjusted returns, Sharpe ratio, stocks for the long run, survivorship bias, transaction costs, Upton Sinclair, Vanguard fund, William of Occam, yield management, zero-sum game

For the full decade, the model has even outpaced the top-decile endowment funds. The Bogle Model Outperforms the Top University Endowments Returns through June 30, 2016 The Bogle Model Average Endowment Top-Quartile Endowment Top-Decile Endowment 3 Years 6.4% 5.2% 6.3% 6.6% 5 Years 6.5 5.4 6.2 6.6 10 Years 6.0 5.0 5.3 5.4 Source: NACUBO-Commonfund Study of Endowments. Mr. Carlson concludes, “This has nothing to do with active vs. passive investing. This is all about simple vs. complex, operationally efficient investment programs vs. operationally inefficient investment programs, and high-probability portfolios vs. low-probability portfolios. Investing is hard enough as it is before introducing a complex, inefficient, low-probability investment style. That’s why the simple, efficient, high-probability Bogle Model wins.” * * * NOTE: The 60/40 Balanced Index Fund, holding only U.S. stocks in its equity allocation, earned significantly higher returns than the “Bogle Model”: 3 years 8.4 percent; 5 years 8.6 percent; 10 years 6.9 percent.


pages: 172 words: 49,890

The Dhandho Investor: The Low-Risk Value Method to High Returns by Mohnish Pabrai

asset allocation, backtesting, beat the dealer, Black-Scholes formula, business intelligence, call centre, cuban missile crisis, discounted cash flows, Edward Thorp, Exxon Valdez, fixed income, hiring and firing, index fund, inventory management, Mahatma Gandhi, merger arbitrage, passive investing, price mechanism, Silicon Valley, time value of money, transaction costs, zero-sum game

Over one-third of mutual funds have greater than 100 positions each. 12 It is no wonder that 80 + percent of mutual funds consistently lag the S&P 500 Index. It is also no wonder that fewer than 1 in 200 mutual funds delivers long-term annualized performance that beats the S&P 500 by three percent or more. 13 Dhandho is all about placing few bets, big bets, infrequent bets; and the Kelly Formula supports this hypothesis. This approach works exceedingly well in making passive investments in the stock market. Finally, as Charlie Munger frequently says, “Invert, Always Invert!” As we examine the investing record of those who place many bets, small bets, and frequent bets, the results are predictably pathetic. Here are some salient observations about the Kelly Formula. Because the formula suggests the maximum bet we ought to make, it optimizes the time it takes a bettor to reach our wealth goals.


pages: 825 words: 228,141

MONEY Master the Game: 7 Simple Steps to Financial Freedom by Tony Robbins

3D printing, active measures, activist fund / activist shareholder / activist investor, addicted to oil, affirmative action, Affordable Care Act / Obamacare, Albert Einstein, asset allocation, backtesting, bitcoin, buy and hold, clean water, cloud computing, corporate governance, corporate raider, correlation does not imply causation, Credit Default Swap, Dean Kamen, declining real wages, diversification, diversified portfolio, Donald Trump, estate planning, fear of failure, fiat currency, financial independence, fixed income, forensic accounting, high net worth, index fund, Internet of things, invention of the wheel, Jeff Bezos, Kenneth Rogoff, lake wobegon effect, Lao Tzu, London Interbank Offered Rate, market bubble, money market fund, mortgage debt, new economy, obamacare, offshore financial centre, oil shock, optical character recognition, Own Your Own Home, passive investing, profit motive, Ralph Waldo Emerson, random walk, Ray Kurzweil, Richard Thaler, risk tolerance, riskless arbitrage, Robert Shiller, Robert Shiller, self-driving car, shareholder value, Silicon Valley, Skype, Snapchat, sovereign wealth fund, stem cell, Steve Jobs, survivorship bias, telerobotics, the rule of 72, thinkpad, transaction costs, Upton Sinclair, Vanguard fund, World Values Survey, X Prize, Yogi Berra, young professional, zero-sum game

When he wrote A Random Walk Down Wall Street in 1973, he had no idea it would become one of the classic investment books in history. The core thesis of his book is that market timing is a loser’s game. In section 4, we will sit down and you’ll hear from Burt but for now what you need to know is that he was the first guy to come up with the rationale of an index fund, which, again, does not to try to beat the market but simply “mimics,” or matches, the market. Among investors, this strategy is called indexing or passive investing. This style is contrary to active investing, in which you pay a mutual fund manger to actively make choices about which stocks to buy or sell. The manager is trading stocks—“actively” working with hopes of beating the market. Jack Bogle, founder of the behemoth Vanguard, subsequently bet the future direction of his company on this idea by creating the first index fund. When I sat down with Jack for this book, he echoed why Vanguard has become the largest index mutual fund manager in the world.

., 14 home: average price of, 252 hedge against inflation, 308 investment in, 237, 249, 307 mortgage payments on, 249–51, 385 in Security/Peace of Mind Bucket, 306–8 tax advantage in, 308 housing crash (2008), 514–15, 516–18 How the Economic Machine Works (Dalio), 380 How to Lie with Statistics (Huff), 116 Huff, Darrell, 116 Huffington, Arianna, 594 Hulbert, Mark, 400–401 human needs, 74–78 certainty/comfort, 75, 206 contribution, 77–78, 266–67, 585 growth, 77, 585 love and connection, 77 significance, 76–77, 204 uncertainty/variety, 75 Hunt, Bunker, 490 Icahn, Carl, 10, 47, 360, 454, 458–67, 458 Icahn Enterprises (IEP), 461, 465–67 ignorance, 85 immediate gratification, 66 impulse purchases, 255 income: access to, 332 actual, 274–75 consistent, 407 for financial security, 215–16, 407–8 lifetime income plan, 46, 613–14 minimum wage, 263 as outcome, 407, 419 spendable, 444–45 stagnant, 263 income insurance, 407–8, 415–16, 427, 437–38, 613–14 index funds, 93–95, 103, 279, 486–87 bond, 305, 319, 320 diversification in, 49, 357, 473, 483 fees, 112, 165, 278 low-cost, 92, 94, 101, 106, 112, 113, 163, 180, 274, 326, 472 passively managed, 97, 472, 533 replacing mutual funds with, 113, 165 indexing (passive investing), 97 indexing plan, 104 inertia, 40 inflation, 329, 386, 413, 474, 525–26 information overload, 41 in-service distribution, 148 Inside Job (documentary), 17 inspiration, 245 insurance guaranty associations, 408n, 424 interest rates, 235n, 264, 310, 353, 411 and All Seasons, 398–99 and bonds, 158, 304, 315 and CDs, 178 long (duration) rates, 398 International Basket Brigades, 74 internet bubble, 349 internet expansion, 560–61 investment advisor, registered, 112 investment portfolio, see portfolio investments: accumulation phase, 89, 90 automated system of, 358–59, 364 with brokers, 86–87 capital gains on, 278 core concept of, 90 critical mass of, 33 decumulation phase, 89, 90 earnings and, 259–72 environment for, 385–88 and fees, 87, 105–15, 534 fixed-income (bonds), 304 goal of, 98 long-term, 93, 104, 329–30, 351, 474, 504 lump-sum, 365–66 mistakes in, 297 offer, 84 passive (indexing), 97 patterns of, 359, 404 purpose of, 70, 338, 406–7 in real estate, 283–86, 308, 323 rebalancing, 359–62, 363, 393n, 402, 613 return on, 116–20, 238, 278, 281–86 savings and, 58, 90, 247–58, 292 secure, 301 surprises in, 387 time horizon for, 283 what goes up will come down, 298–99 in yourself, 260–66 Investopedia, 84n investors: accredited, 286, 447 becoming, 6–7, 230, 292 expectations of, 387 individual, 380 women as, 334 IRAs, 93, 110, 148 and annuities, 439 401(k)s rolled over into, 154–55 Roth IRA, 150, 153–54, 236, 278, 442 and taxes, 235, 236 irrational exuberance, 334–35 It’s Your Money, 234 Jackman, Hugh, 15 jackpots, 343 Jackson, Michael, 53 Jagger, Mick, 34 Japan, economy of, 520–21 Jhoon Rhee, 42–43 Jobs, Steve, 287, 594 Johnson, Theodore, 60, 62, 67, 192 John Templeton Foundation, 62 Jones, Paul Tudor, 15–16, 30, 99, 455, 488 on asset allocation, 296, 493–94 on asymmetric risk/reward, 173, 281–82, 493 author’s interview with, 46–47, 456, 488–95 and Black Monday, 15, 46–47, 350, 488, 493 on diversification, 490–91 market forecasting, 352, 353, 354, 489, 492 and Robin Hood Foundation, 16, 489 J.P.

., 370–71 Nixon rally, 371–72 Norton, Michael, 589, 601 Notes from a Friend (Robbins), 597–98 numbers: off base, 240–41 “real,” 238, 364 Obama, Barack, 208, 560 Oduyoye, Darin, 499–500 O’Higgins, Michael, 398 oil, 506, 509, 510–11, 556–57 online rewards programs, 255–56 OPEC, 506, 511 opportunity, 269 optical illusions, 38–39 organ donation, 39–40 O’Rielly, William, 115 Orman, Suze, 254 Page, Larry, 377 Palm Beach, Florida, 289–90 passion, 573–87 passive investing (indexing), 97 paycheck, automatic deductions from, 64 pay to play, 144, 157 penny wisdom, 63 pensions, 34–35, 409 cash-balance plans, 155, 156 defined benefit plans, 155 do-it-yourself, 86 hidden fees in, 86 in Security/Peace of Mind Bucket, 308 Personal Fund, 111 Personal Power (Robbins), xxvi Peter, Irene, 297 philanthropy, 392, 457, 466, 486, 489, 494, 538, 595–96, 601; see also giving back photography, 269–70 physical mastery, 42 physiology, changing, 196–99 Pickens, T.


pages: 433 words: 53,078

Be Your Own Financial Adviser: The Comprehensive Guide to Wealth and Financial Planning by Jonquil Lowe

AltaVista, asset allocation, banking crisis, BRICs, buy and hold, correlation coefficient, cross-subsidies, diversification, diversified portfolio, estate planning, fixed income, high net worth, money market fund, mortgage debt, mortgage tax deduction, negative equity, offshore financial centre, Own Your Own Home, passive investing, place-making, Right to Buy, risk/return, short selling, zero-coupon bond

Although specific risk can be substantially reduced by holding relatively few shares, it can be completely eradicated by holding all the shares on the market – in other words, holding an investment fund that simply aims to track the market as a whole. If you want to adjust the risk–return balance, then you can split your money between the market and a risk-free or nearly risk-free asset such as cash. So to reduce risk you hold the market and cash; to increase risk you borrow extra cash to buy more of the market. This strategy is called ‘passive’ investing. The main tools of passive investing are tracker funds. A tracker fund is constructed to reproduce the performance of a selected stock market index. Some funds do actually hold every single stock in the market. But an alternative technique – there are others – is ‘representative sampling’. A reduced number of shares held are those that account for the majority 5 Fama, E., 1970, ‘Efficient capital markets: a review of theory and empirical works’ in Journal of Finance, May.


pages: 274 words: 60,596

Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School by Andrew Hallam

Albert Einstein, asset allocation, Bernie Madoff, buy and hold, diversified portfolio, financial independence, George Gilder, index fund, Long Term Capital Management, new economy, passive investing, Paul Samuelson, Ponzi scheme, pre–internet, price stability, random walk, risk tolerance, Silicon Valley, South China Sea, stocks for the long run, survivorship bias, transaction costs, Vanguard fund, yield curve

It’s just not going to happen.4 David Kahneman, 2002 Nobel Prize in Economics, when asked about investors’ long-term chances of beating a broad-based index fund Kahneman won the Nobel Prize for his work on how natural human behaviors negatively affect investment decisions. Too many people, in his view, think they can find fund managers who can beat the market index over the long haul. Any pension fund manager who doesn’t have the vast majority—and I mean 70% or 80% of his or her portfolio—in passive investments [index funds] is guilty of malfeasance, nonfeasance, or some other kind of bad feasance! There’s just no sense for most of them to have anything but a passive [indexed] investment policy.5 Merton Miller, 1990 Nobel Prize in Economics Pension fund managers are trusted to invest billions of dollars for governments and corporations. In the U.S., more than half of them use indexed approaches.


100 Baggers: Stocks That Return 100-To-1 and How to Find Them by Christopher W Mayer

bank run, Bernie Madoff, business cycle, buy and hold, cloud computing, disintermediation, Dissolution of the Soviet Union, dumpster diving, Edward Thorp, hindsight bias, housing crisis, index fund, Jeff Bezos, market bubble, Network effects, new economy, oil shock, passive investing, peak oil, shareholder value, Silicon Valley, Stanford marshmallow experiment, Steve Jobs, survivorship bias, The Great Moderation, The Wisdom of Crowds

Even if a business earning 14 percent paid out all of its earnings in dividends, taxes would reduce your return below inflation. How can you value such a business in such an environment? Buffett uses the analogy of a bond. Let’s say you had a tax-exempt bond issued in prior years that paid you 7 percent. Such a bond would be worth 50 percent of its par value in an environment where tax-exempt bonds pay 14 percent. And so it is with stocks. “Thus,” Buffett wrote, “with interest rates on passive investments at late 1981 levels, a typical American business is no longer worth one hundred cents on the dollar to owners who are individuals.” (italics in the original) The year 1982 was the last year of that kind of inflation, which diminished thereafter. No wonder it proved to be such a great bottom in the stock market. As rates fell, businesses became more and more valuable. This explains why interest rates are a big deal and why people are so keen on what the Fed is going to do.


pages: 295 words: 66,824

A Mathematician Plays the Stock Market by John Allen Paulos

Benoit Mandelbrot, Black-Scholes formula, Brownian motion, business climate, business cycle, butter production in bangladesh, butterfly effect, capital asset pricing model, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, diversified portfolio, dogs of the Dow, Donald Trump, double entry bookkeeping, Elliott wave, endowment effect, Erdős number, Eugene Fama: efficient market hypothesis, four colour theorem, George Gilder, global village, greed is good, index fund, intangible asset, invisible hand, Isaac Newton, John Nash: game theory, Long Term Capital Management, loss aversion, Louis Bachelier, mandelbrot fractal, margin call, mental accounting, Myron Scholes, Nash equilibrium, Network effects, passive investing, Paul Erdős, Paul Samuelson, Ponzi scheme, price anchoring, Ralph Nelson Elliott, random walk, Richard Thaler, Robert Shiller, Robert Shiller, short selling, six sigma, Stephen Hawking, stocks for the long run, survivorship bias, transaction costs, ultimatum game, Vanguard fund, Yogi Berra

It was probably this last, rather ludicrous version of the hypothesis that prompted the joke about the two efficient market theorists walking down the street: They spot a hundred dollar bill on the sidewalk and pass by it, reasoning that if it were real, it would have been picked up already. And of course there is the obligatory light-bulb joke. Question: How many efficient market theorists does it take to change a light bulb? Answer: None. If the light bulb needed changing the market would have already done it. Efficient market theorists tend to believe in passive investments such as broad-gauged index funds, which attempt to track a given market index such as the S&P 500. John Bogle, the crusading founder of Vanguard and presumably a believer in efficient markets, was the first to offer such a fund to the general investing public. His Vanguard 500 fund is unmanaged, offers broad diversification and very low fees, and generally beats the more expensive, managed funds.


pages: 265 words: 71,143

Empires of the Weak: The Real Story of European Expansion and the Creation of the New World Order by Jason Sharman

British Empire, cognitive dissonance, colonial rule, corporate social responsibility, death of newspapers, European colonialism, joint-stock company, joint-stock limited liability company, land tenure, offshore financial centre, passive investing, Peace of Westphalia, performance metric, profit maximization, Scramble for Africa, South China Sea, spice trade, trade route, transaction costs

Journal of Economic History 49 (4): 803–832. Odegard, Erik. 2014. “Fortifications and the Imagination of Colonial Control: The Dutch East India Company in Malabar 1663–1795.” Paper presented at the Urban History Conference, September 3–7, 2014, Lisbon. Oman, C.M.C. 1885 [1953]. The Art of War in the Middle Ages, AD 378–1515. Ithaca, NY: Cornell University Press. Pace, Desmond, Jana Hili, and Simon Grima. 2016. “Active versus Passive Investing: An Empirical Study on the US and European Mutual Funds and ETFs.” In Contemporary Issues in Bank Financial Market, edited by Simon Grima and Frank Bezzina, 1–35. Bingley, UK: Emerald Group. Padden, Robert Charles. 1957. “Cultural Change and Military Resistance in Araucanian Chile, 1550–1730.” Southwestern Journal of Anthropology 13 (1): 103–121. Parker, Geoffrey. 1976 [1995]. “The ‘Military Revolution, 1560–1660’–A Myth?”


The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk by William J. Bernstein

asset allocation, backtesting, buy and hold, capital asset pricing model, commoditize, computer age, correlation coefficient, diversification, diversified portfolio, Eugene Fama: efficient market hypothesis, fixed income, index arbitrage, index fund, intangible asset, Long Term Capital Management, p-value, passive investing, prediction markets, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, South Sea Bubble, stocks for the long run, survivorship bias, the rule of 72, the scientific method, time value of money, transaction costs, Vanguard fund, Yogi Berra, zero-coupon bond

High-yield (“junk”) bond: A debt instrument with a Standard & Poor’s rating of BB or less. By definition, such bonds have yields higher than less risky investment grade bonds. Index fund: A mutual fund designed to mimic the returns of a given stock market index, such as the S&P 500. Indexing: The strategy of exactly matching the performance of a given stock index, such as the S&P 500. See also passive investing strategy. Initial public offering (IPO): The initial, or primary, public security sale of a corporation. After the IPO, the security thus issued trades in the secondary market. Institutional investors: Large investment organizations, including insurance companies, depositary institutions, pension funds, and philanthropies. Ladder: A bond portfolio with equal amounts invested in evenly spaced maturities.


pages: 1,164 words: 309,327

Trading and Exchanges: Market Microstructure for Practitioners by Larry Harris

active measures, Andrei Shleifer, asset allocation, automated trading system, barriers to entry, Bernie Madoff, business cycle, buttonwood tree, buy and hold, compound rate of return, computerized trading, corporate governance, correlation coefficient, data acquisition, diversified portfolio, fault tolerance, financial innovation, financial intermediation, fixed income, floating exchange rates, High speed trading, index arbitrage, index fund, information asymmetry, information retrieval, interest rate swap, invention of the telegraph, job automation, law of one price, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, market clearing, market design, market fragmentation, market friction, market microstructure, money market fund, Myron Scholes, Nick Leeson, open economy, passive investing, pattern recognition, Ponzi scheme, post-materialism, price discovery process, price discrimination, principal–agent problem, profit motive, race to the bottom, random walk, rent-seeking, risk tolerance, risk-adjusted returns, selection bias, shareholder value, short selling, Small Order Execution System, speech recognition, statistical arbitrage, statistical model, survivorship bias, the market place, transaction costs, two-sided market, winner-take-all economy, yield curve, zero-coupon bond, zero-sum game

To select good active investment managers, you must predict which ones will speculate successfully. If you cannot predict which managers will be successful, you should not employ active investment managers. The most important decision investment sponsors make is whether to employ active managers. Investors who believe that they cannot speculate successfully often invest their money with passive investment managers. Passive investment managers use buy and hold strategies. They simply buy and hold securities. Passive managers therefore rarely trade. The most common buy and hold strategy is the index replication strategy. Index replicators buy and hold portfolios that they design to replicate the returns to a broad market index. We discuss how they do this in chapter 23. Indexing is very popular because many investors have decided that they do not want to speculate.

Profit-motivated traders do not always profit when they trade. Even the best traders often lose because of events that they could not anticipate. Successful traders win more often than they lose, however. Those who do not are futile traders. * * * ▶ A Trading Oxymoron Investment managers help people manage their funds. They may help people invest, as their name implies, or they may help people speculate. Passive investment managers pursue buy and hold strategies. Managers who buy and hold rarely trade. Indexing is the most common buy and hold strategy. Indexers try to replicate the returns to an index. Such strategies are often appropriate for investors. Active investment managers are speculators who try to beat the market. Traders who “invest” with such managers actually speculate on whether the manager can beat the market. ◀ * * * 8.3 FUTILE TRADERS Futile traders expect to profit from trading, but they do not profit on average.


pages: 258 words: 74,942

Company of One: Why Staying Small Is the Next Big Thing for Business by Paul Jarvis

Airbnb, big-box store, Cal Newport, call centre, corporate social responsibility, David Heinemeier Hansson, effective altruism, Elon Musk, en.wikipedia.org, endowment effect, follow your passion, gender pay gap, glass ceiling, Inbox Zero, index fund, job automation, Kickstarter, Lyft, Mark Zuckerberg, Naomi Klein, passive investing, Paul Graham, pets.com, remote working, Results Only Work Environment, ride hailing / ride sharing, Ruby on Rails, side project, Silicon Valley, Skype, Snapchat, software as a service, Steve Jobs, supply-chain management, Tim Cook: Apple, too big to fail, uber lyft, web application, Y Combinator, Y2K

Having a runway buffer of liquid savings also helps when unexpected events come up. A family member falling ill or passing away can require you to take time off that you hadn’t planned for. In this event a recurring income stream and runway buffer can be a great help at a difficult time. Savings Alongside a salary and a runway buffer, I truly think companies of one should invest as much money as they can save up in passive investments like index funds. If inflation is approximately 3 percent per year, then you’re losing money on any assets you’ve got that aren’t making at least 3 percent per year in returns. This applies, by the way, to all the money in your bank account, since checking and savings accounts pay barely any interest. Since I don’t have an employer putting money into a 401(k) or Registered Retirement Savings Plan, created by the Canadian government for Canadians like me, I’ve got to consider how I can make the most of being in the prime of my earning potential and save for the future, when that might not be the case.


pages: 300 words: 77,787

Investing Demystified: How to Invest Without Speculation and Sleepless Nights by Lars Kroijer

Andrei Shleifer, asset allocation, asset-backed security, Bernie Madoff, bitcoin, Black Swan, BRICs, Carmen Reinhart, cleantech, compound rate of return, credit crunch, diversification, diversified portfolio, equity premium, estate planning, fixed income, high net worth, implied volatility, index fund, intangible asset, invisible hand, Kenneth Rogoff, market bubble, money market fund, passive investing, pattern recognition, prediction markets, risk tolerance, risk/return, Robert Shiller, Robert Shiller, selection bias, sovereign wealth fund, too big to fail, transaction costs, Vanguard fund, yield curve, zero-coupon bond

In general the taxes I will refer to are: income tax, including taxes on dividends and coupons; capital gains tax (CGT): this covers a broad range and depending on jurisdiction will be greatly affected by the holding period and type of asset; transaction taxes, such as stamp duty in the UK; other taxes such as inheritance tax, corporation tax, taxes on gifts, etc. Owing to its simple construction with a strong bias towards minimum turnover and very long-term holding periods, the rational portfolio is very tax-efficient for most people. Below are some of the most obvious tax benefits most people would realise from holding a rational portfolio: Low turnover = less capital gains and transaction tax A passive investment product will have fewer trades than an active fund. This will typically lead to lower capital gains (including short-term ones often taxed at higher rates), but also fewer payments of transaction taxes such as stamp duty. In addition to tax, there are other obvious advantages such as trading costs associated with the low turnover. Fewer fund changes = defer tax on gains into the future Related to the low turnover of securities in the fund, investors in index trackers also change funds far less frequently than investors in active funds.


pages: 219 words: 15,438

The Essays of Warren Buffett: Lessons for Corporate America by Warren E. Buffett, Lawrence A. Cunningham

buy and hold, compound rate of return, corporate governance, Dissolution of the Soviet Union, diversified portfolio, dividend-yielding stocks, fixed income, George Santayana, index fund, intangible asset, invisible hand, large denomination, low cost airline, low cost carrier, oil shock, passive investing, price stability, Ronald Reagan, the market place, transaction costs, Yogi Berra, zero-coupon bond

In doing that, we always mentally 41 [Divided by hash lines: 1995; 1991 (the latter with similar versions beginning in 1982 and continuting thereafter).] 152 CARDOZO LAW REVIEW [Vol. 19:1 compare any move we are contemplating with dozens of other opportunities open to us, including the purchase of small pieces of the best businesses in the world via the stock market. Our practice of making this comparison-acquisitions against passive investments-is a discipline that managers focused simply on expansion seldom use. Talking to Time Magazine a few years back, Peter Drucker got to the heart of things: "I will tell you a secret: Dealmaking beats working. Dealmaking is exciting and fun, and working is grubby. Running anything is primarily an enormous amount of grubby detail work ... dealmaking is romantic, sexy. That's why you have deals that make no sense."


pages: 297 words: 84,009

Big Business: A Love Letter to an American Anti-Hero by Tyler Cowen

23andMe, Affordable Care Act / Obamacare, augmented reality, barriers to entry, Bernie Sanders, bitcoin, blockchain, Bretton Woods, cloud computing, cognitive dissonance, corporate governance, corporate social responsibility, correlation coefficient, creative destruction, crony capitalism, cryptocurrency, dark matter, David Brooks, David Graeber, don't be evil, Donald Trump, Elon Musk, employer provided health coverage, experimental economics, Filter Bubble, financial innovation, financial intermediation, global reserve currency, global supply chain, Google Glasses, income inequality, Internet of things, invisible hand, Jeff Bezos, late fees, Mark Zuckerberg, mobile money, money market fund, mortgage debt, Network effects, new economy, Nicholas Carr, obamacare, offshore financial centre, passive investing, payday loans, peer-to-peer lending, Peter Thiel, pre–internet, price discrimination, profit maximization, profit motive, RAND corporation, rent-seeking, reserve currency, ride hailing / ride sharing, risk tolerance, Ronald Coase, shareholder value, Silicon Valley, Silicon Valley startup, Skype, Snapchat, Social Responsibility of Business Is to Increase Its Profits, Steve Jobs, The Nature of the Firm, Tim Cook: Apple, too big to fail, transaction costs, Tyler Cowen: Great Stagnation, ultimatum game, WikiLeaks, women in the workforce, World Values Survey, Y Combinator

Finally, if you add in how much Vanguard has encouraged or forced other funds to lower their fees too, it is not difficult to come up with a figure of $1 trillion as a financial benefit from Vanguard. You can take that as praise for Vanguard, or an indictment of the previous state of affairs, or perhaps a bit of both. Nonetheless, these figures, even though they are rough estimates, show good progress in lowering fees. But do note the fees are still high: one estimate from 2004 measures various kinds of mutual fund broker fees at $23.8 billion. Since that time indexing and passive investing have grown, but the core problem of excess fees has by no means vanished.27 Keep in mind also that mutual fund growth, as it represents a growing part of financial service fees, stems from a fundamental change in the nature of retirement. In the supposed “good old days” (which were in fact not always so wonderful), workers relied more frequently on defined benefit pensions from corporations.


Griftopia: Bubble Machines, Vampire Squids, and the Long Con That Is Breaking America by Matt Taibbi

addicted to oil, affirmative action, Affordable Care Act / Obamacare, Bernie Sanders, Bretton Woods, buy and hold, carried interest, clean water, collateralized debt obligation, collective bargaining, computerized trading, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, David Brooks, desegregation, diversification, diversified portfolio, Donald Trump, financial innovation, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, illegal immigration, interest rate swap, laissez-faire capitalism, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, medical malpractice, money market fund, moral hazard, mortgage debt, obamacare, passive investing, Ponzi scheme, prediction markets, quantitative easing, reserve currency, Ronald Reagan, Sergey Aleynikov, short selling, sovereign wealth fund, too big to fail, trickle-down economics, Y2K, Yom Kippur War

At least that’s what Goldman Sachs told its institutional investors back in 2005, in a pamphlet entitled Investing and Trading in the Goldman Sachs Commodities Index, given out mainly to pension funds and the like. Commodities like oil and gas, Goldman argued, would provide investors with “equity-like returns” while diversifying portfolios and therefore reducing risk. These investors were encouraged to make a “broadly-diversified, long-only, passive investment” in commodity indices. But there were several major problems with this kind of thinking—i.e., the notion that the prices of oil and gas and wheat and soybeans were something worth investing in for the long term, the same way one might invest in stock. For one thing, the whole concept of taking money from pension funds and dumping it long-term into the commodities market went completely against the spirit of the delicate physical hedger/speculator balance as envisioned by the 1936 law.


pages: 366 words: 94,209

Throwing Rocks at the Google Bus: How Growth Became the Enemy of Prosperity by Douglas Rushkoff

activist fund / activist shareholder / activist investor, Airbnb, algorithmic trading, Amazon Mechanical Turk, Andrew Keen, bank run, banking crisis, barriers to entry, bitcoin, blockchain, Burning Man, business process, buy and hold, buy low sell high, California gold rush, Capital in the Twenty-First Century by Thomas Piketty, carbon footprint, centralized clearinghouse, citizen journalism, clean water, cloud computing, collaborative economy, collective bargaining, colonial exploitation, Community Supported Agriculture, corporate personhood, corporate raider, creative destruction, crowdsourcing, cryptocurrency, disintermediation, diversified portfolio, Elon Musk, Erik Brynjolfsson, Ethereum, ethereum blockchain, fiat currency, Firefox, Flash crash, full employment, future of work, gig economy, Gini coefficient, global supply chain, global village, Google bus, Howard Rheingold, IBM and the Holocaust, impulse control, income inequality, index fund, iterative process, Jaron Lanier, Jeff Bezos, jimmy wales, job automation, Joseph Schumpeter, Kickstarter, loss aversion, Lyft, Marc Andreessen, Mark Zuckerberg, market bubble, market fundamentalism, Marshall McLuhan, means of production, medical bankruptcy, minimum viable product, Mitch Kapor, Naomi Klein, Network effects, new economy, Norbert Wiener, Oculus Rift, passive investing, payday loans, peer-to-peer lending, Peter Thiel, post-industrial society, profit motive, quantitative easing, race to the bottom, recommendation engine, reserve currency, RFID, Richard Stallman, ride hailing / ride sharing, Ronald Reagan, Satoshi Nakamoto, Second Machine Age, shareholder value, sharing economy, Silicon Valley, Snapchat, social graph, software patent, Steve Jobs, TaskRabbit, The Future of Employment, trade route, transportation-network company, Turing test, Uber and Lyft, Uber for X, uber lyft, unpaid internship, Y Combinator, young professional, zero-sum game, Zipcar

“It’s good for a market economy to have income inequality but to extremes, it can actually damage growth long term and make it less sustainable.”19 Bovino showed that it’s not just the extreme of inequality that’s to blame but the decline of labor and business income in the face of rising capital gains. Simply stated, it’s harder to make money by working or creating value when the scales tip too far in favor of investors and shareholders. In a sense, though, the aim of the original corporate program has been achieved: those who create value have been utterly subsumed by those who passively invest. But as Bovino is trying to warn us, corporate shareholders can’t take this much money out of circulation without killing the goose. Those who run real businesses or, worse, work for a living end up like the musicians on the bad end of the long tail. Meanwhile, passive investors who depend on economic growth end up sitting on their bags of money, unable to find new productive investments. That’s why the S&P cut its growth forecasts for U.S. corporations, which are still flummoxed by the whole situation.


pages: 1,088 words: 228,743

Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, Bernie Madoff, Black Swan, Bretton Woods, business cycle, buy and hold, buy low sell high, capital asset pricing model, capital controls, Carmen Reinhart, central bank independence, collateralized debt obligation, commoditize, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, G4S, George Akerlof, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, information asymmetry, interest rate swap, invisible hand, Kenneth Rogoff, laissez-faire capitalism, law of one price, London Interbank Offered Rate, Long Term Capital Management, loss aversion, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, Myron Scholes, negative equity, New Journalism, oil shock, p-value, passive investing, Paul Samuelson, performance metric, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, Robert Shiller, savings glut, selection bias, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, stocks for the long run, survivorship bias, systematic trading, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond, zero-sum game

Active management is a zero-sum game even before costs; after trading costs and fees it is a negative-sum game (this observation is mathematically true regardless of whether the market is efficient). Empirical analyses unequivocally confirm that most managers underperform passive indices after fees and leave open the possibility that winners have just been lucky. People’s innate optimism and the financial industry’s marketing machines have been able to muddle these messages, thereby slowing the lure of passive investing. In its early years, the EMH was often equated with the random walk hypothesis (RWH). The ideas are closely linked. According to the RWH, aggressive competition among market participants to exploit any predictable patterns makes price changes fully random and unpredictable. All news is instantly incorporated into market prices. However, the EMH allows time variation in rational risk premia whereas the RWH assumes the special case of constant expected returns.

A common view is that skill is best applied in illiquid asset classes and in market segments where mispricings are harder to arbitrage and thus they survive longer. A counterview is that it is easier to identify skill vs. luck in liquid assets with frequent performance measurement. With illiquid assets, effective sample sizes will be tiny. Moreover, if you reassess a manager’s skill over time, there will be times (say in 2008) when you may want to get out but you have no flexibility to do so. 28.1.4 Cost control Passive investing minimizes trading costs. However, some costs are worth paying. Buying an equity index fund costs more than investing in a bank deposit, but the equity premium should make the extra cost worthwhile in the long run. Value-oriented non-market-cap weighting involves higher turnover and fees than market cap indices, but proponents of fundamental indexation argue that long-run net returns will be better.


pages: 364 words: 101,286

The Misbehavior of Markets: A Fractal View of Financial Turbulence by Benoit Mandelbrot, Richard L. Hudson

Albert Einstein, asset allocation, Augustin-Louis Cauchy, Benoit Mandelbrot, Big bang: deregulation of the City of London, Black-Scholes formula, British Empire, Brownian motion, business cycle, buy and hold, buy low sell high, capital asset pricing model, carbon-based life, discounted cash flows, diversification, double helix, Edward Lorenz: Chaos theory, Elliott wave, equity premium, Eugene Fama: efficient market hypothesis, Fellow of the Royal Society, full employment, Georg Cantor, Henri Poincaré, implied volatility, index fund, informal economy, invisible hand, John Meriwether, John von Neumann, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market microstructure, Myron Scholes, new economy, paper trading, passive investing, Paul Lévy, Paul Samuelson, plutocrats, Plutocrats, price mechanism, quantitative trading / quantitative finance, Ralph Nelson Elliott, RAND corporation, random walk, risk tolerance, Robert Shiller, Robert Shiller, short selling, statistical arbitrage, statistical model, Steve Ballmer, stochastic volatility, transfer pricing, value at risk, Vilfredo Pareto, volatility smile

But Wall Street’s customers were even more grumpy and difficult. So the financial industry became a convert to the new, “modern” finance. Merrill Lynch turned CAPM into an industry in its own right, producing a periodical “Beta Book” for its brokers and customers eager to do the math themselves. Across the world, financial firms started constructing efficient portfolios for their clients. After a few false starts, the index fund, the ultimate in passive investing, was born. It now constitutes more than a fourth of U.S. fund investments. Options took off. The industry was transformed. It discovered economies of scale: If there is just one market portfolio and one size fits all, then the same funds and same analysts can serve all customers. Merge and save. Bigger is better. And the academics themselves turned from disparaged outsiders to valued insiders.


pages: 323 words: 95,939

Present Shock: When Everything Happens Now by Douglas Rushkoff

algorithmic trading, Andrew Keen, bank run, Benoit Mandelbrot, big-box store, Black Swan, British Empire, Buckminster Fuller, business cycle, cashless society, citizen journalism, clockwork universe, cognitive dissonance, Credit Default Swap, crowdsourcing, Danny Hillis, disintermediation, Donald Trump, double helix, East Village, Elliott wave, European colonialism, Extropian, facts on the ground, Flash crash, game design, global pandemic, global supply chain, global village, Howard Rheingold, hypertext link, Inbox Zero, invention of agriculture, invention of hypertext, invisible hand, iterative process, John Nash: game theory, Kevin Kelly, laissez-faire capitalism, lateral thinking, Law of Accelerating Returns, loss aversion, mandelbrot fractal, Marshall McLuhan, Merlin Mann, Milgram experiment, mutually assured destruction, negative equity, Network effects, New Urbanism, Nicholas Carr, Norbert Wiener, Occupy movement, passive investing, pattern recognition, peak oil, price mechanism, prisoner's dilemma, Ralph Nelson Elliott, RAND corporation, Ray Kurzweil, recommendation engine, selective serotonin reuptake inhibitor (SSRI), Silicon Valley, Skype, social graph, South Sea Bubble, Steve Jobs, Steve Wozniak, Steven Pinker, Stewart Brand, supply-chain management, the medium is the message, The Wisdom of Crowds, theory of mind, Turing test, upwardly mobile, Whole Earth Catalog, WikiLeaks, Y2K, zero-sum game

Members of the various local networks meet on regular market days to purchase goods or negotiate simple service agreements for the coming week. This is a presentist economy, at least in comparison with the storage-based economics of the euro and traditional banking. Nothing is spring-loaded or leveraged, which makes it harder for these markets to endure changing seasonal conditions, support multiyear contracts, or provide opportunities for passive investment. But this style of transaction still does offer some long-term benefits to the communities who use it. Human relationships are strengthened, local businesses enjoy advantages over larger foreign corporations, and investment of time and energy is spent on meeting the needs of the community itself. Greek villagers in the shadow of a failing euro aren’t the only ones abandoning time-compressed investment strategies.


pages: 447 words: 104,258

Mathematics of the Financial Markets: Financial Instruments and Derivatives Modelling, Valuation and Risk Issues by Alain Ruttiens

algorithmic trading, asset allocation, asset-backed security, backtesting, banking crisis, Black Swan, Black-Scholes formula, Brownian motion, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discounted cash flows, discrete time, diversification, fixed income, implied volatility, interest rate derivative, interest rate swap, margin call, market microstructure, martingale, p-value, passive investing, quantitative trading / quantitative finance, random walk, risk/return, Satyajit Das, Sharpe ratio, short selling, statistical model, stochastic process, stochastic volatility, time value of money, transaction costs, value at risk, volatility smile, Wiener process, yield curve, zero-coupon bond

Hence, it makes sense to consider that in a risky investment (r, σ) it should be the excess return only, that is, r − rf, that pays for the supported risk. Hence the Sharpe ratio: Practically speaking, for a given period of past data leading to r and σ measures, the rf rate must be of a non-defaultable government bill or bond of maturity coinciding with the same period of time as used for r and σ. The data for r and rf being usually expressed on a p.a. basis, σ must also be computed on a p.a. basis. Example. For a fund passively invested in the S&P 500 in 2009, the computed return and risk were 17.96% p.a. and 27.04% p.a. respectively (based on daily closing prices). The corresponding 12-month T-Bill was 2.004%. The Sharpe ratio is Note that in the fund industry, it is hard to achieve a Sharpe ratio above 1, which may be viewed as a reference level. The Treynor Ratio In the funds industry, the performance objective of a portfolio P is generally referring to a benchmark, typically an equity index.


pages: 339 words: 109,331

The Clash of the Cultures by John C. Bogle

asset allocation, buy and hold, collateralized debt obligation, commoditize, corporate governance, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, estate planning, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, Flash crash, Hyman Minsky, income inequality, index fund, interest rate swap, invention of the wheel, market bubble, market clearing, money market fund, mortgage debt, new economy, Occupy movement, passive investing, Paul Samuelson, Ponzi scheme, post-work, principal–agent problem, profit motive, random walk, rent-seeking, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, statistical arbitrage, survivorship bias, The Wealth of Nations by Adam Smith, transaction costs, Vanguard fund, William of Occam, zero-sum game

We were the only mutual mutual fund complex; and the index fund was a perfect fit. It was a marriage made in heaven, strongly supported by the unequivocal data that I had assembled on fund performance relative to the S&P 500 over the previous three decades. Simple Arithmetic: An Unarguable Conclusion Few commentators have recognized that two distinct intellectual ideas formed the foundation for passive investment strategies. Academics and sophisticated students of the markets—“quants,” as they are known today—rely upon the EMH—the Efficient Market Hypothesis, first articulated by University of Chicago Professor Eugene Fama in the mid-1960s. This theory suggests that by reflecting the informed opinion of the mass of investors, stocks are continuously valued at prices that accurately reflect the totality of investor knowledge, and are thus fairly valued.


pages: 416 words: 106,532

Cryptoassets: The Innovative Investor's Guide to Bitcoin and Beyond: The Innovative Investor's Guide to Bitcoin and Beyond by Chris Burniske, Jack Tatar

Airbnb, altcoin, asset allocation, asset-backed security, autonomous vehicles, bitcoin, blockchain, Blythe Masters, business cycle, business process, buy and hold, capital controls, Carmen Reinhart, Clayton Christensen, clean water, cloud computing, collateralized debt obligation, commoditize, correlation coefficient, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, disintermediation, distributed ledger, diversification, diversified portfolio, Donald Trump, Elon Musk, en.wikipedia.org, Ethereum, ethereum blockchain, fiat currency, financial innovation, fixed income, George Gilder, Google Hangouts, high net worth, Jeff Bezos, Kenneth Rogoff, Kickstarter, Leonard Kleinrock, litecoin, Marc Andreessen, Mark Zuckerberg, market bubble, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Network effects, packet switching, passive investing, peer-to-peer, peer-to-peer lending, Peter Thiel, pets.com, Ponzi scheme, prediction markets, quantitative easing, RAND corporation, random walk, Renaissance Technologies, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ross Ulbricht, Satoshi Nakamoto, Sharpe ratio, Silicon Valley, Simon Singh, Skype, smart contracts, social web, South Sea Bubble, Steve Jobs, transaction costs, tulip mania, Turing complete, Uber for X, Vanguard fund, WikiLeaks, Y2K

But maybe the hedge fund structure will largely become a relic of the past, with asset management infrastructure decentralized through platforms like Melonport. The potential products and vehicles are endless and provide investors and money managers with great opportunities for profit. Will individual money managers become famous for their expertise and active management of these assets, or will passive investments consisting of rules-based categories of cryptoassets become the vehicle of choice? In the 1980s, Fidelity’s Magellan Fund was where investors wanted to place their money, and it was all because of one person: Peter Lynch. During Lynch’s time, the fund grew from $20 million to $14 billion, and he beat the S&P 500 index 11 out of 13 years. It was a heyday for active managers and for mutual funds in general, and investors chased money managers, not stocks.


Capital Ideas Evolving by Peter L. Bernstein

Albert Einstein, algorithmic trading, Andrei Shleifer, asset allocation, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, computerized trading, creative destruction, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, diversification, diversified portfolio, endowment effect, equity premium, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, high net worth, hiring and firing, index fund, invisible hand, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, market bubble, mental accounting, money market fund, Myron Scholes, paper trading, passive investing, Paul Samuelson, price anchoring, price stability, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical model, survivorship bias, systematic trading, technology bubble, The Wealth of Nations by Adam Smith, transaction costs, yield curve, Yogi Berra, zero-sum game

Those problems invalidate the model’s use in some applications. But the model’s power has turned out to be astonishing where its use is appropriate. In recent years, CAPM has inspired widespread and radical changes in the way institutional investors allocate assets, and the order in which they sequence their allocation decisions. CAPM also inf luences the way investors arrive at judgments between active and passive investing, select active managers, and confront the risks imbedded in their portfolio decisions. CAPM is indeed alive and well as an effective tool of portfolio management, although in ways that none of its developers would ever have predicted. What is the Capital Asset Pricing Model all about? The answer to that question depends in part on which of the living originators of this model you ask, Jack Treynor or Bill Sharpe.


pages: 416 words: 118,592

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing by Burton G. Malkiel

accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, backtesting, beat the dealer, Bernie Madoff, BRICs, butter production in bangladesh, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, money market fund, mortgage tax deduction, new economy, Own Your Own Home, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, stocks for the long run, survivorship bias, The Myth of the Rational Market, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

A Broader Definition of Indexing The indexing strategy is one that I have recommended since the first edition in 1973—even before index funds existed. It was clearly an idea whose time had come. By far the most popular index used is the Standard & Poor’s 500-Stock Index, an index that well represents the major corporations in the U.S. market. But now, although I still recommend indexing, or so-called passive investing, there are valid criticisms of too narrow a definition of indexing. Many people incorrectly equate indexing with a strategy of simply buying the S&P 500 Index. That is no longer the only game in town. The S&P 500 omits the thousands of small companies that are among the most dynamic in the economy. Thus, I believe that if an investor is to buy only one U.S. index fund, the best general U.S. index to emulate is one of the broader indexes such as the Russell 3000, the Wilshire 5000 Total Market Index, or the MSCI U.S.


pages: 397 words: 112,034

What's Next?: Unconventional Wisdom on the Future of the World Economy by David Hale, Lyric Hughes Hale

affirmative action, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Berlin Wall, Black Swan, Bretton Woods, business cycle, capital controls, Cass Sunstein, central bank independence, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate social responsibility, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, debt deflation, declining real wages, deindustrialization, diversification, energy security, Erik Brynjolfsson, Fall of the Berlin Wall, financial innovation, floating exchange rates, full employment, Gini coefficient, global reserve currency, global village, high net worth, Home mortgage interest deduction, housing crisis, index fund, inflation targeting, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, Just-in-time delivery, Kenneth Rogoff, Long Term Capital Management, Mahatma Gandhi, Martin Wolf, Mexican peso crisis / tequila crisis, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, mortgage tax deduction, Network effects, new economy, Nicholas Carr, oil shale / tar sands, oil shock, open economy, passive investing, payday loans, peak oil, Ponzi scheme, post-oil, price stability, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, regulatory arbitrage, rent-seeking, reserve currency, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, sovereign wealth fund, special drawing rights, technology bubble, The Great Moderation, Thomas Kuhn: the structure of scientific revolutions, Tobin tax, too big to fail, total factor productivity, trade liberalization, Washington Consensus, Westphalian system, WikiLeaks, women in the workforce, yield curve

According to LCM Research, adding exchange-traded options and futures contracts to the latter figure represents no less than seven billion barrels of oil. The deleveraging that took place in the second half of 2008 reduced this amount to about 1.7 billion barrels. Over-the-counter crude oil contracts exacerbated this speculative spike, adding a full 120 percent to the peak figure as opposed to a fraction (on the order of 80 percent) before and after the spring 2008 episode. Similarly, passive investment into index funds also rose and fell spectacularly, from about $75 billion in 2006 to $280 billion by mid-summer 2008, and back to the 2006 level six months later.40 The Goldman Sachs–fed allure of $200-per-barrel oil has faded, and it is unlikely that the next couple of years will see an episode of exuberant investing comparable to the year 2008 that is still remembered for oil at $147 per barrel.


pages: 386 words: 116,233

The Millionaire Fastlane: Crack the Code to Wealth and Live Rich for a Lifetime by Mj Demarco

8-hour work day, Albert Einstein, AltaVista, back-to-the-land, Bernie Madoff, bounce rate, business process, butterfly effect, buy and hold, cloud computing, commoditize, dark matter, delayed gratification, demand response, Donald Trump, fear of failure, financial independence, fixed income, housing crisis, Jeff Bezos, job-hopping, Lao Tzu, Mark Zuckerberg, passive income, passive investing, payday loans, Ponzi scheme, price anchoring, Ronald Reagan, upwardly mobile, wealth creators, white picket fence, World Values Survey, zero day

They used time to accelerate wealth, and what it got them was old age. I don't say that to be mean-spirited to older generations, but to cast light on the point: Compound interest (401(k)s, mutual funds, the stock market) cannot accelerate wealth fast. According to research and marketing firm The Harrison Group (HarrisonGroupInc.com), only 10% of penta-millionaires (net worth $5 million) report that their wealth came from passive investments. Age data was not provided but you can guess that none of the 10% were under 30. Think about it. Have you ever met a college student who got rich investing in mutual funds or his employer's 401(k)? How about the guy who bought municipal bonds in 2006 and retired in 2009? I wonder if that guy driving a $1.2-million car can because of his well-balanced portfolio of mutual funds? These people don't exist because the youthful rich are not leveraging 8% returns but 800%!


pages: 426 words: 115,150

Your Money or Your Life: 9 Steps to Transforming Your Relationship With Money and Achieving Financial Independence: Revised and Updated for the 21st Century by Vicki Robin, Joe Dominguez, Monique Tilford

asset allocation, Buckminster Fuller, buy low sell high, credit crunch, disintermediation, diversification, diversified portfolio, fiat currency, financial independence, fixed income, fudge factor, full employment, Gordon Gekko, high net worth, index card, index fund, job satisfaction, Menlo Park, money market fund, Parkinson's law, passive income, passive investing, profit motive, Ralph Waldo Emerson, Richard Bolles, risk tolerance, Ronald Reagan, Silicon Valley, software patent, strikebreaker, Thorstein Veblen, Vanguard fund, zero-coupon bond

At its core, index fund investing means you are using an approach and strategy that seeks to track the investment returns of a specified stock or bond market benchmark or index. One of the most popular index funds today is the S&P 500 Index Fund, which attempts to replicate the investment results of this specific target index. There is no attempt to use traditional “active” money management or to make “bets” on individual stocks. Indexing is a passive investment approach emphasizing broad diversification and low portfolio trading activity. Low cost is a key advantage of index funds, leaving a larger share of the pie for investors, which is why this choice aligns well for your FI investment plan. Low Fees Are Key Fees, by far, are one of the most overlooked areas in terms of investment decisions. Index funds boast some of the lowest portfolio-management fees in the industry, which is why they are the vehicle of choice for investors looking for value as well as performance.


eBoys by Randall E. Stross

barriers to entry, business cycle, call centre, carried interest, cognitive dissonance, disintermediation, edge city, high net worth, hiring and firing, Jeff Bezos, job-hopping, knowledge worker, late capitalism, market bubble, Menlo Park, new economy, old-boy network, passive investing, performance metric, pez dispenser, railway mania, rolodex, Sand Hill Road, shareholder value, Silicon Valley, Silicon Valley startup, Steve Ballmer, Steve Jobs, Y2K

I mean, we’re playing with guys that are worth billions of dollars or hundreds of millions of dollars. They think they’re playing in the big leagues and we’re in Little League. That’s fine.” More silence. Kagle tried to offer a compromise that both Beirne and the partners could live with. What about relaxing the partnership’s 15 percent ownership minimum? Why not have Benchmark take a smaller piece as a passive investment, that is, one in which Beirne would not serve as a director on the board? Beirne kept his voice low, but the thought of missing the opportunity was too much to bear. “I think if this is what we think it is, if they nail one of the top six carriers, this will be such a massive company. The fact that we’ve sold ourselves into a position of owning 15 percent of it, I think, will be unbelievable.


pages: 519 words: 118,095

Your Money: The Missing Manual by J.D. Roth

Airbnb, asset allocation, bank run, buy and hold, buy low sell high, car-free, Community Supported Agriculture, delayed gratification, diversification, diversified portfolio, estate planning, Firefox, fixed income, full employment, hedonic treadmill, Home mortgage interest deduction, index card, index fund, late fees, mortgage tax deduction, Own Your Own Home, passive investing, Paul Graham, random walk, Richard Bolles, risk tolerance, Robert Shiller, Robert Shiller, speech recognition, stocks for the long run, traveling salesman, Vanguard fund, web application, Zipcar

But a funny thing happens the longer you hold onto them: They begin to float to the top of the stack. That's because the "hot" funds don't stay hot year after year—they cool down. So while index funds are usually in the middle of the pack in any given one-year period, they shine over the long term. During the recent stock market tumble, some folks shouted, "Look! Buy-and-hold investing is dead!" They took the stock market's decline as evidence that passive investing with index funds doesn't work. Well, it doesn't work if you sell after a fall, but if you hold onto your investments, you're fine—you haven't lost anything but time. In fact, many savvy investors viewed the market crash as a chance to buy—and hold onto—even more shares of their index funds. Investing is a game of years and decades, not months. What your investments did this year is far less important than what they'll do over the next decade (or two, or three).


pages: 413 words: 117,782

What Happened to Goldman Sachs: An Insider's Story of Organizational Drift and Its Unintended Consequences by Steven G. Mandis

activist fund / activist shareholder / activist investor, algorithmic trading, Berlin Wall, bonus culture, BRICs, business process, buy and hold, collapse of Lehman Brothers, collateralized debt obligation, commoditize, complexity theory, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, disintermediation, diversification, Emanuel Derman, financial innovation, fixed income, friendly fire, Goldman Sachs: Vampire Squid, high net worth, housing crisis, London Whale, Long Term Capital Management, merger arbitrage, Myron Scholes, new economy, passive investing, performance metric, risk tolerance, Ronald Reagan, Saturday Night Live, Satyajit Das, shareholder value, short selling, sovereign wealth fund, The Nature of the Firm, too big to fail, value at risk

Goldman creates GSCI, a benchmark for investment performance in the commodities markets (T). 1992: Bob Rubin leaves Goldman to become assistant to the president on economic policy (O). The move adds to the Goldman mystique but is unusual in that Rubin’s is one of the shortest tenures as senior partner. A Hawaiian educational trust, the Kamehameha Schools/Bishop Estate, invests $250 million in Goldman and receives a stake of more than 5 percent in the firm. It is a passive investment; the trust has no voting privileges but will participate in Goldman’s profits and losses. In an effort to further link pay to performance, and to create a new source of developmental feedback, Goldman institutes 360-degree performance reviews (meaning that even junior staff reviews senior staff). New offices are opened in Frankfurt, Milan, and Seoul (O, C). 1993: Goldman is one of the most profitable firms in the world with record profits and experiences rapid growth and global expansion.


pages: 288 words: 16,556

Finance and the Good Society by Robert J. Shiller

Alvin Roth, bank run, banking crisis, barriers to entry, Bernie Madoff, buy and hold, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, cognitive dissonance, collateralized debt obligation, collective bargaining, computer age, corporate governance, Daniel Kahneman / Amos Tversky, Deng Xiaoping, diversification, diversified portfolio, Donald Trump, Edward Glaeser, eurozone crisis, experimental economics, financial innovation, financial thriller, fixed income, full employment, fundamental attribution error, George Akerlof, income inequality, information asymmetry, invisible hand, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, land reform, loss aversion, Louis Bachelier, Mahatma Gandhi, Mark Zuckerberg, market bubble, market design, means of production, microcredit, moral hazard, mortgage debt, Myron Scholes, Nelson Mandela, Occupy movement, passive investing, Ponzi scheme, prediction markets, profit maximization, quantitative easing, random walk, regulatory arbitrage, Richard Thaler, Right to Buy, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, selection bias, self-driving car, shareholder value, Sharpe ratio, short selling, Simon Kuznets, Skype, Steven Pinker, telemarketer, Thales and the olive presses, Thales of Miletus, The Market for Lemons, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, Vanguard fund, young professional, zero-sum game, Zipcar

If statistical evidence proves that no one can outperform a strategy of choosing investments randomly, then their attempts to claim that they do so must be fundamentally dishonest. There is an element of truth to this academic view: many investment managers have succeeded in creating false impressions as to their superiority as investors. Evidence in the academic nance literature shows that actively managed stock market mutual funds have generally been worse investments in recent decades than funds that follow a passive investment strategy and merely invest in all shares in the stock market. For example, Martin Gruber found in 1996 that mutual funds underperformed a diversi ed investment in the stock market by about 1.5% a year.1 This underperformance re ected the regularly scheduled management fees imposed by the mutual funds on their investors, but not the load fees (large one-time-only fees that are collected when money is invested or taken out), so the actual performance of mutual funds was even worse.


pages: 550 words: 124,073

Democracy and Prosperity: Reinventing Capitalism Through a Turbulent Century by Torben Iversen, David Soskice

Andrei Shleifer, assortative mating, augmented reality, barriers to entry, Bretton Woods, business cycle, capital controls, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, centre right, cleantech, cloud computing, collateralized debt obligation, collective bargaining, colonial rule, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, deindustrialization, deskilling, Donald Trump, first-past-the-post, full employment, Gini coefficient, hiring and firing, implied volatility, income inequality, industrial cluster, inflation targeting, invisible hand, knowledge economy, labor-force participation, liberal capitalism, low skilled workers, low-wage service sector, means of production, mittelstand, Network effects, New Economic Geography, new economy, New Urbanism, non-tariff barriers, Occupy movement, offshore financial centre, open borders, open economy, passive investing, precariat, race to the bottom, rent-seeking, RFID, road to serfdom, Robert Bork, Robert Gordon, Silicon Valley, smart cities, speech recognition, The Future of Employment, The Great Moderation, The Rise and Fall of American Growth, too big to fail, trade liberalization, union organizing, urban decay, Washington Consensus, winner-take-all economy, working-age population, World Values Survey, young professional, zero-sum game

The cross-class coalition in the industrial relations system depended in some measure on the state playing a supportive or enabling role. Wage restraint presented a time inconsistency problem insofar as companies were not required to reinvest higher profits but could disburse them as dividends or bonuses instead (Eichengreen 1997). But they were encouraged to reinvest by tax, industrial, educational, and regulatory policies that prioritized active over passive investments. Dividend payouts were heavily taxed, and “advanced” sectors of the economy were aided through infrastructure and educational investments, and by targeting subsidies and low-interest loans to sectors where unions displayed wage restraint and where firms were willing to support apprenticeship training and invest in R&D (Katzenstein 1985). Governments also assumed a supporting role by providing unemployment, health, and retirement programs—central institutions of the welfare state—which reduced workers’ uncertainty about their future welfare and, therefore, their temptation to engage in short-termism and industrial conflict.


pages: 490 words: 117,629

Unconventional Success: A Fundamental Approach to Personal Investment by David F. Swensen

asset allocation, asset-backed security, buy and hold, capital controls, cognitive dissonance, corporate governance, diversification, diversified portfolio, fixed income, index fund, law of one price, Long Term Capital Management, market bubble, market clearing, market fundamentalism, money market fund, passive investing, Paul Samuelson, pez dispenser, price mechanism, profit maximization, profit motive, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, Silicon Valley, Steve Ballmer, stocks for the long run, survivorship bias, technology bubble, the market place, transaction costs, Vanguard fund, yield curve, zero-sum game

While the value added by operationally oriented buyout partnerships may, in certain instances, overcome the burden imposed by the typical buyout fund’s generous fee structure, in aggregate, buyout investments fail to match public market alternatives. After adjusting for the higher level of risk and the greater degree of illiquidity in buyout transactions, publicly traded equity securities gain a clear advantage. Active Management and Buyout Funds In the private equity world, active management success goes hand-in-glove with investment success. In asset classes such as domestic equities and fixed income, which contain passive investment alternatives, investors can buy the market. By owning a marketable-security index fund, investors reap market returns in a cost-efficient, reliable manner. In the inefficient private equity world, investors cannot buy the market, as no investable index exists. Even if a leveraged-buyout index existed, based on past performance, index-like results would fail to satisfy investor desires for superior risk-adjusted returns.


pages: 1,073 words: 302,361

Money and Power: How Goldman Sachs Came to Rule the World by William D. Cohan

asset-backed security, Bernie Madoff, business cycle, buttonwood tree, buy and hold, collateralized debt obligation, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, fear of failure, financial innovation, fixed income, Ford paid five dollars a day, Goldman Sachs: Vampire Squid, Gordon Gekko, high net worth, hiring and firing, hive mind, Hyman Minsky, interest rate swap, John Meriwether, Kenneth Arrow, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, mega-rich, merger arbitrage, moral hazard, mortgage debt, Myron Scholes, paper trading, passive investing, Paul Samuelson, Ponzi scheme, price stability, profit maximization, risk tolerance, Ronald Reagan, Saturday Night Live, South Sea Bubble, time value of money, too big to fail, traveling salesman, value at risk, yield curve, Yogi Berra, zero-sum game

“Fed officials seem to worry that control is a subtle influence and that, despite the nonvoting agreement, Sumitomo might end up exerting some influence over Goldman’s activities and decisions.” The Fed decided to hold a public hearing on October 10. “We want people to discuss not only the specific terms of the Sumitomo-Goldman deal but the broader issues,” a Fed official explained. “Is this the end of Glass-Steagall, or is this indeed just a passive investment?” At a rare public hearing at the Fed, which was attended by more than two hundred people, Michael Bradfield, the general counsel, seemed particularly focused on whether the investment would “lead to Sumitomo influencing the management decisions of Goldman Sachs” and be a violation both of Glass-Steagall and the Bank Holding Company Act of 1956, which limits to 25 percent the nonvoting stock ownership from another entity.

“In our view, with these changes the investment is truly passive,” Bradfield said. In a statement, the Fed said, “The board was concerned that this combination of significant equity investment and maintenance of extensive business relationships would give the investor both the economic incentive and means to exercise a controlling influence over the management policies” of Goldman. Weinberg seemed happy to make the changes. “This was a passive investment from the first word,” he said, “and there was never a desire on Sumitomo’s part to get control.” The Fed’s approval cleared the way for Goldman to get Sumitomo’s money by December 1. “This will give us additional capital to provide clients with a broad range of investment,” Weinberg said. But the bigger question floating around the halls of 85 Broad Street was whether the Sumitomo capital was enough.


Mastering Private Equity by Zeisberger, Claudia,Prahl, Michael,White, Bowen, Michael Prahl, Bowen White

asset allocation, backtesting, barriers to entry, Basel III, business process, buy low sell high, capital controls, carried interest, commoditize, corporate governance, corporate raider, correlation coefficient, creative destruction, discounted cash flows, disintermediation, disruptive innovation, distributed generation, diversification, diversified portfolio, family office, fixed income, high net worth, information asymmetry, intangible asset, Lean Startup, market clearing, passive investing, pattern recognition, performance metric, price mechanism, profit maximization, risk tolerance, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, Silicon Valley, sovereign wealth fund, statistical arbitrage, time value of money, transaction costs

Aside from the “risk smoothing” common to all diversification efforts, allocation across vintage years in particular helps create a steadier investment program, especially in light of the J-curve effect from individual fund allocations. Oftentimes, an LP’s diversification strategy and allocation decisions are shaped by views on the macroeconomic environment, preferences for or against specific countries or investment strategies and the overall experience of the investment team. These dynamics mirror in some way the discussion on active and passive investment in public equities. Box 18.1 LP COMMITMENT STRATEGIES Achieving and maintaining a desired allocation to PE is an ongoing process, as an LP’s exposure to the asset class is subject to the unpredictability of capital calls and distributions and the evolution of fund net asset values (NAVs). When building a PE program through primary fund commitments, an LP’s exposure to the asset class grows gradually as managers in its portfolio draw down and invest capital; achieving an LP’s target allocation to PE takes time.


Triumph of the Optimists: 101 Years of Global Investment Returns by Elroy Dimson, Paul Marsh, Mike Staunton

asset allocation, banking crisis, Berlin Wall, Bretton Woods, British Empire, buy and hold, capital asset pricing model, capital controls, central bank independence, colonial rule, corporate governance, correlation coefficient, cuban missile crisis, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, European colonialism, fixed income, floating exchange rates, German hyperinflation, index fund, information asymmetry, joint-stock company, negative equity, new economy, oil shock, passive investing, purchasing power parity, random walk, risk tolerance, risk/return, selection bias, shareholder value, Sharpe ratio, stocks for the long run, survivorship bias, technology bubble, transaction costs, yield curve

It is preferable to control bets, and to emphasize broad market exposure. When the premium is assessed as large, many so-called active investors will nevertheless appear to run closet index funds. That can be rational since it optimizes the portfolio’s reward-to-risk ratio. Our assertion in this book, however, is that the equity premium is markedly lower than many people suggest. The reward from passive investing must therefore be lower, in relative terms, than was previously thought. For skilled investors, the size of their portfolio bets should therefore be larger. Our evidence on the small magnitude of the equity risk premium provides encouragement for active investors to deviate more from benchmark, and to take on more active risk. Active investors are often interested in anomalies and regularities in stock returns.


pages: 554 words: 168,114

Oil: Money, Politics, and Power in the 21st Century by Tom Bower

addicted to oil, Ayatollah Khomeini, banking crisis, bonus culture, corporate governance, credit crunch, energy security, Exxon Valdez, falling living standards, fear of failure, forensic accounting, index fund, interest rate swap, kremlinology, LNG terminal, Long Term Capital Management, margin call, Mikhail Gorbachev, millennium bug, MITM: man-in-the-middle, Nelson Mandela, new economy, North Sea oil, offshore financial centre, oil shale / tar sands, oil shock, passive investing, peak oil, Piper Alpha, price mechanism, price stability, Ronald Reagan, shareholder value, short selling, Silicon Valley, sovereign wealth fund, transaction costs, transfer pricing, zero-sum game, éminence grise

In 1987 Conoco had lost millions of dollars drilling dry holes there. Unable to afford further exploration from rigs floating 3,000 feet above the seabed, the company sold the rights to Shell. Bookout was convinced that the drill should have been placed just 400 yards away. Soon after Shell’s purchase, Jack Golden, BP’s head of exploration in the Gulf, offered to buy a third of Shell’s investment in return for sharing a proportion of the cost. Passive investment, or “farming in,” by competitors was not unusual in big projects. Even the mighty oil corporations needed to mitigate their risks. Golden had regretted BP’s tardiness in bidding for the US government’s first round of 10-year licenses for deep-water exploration in the Gulf, and his irritation was compounded by Shell’s perfunctory rebuff of his offer. Shell’s executives did not want to share their potential profits, especially with BP.


pages: 1,336 words: 415,037

The Snowball: Warren Buffett and the Business of Life by Alice Schroeder

affirmative action, Albert Einstein, anti-communist, Ayatollah Khomeini, barriers to entry, Bob Noyce, Bonfire of the Vanities, Brownian motion, capital asset pricing model, card file, centralized clearinghouse, Charles Lindbergh, collateralized debt obligation, computerized trading, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, desegregation, Donald Trump, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, global village, Golden Gate Park, Haight Ashbury, haute cuisine, Honoré de Balzac, If something cannot go on forever, it will stop - Herbert Stein's Law, In Cold Blood by Truman Capote, index fund, indoor plumbing, intangible asset, interest rate swap, invisible hand, Isaac Newton, Jeff Bezos, John Meriwether, joint-stock company, joint-stock limited liability company, Long Term Capital Management, Louis Bachelier, margin call, market bubble, Marshall McLuhan, medical malpractice, merger arbitrage, Mikhail Gorbachev, money market fund, moral hazard, NetJets, new economy, New Journalism, North Sea oil, paper trading, passive investing, Paul Samuelson, pets.com, plutocrats, Plutocrats, Ponzi scheme, Ralph Nader, random walk, Ronald Reagan, Scientific racism, shareholder value, short selling, side project, Silicon Valley, Steve Ballmer, Steve Jobs, supply-chain management, telemarketer, The Predators' Ball, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, transcontinental railway, Upton Sinclair, War on Poverty, Works Progress Administration, Y2K, yellow journalism, zero-coupon bond

He, of course, wanted them to choose the cash, leaving the Berkshire Hathaway and Diversified Retailing stocks for himself. Nevertheless, he was honest with them. In a letter of October 9, 1969, he made a market forecast, which he had previously declined to do. With the market at such heights, “…[f]or the first time in my professional life,” he wrote, “I now believe there is little choice for the average investor between professionally managed money in stocks and passive investment in bonds”5—although he did allow as how the very best money managers might be able to squeeze out a few percentage points over the earnings of bonds. Nonetheless, the departing partners shouldn’t have high hopes for what they could do with the cash. Two months later, on December 5, he gave a prediction about how these two stocks would do, along with telling the partners what he was going to do himself.

Book value. Tangible book value was $43. Warren Buffett letter to partners, October 9, 1969. 3. Ibid. 4. The more inquisitive partners may have discovered that Berkshire Hathaway owned Sun Newspapers by reading its 1968 annual report. 5. Letter to partners, October 9, 1969. Buffett explained that he expected stocks to yield about 6½% after tax for the next ten years, roughly the same as a “purely passive investment in tax-free bonds.” Even the best managers, he said, were unlikely to do better than 9½% after tax. Compare this to the 17% return he had projected to partners in the early years of the partnership and the 30% average he had actually achieved. 6. Letter to partners, December 5, 1969. 7. According to Buffett, a couple of them never were able to find anyone they trusted to manage their money, and one ended up working as a fortune-teller in San Diego. 8.


pages: 613 words: 200,826

Unreal Estate: Money, Ambition, and the Lust for Land in Los Angeles by Michael Gross

Albert Einstein, Ayatollah Khomeini, bank run, Bernie Madoff, California gold rush, clean water, corporate raider, Donald Trump, estate planning, family office, financial independence, Irwin Jacobs, Joan Didion, Maui Hawaii, McMansion, mortgage debt, Norman Mailer, offshore financial centre, oil rush, passive investing, pension reform, Ponzi scheme, Right to Buy, Robert Bork, Ronald Reagan, Silicon Valley, stem cell, Steve Jobs, Steve Wozniak, The Predators' Ball, transcontinental railway, yellow journalism

Stewart had the Midas touch when it came to making it—and after moving to Sunset House, he made lots more, unlike so many who moved to the Triangle only to flame out financially and leave again. Stewart bought their first farmland—2,500 acres of citrus trees and a packing plant in Delano, California—in 1978. Lynda would later claim it was a calculated plan to develop businesses that were “good for people.” Stewart, on the other hand, considered it a passive investment. They were more active in Teleflora (a small, profit-making competitor of the huge nonprofit, florist-owned cooperative FTD), which they bought the next year. It was the first example of the teamwork that would build their empire. “Stewart and I together make one perfect person,” Lynda later said. “We’re like little salt and pepper shakers.” Stewart handles strategy, administration, and finance; Lynda, marketing and image.


pages: 670 words: 194,502

The Intelligent Investor (Collins Business Essentials) by Benjamin Graham, Jason Zweig

3Com Palm IPO, accounting loophole / creative accounting, air freight, Andrei Shleifer, asset allocation, business cycle, buy and hold, buy low sell high, capital asset pricing model, corporate governance, corporate raider, Daniel Kahneman / Amos Tversky, diversified portfolio, dogs of the Dow, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, George Santayana, hiring and firing, index fund, intangible asset, Isaac Newton, Long Term Capital Management, market bubble, merger arbitrage, money market fund, new economy, passive investing, price stability, Ralph Waldo Emerson, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, sharing economy, short selling, Silicon Valley, South Sea Bubble, Steve Jobs, stocks for the long run, survivorship bias, the market place, the rule of 72, transaction costs, tulip mania, VA Linux, Vanguard fund, Y2K, Yogi Berra

Incidentally, 35 years later I called Tom to ascertain some of the facts involved here and I found him on the beach again. The only difference is that now he owns the beach! In 1968 Tom Knapp and Ed Anderson, also a Graham disciple, along with one or two other fellows of similar persuasion, formed Tweedy, Browne Partners, and their investment results appear in Table 2. Tweedy, Browne built that record with very wide diversification. They occasionally bought control of businesses, but the record of the passive investments is equal to the record of the control investments. Table 3 describes the third member of the group who formed Buffett Partnership in 1957. The best thing he did was to quit in 1969. Since then, in a sense, Berkshire Hathaway has been a continuation of the partnership in some respects. There is no single index I can give you that I would feel would be a fair test of investment management at Berkshire.


pages: 695 words: 194,693

Money Changes Everything: How Finance Made Civilization Possible by William N. Goetzmann

Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, banking crisis, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bretton Woods, Brownian motion, business cycle, capital asset pricing model, Cass Sunstein, collective bargaining, colonial exploitation, compound rate of return, conceptual framework, corporate governance, Credit Default Swap, David Ricardo: comparative advantage, debt deflation, delayed gratification, Detroit bankruptcy, disintermediation, diversified portfolio, double entry bookkeeping, Edmond Halley, en.wikipedia.org, equity premium, financial independence, financial innovation, financial intermediation, fixed income, frictionless, frictionless market, full employment, high net worth, income inequality, index fund, invention of the steam engine, invention of writing, invisible hand, James Watt: steam engine, joint-stock company, joint-stock limited liability company, laissez-faire capitalism, Louis Bachelier, mandelbrot fractal, market bubble, means of production, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, new economy, passive investing, Paul Lévy, Ponzi scheme, price stability, principal–agent problem, profit maximization, profit motive, quantitative trading / quantitative finance, random walk, Richard Thaler, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, spice trade, stochastic process, the scientific method, The Wealth of Nations by Adam Smith, Thomas Malthus, time value of money, too big to fail, trade liberalization, trade route, transatlantic slave trade, tulip mania, wage slave

Venetian citizens could take the economic value saved up from past labor or trade and convert it into future cash flows. In this way, it was possible to economically hedge against the depletion of earnings capacity as the body and mind grow old; it was possible to create a perpetual stream of benefits to endow a charity. It was also a way to pass along an asset that did not have to be managed. Venetian prestiti were attractive particularly because they were passive investment vehicles whose value depended only on the viability and honesty of the state, not on the capabilities of the owner. USURY AND A REVOLUTION IN THOUGHT In institutionalizing government loans, Venice would seem to have directly contradicted the well-known ecclesiastical proscription against usury. The mendicant orders of the Catholic Church were founded in the early thirteenth century: the Franciscans in 1206 and the Dominicans in 1216.


pages: 716 words: 192,143

The Enlightened Capitalists by James O'Toole

activist fund / activist shareholder / activist investor, anti-communist, Ayatollah Khomeini, Bernie Madoff, British Empire, business cycle, business process, California gold rush, carbon footprint, City Beautiful movement, collective bargaining, corporate governance, corporate social responsibility, Credit Default Swap, crowdsourcing, cryptocurrency, desegregation, Donald Trump, double entry bookkeeping, end world poverty, equal pay for equal work, Frederick Winslow Taylor, full employment, garden city movement, germ theory of disease, glass ceiling, God and Mammon, greed is good, hiring and firing, income inequality, indoor plumbing, inventory management, invisible hand, James Hargreaves, job satisfaction, joint-stock company, Kickstarter, knowledge worker, Lao Tzu, longitudinal study, Louis Pasteur, Lyft, means of production, Menlo Park, North Sea oil, passive investing, Ponzi scheme, profit maximization, profit motive, Ralph Waldo Emerson, rolodex, Ronald Reagan, shareholder value, Silicon Valley, Social Responsibility of Business Is to Increase Its Profits, Socratic dialogue, sovereign wealth fund, spinning jenny, Steve Jobs, Steve Wozniak, stocks for the long run, stocks for the long term, The Fortune at the Bottom of the Pyramid, The Wealth of Nations by Adam Smith, Tim Cook: Apple, traveling salesman, Uber and Lyft, uber lyft, union organizing, Vanguard fund, white flight, women in the workforce, young professional

I am lucky, indeed, to have such wonderful colleagues, mentors, friends, and family members. Notes Preface: The Good Unearthed 1.James O’Toole, Vanguard Management (New York: Doubleday, 1985). 2.“Business Must Help Fix the Failures of Capitalism,” editorial, Financial Times, October 23, 2017. 3.“A Better Deal between Business and Society,” editorial, Financial Times, January 2, 2018. Report on Davos executives and McNabb quote in Gillian Tett, “Passive Investing Goes Active,” Financial Times, February 2, 2018; Fink quote in Andrew Ross Sorkin, “A Demand for Change Backed Up by $6 Trillion,” New York Times, January 16, 2018, Business Day. 4.Quoted in David Reid, The Brazen Age (New York: Pantheon, 2016), 426. Introduction and Background: Why It Is Hard to Do Good 1.Iris Origo, The Merchant of Prato (London: Penguin, 1963). 2.Charles Handy, “Best Business Books 2002: Management’s Renaissance Man,” Strategy+Business, October 16, 2002. 3.Origo, Merchant of Prato, 10. 4.Origo, 12. 5.Origo, 221. 6.Greg Steinmetz, The Richest Man Who Ever Lived: The Life and Times of Jacob Fugger (New York: Simon & Schuster, 2016). 7.Martha Howell, “The Amazing Career of a Pioneer Capitalist,” New York Review of Books, April 7, 2016, 55–56.


pages: 1,106 words: 335,322

Titan: The Life of John D. Rockefeller, Sr. by Ron Chernow

business cycle, California gold rush, collective bargaining, death of newspapers, delayed gratification, double entry bookkeeping, endowment effect, family office, financial independence, Frederick Winslow Taylor, George Santayana, God and Mammon, income inequality, invisible hand, Joseph Schumpeter, Louis Pasteur, Mahatma Gandhi, Menlo Park, New Journalism, oil rush, oil shale / tar sands, passive investing, plutocrats, Plutocrats, price discrimination, profit motive, Ralph Waldo Emerson, refrigerator car, The Chicago School, Thorstein Veblen, transcontinental railway, traveling salesman, union organizing, Upton Sinclair, white picket fence, yellow journalism

Gates would handle investments and benevolent matters; Gates’s Montclair neighbor Starr Murphy would assume legal responsibilities; and Rogers would take care of office matters, each to be paid $10,000 a year. As Rogers candidly told his chastened boss, “This will seem to you at first as very high but it will be considerable [sic] cheaper than being robbed as you have been and even now you are without exact knowledge as to many of the investments in which you have large sums involved.” 29 Pointing out the perils of passive investment, he suggested that Rockefeller assign deputies to oversee these companies. Beyond the shocking misrepresentation of his investments, Rockefeller had another dispiriting discovery in store: Hoyt and Colby had surreptitiously bailed out of the worthless operations and left him holding the bag, often with a majority stake. Even though he terminated relations with this pair, he could not dispose of their sour investments so easily and thought the most prudent course was to buy total control of the companies and turn them around.


Wealth and Poverty of Nations by David S. Landes

"Robert Solow", Admiral Zheng, affirmative action, agricultural Revolution, Atahualpa, Ayatollah Khomeini, Bartolomé de las Casas, British Empire, business cycle, Cape to Cairo, clean water, colonial rule, Columbian Exchange, computer age, David Ricardo: comparative advantage, deindustrialization, deskilling, European colonialism, Fellow of the Royal Society, financial intermediation, Francisco Pizarro, germ theory of disease, glass ceiling, illegal immigration, income inequality, Index librorum prohibitorum, interchangeable parts, invention of agriculture, invention of movable type, invisible hand, Isaac Newton, James Watt: steam engine, John Harrison: Longitude, joint-stock company, Just-in-time delivery, Kenneth Arrow, land tenure, lateral thinking, mass immigration, Mexican peso crisis / tequila crisis, MITM: man-in-the-middle, Monroe Doctrine, Murano, Venice glass, new economy, New Urbanism, North Sea oil, out of africa, passive investing, Paul Erdős, Paul Samuelson, Philip Mirowski, rent-seeking, Right to Buy, Scramble for Africa, Simon Kuznets, South China Sea, spice trade, spinning jenny, The Wealth of Nations by Adam Smith, trade route, transaction costs, transatlantic slave trade, Vilfredo Pareto, zero-sum game

Unions have struck, sometimes only hastening plant closings or transfer o f orders to cheaper suppliers. (Mutatis mutandis, one finds similar developments today in western Europe.) So in Holland two centuries ago. The United Provinces pared and trimmed to meet the competition, but the best they could do was run in place. Many businessmen gave up the fight and retired to the coun­ try and to a life of passive investment. Incomes polarized between the rich few and the poor many, with a diminishing middle in between. Tax returns show that by the late 1700s, most wealthy Dutch were big landowners, high state officials, or rentiers. Gone the prosperous en­ terprisers of the "golden age": employers were now confined to the middle and lower ranks. In the process, the United Provinces abdicated as world leader in trade and manufacture and went into a postindustrial mode.