The best investment advice you'll never get

Sunday, December 17, 2006 | 07:41 AM

I  stumbled across a fascinating history of indexing in San Francisco magazine.

It begins with an amazing discussion of how Google -- pre IPO -- prepared the soon to be wealthy troops with a crash course in investment theory (from Bill Sharpe, Burton Malkiel, and John Bogle) before the Wall Street sales crew came tromping thru Mountain View.

One by one, some of the most revered names in investment theory were brought in to school a class of brilliant engineers, programmers, and cybergeeks on the fine art of personal investing, something few of them had thought much about. First to arrive was Stanford University’s William (Bill) Sharpe, 1990 Nobel Laureate economist and professor emeritus of finance at the Graduate School of Business. Sharpe drew a large and enthusiastic audience, which he could have wowed with a PowerPoint presentation on his “gradient method for asset allocation optimization” or his “returns-based style analysis for evaluating the performance of investment funds.” But he spared the young geniuses all that complexity and offered a simple formula instead. “Don’t try to beat the market,” he said. Put your savings into some indexed mutual funds, which will make you just as much money (if not more) at much less cost by following the market’s natural ebb and flow, and get on with building Google.

The following week it was Burton Malkiel, formerly dean of the Yale School of Management and now a professor of economics at Princeton and author of the classic A Random Walk Down Wall Street. The book, which you’d be unlikely to find on any broker’s bookshelf, suggests that a “blindfolded monkey” will, in the long run, have as much luck picking a winning investment portfolio as a professional money manager. Malkiel’s advice to the Google folks was in lockstep with Sharpe’s. Don’t try to beat the market, he said, and don’t believe anyone who tells you they can—not a stock broker, a friend with a hot stock tip, or a financial magazine article touting the latest mutual fund. Seasoned investment professionals have been hearing this anti-industry advice, and the praises of indexing, for years. But to a class of 20-something quants who’d grown up listening to stories of tech stocks going through the roof and were eager to test their own ability to outpace the averages, the discouraging message came as a surprise. Still, they listened and pondered as they waited for the following week’s lesson from John Bogle.

“Saint Jack” is the living scourge of Wall Street. Though a self-described archcapitalist and lifelong Republican, on the subject of brokers and financial advisers he sounds more like a seasoned Marxist. “The modern American financial system,” Bogle says in his book The Battle for the Soul of Capitalism, “is undermining our highest social ideals, damaging investors’ trust in the markets, and robbing them of trillions.” But most of his animus in Mountain View was reserved for mutual funds, his own field of business, which he described as an industry organized around “salesmanship rather than stewardship,” which “places the interests of managers ahead of the interests of shareholders,” and is “the consummate example of capitalism gone awry.”

As you can imagine, after that brief education, things did not go as planned when Wall Street's sharpest were paraded through. (heh heh)

The rest of the article is all about the quantitative underpinnings of indexing, and how the entire process came about.

As I've written here before, for many people, indexing is the way to go.

Indexing's largest "flaw" (if you could call it that) comes about during bubble purchases and the ensuing long periods of flat performance. Think about the 1895-1905, the post-1929 crash era, or 1966-82 period. It seems that about every 3 decades or so, markets go thru these underperforming periods. Eventually, they mean revert, but during these decadelong lulls, Indexing requires extreme amounts of patience.   

Regardless, is a fascinating article well worth checking out . . .


The best investment advice you'll never get   
Mark Dowie
San Francisco magazine, December 2006
(One Page Print Version)

Portfolio Theory and Capital Markets (Capital Asset Pricing Model)
William Sharpe

Investments (6th Edition)
William Sharpe

Investors and Markets: Portfolio Choices, Asset Prices, and Investment Advice
William Sharpe
Princeton Lectures in Finance

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

Investing: The First 50 Years (Hardcover)
John C. Bogle

Common Sense on Mutual Funds
New Imperatives for the Intelligent Investor (Paperback)
John C. Bogle

Sunday, December 17, 2006 | 07:41 AM | Permalink | Comments (27) | TrackBack (0) add to | digg digg this! | technorati add to technorati | email email this post



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Weights and measures
A squabble erupts over how best to create a stockmarket index

" indices will tend to overweight expensive stocks and underweight cheap ones.

"That is where fundamental indices can have an advantage. If stocks are weighted by objective measures, enthusiasts argue, then the irrationality introduced by the price mechanism is eliminated. And the process does seem to generate better performance. A study* by Robert Arnott and John West of Research Affiliates, an investment-management firm, found that a fundamental-weighted index beat the S&P 500 by an average of two percentage points a year over the period 1962-2005. The results were similar with smaller American stocks and international ones..."

Posted by: post pc | Dec 17, 2006 9:35:02 AM

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