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One more point regarding Eddie Lampert. I really hate the comparisions where he was hailed as the next Warren Buffett and I think they are way off base. If you read Berkshires annual report, you can clearly see how Buffett operates his business. He has some passive investments such as stock in Coca Cola, Amex, Walmart, etc. but he also runs and operates very successful and diverse businesses such as General RE and Geico. While some of his profits come from financial engineering such as the writing of derivatives contracts, he also knows how to run a real business.
That is where I believe Lampert failed. He made a killing in the finance end of the Kmart/Sears deals but when it came down to actually running the stores, his performance has been downright atrocious. To compare Lampert to either Buffett or Simons is a huge insult to both men.
I agree that value investing is the good old fashioned time tested approach to investing and is way more suited for the average investor. However, to claim that more billionaires have been minted from value investing than from hedge funds is probably inaccurate. I can't say for sure but I'd bet off the top of my head that there are more billionaires that made their fortune from hedge funds than from value investing. And even though you can learn the same value investing principles that Warren Buffett uses, what he does is by no means easy to replicate.
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On June 09 2009 17:28 SaveMySoul wrote:
"sheer number of running horses" didnt mean that simons performance was lucky. Just that out of the thousands of hedge funds that trades with a complex//statistical macro strategy, simons is one of the very few that actually succeeds.
Also, i don't care whether Simons is actually better than Lampert. But its a bit weird coming from a Buffett fan to be praising someone like Simons, who uses a method that Buffett ridicules in each of his essays.
It comes down to cold hard numbers and performance. Simons is so secretive that no one really knows what his strategy is, so of course I have no idea how he is doing it. It is the long term performance of both Buffett and Simons that is totally mind boggling and worthy of praise. Buffett's strategy is in plain view and he writes letters to the public about it and therefore we can all marvel at his excellence. Simons on the other hand gives out zero information so we can't even independtly verify the accuracy of his results let alone his actual strategy. So while we praise Buffett on both his results and his method, we can praise Simons only on his results alone.
But the name of this game is making money and that is how the score is kept. When you see a tiger woods or federer dominate the competition year over year, you marvel at their accomplishments. This situation is a bit different because we cannot see the actual game and only the results. So everyone is left to wonder, WTF is Simons doing to accomplish this? But the results speaks for itself and it is kinda hard to fathom how truly amazing and remarkable it is to have 20 years no down years, 10 years of no down quarters and a ROI of over 100K% in 20 years.
And the reason why I am comparing Simons and Lampert is because you said the following:
On June 09 2009 15:42 SaveMySoul wrote:
Lampert is truly one of the best. Probably Buffett's successor. One of the best investors of his generation.
I just happen to disagree with that statement and I was merely giving facts to support my case.
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smart money is in gold/silver
US is printing money like wildfire , gold/silver can only go up whilst that occurs
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While it's true that precious metals like gold see a significant bump during a recession, they can be highly volatile and are susceptible to speculation. I also don't see how one could advocate a mid-long term investment unless it's a small part of a diversified portfolio.
I had a friend who spent two years of his life at J.P. Morgan working 70 hours a week entirely on gold. After he left he gave me one piece of advice: stay away from gold.
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On June 09 2009 17:37 tenbagger wrote:
One more point regarding Eddie Lampert. I really hate the comparisions where he was hailed as the next Warren Buffett and I think they are way off base. If you read Berkshires annual report, you can clearly see how Buffett operates his business. He has some passive investments such as stock in Coca Cola, Amex, Walmart, etc. but he also runs and operates very successful and diverse businesses such as General RE and Geico. While some of his profits come from financial engineering such as the writing of derivatives contracts, he also knows how to run a real business.
That is where I believe Lampert failed. He made a killing in the finance end of the Kmart/Sears deals but when it came down to actually running the stores, his performance has been downright atrocious. To compare Lampert to either Buffett or Simons is a huge insult to both men.
I agree that value investing is the good old fashioned time tested approach to investing and is way more suited for the average investor. However, to claim that more billionaires have been minted from value investing than from hedge funds is probably inaccurate. I can't say for sure but I'd bet off the top of my head that there are more billionaires that made their fortune from hedge funds than from value investing. And even though you can learn the same value investing principles that Warren Buffett uses, what he does is by no means easy to replicate.
You can't compare hedge funds and value investing; one is an investment vehicle, the other is an investment strategy. A lot of successful hedge funds use value-oriented investing strategies. Despite your disdain for Eddie Lampert, his value-oriented hedge fund has been able to return 25-30% annually for over 10 years now. You forget that he was successful before Sears (and I suspect will continue to be despite recent market turmoil--SHLD is up 100% since it hit $30 something a few months ago).
I agree though, value-oriented investing isn't the only way to invest successfully. I'm also a huge fan of Soros who runs much more of a top-down trading fund, although most of his profits go to his philanthropic projects now.
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On June 09 2009 02:32 kewlsunman wrote:
--There's no mistake in the mathematics but the assumptions which the math derives from are false.
I went at length to describe the assumptions involved and admitted they are unrealistic. However, like the Mogdigliani-Miller theorems, the insight lies in what happens when some of these assumptions are violated and how well the theory can still approximate for that. In the case of the CAPM and APT the empirical performance is still decent, depending on how you define the market portfolio for CAPM and I've already talked about how APT does work well empirically.
--Sure, volatility can be measured; nobody is arguing that beta is not a good measure of volatility. But volatility IS NOT risk, whereas the standard interpretation of the models suggests that it IS.
Related to a point below.
--Again, a rational argument based on a false premise. Most young people do not rely on their investments for consumption income, they rely on them for capital gains. Even if we step away from the assumptions about the investing rationale of a specific demographic, the simple fact that the intelligent investor CAN ignore short-term unrealized gains/losses is enough to disprove the necessity of equating risk with volatility. My solvency is not at risk if I don't employ leverage (because I'm not deluded into thinking my models are perfectly correct).
People earn a certain amount each period and choose to invest the rest. For many the investment is a savings account of some kind. However, there will inevitably be fluctuations to disposable income, such as unexpected medical bills, and in those times you need to draw upon the money tied into your investments. If you're 100% in equity and due to unfavorable market conditions your portfolio is doing badly then you're taking a hit in your income. I think it's intuitive that people like to smooth consumption through time (to some extent) and that implies smoothing portfolio returns through time. Going 100% in one asset doesn't lead to smoothing.
[Emphasis added]. Sure, but there's market-wide systematic risks which screw up the predictions of the models by turning historically uncorrelated assets into correlated assets.
Thanks for the emphasis. I said idiosyncratic risk for very good reason - precisely because be definition only the systemic risk is left. Hence, the variance of the portfolio can only be the systemic risk - therefore - the variance of the portfolio is reflecting the risk of the portfolio.
Also, most models do account for the leverage effect. There's a lot of literature showing how squared returns are correlated. This empirical fact then allows a prediction of which direction the market may move tomorrow. I've said this more than once now and mentioned the leverage effect more than once too. I don't know where the comment of "screw up the predictions of the models by turning historically uncorrelated assets into correlated assets" is coming from.
I'm not responding to the rest of your post because it misses the point. Nobody doubts the mathematics behind the models, what we're saying is that the assumptions that drive those mathematics are false. I can state that "apples are blue" and then follow it consistently by saying that "apples are the color of the sky"; which would be true, if apples really were blue, but they're not! Similarly, these models can draw impressive mathematical predictions about the movement of real assets IF volatility really does equal risk, but it doesn't!
I didn't miss the point. I was challenged about my claim that CAPM is a special case of APT and there was some surprising comment about how CAPM is empirically more sound than APT. I disputed this and discussed the empirical literature to back up my claim. I haven't seen a response yet.
Model assumptions discussed above. Use of volatility for a portfolio discussed above. Saying something like: "I'd argue that CAPM doesn't make any theoretical sense" is like saying "M-M1 (market value irrelevant of capital structure under perfect markets and no taxes) makes no theoretical sense". I won't repeat myself here.
Risk does have various definitions. I've explained why I'm referring to it as variance. Otherwise risk for an individual asset may be the factor premia associated with that asset (since stocks are essentially discounted future cash flows the factors are usually unexpected inflation, industrial output index etc.). You make quite an outrageous statement:
If I gave you a bet with a 90% chance of doubling your money; a 5% chance of losing half; and a 5% chance of not gaining or losing anything; the correct response is to put ANY AND ALL your money into this bet, over and over and over again. That's what risk is, and what risk management should be from the investor's standpoint--a series of expected return calculations based on the potential for permanent capital loss/gain, not on relative correlation and the magnitude of price movements.
Have you never heard of the St. Petersburg Paradox? One of the oldest insights in Economics is that people want to maximize the expected utility from gambling - people don't just look at the expected value of a gamble.
Furthermore, you're encouraging people to only consider the expected value. Higher moments matter to investors, at the very least the variance of any asset. Forget about CAPM or APT, idiosyncratic or systemic risk but an asset's historical volatility. Are you honestly saying if a stock with an expected return of 10% is better for everyone and you should invest everything into if the only other asset in the world gives an expected return of 5%? If you consider the variance then the 10% expected return asset may have a variance of 20%, while the 5% expected return asset has a variance of 5%. Which asset someone chooses depends on his appetite for bearing higher variance as risk. Mean and variance are only the first two moments - higher moments matter.
--you have control over when you sell, so you can hold out for the long run and ignore the short run.
I'll take this to mean you do know there's a stochastic component to stock price movement (because it's not at all clear from everything else you've said). Everything links together: the need for portfolio diversification to smooth consumption means you can't always hold onto stocks forever. Plus, I'll add in Shiller's favorite example that stock markets don't always rise indefinitely over long periods of time: the Nikkei.
I have never said the theories I have mentioned are perfect. But I consider them more informative for investing than the basic advice of looking at the expected value of a stock by reading the company balance sheet. Indeed, considering equity based performance measures has its own share of problems, e.g. a firm that increases it's leverage and changes its Debt-Equity ratio lowers its EPS but raises its P/E ratio or that you should consider the measurements for all companies within that sector but different firms have different D/E values (thus different equity Betas) although admittedly within a sector the variation is low, so an approximation is quite possible. However, I'm sure you see my point.
I read that you started out as a Investment Banker, which I'm guessing explains your focus on looking at balance sheets. And probably explains why I talk from a more financial perspective.
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Awesome guide kewlsunman!
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+ Show Spoiler +On June 10 2009 13:40 Milton Friedman wrote:Show nested quote +On June 09 2009 02:32 kewlsunman wrote:
--There's no mistake in the mathematics but the assumptions which the math derives from are false. I went at length to describe the assumptions involved and admitted they are unrealistic. However, like the Mogdigliani-Miller theorems, the insight lies in what happens when some of these assumptions are violated and how well the theory can still approximate for that. In the case of the CAPM and APT the empirical performance is still decent, depending on how you define the market portfolio for CAPM and I've already talked about how APT does work well empirically. Show nested quote +
--Sure, volatility can be measured; nobody is arguing that beta is not a good measure of volatility. But volatility IS NOT risk, whereas the standard interpretation of the models suggests that it IS.
Related to a point below. Show nested quote +--Again, a rational argument based on a false premise. Most young people do not rely on their investments for consumption income, they rely on them for capital gains. Even if we step away from the assumptions about the investing rationale of a specific demographic, the simple fact that the intelligent investor CAN ignore short-term unrealized gains/losses is enough to disprove the necessity of equating risk with volatility. My solvency is not at risk if I don't employ leverage (because I'm not deluded into thinking my models are perfectly correct). People earn a certain amount each period and choose to invest the rest. For many the investment is a savings account of some kind. However, there will inevitably be fluctuations to disposable income, such as unexpected medical bills, and in those times you need to draw upon the money tied into your investments. If you're 100% in equity and due to unfavorable market conditions your portfolio is doing badly then you're taking a hit in your income. I think it's intuitive that people like to smooth consumption through time (to some extent) and that implies smoothing portfolio returns through time. Going 100% in one asset doesn't lead to smoothing. Show nested quote +
[Emphasis added]. Sure, but there's market-wide systematic risks which screw up the predictions of the models by turning historically uncorrelated assets into correlated assets.
Thanks for the emphasis. I said idiosyncratic risk for very good reason - precisely because be definition only the systemic risk is left. Hence, the variance of the portfolio can only be the systemic risk - therefore - the variance of the portfolio is reflecting the risk of the portfolio. Also, most models do account for the leverage effect. There's a lot of literature showing how squared returns are correlated. This empirical fact then allows a prediction of which direction the market may move tomorrow. I've said this more than once now and mentioned the leverage effect more than once too. I don't know where the comment of "screw up the predictions of the models by turning historically uncorrelated assets into correlated assets" is coming from. Show nested quote +I'm not responding to the rest of your post because it misses the point. Nobody doubts the mathematics behind the models, what we're saying is that the assumptions that drive those mathematics are false. I can state that "apples are blue" and then follow it consistently by saying that "apples are the color of the sky"; which would be true, if apples really were blue, but they're not! Similarly, these models can draw impressive mathematical predictions about the movement of real assets IF volatility really does equal risk, but it doesn't! I didn't miss the point. I was challenged about my claim that CAPM is a special case of APT and there was some surprising comment about how CAPM is empirically more sound than APT. I disputed this and discussed the empirical literature to back up my claim. I haven't seen a response yet. Model assumptions discussed above. Use of volatility for a portfolio discussed above. Saying something like: "I'd argue that CAPM doesn't make any theoretical sense" is like saying "M-M1 (market value irrelevant of capital structure under perfect markets and no taxes) makes no theoretical sense". I won't repeat myself here. Risk does have various definitions. I've explained why I'm referring to it as variance. Otherwise risk for an individual asset may be the factor premia associated with that asset (since stocks are essentially discounted future cash flows the factors are usually unexpected inflation, industrial output index etc.). You make quite an outrageous statement: Show nested quote +If I gave you a bet with a 90% chance of doubling your money; a 5% chance of losing half; and a 5% chance of not gaining or losing anything; the correct response is to put ANY AND ALL your money into this bet, over and over and over again. That's what risk is, and what risk management should be from the investor's standpoint--a series of expected return calculations based on the potential for permanent capital loss/gain, not on relative correlation and the magnitude of price movements. Have you never heard of the St. Petersburg Paradox? One of the oldest insights in Economics is that people want to maximize the expected utility from gambling - people don't just look at the expected value of a gamble. Furthermore, you're encouraging people to only consider the expected value. Higher moments matter to investors, at the very least the variance of any asset. Forget about CAPM or APT, idiosyncratic or systemic risk but an asset's historical volatility. Are you honestly saying if a stock with an expected return of 10% is better for everyone and you should invest everything into if the only other asset in the world gives an expected return of 5%? If you consider the variance then the 10% expected return asset may have a variance of 20%, while the 5% expected return asset has a variance of 5%. Which asset someone chooses depends on his appetite for bearing higher variance as risk. Mean and variance are only the first two moments - higher moments matter. Show nested quote +--you have control over when you sell, so you can hold out for the long run and ignore the short run. I'll take this to mean you do know there's a stochastic component to stock price movement (because it's not at all clear from everything else you've said). Everything links together: the need for portfolio diversification to smooth consumption means you can't always hold onto stocks forever. Plus, I'll add in Shiller's favorite example that stock markets don't always rise indefinitely over long periods of time: the Nikkei. I have never said the theories I have mentioned are perfect. But I consider them more informative for investing than the basic advice of looking at the expected value of a stock by reading the company balance sheet. Indeed, considering equity based performance measures has its own share of problems, e.g. a firm that increases it's leverage and changes its Debt-Equity ratio lowers its EPS but raises its P/E ratio or that you should consider the measurements for all companies within that sector but different firms have different D/E values (thus different equity Betas) although admittedly within a sector the variation is low, so an approximation is quite possible. However, I'm sure you see my point. I read that you started out as a Investment Banker, which I'm guessing explains your focus on looking at balance sheets. And probably explains why I talk from a more financial perspective.
I spent a while trying to think of how to respond to you. I wanted to address your argument point by point, especially because you have a tendency to talk down to people;
Have you never heard of the St. Petersburg Paradox? One of the oldest insights in Economics
I'll take this to mean you do know there's a stochastic component to stock price movement (because it's not at all clear from everything else you've said).
it would have felt pretty good to shut you down. But I realized that outside of satisfying my ego, that wouldn't have accomplished anything except to clutter this thread up even further.
You're obviously a well-read guy, and my posts on the internet aren't going to change years of indoctrination that your financial models and assumptions make sense. Do you know how I know this?
Because this statement is false:
I read that you started out as a Investment Banker, which I'm guessing explains your focus on looking at balance sheets. And probably explains why I talk from a more financial perspective.
I started out in a university finance class, which is where I assume you are now. You're not talking from a more "financial" perspective, you're talking from a more "academic" perspective. And I started there too, because the first things I learned about investing came from my professor's mouth, which in turn came from Fama, Miller, Markowitz, Sharp, Scholes, Black (look I can name-drop too!). But you know what's interesting? Every single one of those guys has something profound and interesting to say about investing, and yet, not a single one of them was able to turn that into real-world investing success. If you, "Milton Friedman", can tell me why these esteemed intellects failed where you assume you can succeed, I'll delete this guide and let everybody know that your academic theories have invalidated fundamental analysis.
But I don't think that's going to happen.
My purpose is simple: I don't care to win an internet debate; I don't have my ego invested in my id, "kewlsunman". I do, however, want to provide useful, understandable knowledge to a heterogeneous community. I read through your post and I can't help but feel that for all your intelligence and apparent knowledge of financial theories and models, you've never actually gone out and invested yours or anybody else's money for a significant period of time.
If you're 100% in equity and due to unfavorable market conditions your portfolio is doing badly then you're taking a hit in your income. I think it's intuitive that people like to smooth consumption through time (to some extent) and that implies smoothing portfolio returns through time.
Also, most models do account for the leverage effect. There's a lot of literature showing how squared returns are correlated. This empirical fact then allows a prediction of which direction the market may move tomorrow.
I was challenged about my claim that CAPM is a special case of APT and there was some surprising comment about how CAPM is empirically more sound than APT. I disputed this and discussed the empirical literature to back up my claim.
Those statements are made by someone who enjoys debating academic theories, ideas, and abstractions, but not someone who has ever made a living handling his own or other people's money. I have, and the people I know have, and everybody in this industry who I've ever met, talked to, or heard of has had to completely erase everything they learned in university before they started working with real money.
There's only been one academic to ever be successful in the real market handling real money and that was Benjamin Graham. Show me one of your finance professors who can live up to that standard and I'll show you someone who no longer believes what he teaches.
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Thank you so much for this guide, it is a pleasure to read it and I'm learning a lot  I don't understand why more people don't appreciate this.
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Extremely informative. Your writing style is utterly fluent and delightfully easy to read; if you wrote a book I would probably buy it.
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Thanks for the guide. It's really clear and informative~ Hope you get your key~~ : ]
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Netherlands1301 Posts
Great guide. I read it all up to the business analysis of ATVI and skimmed the rest after that. It helped me understand more of basic market and stockmarketing principles about which I knew very little before, so thanks for that!
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As I've stated before: volatility is correlated. If you don't use historic data to take advantage of this fact when making financial decisions then how are you going incorporate it in analysis? I don't believe the correct response is to ignore volatility. Anyway, this volatility discussion is at an impasse; I'll leave it be.
I like academic literature because respected publications tend to have controlled for various factors when making their analysis. To simply go by anecdotal evidence is too easily subject to myopia about the situation. Also, I wasn't invalidating "fundamental analysis" or asking you to delete the guide. In my second post (I think) in this thread I said at the end it would've been nice for you to have taken the basic analysis further by reducing the amount you wrote on who should be an investor and the introduction, since I felt those areas didn't provide much insight into investing and came across as more journalistic. What then got debated was the validity of CAPM, APT, volatility etc. In fact, I was the one who had to defend these theories from being invalidated by you.
Clearly these things won't get added since you don't even agree with them so we're done.
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EPT
