Sharing one of the extract that I liked in Traders Guns and Money – From the Investment bankers prospective all clients are real arseholes but investors are real arseholes. If the buy side say F*** you, before they hang up, investors also say F*** you when they pick up the phone. Here are some key principles for fund management:
1) Diversification: Harry Markowitz proved that putting all your eggs in one basket was risky. Warren buffet continues to defy this successfully. He argues you are better off putting your money into a few things you know and understand, and that are cheap. He doesn’t like the thought of buying all the stuff you know nothing about.
2) Efficient Markets: Eugene Fama and his colleagues’ hypothised that prices follow a random walk. Prices do not follow specific discernible patters at least from the past prices. All known information is already built in to the prices. Dealers and investors exist to exploit market inefficiency. If markets are truly efficient the where is the boodle coming from.
3) Mean/ Variance: The risk of financial markets is reduced to two statistics mean (average) return and variability of the returns, standard deviation or variance as measure of volatility. For investors the wilder the swings in price, the higher the risk, Risk is now a known Known. No one told risk. There is the unkown unkown – pure uncertainty, things that never happened before.
4) Risk/Reward: Wlliam Sharpe, John Linter and Jack Treynor showed, using the CAPM (Capital asset price Model) that risk and returns were related. If you took the more risk than you needed higher returns. Old time investors wept with Joy. They had been doing CAPM without knowing it.