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Where Markets Fail: Visible Hands
Markets are less perfect than commonly assumed. I have discussed their inability to price unknowns; the blindness of the assumptions that underlie market activity; that the implicit presumption that market fungibility bears consequences; and that markets are not systemic. How else do markets fail? They have visible hands, not invisible ones. Markets rely on symmetries between sellers and buyers, but due to these interventions — visible hands — those symmetries do not exist. Market information is asymmetric. Tobacco companies hid evidence of...
read moreMeditation Tips for Investment Professionals: Visualization Meditation
Meditation provides investors with many benefits. Below are meditation tips from the newly released Meditation Guide for Investment Professionals, the full version of which is available online for CFA Institute members. Visualization meditation, or creative visualization, is a basic meditation practice that features a tremendous variety and depth of techniques. As such, it is difficult to adequately describe in concise form. As with the previous articles in this series — on how to start meditating, open-monitoring meditation, and focused...
read moreWhere Markets Fail: Markets Are Not Systemic
How else do markets fail? Markets are usually not systemic. Instead, from the bird’s-eye perspective of “Capitalism,” many businesses are “opportunities” in the same way that it feels good to hit yourself in the head with a hammer: It’s much better once you stop. For example, the rising sea levels induced by climate change necessitate the construction of seawalls to prevent flooding. From the market standpoint, investors in the seawall-building company will benefit. Yet, at the systemic level, for capitalism as a...
read moreThe Active Equity Renaissance: Renaissance Investment Management Firms
Throughout The Active Equity Renaissance series, we have pointed out the obvious need to overturn modern portfolio theory (MPT) and replace it with something better. How have we done this? By describing the broken 1970s model of portfolio management, enumerating what we call The Cult of Emotion, and declaring the fall of MPT. But what should replace MPT? We first proposed new frontiers of risk assessment, then new behavioral portfolio management concepts, and last what we call Renaissance Portfolio Management. Active management is in our DNA...
read moreThe Active Equity Renaissance: Renaissance Portfolio Management
What can we do to inspire the renaissance in active equity portfolio management? Over the course of The Active Equity Renaissance series, we have dismissed the broken 1970s model of portfolio management and the cult of emotion. We also charted the rise and fall of modern portfolio theory (MPT), considered new frontiers of risk assessment, and discussed behavioral portfolio management concepts. But how do we revive and sustain active equity? After Clients, Elevate Buy-Side Analysts to the Starring Role The Active Equity Renaissance needs...
read moreThe Active Equity Renaissance: Behavioral Financial Markets
We have questioned many orthodoxies of modern portfolio theory (MPT) in this series, challenging currently accepted models of financial markets and exploring the decline of MPT and the folly of using volatility as a measure of investment risk. But in undermining the foundations of MPT, what do we propose to take its place? Behavioral Finance Is a More Promising Alternative It is time to move away from MPT to a more promising alternative: behavioral finance. The analytical tools derived from behavioral finance’s more realistic...
read moreMeditation Tips for Investment Professionals: Focused Attention
Meditation provides investors with many benefits. Below are meditation tips from the newly released Meditation Guide for Investment Professionals, the full version of which is available online for CFA Institute members. In focused attention meditation, also known as Zen, practitioners concentrate on one object. The object can be the breath, a candle flame, a white wall, the repetition of a word, a series of words — or mantra — etc. When awareness inevitably strays, meditators return their focus to that object. In previous articles in this...
read moreThe Active Equity Renaissance: New Frontiers of Risk
One modern portfolio theory (MPT) pillar that is unquestionably broken is the use of volatility, specifically standard deviation, as a measure of risk. This initial error in MPT’s development is a major contributor to active investment management underperformance. Volatility Is Not Risk The concept of volatility as risk rests on a critical assumption that is overlooked by most of the industry: Only in finance is risk defined as volatility, or the bumpiness of the ride. Various dictionary definitions of risk converge on something like...
read moreThe Active Equity Renaissance: The Rise and Fall of MPT
In the early 18th century, Daniel Bernoulli proposed that individuals maximize expected utility when they make decisions under uncertainty. This reasoning launched the rationality model of human behavior that underpins many of today’s theories in economics and finance, including modern portfolio theory (MPT). The mathematical models that sprang from these theories provide a veneer of orderliness while obscuring the behavioral messiness of real-world financial markets. The Rise of MPT Pillar I In 1952, Harry Markowitz published his article on...
read moreWhere Markets Fail: Markets Assume Fungibility
Have you ever lent a postage stamp to someone who rather than paying you back with an actual postage stamp, gave you the nominal amount of the stamp, say US 40¢, instead? This is aggravating because while the transaction is fungible due to the presumed exchangeability of currency, it is not an equal transaction. Why? Because acquiring a postage stamp requires much more than just 40¢. It also means a trip to the post office, waiting in line, transacting, and then returning home. In the last two articles in the Where Markets Fail series, this...
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