Monday, October 19, 2009

Review: More than you know

More than you know is written by Michael J. Mauboussin, who teaches Security Analysis at Columbia University, the class that was pioneered by Benjamin Graham and graduated famous investors such as Warren Buffett. This is a collection of fifty essays about investing, with each essay being about 4 pages long, capable of being read in about 2 hours in total.

Yet it would probably be a mistake to just read the book in one sitting --- each essay by itself is worth contemplating for a little bit. For instance, the first few essays cover many of the same topics in Nassim Taleb's Fooled by Randomness, and yet does a better job of communicating Taleb's point than Taleb himself, in providing a decision tree for Taleb's reasoning.

Another essay points out that the market's participants is composed of many individuals, all with different time horizons, which plays a major role in your investment decisions, hence not only is a one size fits all approach is doomed to fail, but any mutual fund with high turnover is shooting for an extremely short term approach, one that long term investors should steer away from.

More essays explore behavioral finance, mean reversions, and the importance of diversity and intellectual curiosity when it comes to investing. Furthermore, he points out that while many financial models use the normal distribution for modeling stock market returns, the actual stock market more closely resembles a fractal distribution --- the implication of these fat tails is why million year floods occur every 10 years or so in the stock market. It also means that predicting stock market returns is fraught with danger. One interesting point he makes is that stable systems found in nature (such as bees in beehives) are composed of individuals that were selected for taking into account how their behavior affects the hive (i.e., fundamentally altruistic with respect to the hive), while markets are unstable because they rely on individuals who are only looking for their own benefit regardless of what happens to the market as a whole. That degree of selfishness naturally leads to bubbles and instability, even though over the long haul markets are relatively resilient.

The last part of the book explores the power law and the implication for large cap companies. This is particularly relevant for fast growing companies that are in the fortune 50 --- because they so dominate the S&P 500, they have a hard time out-performing the index, which means that owning those companies individually is less ideal than owning the index itself.

All in all, I found that this book gave me a lot to think about, and I will look for more books by Mauboussin in the future. Recommended.
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