Synopses & Reviews
When it comes to investment models and theories of how markets work, convenience usually trumps reality. The simple fact is that many revered investment theories and market models are flatly wrong—that is, if we insist that they work in the real world. Unfounded assumptions, erroneous theories, unrealistic models, cognitive biases, emotional foibles, and unsubstantiated beliefs all combine to lead investors astray—professionals as well as novices.In this engaging new book, Jack Schwager, bestselling author of the
Market Wizards series, takes aim at some of the most pervasive market precepts, money management misconceptions, and irrational investor behaviors. From the theory of efficient markets to buying in up markets and selling in down markets, Schwager turns each misguided idea on its head, one at a time. Supported by a wealth of well-documented historical evidence and a healthy dose of common sense, he exposes the truth about the cherished assumptions and fallacious thinking at the core of some of the most respected investment theories and models and explores many common investor errors. In this book, you'll discover why:
- Expert opinion is NOT more reliable than the proverbial dart-throwing chimp
- The markets are NOT efficient
- Low volatility does NOT necessarily imply low risk, and high volatility does NOT necessarily imply high risk
- Market prices are NOT normally distributed
- Investing in equities when markets are doing well is NOT conducive to achieving above-average returns
- Concentrating on funds with the strongest record of returns is NOT a sound strategy
- Past returns are NOT a reliable indicator of future performance
- A hedge fund portfolio strategy is NOT riskier than a traditional portfolio approach
- VaR does NOT provide a good indication of worst-case risk
- Superior performance does NOT necessarily imply manager skill
But Schwager does much more than simply burst bubbles; he offers a sobering draught of real-world investment insight and guidance spanning both traditional and alternative investment classes. Drawing upon his years as an asset manager and trader, he shares priceless lessons on an array of investing topics, both basic and advanced, including portfolio management, risk assessment, investment selection, hedge fund investing, investment timing, and much more.
Market Sense and Nonsense is an indispensable source of real-world market wisdom and investing know-how for investors of every ilk.
Synopsis
Investment errors are hardly the exclusive domain of novice investors. Investment professionals commit their own share of routine errors. One common error that manifests itself in many different forms is the tendency to draw conclusions based on insufficient or irrelevant data. The housing bubble of the 2000s provided a classic example. This book is a compilation of the fundamental investment errors the author has observed over his career in the markets. Errors that permeate widely accepted academic precepts, professional money management methodologies, and investment behavior. This book will be insightful to professionals and yet readable by the broader audience with an interest in investment, trading, and finance. This book combines multiple concepts, spanning both traditional and alternative investments, and topics ranging from basic to sophisticated, into a single accessible book. How Markets Really Work challenges many of the concepts that are at the core of both investment theory and practice.
Synopsis
Bestselling author, Jack Schwager, challenges the assumptions at the core of investment theory and practice and exposes common investor mistakes, missteps, myths, and misreadsWhen it comes to investment models and theories of how markets work, convenience usually trumps reality. The simple fact is that many revered investment theories and market models are flatly wrong—that is, if we insist that they work in the real world. Unfounded assumptions, erroneous theories, unrealistic models, cognitive biases, emotional foibles, and unsubstantiated beliefs all combine to lead investors astray—professionals as well as novices. In this engaging new book, Jack Schwager, bestselling author of Market Wizards and The New Market Wizards, takes aim at the most perniciously pervasive academic precepts, money management canards, market myths and investor errors. Like so many ducks in a shooting gallery, Schwager picks them off, one at a time, revealing the truth about many of the fallacious assumptions, theories, and beliefs at the core of investment theory and practice.
- A compilation of the most insidious, fundamental investment errors the author has observed over his long and distinguished career in the markets
- Brings to light the fallacies underlying many widely held academic precepts, professional money management methodologies, and investment behaviors
- A sobering dose of real-world insight for investment professionals and a highly readable source of information and guidance for general readers interested in investment, trading, and finance
- Spans both traditional and alternative investment classes, covering both basic and advanced topics
- As in his best-selling Market Wizard series, Schwager manages the trick of covering material that is pertinent to professionals, yet writing in a style that is clear and accessible to the layman
Synopsis
Praise for Market Sense and Nonsense"This book is a real joy. Smart, clever, funny; deliciously concise. No bull. It tells you what investing is really about, which most certainly isn't what the fakes in the financial services industry, and their paid cheerleaders in the media and academia, want you to think it is about. Mr. Schwager has performed a major service for anyone who ever gets a spare dime to invest and wants to know how to avoid making a mistake. This book is destined to be one of the greatest texts on markets and investing for discussion in schools, universities and barrooms the world over."
—Martin Taylor, Investment Manager, Nevsky Fund PLC
"This is a very ambitious book which succeeds on all counts. It is not a book with just one idea explained repeatedly with different anecdotes. It covers a huge amount of ground across the spectrum of risk and investing, both in theory and in practice. It addresses many of the difficult issues faced by investment professionals today, but written in a way which is designed to be understood by people without a background in investing or finance."
—Colm O'Shea, Founding Partner and CIO, COMAC Capital LLP
"If this book had been available when I started out in the financial markets I would have saved a lot of learning time over the next fifty years. A great guide to understanding how investing and markets really work."
—Edward O. Thorp, author of Beat the Dealer and Beat the Market
"Jack Schwager's new book, Market Sense and Nonsense, deftly addresses a large number of seldomly clarified facts and myths about the investment management business."
—Jaffray Woodriff, cofounder, Chairman, and CEO, Quantitative Investment Management
"If you believe in investigating before you invest, and in knowing what works and what doesn't work, you are likely to do well reading Schwager."
—Ed Seykota
About the Author
JACK D. SCHWAGER is a recognized industry expert on futures and hedge funds and the author of the widely acclaimed Market Wizards and Schwager on Futures book series. He is currently the co-portfolio manager for the ADM Investor Services Diversified Strategies Fund, a portfolio of futures and FX managed accounts. He is also an advisor to Marketopper, an India-based quantitative trading firm. Previously, Mr. Schwager was a partner in the Fortune Group, a London-based hedge fund advisory firm, which specialized in creating customized hedge fund portfolios for institutional clients, and also spent over twenty years as a director of futures research for some of Wall Street's leading firms.
Table of Contents
Foreword xv
Prologue xvii
Part One Markets, Return, and Risk
Chapter 1 Expert Advice 3
Comedy Central versus CNBC 3
The Elves Index 6
Paid Advice 8
Investment Insights 11
Chapter 2 The Deficient Market Hypothesis 13
The Efficient Market Hypothesis and Empirical Evidence 14
The Price Is Not Always Right 15
The Market Is Collapsing; Where Is the News? 24
The Disconnect between Fundamental Developments and Price Moves 27
Price Moves Determine Financial News 37
Is It Luck or Skill? Exhibit A: The Renaissance Medallion Track Record 39
The Flawed Premise of the Efficient Market Hypothesis: A Chess Analogy 40
Some Players Are Not Even Trying to Win 42
The Missing Ingredient 44
Right for the Wrong Reason: Why Markets Are Difficult to Beat 47
Diagnosing the Flaws of the Efficient Market Hypothesis 49
Why the Efficient Market Hypothesis Is Destined for the Dustbin of Economic Theory 50
Investment Insights 52
Chapter 3 The Tyranny of Past Returns 55
S&P Performance in Years Following High- and Low-Return Periods 57
Implications of High- and Low-Return Periods on Longer-Term Investment Horizons 59
Is There a Benefit in Selecting the Best Sector? 63
Hedge Funds: Relative Performance of the Past Highest-Return Strategy 70
Why Do Past High-Return Sectors and Strategy Styles Perform So Poorly? 77
Wait a Minute. Do We Mean to Imply . . . ? 78
Investment Insights 85
Chapter 4 The Mismeasurement of Risk 87
Worse Than Nothing 87
Volatility as a Risk Measure 88
The Source of the Problem 92
Hidden Risk 95
Evaluating Hidden Risk 100
The Confusion between Volatility and Risk 103
The Problem with Value at Risk (VaR) 105
Asset Risk: Why Appearances May Be Deceiving, or Price Matters 107
Investment Insights 109
Chapter 5 Why Volatility Is Not Just about Risk, and the Case of Leveraged ETFs 111
Leveraged ETFs: What You Get May Not Be What You Expect 112
Investment Insights 121
Chapter 6 Track Record Pitfalls 123
Hidden Risk 123
The Data Relevance Pitfall 124
When Good Past Performance Is Bad 126
The Apples-and-Oranges Pitfall 128
Longer Track Records Could Be Less Relevant 129
Investment Insights 132
Chapter 7 Sense and Nonsense about Pro Forma Statistics 133
Investment Insights 136
Chapter 8 How to Evaluate Past Performance 137
Why Return Alone Is Meaningless 137
Risk-Adjusted Return Measures 142
Visual Performance Evaluation 156
Investment Insights 166
Chapter 9 Correlation: Facts and Fallacies 169
Correlation Defined 169
Correlation Shows Linear Relationships 170
The Coefficient of Determination (r2) 171
Spurious (Nonsense) Correlations 171
Misconceptions about Correlation 173
Focusing on the Down Months 176
Correlation versus Beta 179
Investment Insights 182
Part Two Hedge Funds as an Investment
Chapter 10 The Origin of Hedge Funds 185
Chapter 11 Hedge Funds 101 195
Differences between Hedge Funds and Mutual Funds 196
Types of Hedge Funds 200
Correlation with Equities 210
Chapter 12 Hedge Fund Investing: Perception and Reality 211
The Rationale for Hedge Fund Investment 213
Advantages of Incorporating Hedge Funds in a Portfolio 214
The Special Case of Managed Futures 215
Single-Fund Risk 217
Investment Insights 220
Chapter 13 Fear of Hedge Funds: It’s Only Human 223
A Parable 223
Fear of Hedge Funds 225
Chapter 14 The Paradox of Hedge Fund of Funds Underperformance 231
Investment Insights 236
Chapter 15 The Leverage Fallacy 239
The Folly of Arbitrary Investment Rules 241
Leverage and Investor Preference 242
When Leverage Is Dangerous 243
Investment Insights 245
Chapter 16 Managed Accounts: An Investor-Friendly Alternative to Funds 247
The Essential Difference between Managed Accounts and Funds 248
The Major Advantages of a Managed Account 249
Individual Managed Accounts versus Indirect Managed Account Investment 250
Why Would Managers Agree to Managed Accounts? 251
Are There Strategies That Are Not Amenable to Managed Accounts? 253
Evaluating Four Common Objections to Managed Accounts 253
Investment Insights 259
Postscript to Part Two: Are Hedge Fund Returns a Mirage? 261
Part Three Portfolio Matters
Chapter 17 Diversification: Why 10 Is Not Enough 267
The Benefits of Diversification 267
Diversification: How Much Is Enough? 268
Randomness Risk 269
Idiosyncratic Risk 272
A Qualification 273
Investment Insights 274
Chapter 18 Diversification: When More Is Less 277
Investment Insights 281
Chapter 19 Robin Hood Investing 283
A New Test 286
Why Rebalancing Works 290
A Clarification 291
Investment Insights 292
Chapter 20 Is High Volatility Always Bad? 295
Investment Insights 299
Chapter 21 Portfolio Construction Principles 301
The Problem with Portfolio Optimization 301
Eight Principles of Portfolio Construction 305
Correlation Matrix 309
Going Beyond Correlation 310
Investment Insights 314
Epilogue 32 Investment Observations 315
Appendix A Options—Understanding the Basics 319
Appendix B Formulas for Risk-Adjusted Return Measures 323
Sharpe Ratio 323
Sortino Ratio 324
Symmetric Downside-Risk Sharpe Ratio 325
Gain-to-Pain Ratio (GPR) 326
Tail Ratio 326
MAR and Calmar Ratios 326
Return Retracement Ratio 327
Acknowledgments 329
About the Author 331
Index 333