Written with the professional investor in mind by one who is a popular guide to wise investment, the book offers tools to understand better the concepts of choice in investment and blended with practical advice and social theory by sampling from a wide variety of sources and disciplines. Most of us have pretty narrow slices of knowledge about investment as most of our time is taken by our workplace and time constraints due to talking on the phone, answering e-mails and going to meetings and get-togethers with no time left to read, think and play with ideas.
According to the author, quality investment philosophies have a number of common themes. First of all, in any probabilistic field – investing, handicapping or gambling – one needs to focus on the decision-making process than on the short-term outcome. This is difficult to achieve because outcomes are objective while processes are more subjective. But a quality process, which often includes a large dose of theory, is the surest path to long-term success according to the author. The four principles of decision making are:
The only certainty is that there is no certainty. Appreciation of uncertainty helps in money management. Numerous crash-and-burn hedge fund stories boil down to committing too much capital to an investment that the manager overconfidently assesses. When allocating capital, portfolio managers need to consider that unexpected events do occur.
Decisions are a matter of weighing probabilities. Focus on probability is sound when outcomes are symmetrical, but completely inappropriate when payoffs are skewed. Some high-probability proportions are unattractive and some low-probability propositions very attractive.
Despite uncertainty we must act. We must make decisions based on our intelligent appraisal of available information
We must judge decisions not only on results but also on how they are made. A good process is to carefully consider price against expected value. Investors can improve their process through quality feedback and ongoing learning.
Part I of the book is devoted to the investment philosophy which is important because it dictates how you should make decisions. A sloppy philosophy inevitably leads to poor long-term results. But even a good investment philosophy has to be combined with discipline and patience. The author says, “A quality investment philosophy is like a good idea; it only works if it is sensible over the long haul and you stick with it.”
The second theme – the importance of taking a long-term perspective – elucidates the point that results cannot be judged in a probabilistic system over the short-term “because there is too much randomness.” A good process has to rest on solid building blocks.
The final theme is the importance of inernalising a probabilistic approach. In this we fail to consider the range of possible outcomes. It is a proper investment philosophy which helps patch up some glitches, improving the chances of long-term success.
Part III talks of innovation and competitive strategy where innovation is the primary mechanism by showing which companies will win and which will lose. The more ides that exist and the quicker we can manipulate them, the more rapidly we can come up with useful solutions – innovations. Innovation means dealing with change.
Part IV is devoted to science and complexity theory in which the essays offer important mechanisms that explain how markets are efficient, delve into important empirical results that standard finance does not handle well and show why it is futile to make simple cause-and-effect links in the market.
Written with the professional investor in mind, this book extends beyond the world of economics and finance. It shows how a multi-disciplinary approach that pays close attention to process and the psychology of decision-making offers the best chance for long-term financial results.
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