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Capital Ideas Evolving – Peter L. Bernstein
August 5, 2007, 8:28 am
Filed under: investments/finance/economics

Personal notes from Peter L. Bernstein’s Capital Ideas Evolving

The book repeats many orthodox and mainstream ideas of finance and investments like behavourial finance and the capital asset pricing model and hence might be a tad boring for the well-read investor. I am of the opinion that the real gems of value in this book lie in Bernstein’s excavation and explication of some interesting and innovative ideas as practised at the forefront of investment and asset management by the foremost financial theorists.

  • Robert Shiller – the people’s risk manager
    • Most people have their largest share in their wealth invested in their homes – they incur lop-sided risks.
    • MacroMarkets LLC seek to help ordinary folk hedge their home risks by creating liquid markets and risk management vehicles.
    • Produce a futures and options market on home prices
    • Shiller’s boldest proposal is to create macro markets where people buy securities based on, amongst other things, GDP.
  • Myron Scholes – Platinum Grove Asset Management
    • Liquidity and risk transfer services – Platinum Grove tends to invest in financial instruments that other investors or business firms employ for hedging risks they do not want to take, helping them balance the risks in their businesses or investment portfolios.
    • Scholes uses the word “omega” to describe the opportunity to make money by carrying risks for other parties.
    • Omega is not a zero-sum game like the search for alpha. Omega involves providing a service.
    • Platinum Grove takes on risks at a favourable price that others lay off.
    • Platinum Grove constantly invests in technology and enhance research to better capitalise on opportunities.
  • Barclays Global Investors – the largest portfolio manager of institutional assets and the largest manager of both index funds and exchange-traded funds
    • Enhanced indexing – small active bets are taken against the index fund in a large number of stocks, but the resulting portfolio will have just the same level of risk as the index fund even as enhanced indexing makes specific bets against the index returns.
    • Grinold’s and Kahn’s Fundamental Law of Asset Management – strategies developed from the index fund concept – high breadth, tight control of risk, and minimal transaction costs, premitting a search for small alphas with low variability and strategies that would work acorss large numbers of stocks in as many different markets as possible.
    • BGI’s competitive edge – an investing strategy must require scale to be profitable, must be developed from proprietary technology, and must be quantitatively driven instead of based on visiting companies or anything resembling that kind of research process.
  • The rising popularity of portable alpha – separating alpha and beta
    • Pimco and Bill Gross’s use of active bond management to achieve alpha for indexed assets – seeking alpha from an asset class outside that of the main asset class
      • StocksPLUS and BondsPLUS
      • The basic methodology involves buying futures contracts instead of the actual security the clients want to own.
      • Barclays, Jeff Hord and the Asset Trust platform
        • Meeting the needs of different investors
        • An Index investor contributes his index funds to a trust under an Alpha investor, on the condition that he receives the index returns plus a specified spread over the index as compensation for providing capital and the guarantee is collateralised by a transfer of the same amount of fixed-income assets to the Index investor.
        • The indexed assets are liquidated and handed over to an alpha manager appointed by the Alpha investor The Alpha investor earns the spread between the loan obligations and actual earnings of the invested fund, on top of the earnings of the fixed-income fund used as collateral.
  • Goldman Sachs Asset Management
    • Focus on creating alpha
    • Much work is derived from the Black-Litterman model devised in 1992
    • Blending a portfolio based on market efficienc and equilibrium and another based on inefficiency
    • Alpha-only investment strategies
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