In the previous post, we linked to the speech by Gerry Frigon given on January 26 in which Gerry showed a slide covered with modern portfolio theory algorithms and said, "This is what's wrong with Wall Street, and it's been wrong for about thirty years now."
What's wrong, he said, is "the financial engineering that's taken place on Wall Street over the last twenty or thirty years, and by that I mean the extreme level to which mathematics have played a role in investment decisions on Wall Street."
In the above video from this past Friday, February 20, Columbia Business School Professor Amar Bhide explains on Bloomberg Television some of the perceptive observations that he has been making for many years. Professor Bhide's insights are very much in agreement with our own experience, and are in line with convictions that we have held for many years as well.
In Friday's interview, he notes the influence of the 1975 article by Nobel Laureate Paul Samuelson in the very first issue of the Journal of Portfolio Management, called "Challenge to Judgment." We discussed that article in some detail in our December 15 post, "Beware of the witch doctors of modern finance," noting that Samuelson's "challenge" to the old-school investment managers with their "practical" experience was that they should have to prove that their way was not inferior to "the new world of the academics with their mathematical stochastic processes."
Since the publication of Paul Samuelson's article, the "new world" has been ascending. In fact, it has come to dominate the decision-making process in most financial firms. Professor Bhide observes that "people were eager and willing to follow his advice" and that too many "gave up on doing any analysis of either stocks or bonds" and instead "just constructed these mathematically well-tuned portfolios."
Professor Bhide argues that the ascendancy of the "new world of the academics with their mathematical stochastic processes" led directly to the disastrous situation Wall Street encountered in 2008. He explains that "it is mathematically convenient for the economics profession to reduce all uncertainty to quantifiable stuff, like the toss of a coin or the odds in a roulette wheel."
In a recent piece he published on January 28th, entitled "In Praise of More Primitive Finance," Professor Bhide elaborates on this problem in greater detail. He notes that in 2002 he wrote that "Everyone has bought into the belief -- investors, intermediaries and implicitly (through the promotion of market liquidity) regulators -- that diversified portfolios make the problem of bad judgment disappear. Actually, diversification complements due diligence and oversight; relying on diversification as a substitute exacerbates the problem of bad judgment" (page 11, note 6). For some of our views on that same subject, see previous posts here, here and here.
We are very pleased to observe Professor Bhide's efforts to articulate this important message to the public, to the financial community, to government officials, and to academia. We are also gratified to find confirmation from a scholar of his caliber of views that we developed independently through many years of practical experience in the day-to-day management of portfolios and "up-close and personal" study of the markets. It often seems as though such dissenting voices have disappeared from financial academia entirely!
We wish Professor Bhide continued success in his efforts, and recommend that investors (and policy-makers) pay close attention to what he has to say.
For later posts on this same subject, see also:
Professor Bhide argues that the ascendancy of the "new world of the academics with their mathematical stochastic processes" led directly to the disastrous situation Wall Street encountered in 2008. He explains that "it is mathematically convenient for the economics profession to reduce all uncertainty to quantifiable stuff, like the toss of a coin or the odds in a roulette wheel."
In a recent piece he published on January 28th, entitled "In Praise of More Primitive Finance," Professor Bhide elaborates on this problem in greater detail. He notes that in 2002 he wrote that "Everyone has bought into the belief -- investors, intermediaries and implicitly (through the promotion of market liquidity) regulators -- that diversified portfolios make the problem of bad judgment disappear. Actually, diversification complements due diligence and oversight; relying on diversification as a substitute exacerbates the problem of bad judgment" (page 11, note 6). For some of our views on that same subject, see previous posts here, here and here.
We are very pleased to observe Professor Bhide's efforts to articulate this important message to the public, to the financial community, to government officials, and to academia. We are also gratified to find confirmation from a scholar of his caliber of views that we developed independently through many years of practical experience in the day-to-day management of portfolios and "up-close and personal" study of the markets. It often seems as though such dissenting voices have disappeared from financial academia entirely!
We wish Professor Bhide continued success in his efforts, and recommend that investors (and policy-makers) pay close attention to what he has to say.
For later posts on this same subject, see also:
- "Another black swan?" 05/13/2010.
Have any practical advice for people who didn't go to business school? Analyzing a business isn't something most people know how to do.
ReplyDeleteMatt -- Thanks for your comment. Many great money managers of the past -- including Thomas Rowe Price, from whom our growth stock investment discipline is descended -- did not go to "b-school" to get their MBA. It's true that, due to the sad state of education today, most people don't know how to analyze a business, but you can teach yourself. Financial statement analysis is covered in many textbooks, and in some of the writings we link to in the blog. You can also study the books by many of the investors of the pre-1974 era, whom we discuss in 'The business focus of the great 20th century investors' at URL http://taylorfrigon.blogspot.com/2009/08/business-focus-of-great-20th-century.html
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