The Finance Professionals' Post

Book Review: Financial Risk Management for Dummies

Financial Risk Management for Dummies. 2016. By Aaron Brown. John Wiley & Sons, Ltd., www.wiley.com. 384 pages, $26.99.

The dummies to whom Financial Risk Management for Dummies is addressed are not outright novices. Rather, they exemplify the maxim that a little bit of knowledge is a dangerous thing. Aaron Brown, chief risk officer of AQR Capital Management, devotes much of the book to dispelling mistaken notions about his subject.

“Risk management is not about predicting or preventing disaster,” he writes. Neither, says Brown, is it about estimating probabilities or outcomes. The “frequentist” approach, with its analogies to casino games, has only limited application. “If all risks were playing roulette or drawing cards,” Brown states, “we wouldn’t need risk managers.” There is little in the book about measuring risk because generally speaking, risk that is measurable can be avoided, insured, hedged, or neutralized via diversification. Contrary to the likely expectations of many investment professionals, Value at Risk (VaR) does not enter the discussion until Chapter 6.

Life Lessons from an Unexpected Source

The week after Thanksgiving, feeling remorseful after all the gluttony that ensued over the holiday weekend, I decided to drag myself to my favorite spin class. I expected to feel energized and accomplished from a nice, intense workout, but I didn’t expect that I would also come away reminded of some of life’s most important lessons.

Jogging on that bike jogged my memory of four key life lessons!

Investment commentary numbers: How to get them right

Investment commentary calls for lots of numbers: benchmark and portfolio returns, economic data, and more. When you get those numbers wrong, you undercut your credibility and embarrass yourself.

I have some ideas about how you can avoid mistakes by proofreading and checking your facts.

My expensive mistake

A bad experience impressed me with the importance of checking numbers. Reading the professionally printed copy of my employer’s third-quarter commentary, I noticed a goof. It referred to the second quarter, instead of the third quarter, in one spot. This happened even though four of us had read the piece before it went to the printer. However, the eye tends to read what it expects to see. We all glossed over my error. Oops!

That was an expensive mistake because we had to get the piece reprinted. However, at least we avoided the embarrassment of clients seeing our mistake. Also, it spurred me to develop techniques for catching numerical errors. 

The Great Mismatch: Addressing Barriers to Global Capital Flows (Part V)

PART V: Ideas for Navigating Capital Flows 

To succeed in the evolving global capital landscape, long-term institutional investors will need to be at the forefront of re-thinking long-standing assumptions and re-shaping markets. Enough success factors have already been identified to serve as a rough guide for investors to navigate the growing opportunities in emerging markets, while mitigating risks, in both the near term and beyond. (See Exhibit below.)

DIY Financial Advisor- A Book Review

The Alpha Architect, LLC team of Wes Gray, Jack Vogel, and David Foulke has produced a dynamic, fun, and accessible text that has the power to free readers from agonizing over implementing a disciplined investment process and making investment decisions. The processes offered convincingly depict a route to success in investing. The authors present ample evidence that provides simple solutions to achieving selected investment objectives considering asset class risks and correlations among domestic and foreign stocks, US Treasuries, US real estate, and commodities.

The book is divided into two parts: Why You Can Beat the Experts, and How You Can Beat the Experts. This division aids the book’s overall purpose: to provide a sensible and systematic introduction to “doing investments yourself.” Why You Can Beat the Experts is fun to read and direct in its message. The authors question the real value of so-called experts. While the experts have access to information, more data, and experience, they are often wrong. Think about it: why would more data necessarily support better investment decisions? Rather than analyzing data until blue in the face, why not model the investment process? The authors “bust” many investment myths in this section of the book, and in doing so, entice the reader to pursue systematic decision-making—and be healthy skeptics.

The Great Mismatch: Addressing Barriers to Global Capital Flows (Part IV)

PART IV: The Barriers to Efficient Capital Flows (continued)

Efficient cross-border capital flows—allowing investors to search for reliable returns, and in the process, meet legitimate capital needs wherever they are—would be a more effective way to finance the global economy than today’s system. In theory, few dispute this. In practice, many barriers have been erected that hamper efficient flows. The deliberate or inadvertent barriers to efficient global capital flows have been erected by a unique combination of regulators, governments, historical conventions and path-dependencies, investor mindsets and capital-seekers themselves (see below exhibit).

Three Critical Steps for Extracting Great Insights (Step 3: Entice a Thorough Response)

Have you ever found yourself going into a store or making a call for something you need only to be disappointed by the salesperson? As soon as the experience began to deteriorate, you probably had little interest in sharing your needs because you thought “let me just end this pain and find a better option.”

The problem here is the salesperson hadn’t developed good influencing skills which are required to entice the customer to share his or her needs.  As analysts, we’re “salespeople” because we need to sell the person we’re interviewing on the idea they will benefit by giving us the information we need. This post continues a 3-part series covering our ICE™ framework for effective questioning. Step 3 focuses on the “E” of the ICE™ framework, “entice a response.”

Water Megatrend Creates Compelling Backdrop for Investors

Despite water covering 70.0% of the earth’s surface, only 3.0% is fresh, and just 0.5% accessible to humanity. Presently, 2.5 billion people, almost 40.0% of the world’s grain production, and approximately 25.0% of global GDP are at risk because of non‐sustainable water use¹. The problems of water scarcity, contamination, and uneven distribution of the resource are becoming increasing prevalent around the world, as water use has grown at more than twice the rate of last century’s rise in population². Consequently, pressure is mounting on the demand side as the global population increases while the availability of potable water dwindles and lessens supply. The supply and demand imbalance also increases pressure on food and energy security around the globe. As a result, according to Ladenburg Thalmann Senior Water Equity Research Analyst, Richard Verdi, water will be the resource to define the next several decades via a substantial increase in its value.

Donald Trump, grade level, and your financial writing

Donald Trump’s appeal has surprised many observers of presidential elections. Love him or hate him, you can’t ignore his presence. Part of his appeal rests on his use of plain language, according to a recent article. That’s something financial professionals should note because of its implications for your writing.

Trump speaks at a fourth-grade level, according to “For presidential hopefuls, simpler language resonates,” which appeared in The Boston Globe. The newspaper calculated the grade level of presidential candidates’ announcement speeches. Lower grade levels use fewer characters and syllables per word, as well as shorter sentence lengths.

Three Critical Steps for Extracting Great Insights (Step 2: Calm Their Concerns)

“I can’t believe you would be so insensitive!”

“How could you say something like that?”

Have you ever heard these statements directed at you? What was your initial reaction? A voice in your head probably said, “Be very, very careful what you say next.” It’s human nature to raise our defenses when we feel attacked, which is an important concept for equity research analysts to internalize when interviewing or emailing information sources (including management of the stocks under coverage).

In a prior post, I made the case that by using best practices found in journalism and the legal and law enforcement professions, analysts can elicit more thorough answers from their information sources.  Using my ICE™ framework, I discussed the “I” for identifying parameters as the first step for success. In this post I cover the “C” to calm their concerns.

The Great Mismatch: Addressing Barriers to Global Capital Flows (Part III)

PART III: The Barriers to Efficient Capital Flows (continued)

Efficient cross-border capital flows—allowing investors to search for reliable returns, and in the process, meet legitimate capital needs wherever they are—would be a more effective way to finance the global economy than today’s system. In theory, few dispute this. In practice, many barriers have been erected that hamper efficient flows. The deliberate or inadvertent barriers to efficient global capital flows have been erected by a unique combination of regulators, governments, historical conventions and path-dependencies, investor mindsets and capital-seekers themselves (see below exhibit).

Mastering ’Metrics: The Path from Cause to Effect

The authors provide an easy-to-read overview of key concepts in econometrics for anyone desiring a strong intuitive description of how to conduct analysis using simple techniques. Covering a limited number of topics with practical examples of each, they offer a useful framework for conducting fundamental econometric analysis. Although the book does not directly discuss financial issues, it provides a good foundational review for the financial empiricist who wishes to better structure econometric tests.

Statistics is second only to accounting among the technical skills necessary for engaging in modern finance and is fundamental for anyone who considers quantitative work a core element of finance. Unfortunately, practitioners’ actual statistical and econometric knowledge and intuition may be more limited than their level of academic exposure would suggest. No one willingly reads a book on econometrics to close this knowledge gap, so technical skills atrophy rather than advance with money management experience.

Elections and Financial Stability

When Hillary Clinton unveiled her proposals to assure financial stability earlier this month, few people bothered to notice. Nonetheless, one central piece of legislature Clinton proposed to increase trust of the everyday investor in our financial markets, a “tax on the high-frequency trading that makes our markets less stable and less fair,” has potentially far-reaching consequences. The Clinton proposals elicited 550-something comments on Bloomberg, with criticism coming from the usual suspects. We are all acquainted with a contemporary practice whereby political operatives stuff “comments” sections with their talking points and completely flood the exchange between the readers.

Heretofore, I took notice only when Larry Harris, a highly respected expert on market microstructure and the author of a seminal textbook, Trading and Exchanges: Market Microstructure for Practitioners, suggested that “any tax on high frequency trading firms’ trading activity will increase the cost of trading for retail investors and for pensions that serve retirees.” In the preface to my 2009 book, Microstructure and Noise in Financial Markets: Rigorous and not-so rigorous results in market microstructure, I quoted his testimony to the US Congress as a model explanation of market microstructure to the laypeople.

Three Critical Steps for Extracting Great Insights (Step 1: Identify Parameters)

Think of your favorite CNBC journalist and ask why he or she is likely to get more information from a CEO than a typical analyst. If you don’t have an answer, it’s because the top journalists have been trained to use best practices for interviewing (or even “interrogating”) which can make them incredibly effective.

Throughout my career as an equity research analyst, I observed some analysts were much better than others at extracting insights from information sources (e.g. proprietary industry sources, company management, etc.), but I didn’t know exactly why. Now in the role of training analysts, I’m routinely asked, “How do I get more insights from others?” In my effort to answer this question and determine why some analysts are better than others in getting insights from others, I identified the best practices in this area, which primarily come from journalism, the legal industry and law enforcement (yes, some of the most sophisticated interviewing practices are used by law enforcement).

THE GREAT MISMATCH PART II: The Barriers to Efficient Capital Flows

Efficient cross-border capital flows—allowing investors to search for reliable returns, and in the process, meet legitimate capital needs wherever they are—would be a more effective way to finance the global economy than today’s system. In theory, few dispute this. In practice, many barriers have been erected that hamper efficient flows. The deliberate or inadvertent barriers to efficient global capital flows have been erected by a unique combination of regulators, governments, historical conventions and path-dependencies, investor mindsets and capital-seekers themselves (see below exhibit).