Just a quick point. Despite the impressive performance of the US equities markets in 2006, after adjusting for currency losses the S&P 500 was only up 1.6% last year in Euro terms. Given that the British Pound just hit $2 for the first time in about 2 decades, I'm sure that the Euro is not an outlier.
So what to do? I'm not feeling completely confident about US equities on the whole, but pulling out of the market exposes me to both inflation and currency devaluation. Looks like international is the way to go. I suppose I'm just as guilty of home bias as the next investor, although I do believe there is some degree of advantage in investing in one's home country - quite simply, I have a better idea of the legal, social, and economic framework that exists in the US than, say, Japan. Nonetheless, I definitely think there are times when one must look beyond perceived advantages and execute on behalf of a larger global strategy.
Since I don't really have the insight necessary to pick undervalued, underfollowed foreign equities, I'm going to have to defer to the markets as a whole and go for ETFs. As for what countries to actually invest in, that will take plenty of analysis and thought, although I'll say right now I'm leaning towards Japan...
Monday, April 23, 2007
Tuesday, April 17, 2007
Book List
I recently saw a list of the (supposedly) 100 best books of all time. I'm definitely not sure what the criteria were for that list, but given that The DaVinci Code was #1, it's obviously not gauged on literary merit. While I was thinking I'd respond by highlighting the ones I had read, the list is just so utterly bad that I simply can't bear to do it. Any list where Tuesdays With Morrie significantly outranks The Great Gatsby just doesn't deserve a response.
Instead, I've posted the Modern Library top 100 Readers' Choice, and hilighted the ones I've read. Their "expert panel's" choices seemed a bit too dense for my tastes, and I do want to give some credence to popularity as opposed to critical acclaim. Here goes:
ATLAS SHRUGGED by Ayn Rand
THE FOUNTAINHEAD by Ayn Rand
BATTLEFIELD EARTH by L. Ron Hubbard
THE LORD OF THE RINGS by J.R.R. Tolkien
TO KILL A MOCKINGBIRD by Harper Lee
1984 by George Orwell
ANTHEM by Ayn Rand
WE THE LIVING by Ayn Rand
MISSION EARTH by L. Ron Hubbard
FEAR by L. Ron Hubbard
ULYSSES by James Joyce
CATCH-22 by Joseph Heller
THE GREAT GATSBY by F. Scott Fitzgerald
DUNE by Frank Herbert
THE MOON IS A HARSH MISTRESS by Robert Heinlein
STRANGER IN A STRANGE LAND by Robert Heinlein
A TOWN LIKE ALICE by Nevil Shute
BRAVE NEW WORLD by Aldous Huxley
THE CATCHER IN THE RYE by J.D. Salinger
ANIMAL FARM by George Orwell
GRAVITY'S RAINBOW by Thomas Pynchon
THE GRAPES OF WRATH by John Steinbeck
SLAUGHTERHOUSE FIVE by Kurt Vonnegut
GONE WITH THE WIND by Margaret Mitchell
LORD OF THE FLIES by William Golding
SHANE by Jack Schaefer
TRUSTEE FROM THE TOOLROOM by Nevil Shute
A PRAYER FOR OWEN MEANY by John Irving
THE STAND by Stephen King
THE FRENCH LIEUTENANT'S WOMAN by John Fowles
BELOVED by Toni Morrison
THE WORM OUROBOROS by E.R. Eddison
THE SOUND AND THE FURY by William Faulkner
LOLITA by Vladimir Nabokov
MOONHEART by Charles de Lint
ABSALOM, ABSALOM! by William Faulkner
OF HUMAN BONDAGE by W. Somerset Maugham
WISE BLOOD by Flannery O'Connor
UNDER THE VOLCANO by Malcolm Lowry
FIFTH BUSINESS by Robertson Davies
SOMEPLACE TO BE FLYING by Charles de Lint
ON THE ROAD by Jack Kerouac
HEART OF DARKNESS by Joseph Conrad
YARROW by Charles de Lint
AT THE MOUNTAINS OF MADNESS by H.P. Lovecraft
ONE LONELY NIGHT by Mickey Spillane
MEMORY AND DREAM by Charles de Lint
TO THE LIGHTHOUSE by Virginia Woolf
THE MOVIEGOER by Walker Percy
TRADER by Charles de Lint
THE HITCHHIKER'S GUIDE TO THE GALAXY by Douglas Adams THE HEART IS A LONELY HUNTER by Carson McCullers
THE HANDMAID'S TALE by Margaret Atwood
BLOOD MERIDIAN by Cormac McCarthy
A CLOCKWORK ORANGE by Anthony Burgess
ON THE BEACH by Nevil Shute
A PORTRAIT OF THE ARTIST AS A YOUNG MAN by James Joyce
GREENMANTLE by Charles de Lint
ENDER'S GAME by Orson Scott Card
THE LITTLE COUNTRY by Charles de Lint
THE RECOGNITIONS by William Gaddis
STARSHIP TROOPERS by Robert Heinlein
THE SUN ALSO RISES by Ernest Hemingway
THE WORLD ACCORDING TO GARP by John Irving
SOMETHING WICKED THIS WAY COMES by Ray Bradbury
THE HAUNTING OF HILL HOUSE by Shirley Jackson
AS I LAY DYING by William Faulkner
TROPIC OF CANCER by Henry Miller
INVISIBLE MAN by Ralph Ellison
THE WOOD WIFE by Terri Windling
THE MAGUS by John Fowles
THE DOOR INTO SUMMER by Robert Heinlein
ZEN AND THE ART OF MOTORCYCLE MAINTENANCE by Robert Pirsig
I, CLAUDIUS by Robert Graves
THE CALL OF THE WILD by Jack London
AT SWIM-TWO-BIRDS by Flann O'Brien
FARENHEIT 451 by Ray Bradbury
ARROWSMITH by Sinclair Lewis
WATERSHIP DOWN by Richard Adams
NAKED LUNCH by William S. Burroughs
THE HUNT FOR RED OCTOBER by Tom Clancy
GUILTY PLEASURES by Laurell K. Hamilton
THE PUPPET MASTERS by Robert Heinlein
IT by Stephen King
V. by Thomas Pynchon
DOUBLE STAR by Robert Heinlein
CITIZEN OF THE GALAXY by Robert Heinlein
BRIDESHEAD REVISITED by Evelyn Waugh
LIGHT IN AUGUST by William Faulkner
ONE FLEW OVER THE CUCKOO'S NEST by Ken Kesey
A FAREWELL TO ARMS by Ernest Hemingway
THE SHELTERING SKY by Paul Bowles
SOMETIMES A GREAT NOTION by Ken Kesey
MY ANTONIA by Willa Cather
MULENGRO by Charles de Lint
SUTTREE by Cormac McCarthy
MYTHAGO WOOD by Robert Holdstock
ILLUSIONS by Richard Bach
THE CUNNING MAN by Robertson Davies
THE SATANIC VERSES by Salman Rushdie
Seems a little heavy on the Ayn Rand and Sci-Fi, no? Guess this list was written by a 16-year old male high school student who's more likely to be in the computer club than on the football team. (Not that I was on the football team either. Hey, when I was 16 I'd have loved this list.)
Instead, I've posted the Modern Library top 100 Readers' Choice, and hilighted the ones I've read. Their "expert panel's" choices seemed a bit too dense for my tastes, and I do want to give some credence to popularity as opposed to critical acclaim. Here goes:
ATLAS SHRUGGED by Ayn Rand
THE FOUNTAINHEAD by Ayn Rand
BATTLEFIELD EARTH by L. Ron Hubbard
THE LORD OF THE RINGS by J.R.R. Tolkien
TO KILL A MOCKINGBIRD by Harper Lee
1984 by George Orwell
ANTHEM by Ayn Rand
WE THE LIVING by Ayn Rand
MISSION EARTH by L. Ron Hubbard
FEAR by L. Ron Hubbard
ULYSSES by James Joyce
CATCH-22 by Joseph Heller
THE GREAT GATSBY by F. Scott Fitzgerald
DUNE by Frank Herbert
THE MOON IS A HARSH MISTRESS by Robert Heinlein
STRANGER IN A STRANGE LAND by Robert Heinlein
A TOWN LIKE ALICE by Nevil Shute
BRAVE NEW WORLD by Aldous Huxley
THE CATCHER IN THE RYE by J.D. Salinger
ANIMAL FARM by George Orwell
GRAVITY'S RAINBOW by Thomas Pynchon
THE GRAPES OF WRATH by John Steinbeck
SLAUGHTERHOUSE FIVE by Kurt Vonnegut
GONE WITH THE WIND by Margaret Mitchell
LORD OF THE FLIES by William Golding
SHANE by Jack Schaefer
TRUSTEE FROM THE TOOLROOM by Nevil Shute
A PRAYER FOR OWEN MEANY by John Irving
THE STAND by Stephen King
THE FRENCH LIEUTENANT'S WOMAN by John Fowles
BELOVED by Toni Morrison
THE WORM OUROBOROS by E.R. Eddison
THE SOUND AND THE FURY by William Faulkner
LOLITA by Vladimir Nabokov
MOONHEART by Charles de Lint
ABSALOM, ABSALOM! by William Faulkner
OF HUMAN BONDAGE by W. Somerset Maugham
WISE BLOOD by Flannery O'Connor
UNDER THE VOLCANO by Malcolm Lowry
FIFTH BUSINESS by Robertson Davies
SOMEPLACE TO BE FLYING by Charles de Lint
ON THE ROAD by Jack Kerouac
HEART OF DARKNESS by Joseph Conrad
YARROW by Charles de Lint
AT THE MOUNTAINS OF MADNESS by H.P. Lovecraft
ONE LONELY NIGHT by Mickey Spillane
MEMORY AND DREAM by Charles de Lint
TO THE LIGHTHOUSE by Virginia Woolf
THE MOVIEGOER by Walker Percy
TRADER by Charles de Lint
THE HITCHHIKER'S GUIDE TO THE GALAXY by Douglas Adams THE HEART IS A LONELY HUNTER by Carson McCullers
THE HANDMAID'S TALE by Margaret Atwood
BLOOD MERIDIAN by Cormac McCarthy
A CLOCKWORK ORANGE by Anthony Burgess
ON THE BEACH by Nevil Shute
A PORTRAIT OF THE ARTIST AS A YOUNG MAN by James Joyce
GREENMANTLE by Charles de Lint
ENDER'S GAME by Orson Scott Card
THE LITTLE COUNTRY by Charles de Lint
THE RECOGNITIONS by William Gaddis
STARSHIP TROOPERS by Robert Heinlein
THE SUN ALSO RISES by Ernest Hemingway
THE WORLD ACCORDING TO GARP by John Irving
SOMETHING WICKED THIS WAY COMES by Ray Bradbury
THE HAUNTING OF HILL HOUSE by Shirley Jackson
AS I LAY DYING by William Faulkner
TROPIC OF CANCER by Henry Miller
INVISIBLE MAN by Ralph Ellison
THE WOOD WIFE by Terri Windling
THE MAGUS by John Fowles
THE DOOR INTO SUMMER by Robert Heinlein
ZEN AND THE ART OF MOTORCYCLE MAINTENANCE by Robert Pirsig
I, CLAUDIUS by Robert Graves
THE CALL OF THE WILD by Jack London
AT SWIM-TWO-BIRDS by Flann O'Brien
FARENHEIT 451 by Ray Bradbury
ARROWSMITH by Sinclair Lewis
WATERSHIP DOWN by Richard Adams
NAKED LUNCH by William S. Burroughs
THE HUNT FOR RED OCTOBER by Tom Clancy
GUILTY PLEASURES by Laurell K. Hamilton
THE PUPPET MASTERS by Robert Heinlein
IT by Stephen King
V. by Thomas Pynchon
DOUBLE STAR by Robert Heinlein
CITIZEN OF THE GALAXY by Robert Heinlein
BRIDESHEAD REVISITED by Evelyn Waugh
LIGHT IN AUGUST by William Faulkner
ONE FLEW OVER THE CUCKOO'S NEST by Ken Kesey
A FAREWELL TO ARMS by Ernest Hemingway
THE SHELTERING SKY by Paul Bowles
SOMETIMES A GREAT NOTION by Ken Kesey
MY ANTONIA by Willa Cather
MULENGRO by Charles de Lint
SUTTREE by Cormac McCarthy
MYTHAGO WOOD by Robert Holdstock
ILLUSIONS by Richard Bach
THE CUNNING MAN by Robertson Davies
THE SATANIC VERSES by Salman Rushdie
Seems a little heavy on the Ayn Rand and Sci-Fi, no? Guess this list was written by a 16-year old male high school student who's more likely to be in the computer club than on the football team. (Not that I was on the football team either. Hey, when I was 16 I'd have loved this list.)
Friday, April 06, 2007
Diseconomies of Scale
Investing might be one of the few environments where participants can easily experience diseconomies of scale. In other words, bigger is not better. Specifically, small hedge funds and, when they're knowledgeable and have adequate resources, individual investors, can often put up better returns than the multi-billion dollar behemoths. Evidence for this claim is mixed, but I believe that as time goes on and the big funds get bigger, we'll see some more proof of this claim.
Fundamentally, there's a very simple reason for this assertion: the bigger a fund gets, the smaller the pool of potential investments becomes. A $50 million fund has a very large pool of potential investments to choose from, the only restriction being securities reserved for QIBs and other high-net worth entities. On the other hand, a $10 billion fund can't realistically put money into, say, a stock with a $300 million market cap. The fund simply can't buy enough of the investment without significantly affecting that investment's price. Any investment the firm could make simply would't "move the needle" as far as returns go, and thus doesn't justify the time and effort of the fund's analysts.
Similarly, large banks and research firms on the street aren't interested in analyzing small securities because their clients, the big funds, can't or won't invest in them. Why do the work if you won't get paid for it? To focus specifically on the equity markets, (my primary area of expertise and interest,) small-cap stocks are generally neglected by the larger banks. Many companies are covered by only a handful of analysts, and quite a few are simply not covered at all.
There are currently over 5000 publicly traded companies in the US, (probably closer to 8000 if you include bulletin board stocks, the NASDAQ SmallCap Market, and various other less-liquid listings.) I'd guess that at least one third of these companies are severely under-followed, if even covered at all by any research firm or bank. That's a huge pool of potential investments that the banks won't cover and the funds won't trade. If even one half of one percent of them are mis-valued, that's approximately 12 securities you could potentially buy. Remember, according to modern portfolio theory, more than around 15 stocks in a portfolio and you're really not getting any marginal benefit.
What's important here is that the small guy can profit in areas where the big guys can't. My belief is that there are plenty more than just 12 mispriced names out there. Take a look at some of the blogs on the sidebar - the value investors out there focusing on small cap names seem to put up some pretty good returns. I'm not as knowledgeable as most of them (yet,) and I don't have quite as much time as they do to do the research, (CFA is still eating up all my free time,) but even I've found a few huge pricing errors over the past year or 2. People - the opportunities are out there. You just have to dig a little.
Fundamentally, there's a very simple reason for this assertion: the bigger a fund gets, the smaller the pool of potential investments becomes. A $50 million fund has a very large pool of potential investments to choose from, the only restriction being securities reserved for QIBs and other high-net worth entities. On the other hand, a $10 billion fund can't realistically put money into, say, a stock with a $300 million market cap. The fund simply can't buy enough of the investment without significantly affecting that investment's price. Any investment the firm could make simply would't "move the needle" as far as returns go, and thus doesn't justify the time and effort of the fund's analysts.
Similarly, large banks and research firms on the street aren't interested in analyzing small securities because their clients, the big funds, can't or won't invest in them. Why do the work if you won't get paid for it? To focus specifically on the equity markets, (my primary area of expertise and interest,) small-cap stocks are generally neglected by the larger banks. Many companies are covered by only a handful of analysts, and quite a few are simply not covered at all.
There are currently over 5000 publicly traded companies in the US, (probably closer to 8000 if you include bulletin board stocks, the NASDAQ SmallCap Market, and various other less-liquid listings.) I'd guess that at least one third of these companies are severely under-followed, if even covered at all by any research firm or bank. That's a huge pool of potential investments that the banks won't cover and the funds won't trade. If even one half of one percent of them are mis-valued, that's approximately 12 securities you could potentially buy. Remember, according to modern portfolio theory, more than around 15 stocks in a portfolio and you're really not getting any marginal benefit.
What's important here is that the small guy can profit in areas where the big guys can't. My belief is that there are plenty more than just 12 mispriced names out there. Take a look at some of the blogs on the sidebar - the value investors out there focusing on small cap names seem to put up some pretty good returns. I'm not as knowledgeable as most of them (yet,) and I don't have quite as much time as they do to do the research, (CFA is still eating up all my free time,) but even I've found a few huge pricing errors over the past year or 2. People - the opportunities are out there. You just have to dig a little.
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