Elegant Nonsense?

Chairman Mao once said, “To be rich is Glorious!”. To which Kantibhai, on Dalal Street, probably replied, when he heard this for the first time “Now that’s a bania my grandpa would like…worldly-wise yet so literary!” Apart from the fact that we gujjus, especially those that work on Dalal Street and suchlike professions, couldn't tell a sonnet from software (as in, “buy software stocks…money should double in 3 months!”), this is not all that bad…after all, somebody has to buy the tickets of the performance of the artistic Bengali dancer!

But more germane to the issue is that eternal question that, say, the quintessential dhoti-clad “kaka” pondered under the banyan tree where shares of companies were traded by old men because their wives banned them from going to cock-fights, the precursor to the Bombay Stock Exchange in its current form: How does One make Money from this Racket?? When I used to try my hand at proprietary trading in stocks in Mumbai, (that means “to lose money” to anybody who needs an explanation) in the late nineties during the IT boom, I always used to marvel at the stock picking prowess and money making ability, of highly paid stock analysts at blue-chip securities firms that were usually named after their founders, names that seemed Very Serious of people who Knew What They Were Doing. This fallacy of mine was finally put to rest after I read Nassim Taleb’s “Fooled by Randomness”, which was such a mind bending, unintuitive book, especially if you regarded highly paid help (i.e., stock analysts) as intelligent & possessing of insight and sophisticated investors (i.e., global securities firms and/or mutual fund companies) as rational entities. An Op-Ed piece in the Financial Times last week, by Taleb, really lays into everything that an investment professional, either on the business or academic side of things, holds dear and completely eviscerates the current state of the investment industry. By comparing the investing profession as something akin to “medieval medicine” that “used to kill more patients than it saved”, and sparing nobody – not William Sharpe nor Harry Markowitz, Robert Merton nor Myron Scholes, he takes no prisoners.

“The asymmetrical payoffs of, statistically, improbable events” is perhaps not as pithy a phrase as “to be rich is Glorious” but it definitely bears further reflection. An investment strategy based on being wrong often (with little at risk) so that one can be right at an unpredictable time (and take down the house, so to speak) seems to be the very epitome of risky investing. But when brokers/analysts talk sophistry like valuation models that lie on the Efficient Frontier or stocks with low beta and a high Sharpe Ratio or six sigma events that are outliers on the Bell Curve perhaps it's time to run for the hills. Read the Op-Ed and ponder if it's time to fire your broker and/or sell your actively managed mutual funds.

PS: I have yet to read "The Black Swan", the latest book by Taleb, which further explores the above issues.