Meadows, Donella H. - Thinking in Systems

Chelsea Green Publishing, 2008, [Surrounding Thinking] Grade 4

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We are systems and we are surrounded by systems. The hydrological cycle of water precipitation and evaporation is a system inside the larger system that is the natural environment. The stock market is a system and it’s a part of the larger systems of financial markets and the economy as a whole. A cell is a system and a building block for the larger system of your body. According to the author, the late Dana Meadows, a systems researcher originally at MIT, a system is “an interconnected set of elements that is coherently organized in a way that achieves something”. Systems always contain elements, interconnections and a function/purpose. A system is more than the sum of its parts and displays varying degrees of complex behaviors. The author aims to show the reader a complementary way to see and understand the world.

Thinking in Systems contains three sections. In the first the author in a reductionist fashion presents the components of systems, then shows how they are interconnected to produce various effects and finally displays an array of archetype systems - what Meadows calls the systems zoo. A key insight is how no system can be understood by analyzing its parts but, if at all, by their exchanges.

In the second part the author goes deeper into her analysis of how systems function – or sometimes mal-function, as in the case of for example the so-called tragedy of the commons. Systems are not always easy to understand or even detect as they manifest themselves through a series of singular events. Mankind is easily seduced by spectacular happenings but by this easily misses underlying patterns and large slow changes. By thinking in systems a different understanding is gained which, if nothing else, often serves as an antidote for the need to find individual scapegoats or succumbing to conspiracy theories. To a very large extent systems cause their own behavior. The concluding section discusses various ways to change system behaviors by focusing on their main leverage points.

Meadows was the lead author of the hugely influential The Limits to Growth, published 1972 and associated with the so-called Rome Club, and she was as such lionized by later day environmentalists. The thoughts then presented by Meadows and her co-writers paved the way for much of the thoughts on peak-oil and a critique of growth-obsessed economism. The reader of Thinking in Systems gets an easily read and well-articulated primer on the topic but must be prepared for an anti-business tone. Economic growth is generally deleterious, GDP is a faulty and perilous measure, interest rates are one of the worst ideas of mankind, the industrial culture has destroyed our moral and companies are compared to cancers – from a systems function aspect, at least. Without getting into the debate of the limits to growth, today it’s not hard to conclude that the authors at that time underestimated the effects of technology and innovation and didn’t understand how the pricing mechanism leads to substitution and change. That said, throughout the book Meadows – probably due to her deep knowledge of complex systems – generally displays a humble and curious attitude.

Those investors who are well versed in George Soros’ concept of reflexivity or in the stock market as a complex adaptive system, as popularized by for example Michael Mauboussin, will feel very much at home in Meadows’ view of systems. Interplays between reinforcing and balancing loops, delays between cause and effect and stocks that reach tipping points cause behaviors that we with our limited rationality only partially can understand. Quite poetically Meadows concludes “We can’t control systems or figure them out. But we can dance with them!” To succeed in the stock market it helps to get a feel for the flow of the market and to respond seamlessly to feedback from it.

For anyone wanting to understand systems this is definitely the place to start. And yes, it will give the reader a different perspective of the world.

Mats Larsson, January 22, 2018

Gladwell, Malcolm - The Tipping Point

Little, Brown and Company, 2000, [Surrounding knowledge] Grade 4

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At an early stage, it's often hard to know if a new idea or product will transform into something big or not. This is why value investors typically stay away from businesses without a track record. They are well aware that some of these ventures will turn into great successes but argue wisely that they are too hard to evaluate and prosper from. Still, some upstart businesses do reach a point of accelerating growth, why it would be great to be able to recognize patterns and signals for when it's about to happen. The author of this book describes a tipping point as an event when something reaches critical mass and begins to accelerate at a much higher rate.

The Tipping Point was the first book by the now famous author Malcolm Gladwell. He has today written five bestsellers - all with a focus on sociology and psychology. He became interested in the subject of tipping points and critical mass after having witnessed the sudden drop in crime rates in New York in the 1990s. After having analyzed the reasons for the escalation of crimes in the 1980s and the subsequent drop, he then shifted focus to other situations that showed similar characteristics. One of these is the story about the Airwalk shoes that had an exponential increase in demand - which then quickly disappeared. Indeed, retail and especially fashion is a sector that value investors often shun due to its unstable characteristics.

Gladwell starts with introducing the reader to how something can turn into an epidemic by describing situations covering the spread of viruses, trends and criminal acts. He describes the ingredients that he finds have led to tipping points with three features. A few special individuals are needed, the power of the few. It needs to be difficult to switch from, stickiness, and the environment or situation needs to be right, power of the context. Thereafter he presents in-depth case studies of different kind of epidemics where he uses the concepts earlier introduced to the reader.

As an example of the power of the context, it has been found that the number of 150 is a “magic number”. The company Gore along with the Hutterites and various military organizations have experienced first-hand that the efficiency suddenly drops drastically when groups surpass a size of 150 persons. The rule of 150 is explained by the fact that in a smaller group the members know each other’s strengths and weaknesses and this increases efficiency. It's vital to know who the best person is for a specific task but when the group becomes larger than 150 people a tipping point is reached and beyond that size this becomes exponentially harder. Gore has solved this by opening a new plant when an old plant reaches 150 workers and it has worked fantastically well for them.

Many of the author’s ideas are very easy to grasp and therefore it's important to stay critical. Gladwell has been critiqued for over-emphasizing the broken window theory when explaining the change in NY crime rates. The theory explains how a broken window or graffiti in the subway leads to more criminal acts if it's not removed. Gladwell has since admitted that he overstated its importance. The concept of tipping points is however an essential mental model with parallels to other powerful concepts. Gladwell for example mentions that it's difficult to grasp how a paper folded over 50 times could reach the sun and that it doesn't make intuitive sense that a 15% compounded return leads to more than 16 times the money after 20 years. But it does and this is also one of the most important insights for an investor.

I chose to read The Tipping Point to try to understand why ideas and businesses take off in order to be able to look for patterns as to when this is in the process of happening. After reading it, I don't think the book gave all the answers but it definitely delivered some. In the end, the greatest takeaway for me is the reinforcement that it's possible to create change with small means. The small details that differentiate one business from another may well be why one survives and thrives while the other goes away which is important to think about when evaluating moats. The book will hopefully also help the reader be even more conscious of the limitations in being a human as well as an investor.

Niklas Sävås, January 18, 2018

Rosenzweig, Philip - The Halo Effect

Free Press, 2014, [Behavioural Finance] Grade 4

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The Halo Effect is something as paradoxical as a business book about how bad business books are. The main objection is that while most management books describe their formulas for success as the result of scientific study they are in fact often just pseudoscience combined with good storytelling. The author, Philip Rosenzweig, has written several books on business performance and behavioural finance. After earning a PhD at Wharton he spent six years at Harvard Business School. He is now a professor of strategy and international business at IMD in Switzerland.

The key premise is that it is hard to know why one company is a success and another is a failure. It is therefore difficult to distil a simple formula for success, as so many management books try to do. An important business delusion that Rosenzweig discusses is the halo effect. It means that a company’s performance creates a halo that affects how the company is perceived. The story of Percy Barnevik and ABB is given as an example. When profits tripled between the years 1988-1996 Barnevik was described by the business press as brilliant, hardworking and humble. A part of the success was also attributed to ABB’s unique organizational structure that made the company action orientated and nimble. But when ABB’s fortunes turned in the early 2000s and profits declined the story changed significantly. Suddenly Barnevik was arrogant, imperial, and resistant to criticism. The organizational structure which was previously a key success factor was now labeled as chaotic and a reason for the company’s problems.

Hence, Rosenzweig argues that there are no simple answers to the question: What leads to high performance? According to him company performance is the result of strategic choices and execution. But there is no simple generic formula that works for all companies and situations.

The book starts with describing the challenges of studying company performance objectively. After some real-world examples, the author describes 9 different delusions when it comes to understanding business performance, focusing on the halo effect. Rosenzweig ends the book with some proposed solutions to the described challenges. The book is a quick, easy and enjoyable read.

The ideas covered in the book are important and I agree with Rosenzweig in his critique against most management books and how business performance is analyzed. Companies that have had recent financial success are often assigned positive and maybe even unique attributes. In a way the book deals with physics envy. Business and management are not exact sciences like physics and should not be treated as such. There are no exact formulas that will tell you how to achieve success. As a manager and investor, you need to be able to handle uncertainty and change. This book is a great reminder of that.

That said, I think the book is a bit unbalanced in terms of how it is structured. Rosenzweig spends the majority of the book discussing the halo effect and criticizing two management gurus and their books. Although those gurus are famous, the majority of authors, journalists and analysts are subject to similar cognitive biases. I would have liked the book to be broader in terms of discussing different pitfalls in analyzing business performance instead of just focusing on the halo effect and the three mentioned books.

Although the book is mainly written for managers, the described delusions are important to keep in mind for investors as well. For example, it is sometimes tempting to assign a competitive advantage, a superior culture or excellent management to a company that happens to be on a good performance streak. The lessons from this book might prevent that mistake. 

So, if you enjoy reading management books or analyzing businesses, the sooner you read The Halo Effect, the better.


Mikael Tarnawski-Berlin, January 11, 2018

Wucker, Michele - The Gray Rhino

St. Martin’s Press, 2016, [Surrounding Knowledge] Grade 3

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Language commends a powerful grip over the mind. That which we have no words for hides in the shade while an expression like for example the black swan as popularized by Nassim Taleb spurs discussion around the subject at hand. In this book the Chicago based journalist, author and opinion maker Michele Wucker launches the concept of a gray rhino as a highly probable and largely predictable, high-impact, yet willfully neglected threat. The question the book tries to answer is why decision makers often keep failing to address these obvious hazards until they turn into a full-blown imminent crisis. Wucker’s aim with this book is to make people react earlier.

After two introductory chapters defining the gray rhino concept, presenting the general outline of the book and discussing the difficulty of forecasting the future, the book dedicates one chapter each to the stages of the below described framework before finishing of with a couple of concluding sections – including a side note on real rhinos. The framework describes a typical but unfortunate five-stage response to facing a gray rhino: 1) denial, 2) muddling, 3) diagnosis, 4) panic and 5) action. The response is unfortunate as it’s too slow. Activities to handle the issue are only done when the threat is imminent and immediate, not earlier when it would have been much cheaper to do something. The gray rhinos that the author brings up are generally something out of the UNs Sustainable Development Goals or sometimes from the last financial crisis but the framework can clearly be applied to any crisis. The human capacity to procrastinate is universal.

In the first stage of the framework the delay, as I read Wucker, is mainly psychological and the threat simply isn’t picked up due to individual biases or groupthink. Since the future is never set in stone the uncertainty gives an excuse to turn the other way. In the second stage the threat is recognized but then more social and institutional obstacles for actions come in play. Naysayers are disruptive for the efficiency of organizations as they walk in the opposite direction from everybody else and the cost of postponing something is in the future while the cost of action hits this year’s budget.

Diagnosing the threat to know how to counter it might be necessary but the process could turn into a delaying tactic in itself. The success of handling the threat comes from the speed of recognizing and defining it plus in prioritizing and acting on the choices made. If the analyzing phase has taken too long leading to inaction, the next stage is panic – ironically leading to everyone freezing for a period before finally acting. The problem of acting while under stress is that the choices made tend to be less thought through.

The author’s solution, which I think is a very wise one, is to create automated systems to aid in the handling of gray rhinos - a system that sends up progressively more red flags as the threat grows larger and that automates responses in accordance to procedures thought out in advance when everyone was in a calm and rational state of mind. Otherwise the general advice from the author is to set up processes and incentive systems to create the ability to think in long-term horizons.

The topic is interesting, I agree with the solutions although it isn’t always easy to - from historical experiences - construct automated systems that will handle future events, but the book isn’t as good as it should have been. Wucker never strongly motivates her framework to start with and the later chapters where the response stages are discussed contain tons of loosely connected stories that bounce back and forth – I lack a stringent story-line. If one removes the many case examples there are very little new generalizable detail in later chapters compared to the initial presentation. The presentation of this important topic, in my opinion, becomes superficial and jumbled.

Instead of focusing too much on unknown unknowns, we should try to handle the unknown knowns; what we should know but refuse to acknowledge. Wucker at least gives us a fair start.


Mats Larsson, January 03, 2018

Dorsey, Pat - The Little Book that Builds Wealth

Wiley, 2008, [Equity Investing] Grade 4

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Warren Buffett has four main principles for investing in businesses. They need to be within his circle of competence, run by good management, have good long-term prospects and be available at a fair price. The little book that creates wealth gives the investor some well needed filters for how to think about good long-term prospects. In order to achieve high returns over the long term the business needs to have some type of competitive advantage or in Buffet terms, moat. A book that is most often recommended for readers who want to understand the concept of a moat is Michael Porter’s book Competitive Advantage. However, this is a book for corporate managers. Dorsey wanted to write a book for investors and it doesn't disappoint.

Pat Dorsey has had a long career at Morningstar where he was Director of Equity Research and where he was one of the main contributors to the firm’s economic moat ratings. Morningstar follows businesses and rank them in terms of the strength of the moat and an ETF has even been created to track these businesses. For a long-term investor that wants to create wealth without having to continuously find new investment opportunities the business then needs to have some kind of moat. Munger refers to this as "sit on your ass investing" in his usual witty way.

Businesses that are undervalued for the short term may give the investor gains but the challenge is that these gains need to be re-invested, causing the need for continuously making good stock picks. It takes time to find good investments, meaning that it's important to benefit from the opportunities that come up. Having a large analyst team makes it possible to analyze a broad set of companies leading to a higher chance of finding continuously good opportunities. This might be harder for the individual investor.

Dorsey divides moats into four categories: intangibles (brand, patents, licenses), switching costs, network effects and economies of scale. The moat can either be strong, wide moat, or weak, narrow moat. It's rather self-explanatory that a business can't be prosperous over the long term without having some kind of advantage against the competitors. A business may have a patent that shuts out the competition for a set period of time or it may have a brand that enables the business to set a price that is above the cost of production. Some businesses have historically had a high degree of customer retention meaning that the switching costs are high. A typical example of a business with high switching costs are banks. An example of a business with high network effects is Facebook where existing users benefit from having more users on the platform. Interestingly, Dorsey explained during a presentation that it's not always a benefit for a company to have all or many types of moats; a really wide moat in any of the categories may well be better.

The book is focused on the US in terms of the majority of businesses examples that is brought up and especially in terms of how to think about taxation which disturbs the flow a bit for a non-US investor. A topic in the book where value investors often have different opinions is about moat versus management. Dorsey is of the view that moat is more important and uses the quote from Buffett: "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact".

I tend to agree with this as there are so many examples of great managers working in tough industries without being able to create sustainable high returns on capital.  However, I would also like to emphasize that an excellent manager may well create a corporate culture that could work as a moat in certain instances and through this achieve extraordinary results in highly competitive industries.

For investors who want to understand the concept of moats this book is a great start. It's short but packed with insights and I have already started to benefit from the book in terms of how I think about barriers to enter an industry. I didn't pick that up the first time I read Porter's Competitive Advantages which is why I have to give a lot of credit to Pat Dorsey for helping me to grasp this important concept better. If the concept of moats isn’t part of your set of mental models yet, then begin with reading this book.

Niklas Sävås, December 30, 2017

Schneider, David - The 80/20 Investor

The Writingale Publishing, 2016, [Equity Investing] Grade 4

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I’m not sure this is the best way for a private person to invest his money but it is one that I feel very sympathetic towards. Fortunately life is so much more than investing. Thus, there is a need of rational investing that occupies very little time and this is where The 80/20 Investor by the entrepreneur and former banker plus asset manager, David Schneider enters the picture. This is a book that takes the private investor seriously. Not because it is a complex book, on the contrary – but because it trusts him to do the right thing, thinking long term.

The author’s 80/20-investment method is as they say simple but not easy. In a nutshell you are advised to get a steady and regular source of cash flow for example from a job or a business venture you enjoy. Then as early as possible in life start the habit of automatically saving 10% of all your income and put the money aside in an easily accessible account. Further, when – but only when – “no-brainer” investment opportunities present themselves, as good assets sell at low prices, a good chunk of the cash should be invested in these. Diversify somewhat. Live your life in peace. Check up on you portfolio with long-between intervals. Only sell if you realize you have made a mistake, if you feel very uncomfortable with a position, if the asset is severely overvalued or if you are forced to do so due to personal emergencies.

The structural advantage of the method is the ability to go against the general market psychology by using a longer time frame. The investor must bide his time, wait for the right moment and let the market come to him - not the reverse. Risk in investments is real loss of money. Mostly these losses come from overpaying for an asset. The main lurking danger is therefore that the investor’s impatience makes him invest his money before there are any no-brainers offered by motivated sellers that need the liquidity the 80/20-investor has available. To avoid being lured into the short-term competitive rat race, discussions around benchmarks, the performance of friends etc. should be avoided like the plague.

To build wealth it is vital to start saving and investing as early as possible to get the force of compound interest on your side. Investment action is only needed very infrequently so the investor should use the time in-between to read up on prospective investments. Schneider suggests to start looking for investments within one’s personal circle of competence, for example in the sector where one works or in an area of special interest. Otherwise other no-brainers could be found during a global market crisis, a country crisis, an industry crisis, an asset class depression and during a single company crisis. Just read the paper and the leads to an idea will probably be on the front page. Don’t time the bottom, simply buy at good prices.

The book is not without its objections. There is a bit too much space in the first half of the text that makes glorious promises of what will come later and that tries to create cliffhangers, instead of just getting to the point immediately. Perhaps the now 195 pages book would have been considered too short otherwise? Given the intended private investor audience I think the next edition should be 150 pages – it would only add to the book’s impact. Also, please make the print and the pictures somewhat prettier.

I’m not sure if the method actually beats simply constantly investing 10% of your income in an index fund ignoring the timing of the investments. Still, the methodology fits well with how I think and with how I would want to say that I invest. I would claim I pass the test when it comes to keeping a long time horizon and letting the market come to me, but I probably should save more while waiting. Instead I have prioritized paying back mortgage loans. It might not be that rational when interest rates are close to zero but for me it’s a matter of gaining independence.

There might be a specific time to sow and a different time to harvest in the financial markets but the time for buying this book is always.

Mats Larsson, December 20, 2017

Millstein, Ira M. - The Activist Director

Columbia Business School Publishing, 2017, [Business] Grade 4

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In this text spanning more than 60 years, Ira Millstein portrays the huge changes that have occurred within the area of corporate governance. Millstein at the business law firm Weil, Gotshal & Manges was one of the early pioneers in establishing an area that we today take for granted. The direction of the field was no so certain in the 1950’s when Millstein set out to improve structures and by this came to challenge many imperial minded CEOs.

In the first chapter the author paints a bleak picture of today’s stock market. He then provides a solution in a board centric imperative. In chapters 3 through 9 noteworthy events during Millstein’s long career are presented. Most of these are disasters due to lack of board oversight and accountability and where the author was called in to clean up the mess. In the last formal chapter Millstein returns to deeper discuss the desired profile of a director. In this section the author adds a number of checklists for interviewing and choosing potential activist directors. These are immediately useful as they as a complement to more practical issues, focus on integrity, courage, intentions etc. Finally, a short written biography in an appendix binds together the previous events.

Even though Millstein’s story told clearly depicts the benefits of breaking the hegemony of the managerial capitalism without accountability to owners that long was the norm, Millstein is not pleased with the state of current owners. There are wolf packs of activist hedge funds and increasingly power is concentrated to index funds or relative performance funds that have few incentives to look to the long-term development of companies. Too many CEOs cave in to the demands of the myopic market and passive directors dare not protest. As long as the company earns money they don’t want to rock the boat.

The solution to this mess and the protection from the market is in Millstein’s mind a board centric cultural revolution. He advocates so-called activist directors who know the business and its finances in depth, who are fully engaged and can act as partners to the CEO in strengthening the long-term competitiveness of the company and by this benefit the shareholders over the long-term. At the same time the activist director must protect the shareholders’ money by preventing the CEO from venturing on foolish projects. More compliance issues should be delegated to committees to free up time for the board to discuss strategy.

Only part of the change can come from board practices. The other part must come from the institutional owners who too often have little experience in managing corporations and thus are ill equipped to search for new directors. During his career Millstein has worked to improve the communication between board directors and institutional investors and to help the latter to find their role as owners. With the increasing power of institutional owners comes a societal obligation to look beyond one’s own portfolios and work for the benefit of the business sector and the economy.

Most change is small and gradual but at times there are large, dramatic breakthroughs that over decades tips the balance from the CEO to the board and shareholders. The most attention-grabbing event described in the book is the board revolution in GE where Millstein was instrumental. A string of CEOs were running the company towards the abyss while keeping the board in the dark. It was seen as betrayal if independent directors discussed issues without executive managers present. In the end the board revolted to save the company, sacked CEOs and as one of the first firms wrote their own corporate governance guidelines.

It would surprise few if a text by a lawyer was winded and complex. The opposite is the case here. Perhaps the book is a bit two-pieced as part memoirs, part pamphlet on corporate governance, but if you want to understand how today’s practices developed and why they need to develop further Millstein’s book is perfect.

Mats Larsson, December 14, 2017

Tian, Charlie - Invest Like a Guru

Wiley, 2017, [Equity Investing] Grade 3

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For the last decade of declining interest rates traditional low valuation multiple, deep value investing has not fared at all well. Thus, value investing has gradually migrated to a position of investing in quality growth, compounding franchise types of stocks. Charlie Tian, the founder of the popular value investing website GuruFocus.com, has written a useful beginner’s guide to this value investing 2.0 style. Quite fittingly Tom Russo has written one of the recommendations on the cover, as he is probably the closest to the ideal investor in the genre that Tian advocates.

Tian gives the largest credit to Peter Lynch, Warren Buffet, Donald Yacktman and Howard Marks in shaping his thinking. I would argue that the largest impact might instead have been the TMT-crash of 2000/02. The author who is a physicist by training and who used to work with fiber optic communication lost his shirt on investing in the companies he thought had a great future and where he knew the technology inside out. Like all good learners Tian turned this setback and defining moment to something positive and he immersed himself in the ways of successful value investors and soon started his website – which must be said, is now a great resource for value investors.

Invest Like a Guru contains numerous wise thoughts from the obviously very learned author. Still the level is quite basic and I sometime miss the nerve of the writing of Tian’s heroes such as Howard Marks. The structure is also fairly basic with a description of what the author has picked up from his role models, why an investor should chose the franchise value type of investing and how to execute it, including the selection of holdings and the portfolio construction. Tian advocates quite categorically for investing in a fairly thin slice of the equity market but he describes the process well. Perhaps somewhat too much attention is given to the historic performance of companies and too little to how to secure that they will perform equally well in the future. A chapter on barriers-to-entries and competitive advantages wouldn’t have been out of place.

At times there are a bit too many references to the author’s web site, which some readers can potentially find disturbing. This isn’t my main objection to the text however. It is the grudge the author seems to hold against deep value investing. Chapter 2 is dedicated to arguing against this “value investing 1.0” and correctly points to the many difficulties it entails. Then later on in the book Tian returns to discuss the main problem with deep value investing – the problem with value traps. Again it is a fair or even good description of the topic but it is to me quite unclear why it’s there. Why discuss the problem of an investment style that you are not writing a book about when you leave out the main difficulty when it comes to investing in high quality growth companies – the gravity of the reversal-to-the mean in performance that so often creates a double whammy when valuation multiples follow the profitability south? What is Tian’s advice in differentiating between temporary problems and a decline that is really the first phase of a secular return to normality for a once great company?

One further unaddressed issue in this is how the allegedly contrarian value investors reconcile their 2.0 style choice with the fact that all value investors now are quality growth investors and almost non – save Seth Klarman – are deep value investors. This makes most value investors more mainstream investors than they should really be comfortable with. This is an okay book. However, it needs to be more forward looking.

Mats Larsson, December 02, 2017

Dalio, Ray - Principles

Simon & Schuster, 2017, [Business] Grade 4

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One of history’s highest achieving hedge fund managers is coming of age and wants to share the insights he has made with the hope that these could be of use to others. Ray Dalio, the founder of the systematic macro hedge fund Bridgewater, the hedge fund that has created the highest amount of alpha measured in absolute cash ever, does this through publishing two books. In this first one he shares his life and work principles – his fundamental truths - and describes how he came to acquire them. In a forthcoming book Dalio will lay bare his views on economics and investments.

This 550 page black brick of a book has three sections. First a biographical part that gives an historical background to the specific intellectual events in Dalio’s life that taught him the lessons that shaped his principles and also as such gives an introduction to what they are. Then, one section where the author goes through the principles for how he has chosen to live his life and finally the lengthiest part where Dalio describes how he applies the same principles to the management of the organization Bridgewater – the latter a process that has generated many news articles through the years. The text is based on a large number of statements and then surrounding commentary writing describing the rational. This is hardly the ideal setup for a fluent text but the book is still easy to read. In a way the three sections are in different literary genres; memoirs, personal development and organizational management but for Dalio all are woven into a seamless whole.

Since the internal Bridgewater version of this book has been downloaded as a pdf in millions of copies through the years, many will potentially refrain from purchasing it. Still, the book and the pdf differ quite markedly. Obviously not when it comes to the core message, but the book is greatly expanded compared to the previous pdf. The biographical part has been added and the descriptive commentary around each principle likewise. All this gives additional insights but the numerous repetitions and explanations, in combination with a somewhat preaching style, is the main drawback of the book. I would almost recommend the reader to choose the angle that he is most interested in – personal development or organizational theory – and then read the biography plus the preferred section.

The description of the author and his principles in my view feels very honest and Dalio has a truly fascinating personality. He is consumed by the will to make sense of things. By uncovering truths he, and the organization he leads, evolve. Dalio is bordering on obsessed with attention to details, data gathering, reflection, learning and rationality. At the same time he is hugely inquisitive, innovative, creative and independent minded in his way of drilling down to the core of issues. Dalio’s attitude could be said to be the absolute opposite of the post-truth political debate or relativistic academic doctrines of today.

Dalio who is a former liberal Harvard student that practices yoga and dresses casually views both his own life journey and that of Bridgewater as a machine that in accordance to set output targets constantly must be adjusted in an trial-and-error-and-learning process – much like a automation system in manufacturing. The principles are the algorithms that go into the automation system. The author holds the cards close to his chest when it comes to his family life but to me it feels a bit mechanical to constantly be this analytical and rational about ones life – and this comes from someone that shares some of the personality traits. In my view, in Dalio’s reductionist worldview lies a need for control and a will to quell an unruly world with it’s psychologically biased people.

Ray Dalio invites everyone to share his principles but he is explicit about that they are not the best principles for the reader. Instead he urges us all to explore how to best live the life’s we have. We would be fools if we didn’t follow through on that.

Mats Larsson, November 26, 2017

Hill, Napoleon - Think and Grow Rich

The Ralston Society, 1937, [Surrounding Knowledge] Grade 4

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Have you ever paused to think about what you are doing subconsciously as a matter of routine? How often you procrastinate? The need to think through our actions in a world where everyone wants to grab the attention has possibly never been greater, which is why I think Think and Grow Rich written by Napoleon Hill is more important than ever. This is a book for anyone looking to develop his or her thought process and improve as an investor.

Hill, an American author that focused his writings on how to achieve success, got the assignment to write a book on the methods used by successful people from the steel king Andrew Carnegie. Thus, the text doesn’t reflect the author’s experiences but instead the insights of many of the most effective people and businessmen through history. Hill did not get paid but accepted the offer anyway and spent 25 years gathering facts on people as Abraham Lincoln, Henry Ford, Thomas Edison and Andrew Carnegie among others.

Within 50 years the book had sold over 20 million copies and successful people still today often recommend the book. Among its supporters is Warren Buffett. Buffett and his partner Charlie Munger often mention the importance of thinking. To think through the long-term prospects and competitive advantages of businesses is seen as one of the keys to successful investing.

The book is about having the correct mindset and to strive for achievement. The importance of setting up goals together with a definite due date are some of the key factors to influence the subconscious mind. A person’s correct mindset is set by his desire and faith plus continuous repetition. Marcus Aurelius once said "the things you think about determine the quality of your mind. Your soul takes on the color of your thoughts" which is a quote that summarizes a lot of this book. In order to achieve success, the thoughts need to lead to action.  Furthermore, few people have succeeded alone. Instead they have progressed with the help of others. Hence, it’s of great value to have people to brainstorm with and also a loving spouse.

The book is easy to read and can be used as a step-by-step guide on how to think and act in order to succeed in life. In the first version, it consisted of thousands of pages which was shorted down to one thousand pages in a later version and then to under 250 pages in this version. A few inspiring examples from the book are about Henry Ford and his V8 engine which his scientists said was impossible to build - but Ford pushed them to triumph. Another describes how Charles M. Schwab convinced JP Morgan and Andrew Carnegie to make a deal which transformed the steel industry.

I think Hill summarizes the ways to become successful in a great way and if the concepts are followed I am confident they will also lead to riches. However, if the book is read only once it probably won't make much difference. In investment circles one of the key factors in getting an edge is having a truly long-term view. In the same mold, I would set the importance of having a good thought process. This is exactly what Think and Grow Rich will help the reader with.

Niklas Sävås, November 23, 2017

Cialdini, Robert B. - Influcence: The Psychology of Persuation

Harper Business Revised Edition, 2006, [Behavioral Finance] Grade 4

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As an investor, it is essential to make rational decisions and at all times choose the alternative where the value is highest compared with price. Psychological biases often distort this thinking, causing investors to make irrational decisions. In this legendary book from 1984, Dr. Robert Cialdini, one of the most influential persons in the field of marketing psychology presents the most important influences on decision making and provides examples where it leads to irrational behavior.

An interesting fact with the book is that Cialdini mainly wrote it to help people to become aware of the tricks that are used by salespeople. Ironically the same salespeople started to use the examples to their benefit. Cialdini describes his interest in the subject similarly to Charlie Munger, they don't want to be fooled or as Munger describes it "be a one-legged man in an ass kicking contest". I don't want to be a fool either and that's one of the main reasons why I chose to read this book. I want to learn more about situations where influences of psychology are strong in order to improve my decision making in life and as an investor.

Cialdini describes situations where animals react to stimuli in certain ways and how humans have inherited a similar pattern of behavior. Automatic behavior is often, but not always, the most efficient form of behaving. The psychological influences presented in the book are: social proof, reciprocity, commitment & consistency, authority, liking and scarcity. These influences are normally the most reliable in helping us to make correct decisions but for the same reason therefore often used to trick us. They are also increased by stress and fatigue, causing them to be amplified by the tempo of the modern world.

What's great with the book are all the powerful real-world events that are presented next to the scientific evidence. Cialdini brings up fascinating examples where the influences described have caused unbelievable situations as when 39 people witnessed a murder without anyone calling the police and when 910 people committed suicide in the jungle of Guyana, both by the impact of social proof. Another fascinating example is the Milgram experiment where students sent supposedly deadly electrical shocks to test persons under the influence of authority.

The structure of the book is really easy to follow and even though the main influences are presented one by one instead of in combinations, which might have been a more logical way, the author succeeds in weaving them together. The focus is not on the investment area but it's unavoidable to draw parallels to such factors as confirmation bias, loss aversion and herding among others and thus get an explanation to why these biases are so powerful.

This is a fascinating book and an eye-opener for those who haven't yet realized the power of psychology and how it impacts behavior and decision making. The influence of the book is confirmed by the many devoted practitioners in sales and marketing making use of the examples provided. By knowing about the effects that the psychological influences lead to, they can be tackled, which is the key takeaway of this book.

Niklas Sävås, November 6, 2017

Friedman, Yali - Pocket Biotech Industry Primer

Logos Press, 2008, [Business] Grade 4

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If you quickly need to gain a basic understanding of the biotech industry this is a very good place to start. Yali Friedman is the publisher of the Journal of Commercial Biotechnology, the head of data analytics at Scientific American and the founder of the site DrugPatentWatch.com. He should know what he is talking about.

To set the reader’s expectations right the book doesn’t aim to give deeper insights into investing in biotech stocks or to provide a multitude of detailed numbers on the market and its many segments from an economic perspective. The book aims to give a basic understanding of the basic functions of the biotech sector and in my view does a good job. Still, if you understand the sector it is then obviously a lot easier to invest successfully.

The author quite broadly defines biotech as “the application of molecular biology for useful purposes” and then on top of medical functions includes applications for farming, environmental remediation and industrial processes. Most of us still relate biotech to the development of drugs. Biotech pharmaceuticals are produced by living organisms like bacteria, yeast cells or animal cells and are often made up of longer molecular chains compared to the small molecule, chemically produced products of the traditional pharma industry. Then to be honest the two industries are gradually converging.

How can we then enlist living organisms like bacteria to produce the products we desire? To answer Friedman takes a step back and describes the foundations of molecular biology, i.e. how the information in our genes produces proteins with different structural and functional characteristics. By manipulating this process and combining DNA from various sources we can get the organisms to work for us and create targeted compounds in a process very different from the industrialized trial-and-error process of traditional pharma companies.

After an introduction the book starts with a historical representation of the birth and upbringing of the still relatively young biotech industry. It gives a good understanding of the historical reasons for the sometimes slightly odd features of the sector. The author’s long experience with the biotech industry shines through. The above-mentioned following description of molecular biology is short and basic but equally excellent. The author follows up with a strong chapter on the long and tedious drug development process that so dominates the day-to-day activities of biotech companies.

Then the book runs out of steam in the last two chapters. The chapter on tools and techniques gives a helter-skelter description of various industry related topics. Many of them are important but there is no storyline to keep the reader interested. In the final chapter on the applications of biotechnology more than half of the text is devoted to industrial and agricultural uses. While this gives a good broad overview it probably isn’t what the reader would expect.

Still, it’s hard to complain. The Pocket Biotech Industry Primer packs a lot of knowledge into a short format. The 83 well written pages are quite possible to read in one sitting. Fairly complicated issues are explained in a simple – but not too simple – manner and with no over-usage of industry jargon.

Granted, this is only a first glimpse into the exciting biotech industry. For the investor who complements with insights into the economics and market conditions for various therapy areas plus an understanding of biotech companies’ business models this book is still a useful tool.

Mats Larsson, October 28, 2017

Bruner, Robert F. & Carr, Sean D. - The Panic of 1907

John Wiley & Sons, 2007, [Equity Investing] Grade 4

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When historic financial crashes are discussed the US Wall Street crisis of 1929 to 1932 often springs to mind. The less well-publicized crisis of 1907 might not have been just as brutal but it was still severe. The stock market declined by 37%, 42 banks and financial institutions went under and in 1908 the US and many other areas around the world saw an “intense” depression. It was a crisis with classic bank runs that had a long lasting effect on the organization of the American financial system. Robert Bruner and Sean Carr of the University of Virginia set out to explore what we can learn from the 1907 events.

In the introduction the authors propose a loosely held framework for how financial crises can be understood and explained. They offer a model with multiple factors that influence the development, instead of succumbing to the one-trick-pony rationalizations of many pundits – “it was the greedy bankers” or “it was the stupid politicians” etc. The major part of the book describes the historical events but in a concluding analytical chapter Bruner and Carr return to their model.

It is obviously a good thing to bring these perhaps too forgotten events into the spotlight. The historical account is despite its sometimes-complex content very readable. The main character of the book is undoubtedly John Pierpont Morgan. Even if the details, companies and persons of this crisis are specific to 1907 the chain of events are easily recognizable from other late day crashes. One thing is however different, the US had no central bank in today’s meaning. J.P. Morgan accompanied by George Baker at the First National Bank and James Stillman at the National City Bank instead shouldered the role as the lender-of-last-resort, in the end - and after many late night sessions - bringing calm to the markets.

The public reactions to the rescue endeavors were however mixed. Some hailed Morgan as a hero. In an increasingly radicalized US where the public opinion often was against Big Finance others accused the “money trust” to have exploited the crisis to their own gain. Morgan had to appear in a number of hostile congressional hearings. In 1913 the Federal Reserve System was formed to take on the role that Morgan and his partners had had previously. Ironically the FED was formed from a blueprint drawn up by much the same investment bankers the bank was set to replace.

So what are the components of the authors’ model of financial crises? They start with the statement that the financial market must be seen as a system where the actors interact with each other by decisions taken on imperfect information. This opens up for contagion where trouble will travel and the chain of events are more often than not non-linear and thus impossible to predict. Some pre-conditions for a bust is a preceding economic boom with increasingly voluminous and loosely controlled credit growth and add to this political decisions within financial and monetary policies that too often affect the market pro-cyclically. An economic shock that manages to reverse the psychological climate then triggers the crisis and greed turns into fear. When collateral values and trust disappear, liquidity quickly does the same. Collectively beneficial calmness is tossed aside as everyone runs for the exit simultaneously.

This book is published pretty much on the top of the 2002 - 2007 bull market. Yet, even if the authors in my opinion identify the components of a crisis correctly the forward looking part that rounds up the concluding section is completely devoid of the factors that only a few months later will create an even worse crisis than the one in 1907. This is no critique but only serves to show how hard it is to foresee financial calamities in advance. For anyone that wants to understand the coming financial crisis – whenever it arrives – it will be beneficial to read this well written account of the events that helped to shape the world we live in today.

Mats Larsson, October 19, 2017

Faber, Meb - The Best Investment Writing, vol. 1

Harriman House, 2017, [Finance] Grade 4

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In a world overflowing with material, the trick is no longer obtaining information but to select what is relevant and screen out what is not. As the CIO of Cambria Investment Management and author of several best selling investment books Meb Faber is perfectly positioned to help out with this task in the investment arena. Faber has taken on himself to select what he thinks to be a collection of the best writings from high quality investment thinkers.

As many collections of short stories these are loosely arranged under broad headlines. Some contributions – unknowingly - argue against each other, for example with regards to the efficacy of the CAPE-ratio. By this they provide the reader with the pros and cons of the topic. Some of the writings are better than the others but the scale is rather from good to excellent. Some of the writings are shorter than others and some are simpler than others but none is too advanced for the lay reader. This has no bearing on the importance of the texts. What is said in a simple way is often the most essential.

Presenting a number of authors in a format like this gives the reader a splendid chance of finding new favorite writers that he or she could follow more closely online. Still, given that authors with quite different vantage points write the texts, not all of them will fit all readers. For me the writings on personal finance that conclude the book feels a bit misplaced since the target audiences for most of the preceding texts are probably professional investors.

Which are my favorites? The introductory text where Jason Zweig draws investment lessons from his antiques hunting as a youth is superbly written. Jason Hsu and John West touch on the partiality for complex solutions in finance - which is one of my pet topics. Wesley Gray discusses the well-known but underappreciated problem of randomness in investment track-records in a very punchy text called Even God Would Get Fired as an Active Investor.

Dave Nadig presented some genuinely new scary insights for me discussing the discrepancy in liquidity of bond ETFs and the underlying securities. It will be crowded by the exit door when the fire alarm rings for that market! The best text in my opinion is Todd Tresidder’s Five “Must Ask” Due Diligence Questions Before Making Any Investment. What is really presented is the framework for building a strong personal investment process.

The book would have benefited from one more editing session. Copying and pasting digital material sent in can prove troublesome as fonts etc. have a tendency to change. Just a pair of examples; in one text two paragraphs are included twice and in another a missing hyphen brings the percentages of 80-90% up to a staggering figure of 8090%. The pictures are in black and white although printing them in their original color often would have improved the understanding of their message greatly. That the text is sometimes bordering on microscopic doesn’t help. It is obviously a publishing budget issue but still.

Whether you like the format with a collection of short texts is rather personal. I do like it and I always have with the books from Michael Mauboussin and James Montier as personal favorites. It is very effortless to continue to read one text after another. Naturally some readers will find the overall impression of such a book somewhat too fragmented.

I very much enjoyed the reading. So, this is volume 1? Where can I sign up for a subscription?

Mats Larsson, September 27, 2017

Mishra, Pankai - Age of Anger: A History of the Present

Farrar, Straus and Giroux, 2017, [Surrounding Knowledge] Grade 4

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I’m quite torn about this book. On the one hand it is monumental and thought provoking, on the other hand I feel that it’s intellectually dishonest. Indian born but UK resident, Pankaj Mishra is an author of several books, a columnist for a number of well known publications in the US and UK and he is a fellow of the Royal Society of Literature. The Age of Anger has been tooted as a book that lets us understand the new post-liberal world we are entering. The author’s thesis is that the “angriness” of our age, be it expressed by Islamistic terror, the election of aggressive populist leaders - like Narendra Modi in India or Donald Trump in the US - or by the UK exodus from the EU, is really a global sequel to an earlier European resistance towards the enlightenment and its acolyte the liberal market economy. Osama Bin Laden is our time’s Mikhail Bakunin. Mishra tells a story of a pendulum movement through time. Just like the romantic movement of the late 18th century until the mid 19th century in the author’s narrative was a countermovement against the enlightenment that ended in Marxist and fascist outbreaks of violence, our time’s reactions against the globalized neo-liberal market economy will, according to Mishra, end in World War III.

The structure of the book is that the author first over a few chapters outlines his thesis, then the voluminous mid-section is dedicated to endless examples and historic references that are meant to display the connection between the previous European counter-movement and the current global one. Finally the author in the end again outlines his proposed Hegelian process towards human destruction. The amount of name-dropping in the central part is close to numbing. For those not supremely interested in a detailed exposé of historic anti-enlightenment composers, poets, philosophers, writers etc. and who only want the gist of the author’s argument the middle section can be disregarded.

Why do I think the writing to be intellectually dishonest? The author tries to portray himself as an objective observer and analyst of this pendulous movement between the enlightenment and its critics. He is only reporting the truth as he (alone) has discovered it. Mishra is anything but impartial. It is not that he shies away from describing the violence of fascists and Islamists but he understands them and their actions are explained by the necessity to react. They are almost excused. When describing the enlightenment, globalization and market economy the tone is hardly equally understanding. The contempt, loathing and scorn displayed when discussing the guilty party is distasteful and frankly bordering on childish.

Enlightenment critics have always seen the belief in reason as oppression and the conviction around universal truths as Western cultural imperialism. Also, from day one the industrial revolution as well as the scientific revolution that followed the enlightenment was accused of killing the spirituality of mankind. The Age of Anger adds nothing new in this respect. Mishra is obviously right in that the argumentation of earlier German romanticists, Marxists and fascists as well as today’s Islamists, populists and left wing neo-colonialists often are strikingly similar when it comes to these topics. This is however hardly a solid foundation for a theory of a deterministic road to hell for humanity.

I am not one to take the rootlessness of people in a globalized world lightly. Liberalism is just a framework of freedom that should be filled with things that give meaning to life. At the same time it becomes absurd to describe our age’s Western World as bordering to hell on Earth. It makes you wonder why Mishra would want to stay in London and attend the meetings of the Royal Society? One is reminded of the intellectual father of the post-colonialist theory, Edward Said, who sat in comfort at his Columbia University professor’s chair.

This book will delight the anti-Western cadre. Its confrontational style will however make any discussion of the relevant topics impossible.

Mats Larsson, September 11, 2017

Sharma, Anurag - Book of Value: The Fine Art of Investing Wisely

Columbia Business School Publishing, 2016, [Equity Investing] Grade 4

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The background here is that a business professor, the author Anurag Sharma, grows increasingly puzzled over the discrepancy between the teachings on finance he meets in his academic environment and the investment customs he witnesses among successful practitioners. After reading up on the subject he rejects his fellow scholars, starts a class in value investing and later writes Book of Value, a book along the lines of Ben Graham’s The Intelligent Investor. Sharma’s thesis is that wise investing comes from making good choices and that investors can learn and internalize the practice of making these. Thus, the aim of the book is to present a framework that helps investors to make better choices.

There are five parts to the book that build up the author’s combined narrative. After the introduction has given the reader a glimpse of academic so-called modern portfolio theory the author in the first part presents a different take on the story, i.e. the behavioral biases witnessed in real life investing, the tendencies of market participants to herd and by the subsequent correlation of faulty opinions create market mispricings. Further, Sharma shows how psychologically shrewd operators – noise producers, fraudsters etc. - can induce behavior that benefit them at the expense of the financial health of investors. In part two a case is made for using the scientific method of falsification in investing. The investor should come up with investment ideas and then have a process to try to shoot them down using logic and data. If they cannot be falsified through a sound process they may constitute an investable idea. The author’s reasoning ends up in a similar place as Charlie Ellis’ views in his classic book The Loser’s Game. In my view Sharma’s text here benefits from systematic thinking of an academic mind but, not being a seasoned practitioner, the examples feel a bit theoretical and the writing in these segments lacks some nerve.

The next two parts of the book bring forward the author’s suggested framework for falsifying an investment idea. First he takes a more quantitative approach in trying to ensure that a company has a satisfactorily strong business and financial standing and that the price of the stock is sufficiently low compared to its value. Then there is a qualitative follow-through of the same areas. The financial strength is checked by controlling the quality of assets and liabilities, reviewing operating leases, pension obligations, off-balance sheet items, lawsuits etc. Business strength is evaluated by Du-Pont analysis, assessment of the business model and the quality of management. Although the writing at times is very basic – in discussing valuation for example – the combined effort of an investor going through all the steps discussed will result in a quite comprehensive picture of the company analyzed. The author is clearly on his home turf discussing business models and management but also in my view shows some good understanding of investment psychology.

In the fifth part of the Book of Value Sharma shows how to assemble a portfolio of stocks that have survived the process of trying to discard them. Essentially a focused portfolio of stocks, each with an asymmetric risk-reward potential and where the investment cases for the stocks depend on a diversified set of drivers, is advocated. After exemplifying this type of portfolio with Berkshire Hathaway’s portfolio of publicly listed stocks the author’s reasoning on how to become a wise investor is summarized in a conclusion with five well-argued main points.

So does Sharma’s sketched framework have the potential to facilitate better investment choices? Yes, clearly. Even if not all details are explicit, it provides the basis for a workflow that will help the investor narrowing down the investment universe, form an opinion on relevant investment considerations and shield him from at least some of the psychological traps of the stock market. Even though nothing new is presented and some text is even a bit basic, in combination I think the author delivers on what he promised.

Mats Larsson, September 04, 2017

Jennings, Marianne M. - The Seven Signs of Ethical Collapse

St. Martin’s Press, 2006, [Business] Grade 3

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Successful investing in stocks is just as much about dodging the loser stocks as it is discovering and keeping the winning ones. The process of knowing what to avoid could focus on qualitative factors such as companies with high leverage, poor return on capital, weakening profit momentum, high valuation multiples or accounting ratios that indicate dodgy accounting. It could also focus on qualitative signs regarding the corporate culture. Marianne Jennings, at the time professor of business ethics at Arizona State University, has with the experience of corporate collapses during three stock market cycles written the latter type of manual. It’s not just a handbook in detecting companies approaching the abyss but the author also gives a number of suggestions for improving the culture, to be used by companies.

The structure of the book is simple. There is an introductory chapter and preface, there are two concluding chapters and in-between there is one chapter for each of the 7 signs that in the author’s view point to the risk of an ethical collapse in the company. Each of the 7 chapters starts with a discussion of the issue, a number of examples mostly centered on the corporate scandals of Enron, WorldCom etc. in the early 2000’s and then a comes number of suggested antidotes that are summed up in a list at the very end. Mild forms of one or two of these signs might not indicate an imminent disaster but extreme cultures and multiple warning signs should be taken notice of.

Which warning signs should we as investors or corporate executives be on the lookout for in Jenning’s opinion? The signs are: 1) “Pressure to Maintain Those Numbers” – an unhealthy and unreasonable obsession in meeting earnings numbers that in the end makes the temptation to make the numbers up too great, 2) “Fear and Silence” – a culture that offers no venues to air concerns or punishes those employees who try, 3) “Young ‘Uns and a Bigger-than-Life CEO” – iconic, idolized and charismatic CEOs surrounded by young and sycophantic executive managers, 4) “Weak Board” – a board comprising of inexperienced, incompetent or too-busy directors or directors with too many business or friendship ties with the management, 5) “Conflicts” – companies full of nepotism, mutual back-scratching and the extraction of benefits on the expense of shareholders, 6) “Innovation Like No Other” – differentiated, innovative and successful companies that over time come to embrace a view that they in their uniqueness stand above petty wordly obstacles like rules and 7) “Goodness in Some Areas Atones for Evil in Others” – CEOs that use shareholder’s money for public and self-glorifying philanthropy or engage in what’s called corporate social responsibility and by these good deeds permit themselves to lie and cheat in others.

Unfortunately, the structuring of the chapters could have been more stringent. Often the texts on suggested antidotes too much continue to describe and exemplify the proposed problem. The author’s writing is somewhat stilted and declamatory at the same time as the opinions and antidotes are in my view sound and fair. I also quite like that she spares no punches – for example, with regards to Jack Welch, the former CEO of GM: “Mr. Welch was often touted as the greatest manager of all times. Mr. Welch would perhaps be more accurately described as the greatest earnings manager of all time”.

I would further love to see the propagation of the virtues discussed by Jennings in business life – and even more pressing in the political life. The question is how to go from wishing to execution of that hope – the author gives no real hints. As a side note, the book is published 2006, today a decade later when corporate social responsibility has developed into an all-embracing religion, the author’s text regarding the seventh sign would be almost impossible for an academic to write.

Often it is reading the subjective, quantitative signs that separates the great investor from the ordinary one. Jennings offers one potential framework to interpret the signals of an approaching fall.

Mats Larsson, August 22, 2017

Bookstaber, Richard - The End of Theory

Princeton University Press, 2017, [Finance] Grade 4

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This is a text on financial theory and the author advocates a switch from the use of a rigid neoclassical theory based on a number of unrealistic assumptions to a fluent, messy but flexible use of so-called agent based modeling (ABM). Epistemology is the type of philosophy that concerns itself with the theory of knowledge, the nature and rationality of belief. Bookstaber wants to challenge how we understand and think about economics and uses the occurrences of financial crisis as the test environment for his endeavor. The author is the Chief Risk Officer at the pension fund University of California Board of Regents. Earlier he has been both a PM and a risk manager at numerous hedge funds and investment banks. Few have longer experience of financial risk than Bookstaber.

In his 2007 bestselling book A Demon of Our Own Design the author reviews his dramatic experiences from the investment bank and hedge fund world and how liquidity, leverage, crowding and tight coupling – the speedy interconnectedness of events – are key parameters in causing cascading that leads to a full blown financial crisis. He also begins to discuss the topic of complexity. The End of Theory could be seen as a freestanding appendix to the first book. By now the author has had the time to better develop a theory around what he had experienced first hand and he also offers a practical tool to use. Since the theory is so vastly different from conventional economics the book becomes a crusade against how economic theory address crises currently (if it does at all).

The financial system is described using 4 building blocks: 1) computational irreducibility – a system without mathematical shortcuts to describe it, 2) emergent phenomena – that the overall effect is different from the sum of the individuals actions, 3) non-ergodicity – the concept that actions of one agent depend on and are shaped by history, context and the actions of other agents and 4) radical uncertainty – the fact that the system cannot be modeled by using historical events. The really important future developments will be unprecedented. All this creates a financial system that I have come to call a complex adaptive system. It is full of self-enforcing loops; developments are non-linear and unpredictable. Then the author goes on and offers the computer modeling technique ABM as a tool to understand and handle the complexity. ABM tries to simulate system effects by the actions and interactions of autonomous agents with separate decision heuristics. Chapters 11 through 13 model the financial system using the method. The exercise is thought provoking and I especially liked the description of the multi-layering within banks.

Nothing of all this is new and Bookstaber never claims that it is. The notion of complex adaptive systems amongst others builds on George Soros’ concept of reflexivity as described in his 1987 book The Alchemy of Finance, on complexity theory popularized by the Santa Fe Institute and on Andrew Lo’s concept of adaptive markets. The merit of this book is rather the compilation of the many parts into a whole and especially the application on special situations – financial crises. The author doesn’t really take the knowledge about complex adaptive markets further, but he improves our crises-knowledge.

The writing and language is relatively accessible for a text on financial theory, the boundaries of human knowledge and the intricacies of the plumbing in the financial system. The author takes the time to explain and exemplify. At first this is a positive but during the course of reading the book the notion is reversed. What starts out as illuminating turns into being repetitive. In an attempt to win the reader over to the author’s point of view too much is said too many times. The book would benefit greatly from being slimmed down some 40-50 pages.

The End of Theory will advance your thinking on financial calamities but it isn’t always fun to read.

Mats Larsson, August 16, 2017

Bookstaber, Richard - A Demon of Our Own Design

John Wiley & Sons, 2007, [Finance] Grade 4

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Why did I wait 10 years to read this book? It is a joy to read. Richard Bookstaber has had a long career in the financial markets. Today he is the Chief Risk Officer at the pension fund University of California Board of Regents and a senior advisor at the US Treasury’s Financial Stability Oversight Council. When he wrote this book he was a hedge fund portfolio manager and prior to that he was in charge of risk management at both Morgan Stanley and Salomon that later turned into Citigroup. The reason for not picking the book out of the bookshelf was that the subtitle “Markets, Hedge Funds, and the Perils of Financial Innovation” gave me the impression that it was a sensationalist, hedge fund-bashing book written by an outsider. This is obviously completely wrong. Few are more qualified than the author to discuss financial risk.

There are three parts to this book although they aren’t presented chronologically. There is one extremely interesting theoretical part comprising of chapter 1, 8 and the conclusion; there is a brilliant autobiographical part covering Bookstaber’s Wall Street career (chapter 2-7) and then chapters 9 through 11 present a somewhat less vivid, semi-theoretical, discussion around hedge funds and much more. For me the chapter on the 1987 crisis was a revelation. Why are researchers still debating what triggered the downturn? Here it’s written out in black and white from someone who had the benefit of both a front row seat and the oversight and understanding to make sense of the event. In short it was a combination of investor psychology, a mismatch in liquidity between the futures market and the cash equities market to act as a trigger and the widespread usage of portfolio insurance that created a self-enforcing negative loop of selling.

In the Wall Street section the author describes the full palette of financial mishaps that he experienced at the investment banks - including the debacle of LTCM, which was closely affiliated to Salomon. In general too many think that only what has recently happened is likely to happen next or that things that seldom happen, will not happen – at least not on their watch. Combine this with the non-linear effects of a constant stream of newly invented derivatives plus complex organizations with plenty of politics and you have an accident waiting to happen. Time after time new financial products are launched without the understanding of unintended consequences. Sometimes the risks are even deliberately ignored as the gains will fall to the banks’ personnel but they will not face the losses.

The theoretical part and especially the chapter “Complexity, Tight Coupling, and Normal Accidents” should be required reading to be eligible for employment at financial regulators. A combination of complexity and tight coupling creates unforeseen events that often cascade through the financial system as a crisis. The complexity arises as the agents in the system change their behavior depending on others behavior and events are often triggered by the use of derivatives – and this is written before the 2007/08 crash. Due to the constant need for liquidity when using derivatives - and the often high leverage - agents in the financial system are critically interdependent and the speed of the market gives little room for error or time for adjustment when things go wrong. That accidents occur in such a system is according to the author to be expected – they are so-called normal accidents that arise by the design. The need for liquidity, not new information, is the main driver of short-term price movements. Less leverage and an incubation period for financial innovation is suggested to tame the system.

The text is colorful, quick-witted and written with a self-irony that adds to the readability. Bookstaber is a quant with a splendid way with words! At this point the book merits a 5-star rating. Unfortunately the hedge fund part isn’t fully up to par. It’s untidy, a bit defensive about hedge funds, searching, and the author doesn’t seem to have fully completed his thoughts. In contrast to earlier parts, no colorful interior from the hedge fund world is offered - pity. In all, if you are to understand financial calamities you should have read this book.

Mats Larsson, August 11, 2017

Partridge, Matthew - Superinvestors

Harriman House, 2017, [Equity Investing] Grade 3

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This book is at the same time in a rewarding but ungrateful genre. Learning from the best is always worthwhile and getting to know the secrets of those who have been the most successful in equity markets never fails to interest a wide audience. Still, profiling a collection of famous investors and turning this into a book has been done numerous times before – it is hard to add much to what has been written previously. In Superinvestors Matthew Partridge, a UK financial journalist, historian and previous investment bank employee, presents his selection of 20 investors to study. Further, the author takes on the hard task of rating those profiled and name the “best” investor of all times.

The structure of the book is – as expected – fairly simple. After a brief introduction 20 “super investors” are portrayed and the book finishes off with the conclusions the author draws from the many individual fates and fortunes. For each investor the reader is served with a short personal and professional history, a discussion on the investor’s method, his performance and potential mistakes made. Then Partridge seeks to distill some learnings from the above and ends the section with a rating where the investor gets a score from 1 to 5 on performance, longevity, influence and ease of replication for the private investor. Many of the profiled names like George Soros, Warren Buffett, Benjamin Graham and Peter Lynch will be well known to many readers.

Although it’s always arguable who should be included in such an illustrious group I would have made some different choices. Even if it is quaint that Paul Samuelson privately acted at odds with what he preached as the high priest of efficient market theory I don’t think that his profile, nor the one on fellow economist David Ricardo (1772-1823), adds much to the discussion and the venture capital pioneers of George Doriot and Kleiner & Perkins feels a bit misplaced. Further, there is obviously much to learn from Jack Bogle but he is more successful as a businessman and advocate of an idea than a successful stock market investor. Who would I want to see instead? Jim Simons, James Chanos and Seth Klarman could in my view be fair alternatives. On the other hand the book benefits from the author’s deep knowledge of UK investors who are less documented in literature and Anthony Bolton’s track record in China will come as a surprise to many – as it did to me.

In my opinion the texts on UK investors Neil Woodford and Nick Train were the most interesting. Also, even though I had heard of Robert Wilson as an early short seller, I knew nothing of him. Overall Partridge, with some minor disagreements, in my view gives a short but fully accurate picture of the investors I had previous knowledge of. The author is clearly well read and even the cover is inspired by Ken Fisher’s 1984 book Super Stocks. My only objections are that I think George Soros’ concept of reflexivity is too vaguely described and given its huge influence on the hedge fund community and its closeness to the current concepts of complexity theory and adaptive markets it is a bit harsh to say that the theory has left little mark. Further, to describe what Ed Thorp did as “nothing new, but more systematic” is to diminish a person who long before academics Black and Myron Scholes came up with an option pricing model that allowed rational derivatives trading.

Even though the book is over 200 pages long it is an easy read and it is quite tempting to time after time read “just one more profile”. The conclusions at the end are sound but hardly novel. So who does Partridge rank as the best investor of all times? Those on the short list are Philip Fisher, Buffett, Bogle and Graham (skip Bogle and add Soros and Thorp and I would have agreed). The winner is Graham, much thanks to his huge influence on later day investors. A good choice.

It is never possible to do an investor justice over 6 to 8 pages. However, it is through books like this that many up and coming investors have gotten a glimpse of their role models for the first time.


Mats Larsson, August 8, 2017