Makliel Random Walk down Wall St Rev [Paperback]

Let's talk about the Random Walk. The stockmarket is a game of chance - you might as well flip a coin to determine which way prices are going. In fact tossing is preferable because researching shares or paying professionals takes time and costs money.

The Random Walk attacks the tenets of professional fund management: that investors can pick shares trading at a lower price than their true value or traders can spot trends in price movements and exploit them.

Malkiel marshals an army of statisticians, back-testing the more common investment strategies and finding them wanting. Sure you may win in the short-term, but that is lady luck. In the long-run, once you take costs into account, all bets are off.

I do not buy it. Back-testing is fine and dandy but does it actually prove anything? Real investors - and I am talking about private investors here - change their strategies, exercise judgement and break the rules. They are not slaves to the slide-rule.

While it is common knowledge that professional money managers are doomed to fail, I suspect private investors have a better chance of beating the market. The problem is private investors are by nature shy animals.

Just because I disagree with his thesis does not mean I do not think you should bother with the book. Malkiel is articulate and his tour through fundamental analysis, technical analysis, modern portfolio theory and the capital asset pricing model is as good as any introduction I have read.

I just cannot bring myself to believe anomalies do not exist when I see them all around me. You know - internet bubbles, overreactions, Warren Buffet. Even Malkiel sees anomalies. But in his world they are rare, difficult to profit from and vanish once common knowledge.

He even has an investment trust habit. C'mon Mr Malkiel admit it - inside every index-hugger is a stock picker desperate to get out. It is more fun!
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A word of warning for British readers. The first three chapters are theory, it is a universal language. The fourth is a practical guide, less practical for us because it is written in American: all IRA's and Keogh plans. Still you can translate some of it and derive general principles from the rest.

If the thought of reading an economics book scares you, this is the book for you. Burton Malkiel's work is one of the most famous investment books of the century, but it is simply a joy to read. The text does an excellent job of introducing the reader the gem of modern economic theory, the Efficient Market Hypothesis. I would like to note, however, that this hypothesis has rightfully undergone a great deal of scrutiny in recent years. Before you subscribe to Malkiel's ideas and hire a chimp to throw darts at the Wall Street Journal, you should take the time to look at the arguments against the EMH. Specifically, I would suggest a few works by Richard Thaller: 1) The Winner's Curse: Paradoxes and Anomalies in Economic Life and 2) Advances in Behavioral Finance. The latter is a bit dry, but it would be very enjoyable for the hard-core economist out there.

Prof Malkiel's strategy is to, at fixed intervals, invest cash split 55-80% (depending on age) into geographically diversified equities, the rest into bonds, to rebalance annually to the set percentages, & always to invest in low cost trackers.

No market timing, no attempt to take cash at the top &/or invest at the bottom other than through rebalancing on the basis that markets are impossible to call in their randomness & efficiency.

Perhaps this was once pioneering, but it's well-travelled now & Vanguard & others with their 50:50, 60:40, lifestyle etc etc funds have pretty much taken care of business. Although the US market is way ahead of the European investment market in this, Deutsche Bank X-Trackers platform also offer all-in-one funds of exchange traded funds that expose investors to 50-70% equities & 30-50% fixed income packages.

So, although his core 'sell' is basically sound & any antidote to the financial 'services' industry is not unwelcome, you do wonder if a new volume, the entirety of the key findings of which are set out on just two pages (377-378), is really called for.

Much of the rest - markets under- & over-shoot, it's hard as a man in the street to beat the market - is also fine as far as it goes, but not exactly groundbreaking.

As regards the idea of a core 60:40 (approximate) passive portfolio, I felt he did not reflect on the thinking others have done as regards portfolio mix & diversification & actively managing a passive core portfolio by at least some reference to momentum &/or mean reversion &/or tactical allocation (aka 'Passive Mark 2').

All this stuff is very in vogue right now & the internet is alive with backtested models on all this.

Sure, one can & should be sceptical as to whether a revisionist take on buy, hold & rebalance is right (& as regards backtesting as with technical analysis as a general matter), but just to take the view that any tweak is doomed because if it works everybody will follow it & render any such strategy neutered is a bit lacking in analytical depth.

And, not least, given Prof Malkiel recognises the boom-bust irrationality wrapping a general upwards drift one would have thought he would at least consider how retail investors could seek to position to avoid buying high. He only really grips this in the page he devotes to advising that 'gold is really high now, there's a high premium to coming in now'.

He does not really consider whether or not, & if not why not, commodities should be part of the core portfolio in the same way as he considers that real estate should be.

Nor does he consider or advise what to do with a lump sum either initial or accumulated (beyond annual rebalancing).

Meaning, in Q2 2011 for example, markets up 89%+ from the last lows, do you not want to go from a 80% or 55% 'risk on' position to a more defensive position waiting for a pullback? Or, at least consider at some point protecting some of your profits otherwise than through the annual rebalance?

And, if you have $100,000, from, say, a redundancy, do you really go totally invested all at once on any random day? Would it not be better to wait for a 20% or so pullback?

What about a core passive holding self-managed with a view to mean reversion, so it is not just annual rebalancing that protects you from buying high? So you might be 80% risk moving towards 50% or 40% over a cycle? So you can invest on pullbacks or invest profits in satellite investments so as to diversify or soup-up the core?

Nor does he consider currency risk as regards your fixed income component. Do you not want some currency diversification so you're not all $ or all £? Given the stress on asset class & currency diversification on the equity component it is surprising that no consideration has been given to this issue on the fixed income side.

He's so committed to arguing for efficient markets that there is too little on the nuts & bolts details of the management of the core portfolio nor focus on those who are developing the buy, hold & rebalancing strategy, &, also, there's precious little on ideas for satellite investments. So, what about harvesting profits into managed futures exchange traded funds & such like, taking a punt with profit?

Overall, it's ok & reading this is going to save you from the active management 'where are the clients' yachts' community but all the info & more is freely available elsewhere & the Prof has not really moved this book on into a practical users' manual based on fusing passivity with momentum & mean reversion & tactical allocation.

I would say that books like Swenson's & Faber's are a better take on all this stuff, even if you approach the 'manage like the ivy league endowments' with healthy scepticism & from a ultra-passive buy, hold & rebalance foundation.