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Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street
Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street
by William Poundstone
Edition: Paperback
Price: £10.18

7 of 7 people found the following review helpful
5.0 out of 5 stars Profitable Gambling Systems, 3 Mar 2011
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This book is an entertaining and non-technical biography of the Kelly criterion -- a betting equation which shows you how much of your wealth to bet on each round of a profitable gamble so as to maximise the growth rate of your wealth.

Suppose you might a biased coin which will land heads twice as often as tails. A fellow gambler is willing to offer even odds against heads; how much should you bet on this profitable gamble? Assuming the bet can be repeated many times, you shouldn't stake your entire bankroll on the first gamble, as, if you lose, you will be unable to gamble again. The Kelly criterion shows you which fraction of your net worth to bet on this gamble -- or any other profitable gamble -- so as to maximise your average end wealth.

William Poundstone describes the life of the Kelly formula by introducing us to some of its most famous users: Ed Thorp, who used it when counting cards at blackjack and in his early hedge fund; and Claude Shannon, who used it in his stock market speculation and who built a roulette wheel prediction device with Thorp. Poundstone also explains how the partners of Long-Term Capital Management (LTCM) would have done well to heed the formula's advice. He also covers the spirited academic debate behind the formula: including the links it shares with the work of Daniel Bernoulli, and Paul Samuelson's witty opposal to its overuse (there are many good reasons to bet less than the amount implied by the Kelly formula).

This is another five star book from William Poundstone.

The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets: How to Manage Your Portfolio Like the Harvard and Yale Endowments
The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets: How to Manage Your Portfolio Like the Harvard and Yale Endowments
by Mebane T. Faber
Edition: Hardcover
Price: £30.25

2 of 3 people found the following review helpful
5.0 out of 5 stars A momentum strategy and lots of information on obscure asset classes, 1 Mar 2011
This book's key selling point is the author's momentum strategy -- which he wrote a widely-read paper on some years ago. The strategy uses the 200-day (equivalently the 10-month) moving average: a simple average of a market's price over each of the previous 200 days. The strategy involves investing when the current price is above this average; otherwise, selling and moving to cash. The system is updated once a month.

This system is designed to arbitrage a key "anomaly" in financial markets: the momentum effect -- the tendency for prices to move in trends over the short-run. The momentum effect is a key fact of recent empirical work in finance, and provides evidence against the "random-walk hypothesis": the theory that stock price changes should be completely unpredictable. Over the medium-term markets also show another effect: the mean-reversal effect -- the tendency for gains/losses to get cancelled out by moves in the opposite direction.

Since markets often trend primarily in one direction for a number of years, the momentum strategy forces you to sell after a period of losses -- so that the current price drops below the average price -- and gets you buying back into the market only after a sequence of gains. This should limit your downside risk, and the author shows that this strategy would give you returns similar to market averages but with much lower risk in much of recent market history.

There is a strong intuition behind this strategy and it has been shown to work very well; however, it isn't something I would personally base my entire investment strategy on. This is because the strategy forces you to buy high and sell low: selling after losses and buying after gains. I prefer to invest based on mean-reversal: buying low after a period of losses, and selling high after a period of gains. However, I still find an appreciation for momentum useful: it can prevent me from buying low too early, as stocks might be cheap but still expected to fall further due to momentum. This alone made the book a great buy for me.

The book also contains a lot of information on esoteric asset classes: timber, private equity, hedge funds, and that sort of thing. This is where the title, "The Ivy Portfolio" comes in, as the Harvard and Yale endowments are famous for investing in these types of asset classes. This information is for only the hardcore finance geeks: these products are often expensive, difficult to invest in, and provide less diversification than you might think (as we saw with the credit crunch, a lot of these "diversifiers" fall even harder in a bear market than standard asset classes). One interesting asset class I hadn't heard about is closed-end listed hedge funds -- these trade like investment trusts at either a premium or discount to net asset value (NAV). These products could be good investments at large discounts to NAV; but as always, "caveat emptor": let the buyer beware.

The Little Book of Commonsense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns (Little Books. Big Profits)
The Little Book of Commonsense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns (Little Books. Big Profits)
by John C. Bogle
Edition: Hardcover
Price: £12.79

6 of 6 people found the following review helpful
5.0 out of 5 stars Minimise the costs of financial intermediation, 28 Feb 2011
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Bogle lays out an emphatic case for why costs matter to the individual investor. Unlike almost every other sector, financial intermediaries have found a clever way of hiding the true cost of their products. When you "buy" a mutual fund or invest through a financial adviser, the total cost of your decision will never be readily advertised.

For starters, there will be your mutual fund expense ratio. This will often be around 1.5-3%. Then there are the internal costs incurred when the fund turns over its holdings: this will often take a hidden 0.5-1%. Sales loads of up to 5% are often incurred when purchasing a new fund; with this your investment immediately shrinks by 1/20th, never to be recovered. Finally, your financial adviser will also take a cut -- often 1-1.5%.

These costs are all hidden, as they are only reflected by a steady drain in your account balance. A few percent every year is masked by the annual volatility of investing; however, this steady drain will greatly impoverish you over a life's investing. If your portfolio is six-figures or more, you can be incurring thousands of pounds of needless costs a year. Bogle shows a chart where a high-cost fund shrinks an investor's final portfolio value by more than half! This is because extra costs greatly diminish the power of compounded returns over time. If you overpay by £1,000 for your investment products in year 1, then not only do you lose this money immediately, you also lose the benefit of any compounded returns on this sum over time.

Bogle outlines a better way to invest: products are on offer with a cost of no more than 0.25% a year. These products -- index funds and ETFs -- are available to any individual investor at the click of a button and can greatly improve your financial future.

Bogle's case for low-cost investing is emphatic; however, in order to implement it yourself, you will need to learn some basics of asset allocation. There are many books that cover this information, including David Darst's title in the Little Book series. Financial advisers who only charge an hourly fee for one-off advice are also available if you are feeling unsure about your plan.

Breakdown: A Personal Crisis and a Personal Dilemma
Breakdown: A Personal Crisis and a Personal Dilemma
by Stuart Sutherland
Edition: Paperback
Price: £7.36

4 of 4 people found the following review helpful
4.0 out of 5 stars The author's breakdown, 24 Feb 2011
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I always enjoy autobiographical accounts; in "Breakdown" Stuart Sutherland describes his experience as a psychology academic and manic-depressive (bipolar) sufferer. The original edition of this book was published in 1976, and it has been added to in the later editions.

Sutherland's condition was sparked by his wife's infidelity, eventually sending him into a depressive phase. I say "eventually" because it took a long time from her confession for it to actually bother him. In fact, Sutherland had a number of his own affairs, and the two of the stuck together doggedly for a long time. I guess it's a sign of how times have changed since the book's original publication.

The depression forces Sutherland to go to a mental hospital, and this part of the book is similar to a factual "One Flew Over the Cuckoo's Nest". The depression eventually clears, and Sutherland enters his first manic phase, with these episodes being the least understood and most tragic episodes of his illness.

Given Sutherland's academic background, there is also a lot of material on the science and pseudoscience of mental illness, with a particularly withering put-down of Freudian psychoanalysis. (Another book on this theme that I'd recommend is Tavris and Aronson - "Mistakes Were Made, But Not by Me". This book shows that much of the "success" of psychoanalysis can be explained with the theory of cognitive dissonance.)

Exorbitant Privilege: The Rise and Fall of the Dollar
Exorbitant Privilege: The Rise and Fall of the Dollar
by Barry Eichengreen
Edition: Hardcover
Price: £14.39

16 of 17 people found the following review helpful
4.0 out of 5 stars The U.S.'s Exorbitant Privilege, 23 Feb 2011
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The U.S. benefits from an "exorbitant privilege" by having the dollar as the world's dominant currency.

The first benefit is convenience. Since dollars are so widely accepted, American individuals and firms need not go through the cost and inconvenience of changing their dollars into foreign currency. Secondly, the Fed can print dollars costlessly; whereas, foreign central banks have to expend real resources to gain dollar reserves -- allowing the U.S. to consume more than it produces.

Since the recent financial crisis more people have been questioning the dollar's role as the world's reserve currency. However, this is by no means the first time such questions have been asked. Similar questions were asked in the 1970s during the collapse of the Bretton Woods agreement, but the dollar's dominance continued unabated.

The dollar wasn't always the world's reserve currency: before that it was the pound. It took a very long time from the U.S. overtaking the U.K. economically -- roughly the period between the two world wars -- for the dollar to eventually overtake the pound. This is because the incumbent currency has clear advantages -- benefits such as more liquid markets and a greater coordination amongst third-parties -- that the rival currency has to overtake sufficiently to give enough people incentive to switch. This means that talk of the dollar's death is very much premature.

Eichengreen looks at the merits at two of the dollar's most prominent rivals: the euro and the renminbi. The euro is currently suffering, and although it covers a large economic area, it suffers doubly from not being under the control of a single government. The euro will have to digest these issues before it could become the world's premier currency. The renminbi has its own problems: the Chinese govenment's policies of strict capital controls and a cheap currency to boost exports aren't concordant with the requirements for the world's reserve currency.

Another floated alternative is for a new world reserve currency, along the lines of Keynes's "bancor" or an expansion of the IMF's program of Special Drawing Rights. These proposals, however, suffer from their own intractabilities.

Eichengreen's conclusion: don't write off the dollar yet, unless the U.S. presses the self-destruct button.
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Making Better Decisions: Decision Theory in Practice
Making Better Decisions: Decision Theory in Practice
by Itzhak Gilboa
Edition: Paperback
Price: £20.69

3 of 3 people found the following review helpful
5.0 out of 5 stars Buying this book is a great decision!, 23 Feb 2011
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This book is aimed as a decision theory textbook slash self-help book. As textbooks go, it's pretty fun to read. Each chapter begins with a series of problems, which are then used to illustrate key concepts.

This book covers both schools of decision theory: the classical theory of "optimal decision making", and the newer theory of decision making biases and errors. In Gilboa's words this is to, "highlight certain biases that most of us are prone to, in the hope that, with awareness and some analysis, you will exhibit only those biases you feel comfortable with".

Gilboa frequently stresses that these biases don't all have to be "irrational" just because they deviate from some academic's normative prescriptions. As long as decision makers know what they are doing, and why some people might disagree, then they can make informed choices. However, some biases, such as the framing effect, are much harder to justify. Gilboa also covers the main theory from each of the two schools about decision making under risk: expected utility theory and prospect theory.

The clarity with which this book espouses some classic problems is commendable. In particular, the graphical explanation of the independence axiom in expected utility theory, and how this axiom is frequently violated in the Allais paradox. The Monty Hall problem is also given a good work over for any stubborn disbelievers. Finally, there is also a great description of the Ellsberg paradox and the theory of subjective probabilities in decision making under uncertainty.

Gilboa gets two thumbs up from me here; I'm now looking forward to digging into his other works.

COMPETITION DEMYSTIFIED: A Radically Simplified Approach to Business Strategy
COMPETITION DEMYSTIFIED: A Radically Simplified Approach to Business Strategy
by Bruce Greenwald
Edition: Paperback
Price: £12.99

2 of 2 people found the following review helpful
5.0 out of 5 stars Barriers to Competition, 21 Feb 2011
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Warren Buffett is famous for preferring companies with "wide moats" -- those with unassailable competitive advantages -- as they are capable of producing superior returns for years on end.

Greenwald and Kahn's book analyses the sources of these advantages. From the preface:

"On a level playing field, in a market open to competitors on equal terms, competition will erode the returns of all players to a uniform minimum. Therefore, to earn profits above this minimum, a company must be able to do something that its competitors cannot. It must, in other words, benefit from competitive advantages."

In the economists' dictionary these advantages are called "barriers to entry". These might be due to a large firm benefiting from an economy of scale -- its large size enables it sell at goods at a lower cost. Some industries, such as utilities, have large barriers to entry because of incredibly high start-up costs. These industries are known as "natural monopolies" and are often strongly regulated to keep profits artificially low.

One recurring competitive advantage in the modern economy is the "network effect": sites such as Facebook and eBay have incredible inherent advantages because the size of their user base presents an insurmountable challenge to competitors.

Older competitive advantages are often due to geography. Wal-Mart is used as a case-study of this barrier. Wal-Mart has benefited from a superior distribution network which allows it to deliver goods in-store cheaper than any of its local rivals. This allows Wal-Mart to undercut competitors or enjoy fatter profit margins; hence explaining the firm's enduring profitability. However, this advantage means that Wal-Mart's domination is inherently limited, as Wal-Mart doesn't possess a cost advantage in markets further from its operational core in midwest USA.

This book presents interesting food-for-thought on the topic of competitive advantages in the modern economy. That is, barriers to entry in many "new" industries are incredibly low, indicating that returns will also be. meagre. Take a second-hand bookstore on Amazon, for example. Literally anyone with access to a post office and a few unwanted books on their shelf can compete with you. Additionally, consumers can find the lowest cost seller at the click of a button. The internet has allowed for a huge expansion in competition, but this has been to the main benefit of the consumer, not the business owner. The best way for companies to create competitive advantages is to offer a product that is truly unique and uncopyable. Either that, or stick to industries that benefit from old-school geographical barriers -- such as hotels.

Peep Show - Series 1 [DVD] [2003]
Peep Show - Series 1 [DVD] [2003]
Dvd ~ David Mitchell
Offered by best_value_entertainment
Price: £2.70

3 of 3 people found the following review helpful
5.0 out of 5 stars Two lovable losers watching telly in an ex-council flat, 21 Feb 2011
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The first few series of Peep Show have some truly classic moments of British comedy. This was before the characters morphed into caricatures, and before the writers became overly reliant on the, "Oh, no: they didn't!" type of shock humour which became tiresomely predictable some time around series five.

Peep Show stars two twenty-something best friends who met at uni: Mark and Jeremy. They are also co-dependent losers; who have struck up a bond of co-habitation as a fix for each of their most significant personality flaws.

Jeremy is the socially successful partner, on account of him having one other friend: the outlandish and infinitely cooler "Superhanz". Mark is the vocationally successful one, on account of him not being unemployed and because he owns the ex-council flat they live in.

Each character is terrible at what the other does best. Jeremy can't get a job, can't pay Mark rent, and his "band" with Superhanz isn't much more than an excuse to take drugs and a vehicle to try and impress girls with. Meanwhile, Mark is completely unable to pluck up the courage and ask out his love interest at work: "Sophie"; getting railroaded into the friend zone while watching a more stereotypically alpha male colleague have his way with her.

However, each character is also objectively terrible in their own sphere. Jeremy was recently dumped by his girlfriend, and spends the series unsuccessfully trying to impress their married neighbour. Mark, on the other hand, is a corporate drone, working as a loan officer at JLB Credit -- which has got to be the most depressing job title ever -- and gets passed over for promotion in favour of his love interest.

These two come home in the evening, and like real people they sit around watching telly, cracking awful jokes about whatever bit of mundane rubbish is on; they leave horribly embarrassing misjudged voicemail messages to people they like; and they make total idiots of themselves at parties. Finally some sitcom characters I can relate to!

This show is shot entirely from first-person camera angles, while Mark and Jeremy annotate the dialogue with their own neurotic internal monologue. This is truly a fantastic innovation, giving us gems such as Mark's series-long personal debate over whether his swollen testicals merit an embarrassing visit to the doctor, while it lets us know that Jeremy is just as insecure as the rest of us.

In later series Jeremy becomes a shallow, self-centred, and implausibly successful sex machine; while Mark becomes his prudish up-tight counterpart, a million miles away from the guy who smoked weed in a bowling alley toilet cubicle to impress a teenage goth (S1E3). I just wish Channel 4 would stop ruining my favourite comedies by commissioning them long after they've overstayed their welcome. I'm not grumbling because the later series are objectively bad, just that they are not nearly as good as what came before. Peep Show series one and two will always reside high up in my personal pantheon of all-time comedy greats. People new to this show must -- seriously, must! -- start off from the very beginning.

Keynes: The Return of the Master
Keynes: The Return of the Master
by Robert Skidelsky
Edition: Paperback
Price: £6.99

25 of 28 people found the following review helpful
5.0 out of 5 stars The Return of Keynesian Economics, 21 Feb 2011
Given that macroeconomists have been thinking about the world's economy since the late eighteenth century, an impartial observer could be forgiven for assuming that the field had reached some kind of a consensus in over 200 years.

They couldn't be more wrong.

The twentieth century saw a great tug-of-war between two separate schools of thought. In the blue corner, stand the economists who see the economy as a well oiled machine, instantly responding to exogenous shocks by reaching a new satisfactory equilibrium -- the classical economists and their latter day equivalent, the rational expectations crowd and real business cycle theorists.

In the red corner, stand Keynes and his myriad followers. When puzzling over the Great Depression, Keynes created a new model of macroeconomics: which stressed the imperfections and frictions in the economic machine that could keep the economy in an unsatisfactory rut for years. These frictions allowed for a role for government: to expand the money supply, cut taxes, and increase spending in the face of recession. Much of this has become modern-day common sense policy, but he was opposed by President Hoover in the U.S., and the British Treasury who insisted that a balanced government budget laid the best foundations for growth.

Sounds familiar?

Robert Skidelsky traces out this theoretical tug-of-war, and explains how the current crisis calls for, "Keynes: The Return of the Master". He also explains how this war was an overtly political one. The modern day economists who wanted to overturn Keynes were mostly conservatives with an innate distrust of government. The modern day neo-Keynesians, such as Nobel prize winners George Akerlof and Joseph Stiglitz, are largely liberals, who emphasise that markets have imperfections and failures as well as governments.

This short book is all about Keynes's ideas, and their enduring relevance in the 21st century. For a biography of Keynes the man, try Peter Clarke - Keynes.

The Little Book of Behavioral Investing: How Not to be Your Own Worst Enemy (Little Books, Big Profits (UK))
The Little Book of Behavioral Investing: How Not to be Your Own Worst Enemy (Little Books, Big Profits (UK))
by James Montier
Edition: Hardcover
Price: £12.78

2 of 2 people found the following review helpful
5.0 out of 5 stars James Montier's Little Book, 17 Feb 2011
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James Montier's reputation as the enfant terrible of behavioural finance put me off for a while. I'm glad I gave him a go: his analysis is always reasonable and accessible, rarely divisive for the sake of it; he does a great job of summarising academic research; and he regularly quotes investing greats such as John Maynard Keynes and Benjamin Graham as well as modern day gurus.

It's a great shame that the classical and behavioural finance schools don't have a more open dialogue. Classical finance should be a "normative" theory -- how things would be in a perfect world. Behavioural finance is a "positive" theory -- how things actually work in the messiness of reality with imperfect decision-makers. By investigating and ironing out flaws in the real-world we can slowly move things closer to the classical idyll. This can be through arbitraging stock market anomalies (e.g. the size and value effects), or by helping investors to avoid common errors (Richard Thaler and Cass Sunstein - Nudge). The trouble started when early empirical tests failed to reject the classical models, and theorists with a bias for rational models starting seeing them as accurate descriptions of reality (Justin Fox - The Myth of the Rational Market).

Like any new field, behavioural finance is rapidly developing. This book therefore benefits from its recent release date, and Montier summarises some of the most interesting developments (such as the technique of fMRI brain scanning), as well as all the classic findings such as overconfidence and loss aversion. Overall, I think this is the best non-technical introduction to behavioural finance out there.

This book is an easygoing quick read, and would benefit anyone who needs to make decisions for a living, as well as individual and professional investors.

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