What books do chief investment officers read to give them an edge?
Earlier in the year we asked Mark Delaney, chief investment officer of AustralianSuper, and Matt Whineray, chief investment officer of NZ Super, to recommend recent books that had changed the way they think about investing.
For good measure, Investment Magazine’s personal choice goes to Crisis and complexity, by Ross Barry, head of research and origination at First State Super.
Antifragile: things that gain from disorder, by Nassim Nicholas Taleb
Matt Whineray describes Antifragile as a guide to what types of systems deal with volatility and what do not.
The book’s blurb says “Just as human bones get stronger when subjected to stress and tension … many things in life benefit from stress, disorder, volatility, and turmoil. What Taleb has identified and calls “antifragile” is that category of things that not only gain from chaos but need it in order to survive and flourish”.
Whineray says Taleb’s thinking is useful for working out the advantages NZ Super has over other investors when volatility hits markets, particularly as it is a much longer-term investor than most.
“Our liquidity at times is going to be worth a lot and the market is prepared to pay for it,” he says. “So how do you set up a bunch of strategies that take advantage of that, without trying to forecast where the market is going next week or next month?”
The signal and the noise: the art and science of prediction, by Nate Silver
A recent influence on Delaney’s thinking has been this best-selling book by the New York Times political forecaster Nate Silver.
Delaney says that as much investing involves predicting the future, it was interesting to see how others, such as weather forecasters, did this.
The book’s blurb states: “From the financial crisis to ecological disasters, we routinely fail to foresee hugely significant events, often at great cost to society”.
Delaney notes Silver’s analysis helps focus the mind on single events that could lead to large financial crises, such as the sub-prime crisis. He was also struck by Silver’s observation about US weather forecasters having a wet-weather bias, i.e., they forecast wet weather more often than it occurs. Apparently, the weather forecasters felt it was not so much their job to accurately forecast the weather, but to get people to watch the weather channel.
In another insight, the book says that the average of all leading economic forecasts gives a much more accurate forecast than any one individual forecaster.
Crisis and complexity: an inquiry into the nature and causes of economic and financial crisis, by Ross Barry
Crisis and complexity explores a dozen economic and financial catastrophes since the Mississippi Bubble of 1720 and how each reset economic and finance theory.
Covering the events of 1929, 1987, 2000 and 2008 among others, Barry makes his thesis that these crashes show financial markets are complex adaptive systems, with a natural tendency towards instability.
Each crisis, says Barry, tends to puncture holes in the work of great financial theorists such as Markowitz, Keynes and Friedman.
He persuasively suggests investors naturally, but vainly, seek the same certainty about economics that Isaac Newton provided for physics. This desire for certainty, says Barry, is often the cause of many investors being lulled into stockmarket bubbles.
He criticises the capital asset pricing model, for presenting the world as made up of a set of rational agents acting independently, such that the whole market can be understood by deconstructing it into its constituent parts and studying each part in isolation. He says this ignores the “connectivity of agents” and leaves no room for the pattern of energy in markets.
He writes: “The financial industry typically gravitates en masse toward the most widely accepted, well-tested model de jour” and that only when these “prevailing fundamental laws fail catastrophically” are alternative models sought.
And he warns the next extreme financial crisis is not far away. He speculates that this could be a climate change-driven crisis, but he is most concerned at a breakdown of government finances in Europe and Japan possibly in 2016–17.
Rather than leave the reader hanging on this gloomy thought, Barry is optimistic for the concept of universal ownership, where the world’s largest sovereign wealth funds and pension funds take on a larger part of the functions performed by government and regulators. Such long-term investors, he posits, will have a better alignment with the public and world, than many of the reckless, greedy and short-term-thinking financial institutions he portrays in his history of major financial crises.