Foreword

Today, most literature or other media on finance tell us how to make money. We are bombarded with stock tips about the next Apple or Google, read articles on how India or biotech investing are the next hot thing, or told how some star investment manager’s outstanding performance is set to continue. The implicit message is that only the uninformed few fail to heed this advice and those that do end up poorer as a result. We wouldn’t want that to be us!

This book starts with a very different premise. It starts with the idea that markets are actually quite efficient. Even if some people are able to outperform the markets, most people are not among them. In financial jargon, most people do not have an edge over the financial markets, which is to say that they can’t perform better than the financial markets through active selection of investments different from those made by the market. Embracing and understanding this absence of an edge as an investor is a key premise of the investment methods suggested in this book, and something I will discuss at length.

Who is this book for?

It is for investors everywhere who have several things in common:

• They feel that they are not getting value for money from the finance industry and find it opaque, but realise how important investments are to their lives. They read about phenomenally wealthy finance types, but feel that in paying fees, for example, the results are poor. Thinking about the great phrase ‘Where are the customer’s yachts?’, they don’t even have a rowing boat.
• Ideally, they would like a simple portfolio of investments, but also want to feel that they can expect the best possible return for the risk they are willing to take.
• They may well have investments with typical investment managers as (despite themselves) they fell for the snazzy ads that showed great historical performance, which perhaps wasn’t matched post-investment.
• They may have shares in blue chip companies like Google, Apple, Exxon or Vodafone, but at the same time recognise they are not expert stock pickers and consider that is something best left to the professionals.
• They may also know a lot about finance and have a genuine interest in it, but with a busy day job are unable to devote a lot of time to their personal portfolio. They need a portfolio that helps them sleep better at night, knowing that their savings are well looked after without having to spend too much time on it.
• They may have been directed by an adviser who they had retained to help simplify the jungle of investment products and were left unable to understand their portfolio mix. Perhaps without knowing if the adviser took a share of the high fees they were paying.
• They probably also think about investing longer term. While this book certainly has many immediate action items it is the opposite of the ‘Spot the next hot stock’ or ‘Make $10,000 a day without getting out of bed’ genre.
• They want a book on how to do a little bit better every year financially, with a big cumulative impact over time. If a hedge fund manager is a turbo-charged Ferrari, this book is akin to the grey Volkswagen that is a far better bet to get you safely to your destination in one piece.

So this book is about taking something as opaque and impenetrable as the financial market sector and demystifying it; thus Investing Demystified. Once investors realise that they do not have the investing edge to outperform the markets, and know that this is perfectly acceptable, the rational next step is quite logical and simple. I call this next step being the rational investor and the portfolio for that investor the rational portfolio.

So what is a rational investor?

While I’m not expecting readers to know about finance, some basic knowledge is helpful. Someone without any finance knowledge may find it harder to distinguish between an unglamorous book that promises improved risk-adjusted performance over the long term and other appealing-looking products from the well-marketed finance industry that tell us we can all be Warren Buffett – or at least that we should try. No wonder that most people would rather aim to be a billionaire superstar.

However, to keep it an easily readable finance book, we will be relatively light on theory and complex maths. They play a central role in supporting the arguments made in this book as I’m keen that you understand that what I suggest is a practical implementation of the best theory on getting the optimum portfolio. But in the interest of readability I have tried to keep theory and maths to a minimum, and put some of it in boxes that you may choose to skip; likewise there are a limited number of footnotes and references for those who want to explore further.

This book uses words like estimate, guess, approximately, around, roughly, fairly, reasonable quite a lot. This is because the discussion is often about what will happen in the future and claiming certainty would be misleading. Most points are fair estimates of what we can expect and hopefully a framework of how to think about the issues. Reality will almost certainly turn out differently from what we forecast here, and perhaps even make a mockery of our logic if we try to be too exact. I use £, $, €, etc. interchangeably in the examples and discussion. This is deliberate as most of the topics discussed do not depend on currencies. Investors obviously care a lot about their specific currency exposure, but the issues faced by a sterling investor are very similar to those faced by a euro-based one.

Who am I to write this book?

This book draws heavily on my experiences managing a hedge fund and practically implementing investments, but also relies on academic research in portfolio construction. A one-time hedge fund manager writing a book about investments without edge may seem like a priest writing the guide to atheism. In my view, however, it is not at all inconsistent. The fact that some investors have an edge on the market does not mean that most people have it. Far from it. ‘Edge’ is confined to a very small minority of investors who typically have access to the best analysis, information, data and other resources. Most other investors simply can’t compete, and would be worse off trying.

Paradoxically, for those who know me as a hedge fund manager (I wrote a book called Money Mavericks about my experiences of starting and running a hedge fund), I was interested in optimal portfolio theory before I even really knew about hedge funds. For a while I planned to get a PhD in the field and perhaps teach. As it turned out, I graduated from university with a lot of debt and had a lucrative offer from Wall Street. From there, I got my MBA and ended up being interviewed at a hedge fund. Events happened, as they say. So I have a lot of experience with optimal portfolio and general financial theory, but also experience operating in the financial markets. Since I stopped running my hedge fund in early 2008 (fortuitous timing) I have mainly focused on investing my own money along the lines discussed in this book, and have extensive experience of trading the products discussed.