Myths and other rubbish we believe as absolute truth

Nassim Nicholas Taleb, author of “The Black Swan,” said investors who lost money in the financial crisis should sue the Swedish

Central Bank for awarding the Nobel Prize to economists whose theories he said brought down the global economy.

“I want to make the Nobel accountable,” Taleb said today in an interview in London. “Citizens should sue if they lost their job or

business owing to the breakdown in the financial system.”

Taleb said that the Nobel Prize for Economics has conferred legitimacy on risk models that caused investors’ losses and

taxpayer-funded bailouts. Sweden’s central bank will announce the winner of this year’s award on Oct. 11.

Taleb singled out the Nobel award to Harry Markowitz, Merton Miller and William Sharpe in 1990 for their work on portfolio

theory and asset-pricing models.

“People are using Sharpe theory that vastly underestimates the risks they’re taking and overexposes them to equities,” Taleb

said. “I’m not blaming them for coming up with the idea, but I’m blaming the Nobel for giving them legitimacy. No one would

have taken Markowitz seriously without the Nobel stamp.” “People used the theory and assigned numerical forecasts to the

algebra,” said Sharpe, a professor of finance, emeritus, at the Graduate School of Business at Stanford University, in a telephone

interview. “But I’m not going to take the blame for the numbers they put in.”

In his 2007 bestseller “The Black Swan: The Impact of the Highly Improbable,” Taleb described how unforeseen events can roil

markets. He warned that bankers were relying too much on probability models and disregarding the potential for unexpected

catastrophes.

“If no one else sues them, I will,” said Taleb.

Source: Bloomberg.com, October 2010

Anyone who considers himself knowledgeable in the capital market believes certain “absolute truths”:

• “You can never time the market”

• “Time in the market is more important than timing the market”

• “Equity is always the best investment”

• “Debt does not provide an inflation hedge”

 • “Always use your income to prepay all debts”

• “High risk – high profits”

Accepting the risk of abuse from my peers I have mentioned a few truths that I consider jokes. Thought and analysis are

reasonable requirements from the student and practitioner of the Investment Advisory Profession. Students need to pass their

examinations and will have to study the various theories. Being able to pick the good from the fanciful will make a career and

create wealth both for the practitioner and. Take your pick between pure academics and a logical analysis for real life, but mug up

on Sharpes or you may not make it to graduation!

May I discuss my pet grouses one at a time?

• “You can never time the market”

Markets check the clock only in technicals, there especially with the DMA (Daily Moving Averages). The market can and must be

timed by value. I believe in the dictum of “Buy low, sell high” and its reverse. Timing the purchase at a low valuation and selling

when these are high are timing by value. This applies equally to the broader market as to individual stocks, bonds and other assets.

• “Time in the market is more important than timing the market”

Many leading stocks of every decade are the dogs of a future time. Seldom does a stock keep its leadership over an extended

period. While active trading is not wise for an investor, neither is a “forever” holding period. Holding “forever” may suit Buffet, but

for lesser mortals money taken off the table may be the only profits earned.

• “Equity is always the best investment”

A study of a 3 or 5 year rolling return of the Sensex from 1992, the year real retail participation commenced in the Indian markets,

shows that the comparatively low interest State Bank of India fixed deposits performed better than the Sensex over most periods.

A notable exception to this would be 5 years from 2002/03 to 2007/08 when the Sensex returned 700% over 5 years. At various

times real estate, gold and silver have performed better than broad equities. If you used the most basic valuation tools you would

find that Indian Equities are largely over-priced in relation to interest rates expect following crashes beyond 50%.

• “Debt does not provide an inflation hedge”

Like the curates egg, good in parts, or true at times. There is a strong lobby suggesting that gold provides protection against

inflation. If this were true gold would have been priced astronomically higher. Debt has out-performed more often than not.
Equity has often under-performed debt. Central Bankers, including India’s RBI strive to ensure some positive real rate of return to

bank depositors. Lack of real returns leads to outflow of funds, as seen in the history of some economies.

• “Always use your income to prepay all debts”

Yes, if it were credit card outstanding or personal loans. This might also apply for auto loans without penalties for pre-payment

and all consumption loans. But never prepay your mortgage (home loan). The tax benefits are only one of several reasons.

• “High risk – high profits”

This is a joke played on anyone who puts his money in any avenue outside casinos, horse racing and other gambling dens. The

greater the risk taken, the greater are the chances of wealth eroding.

While my teacher was taking our class through the Gordon’s Growth formula for share valuation, I suggested that my brilliant

colleague heading research might sack the analyst using it. I could not believe that a system, possibly better suited to valuation of

debt would work effectively for Equity. By Gordon, Berkshire Hathaway has no value and Microsoft is an underperformer. I

believed then, and do now, that equities are purchased more for the appreciation they offer, than dividend yield (though this is

also a good reason).

Sensex returns calculated from 1979 is another joke that the investor advisory industry plays on investors. The Sensex was formed

in 1986. Any fund manager who prepares a dummy historical portfolio based on data already available would be, well, a dummy.

Naveen Fernandes, CFP