Book Reviews – Page 24 – The Aleph Blog

Book Review: Quantitative Strategies for Achieving Alpha

Posted on 20 May 2009 by David Merkel

In order to do this book review, I have to compare the book to five others that I have reviewed.

I chose these five, because they deal with factors that affect stock performance.? With 1 and 4, you can learn a great deal about price momentum.? With 4, you learn how price momentum and mean reversion interact, and even get taste of why even fundamentalists should grab onto this.

Today’s book, Quantitative Strategies for Achieving Alpha, takes a mix of factors, including price momentum, and attempts to show how investors can achieve above average returns.? That is similar to what was posited in books 2 and 3 in rudimentary ways, and in book 5 in more sophisticated ways.? The book that is most similar to this book is What Works on Wall Street.? More on that later.

The author has seven “basics” that must be applied to all investments:

Profitability
Valuation
Cash Flow
Growth
Capital Allocation
Price Momentum
Red Flags

These are the building blocks of good investment strategies, and the best strategies use 2 or more of the “basics.”? This is consistent with the book What Works on Wall Street.? The most important “basics” are Profitability, Valuation, Cash Flow, and Price Momentum.? Good strategies will look at most of them.

Quibbles

The data period for the analyses was short — a mere 20 years 1987-2006.? As time has gone on, data collection has gotten richer, but the 20 year period chosen was one of a big bull market, and not necessarily representative of the next 20 years.
Data mining — when testing a wide number of similar hypotheses, data snooping is a problem.? If theory A works well, why not test theories A’, A+, A-, A*, etc?? That happens in this book, but it does not make the error of What Works on Wall Street, because it does not make claims that the best strategies from the sample period will be the best strategies for the future.
Also on data mining, in the price momentum section, analyses are done to see which momentum strategies did best over the sample period, and then those strategies are applied.? Someone starting out in 1987 would not have had the benefit of that knowledge.
Strategies that favor increasing debt worked well, but that is a relic of the Greenspan era, where overages of debt were never punished.
Cash flow was an important variable, and there were variables for capital allocation, but there was not much discussion of earnings quality by itself, which has significant predictive powers.

The book is data and statistics heavy, but not equation heavy.? If your eyes glaze over from numbers and statistics, this is not for you.

Wrong way to use the book

Look for the strategies that gave the highest excess returns, Sharpe ratios, etc.? Follow those strategies religiously.? If you do this, you will mimic the excesses of the period 1987-2006.? Those won’t recur in the same way 2009-2028.

Right way to use the book

Use the book to guide your strategies.? Look at how you currently analyze stocks, and see if you aren’t missing significant factors that could improve your performance.? Look to balance your strategies such that all of the main factors get some representation.

Also, the summaries of each chapter are simple, and give the main thrust for those who get tired.? Tortoriello does a good job boiling it down for those needing a summary.? He also does not overpromise; the book is free from overselling, in my opinion.

If you want to buy it you can buy it here: Quantitative Strategies for Achieving Alpha (McGraw-Hill Finance & Investing)

Remember, I read the books that I review.? Not all do.? Those entering Amazon through my site, and buying anything, I get a small commission, and their prices do not rise at all.? This is my version of the “tip jar.”

Book Review: Street Fighters

Posted on 16 May 200916 May 2009 by David Merkel

This week, amid everything else I was doing, I read the entirety of the newly released book, “Street Fighters: The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street,”? written by Kate Kelly, Wall Street Journal reporter who covered Securities firms like Bear Stearns, and wrote three major articles as it declined.

Here is how the book works: it takes you from Thursday evening to Sunday evening during the crisis.? When a new topic or person is brought in in an important way, Kate Kelly does a flashback to give readers the needed background.? It detracts from the urgency of the rest of the story, but does flesh out how Bear Stearns came to this ugly situation.

Culture matters in an organization.? A well-run organization, such as existed under Ace Greenberg developed pride in the organization, because it worked so well.? But pride, once engendered, is a fickle mistress.? Under James Cayne, once he stopped checking the details, and even major issues like exposure to the mortgage markets, pride was destructive.? Alan Schwartz believed that Bear Stearns was a great institution, and it blinded him regarding raising capital.? They couldn’t need additional liquidity, until it was too late to raise it.

Kate Kelly interviewed many people extensively for her book, and includes footnotes where parties don’t agree with her renderings.? She does make? the? last 72 hours live, with all of the uncertainty and fear of the situation.? I liked the book, and would recommend it.? That said, there are other books out on Bear Stearns, and I have not read them.

It’s a Small World After All

Now, what are the odds that a kid I used to stand with at the bus stop to go to kindergarten would end up in this book that I am reviewing?? To an actuary, it boggles the mind.? There is a “bit player” who appears twice in the book, my old friend Pat Lewis.? He lived three doors down from me, and was the popular, tall athlete, while I was a short nerd who tried my best in athletics.? We were both long distance runners, but he was my better by far.

After many years, I came back into contact with him in 2000 or so, when he had gotten a job in risk control at Bear Stearns.? I met him for lunch during an actuarial conference in midtown Manhattan — what a place to meet for two guys from the Milwaukee suburbs.? We caught up on each other lives and careers.? Me, married with seven children (then — eventually eight) — he, unmarried, but still more handsome than me.? Both of us are risk managers — he at Bear, me at F&G Life.? As the book records, Pat and those working with him try to create mathematical models that will highlight the risks of Bear.? James Cayne, not understanding the value of them, kills the project.

There are other references to him in the book, but this is a tale where those more powerful would not listen to reason.? Pat Lewis is a standup guy, and stated what he believed, even when things were chaotic.

Lessons

Though the book gives its own set of lessons, I want to give a few of my own.

Love beats fear… we need friends

Bear might have felt like a big swinging dick after LTCM, where they stiffed the rest of the securities industry by refusing to pony up capital, but that cemented the view of the rest of the industry: Bear was not a team player.? That cost them when their disaster hit.? My conclusion: love beats arrogance in the long run.? Better to have friends than to suffer alone.

Don’t take your eye off the ball

Cayne clearly took his eye off the ball thinking that the business would do fine without close attention — he could go off and play bridge and smoke pot.? Inattention destroys businesses.

Risk control wins in the long run.

Cayne ignored risk control.? He was happy with a high ROE, and did not look closely to see how it was generated.

Liquidity is lifeblood — consider the BONY box.

Goldman is the only securities firm to come through this crisis almost unscathed.? Rather than pressing it to the limit, they would add assets during good times to the BONY box.? That is, they would save safe assets to protect themselves in the long run.? What a wise strategy.? No wonder that they run our government.

Summary

This is a good book that deserves to be read by those that want a clear view of how Bear Stearns went down.? It is engaging and informative.

As For Me

Here are some posts that I wrote during the crises:

If you want to buy the book you can buy it through the link in my leftbar. ?? Or, you can buy it here:

Street Fighters: The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street

For those that want to sponsor me, anytime that anyone buys at Amazon after entering through my my site, I get a small commission, and your price at Amazon remains the same.

Book Review: Trend Following (5)

Posted on 30 April 200930 April 2009 by David Merkel

There are many places where I agree with Michael Covel.? Here are two:

Trend following, or, price momentum, is a good strategy.
Most investment advisors charge a lot, and on average deliver suboptimal performance.
The weak form of the efficient markets hypothesis doesn’t work.

Most of the Wall Street establishment, and those trained by universities and the CFA program believe that the weak form of the efficient markets hypothesis works.? I.e., You can’t make money from past price and volume information. This is why most of them don’t use price momentum.? They would get laughed at.? The weak form of the EMH is holy stuff.

Beyond that, the fund manager consultants try to cram every manager into a simplistic risk control model, leaving managers little room to hold cash, or invest in promising places that don’t fit the narrow pigeonhole that the fund manager consultants use to simplify their work.? Someone who rotates styles, sectors, domestic versus international, or who simply raises cash when opportunities don’t seem so good are anathema to the fund management consultants, no matter how good their performance is.

But as time has gone on, the behavioral finance folks have shown that valuation, price momentum, normalized operating accruals, and other factors have significant predictive potential on future returns.? Hedge fund managers, who have less of a tendency to listen to the fund management consultants, and a greater tendency to do what works, do use trend following, or price momentum in their investing.

What if Everyone Followed Trends?

Suppose everyone except Warren Buffett decided to follow trends.? The market would become very volatile, as was suggested in Investing by the Numbers.? (By his model, anytime momentum investors are more than 20% of the market, things go nuts.)? Buffett would make money hand over fist as he would sell holdings as they soared over fair value, and buy as they crashed well below fair value.? The valid strategy that is less employed makes more money.

There would be another effect.? There is a limitation on the ability to short on the market as a whole, if the borrow is enforced.? The whole world is 100% net long every night.? Shorts and leveraged longs are side-bets in the game of investing.? The more trend followers there are, the more that shorting capacity would prove to be a constraint, because once things start going down, the available shares to borrow would disappear.? The profitability of trend following in a bear market relies on a small enough number of parties selling short.? Everyone can’t sell short at the ame time.? Everyone can’t go to cash at the same time.? The assets must be owned by someone at the end of each day.

There’s only one strategy that could be followed by everyone — Indexing (and not fundamental indexing).? Returns to any strategy decrease as more pursue it.

On Audited Track Records

Bill Miller had a great audited track record, and it imploded in two years, largely because he did not understand the financial stocks that he owned.? While working at Provident Mutual, I interviewed a growth manager who used price momentum heavily, and had a tremendous track record.? I pointed out 10% of his portfolio that had poor earnings quality, and he gave me a “you don’t know the right things to look for” answer.? In the next week, a number of those companies preannounced earnings shortfalls.? The marketing guys came over to me and said, “You called that one.”

In truth, I didn’t.? Rarely do things happen that fast.? But that manager did disappear within a few years, despite his great past track record.

There’s a reason why we say, “Past performance does not indicate future results.”? Because it doesn’t.

I am not saying that I manage money better than Michael Covel, or anyone else.? He has done better than me, even though I have done better than 90% of all long only equity managers over the last nine years.

I do not have an audited track record, but only because I don’t want to pay for something that I don’t have use for.? I am not broadly advertising my services.? If an institutional investor would want to use me, I would get my returns audited.

I write my blog because I enjoy teaching, nothing more.? It fills a hole in my life, a part of a need to give back.

In closing, I can endorse “Trend Following” because its basic premise is true.? Follow price momentum and you will beat the equity market 80% of the time.? I just did not enjoy the lack of logic from Mr. Covel.? Correlation is not causation.? Making money in the past is not proof.? Picking and choosing trend followers does not constitute proof.? Take a more humble attitude, and you have a good book.

Book Review: Trend Following (4)

Posted on 28 April 2009 by David Merkel

While reading the book Trend Following, I was reminded of something that I read in The Intelligent Investor (I have the Fourth Revised Edition.)? These are two very different books.? What could be the same?

Fortunately, you don’t have to have a copy of The Intelligent Investor to see this.? Appendix 1 of the book is, the edited transcript of Warren Buffett’s talk that he gave at Columbia University in 1984 for the 50th anniversary of publication of Security Analysis can be found here.? The PDF version can be found here — it has the tables, but will take a while to load.

Buffett chooses 9 investors in the mold of Ben Graham, all value investors, and shows how they have soundly trounced the market over their tenures.? He uses that correlation to demonstrate that since they all used the same basic theory of investing, it is unlikely that their wonderful performance is due to mere chance.

In appendix B of his book, Michael Covel chooses 14 (or so) investors who are trend followers, and shows how they have soundly trounced the market over their tenures.? He uses that correlation to demonstrate that since they all used the same basic theory of investing, it is unlikely that their wonderful performance is due to mere chance.

See the similarity?? Now, I think that both approaches work to some degree, though not all of the time.? I have known a number of managers that have married the two approaches, usually with some success.? (As Humble Student Cam Hui points out, marrying the two may be more difficult than it seems.? I’m going to have to dig up that copy of the Financial Analysts Journal.)

I would criticize one aspect of Buffett’s logic, and the same would apply to Covel.? I’ve known my share of bad value investors.? Usually they overemphasize cheapness, and forget “margin of safety” as the key intellectual concept of value investing.? It’s easy to come up with a group of great managers following a certain strategy in hindsight.? Where is the grand study of all investors of that class, be it value investing or trend following?? Almost any strategy could be made to look good if one can cherry-pick the investors with the advantage of hindsight.

So, what would qualify as a valid study?? You’d need a relatively complete census of the group following a given strategy, including those that failed and dropped out.? After that, audited returns would help, as Mr. Covel likes to point out.? An alternative would be to follow a smaller closed cohort of managers following a certain management style.? The problem with that is you yourself might have a really good eye for management talent apart from the investment style.

Another alternative would be an academic-style study where the researcher defines the buy and sell criteria and then sees if the method beats the market, whether adjusted for risk or not.? Now, regarding risk, that is one of many places where I agree with Mr. Covel.? Standard deviation does not measure it; beta doesn’t measure it; tracking error doesn’t measure it.? Maximum drawdown, or maybe some obscure statistic from extreme value theory would probably be the best measure.

Why drawdown?? It best measures the ability of a manager to continue his strategy without panicking.? Most of us would question our sanity after a certain level of loss, and give up.? For different investors, the number is different.? For those managing external money, it is more important, because normal investing processes get destroyed when investors pull their money.? Where is that maximum level where investors will stay on board?? It depends on how they were sold on investing their money with the manager.

What are the problems with doing an academic-style study?

Often does not include costs of commisions, market impact, etc.? Liquidity is implicitly free, while in the real world, it is costly, particularly for undervalued oddball securities.
Data-mining may allow anomalous result that are noise to be reported as signal.
Managers using the style being modeled argue that it does not truly represent what they do.
Some studies get skewed by using calendar-year-end dates, where trading is often unusual.

Does that mean doing? definitive studies of trading strategies is impossible?? No, but it is quite expensive to do, so those interested in questions like this often resort to shortcuts, such as academic studies, limited peer group studies, etc.

Now, fairly comprehensive studies for things like growth and value managers exist (tsst… value wins), and some studies for CTAs exist.? But I’m not aware of any comprehensive studies for trend followers.? The academic studies show that price momentum is an important factor in market returns, and many investors with good returns use momentum.

It begs the question, if price momentum, or trend following is a panacea, why is it not more broadly embraced by the money management community?? That is tomorrow’s essay.

Book Review: Trend Following (3)

Posted on 28 April 2009 by David Merkel

What I find interesting about this subject, whether we call it “trend following” or “price momentum,” there has been a confluence of different parties agreeing that price momentum works.? I have reviewed many books recommending momentum strategies (an example), and have usually recommended them (sometimes with reservations).? I will even recommend Trend Following to those who don’t know that positive price momentum aids investment performance about 80% of the time.

What groups of people have come in to support price momentum?

Most quantitative stock screeners/graders use a mix of momentum and valuation factors.
The academics behind behavioral finance support price momentum and valuation factors, in addition to some others.
Many large (and smaller) hedge funds that trade stocks do so using momentum as a positive factor in stock selection, along with valuation, earnings quality, and a host of other factors.

I know, there are still Efficient Markets Hypothesis zealots in the academic community, but they are being outflanked by the behavioral economists who have hard data to support their theories.? The Adaptive Markets Hypothesis describes the way the markets really work.? Rather than using a physics-based analogy, better to use a biological analogy — I view investment strategies through an ecological frame.? Multiple strategies compete to obtain scarce excess investment returns.? The strategies that are least pursued relative to their validity usually have the greatest punch.

Is everyone a fundamentalist?? Momentum strategies win.? Are there a lot of traders chasing momentum?? Value strategies win.? Is there a dominant view to seek dividends?? Growth strategies win.? Is everyone chasing after growth?? Perhaps we should look for dividends.

I don’t know about everyone, but among quantitative investors the opinion is virtually universal that trend following is the right strategy.? Follow price and earnings momentum.? I even put out a small piece weekly on short-term performance of industry groups, which is largely based off of price momentum.

So, if Mr. Covel thinks that trend following is an underfollowed idea, I can simply say that there are a lot of us following it, to the point where the trade might be crowded.? Trend following is a significant part of the total market ecology, and when it becomes dominant, its short-term returns become curtailed, until enough money leaves the trade.

I’ll discuss this more tomorrow, when I discuss how we test the validity of investment strategies.

Book Review: Trend Following (2)

Posted on 25 April 2009 by David Merkel

I had a long debate inside myself before writing my book review last night.? I could have written the review recommending purchase of Trend Following, because it teaches a truth that often gets ignored in the market — following price momentum pays around 80% of the time.? As a value investor, that was a hard lesson for me to learn, but I accepted it once the evidence was clear enough.

Why I did not recommend the purchase of the book was more over tone and style.? Here are two examples: on pages 294-296, he discusses this paper that shows that Commodity Trading Advisor [CTA] performance is little better than T-bills.? There is one substantive complaint, and I agree with it, that the Sharpe ratio is a lousy measure of performance.? Most of the other arguments focus on the author’s affiliations — AIG Financial Products and Vanguard.? It is not valid to dismiss evidence off of the background of the individual.? Deal with his arguments.? So what if he worked for AIGFP?? That doesn’t make him liable for everything done there.? Same for Vanguard.? Merely because you work for Vanguard does not mean that you shill for mutual fund industry in everything that you do.

Humble Student of the Markets Cam Hui raises these objections in his comments to my piece last night.? I object to the ad hominem arguments of Mr. Covel.? If we must argue, let us argue on the basis of principle, and may the best side win.

Now, when Mr. Covel responded to me, it was also an ad hominem argument, tying me to Jim Cramer.? Now note, the first piece has disappeared from the internet, and I know not why.? Perhaps he gets that I am not a Jim Cramer clone.? To my readers I ask, how many of you think that I am like Jim Cramer in the way I advise?? I wrote a long series of articles on using investment advice to inoculate people against using stock tips from the media, partially because as Jim Cramer became more of a media phenomenon, his recommendations became worse.? He is at his best when he writes/says less, and gives you his considered opinion.? Investing and doing something sensational for the media do not mix.? That’s the conundrum of the value proposition for TSCM.

That said, Cramer does use price momentum as one of the factors in his stock selections.? He is generally a “trend follower.”? Cramer also is not a value investor.? Much as I appreciate him giving me a chance to write, we aren’t very similar.? That’s consistent with TSCM philosophy — they want a large range of views.? I wrote there for four years, and was one of their leading writers.? I rarely interacted directly with Cramer, instead, putting forth my own views, which did better (in my opinion).

I’m not Cramer, and he’s not me.? He just gave me a chance to write, for which many are grateful.? (I would tell you that he taught me how to trade corporate bonds, even though he has never traded corporates, but that would be a long story.)

Pressing on

This is not my last article on this topic.? I intend on continuing this discussion, to flesh out where I agree with Mr. Covel, because at many points I do agree, but there are complexities that need further elucidation.

The main areas I will cover in the future include:

When does trend following fail?
What other factors should we consider?
What constitutes adequate proof that a strategy is superior?

I credit Michael Covel for commenting at my blog, and I will answer his question, but not today.? It is a valid question, but there are other questions that can be posed to him as well.? Let the debate commence on a fair basis.

Book Review: Trend Following

Posted on 25 April 2009 by David Merkel

This review is unlikely to make me friends, and likely to generate some negative mail.? Let me start with the conclusion: don’t buy the book.? That said, my reasons for stating this are different from those who typically criticize Michael Covel.? I agree with much of what he says; I disagree with much of his rhetoric.? Let me give you my thoughts:

1) Momentum is a pervasive factor in the markets.? It works about 80% of the time and produces significant excess returns on average.? Behavioral finance points out that people are slow to adapt to new information, so momentum tends to work because the initial moves on new information aren’t sufficient.? That said, when too many are chasing momentum, the market becomes extremely volatile, and the strategy ceases to work, until it shakes out enough momentum-followers.

What is hard, is distinguishing trend following from technical analysis from momentum.? Personally, I think momentum explains the other two.? It’s a much simpler theory, and much as Covel appeals to Occam’s Razor, I apply it back to him here.

2) He draws on a series of investors that have done well in the past, and touts them as proof of his theories.? Hindsight is 20/20.? What of those that have tried to apply trend following and failed?? Is it many or few?? Keeping a tight stop loss for some means the death of a thousand cuts.? The studies that I have seen show that frequency of trading tends to decrease returns.? Now, trend following does not necessarily mean a lot of trading, but for many it ends up being that way.

It is easy to locate a bunch of trend followers in hindsight, and tout their abilities.? What would be harder would be to find the whole universe of people following trends, and see how they do as a whole.

3) Mean reversion is a weaker factor, but still significant in making money.? Value investors typically do well with it, but only reliably when they insist on strong balance sheets.? I’ve studied mean reversion for years, and it exists in almost all markets as a weak factor.? Over enough time, that weak factor has punch, but in the short run, momentum rules on average.

4) Covel spends a lot of time trashing fundamental analysis, without much meat behind it.? Fundamental analysis works well, but doesn’t have so much value because so many are applying it.? It’s not like the situation Ben Graham found, where few were doing it.

Aside from that, technicians implicitly rely on fundamental analysis, because their support and resistance levels stem from the decisions of fundamental investors.? Same for those that follow trends.? The trends exist because fundamental investors react slowly to changes in the fundamentals, and trend followers exploit them.

5) There is no mention of the Adaptive Markets Hypothesis, and little discussion of Behavioral Finance.? These are much richer theories that encompass “trend following.”

6) Covel takes “pot shots” at Buffett over issues that are unrelated to his main point in an effort to discredit him.? Buffett is a bright guy who can criticize derivatives in aggregate, while still using them in specific to his advantage.? (Cough, cough.? Please ignore his put option trades.)

7) There was not enough time spent on “how to trend follow.”? After reading the book, if I didn’t have prior background knowledge, I would be scratching my head to figure out how I could reliably pick investments in a trend following mode in order to make significant excess profits, as well as know where to sell them.

I don’t recommend it, but you can buy it here: Trend Following (Updated Edition): Learn to Make Millions in Up or Down Markets

Final note — Covel needs to grow up and learn that there are other factors in the market aside from momentum.? He has become a fundamentalist about “trend following” and does not seem to have the open mind that he harps about.

PS ? Remember, I don?t have a tip jar, but I do do book reviews.? If you enter Amazon through a link on my site and buy things from them, I get a small commission, and you don?t pay anything extra.? Such a deal if you wanted to get it anyway?

Book Review: Two Books on Options by Anthony Saliba

Posted on 23 April 2009 by David Merkel

I’m usually pretty open to reviewing books.? Sometimes I get books that I can’t do justice to in reviewing.? The following two books may be examples of that:

Option Spread Strategies: Trading Up, Down, and Sideways Markets

Option Strategies for Directionless Markets: Trading with Butterflies, Iron Butterflies, and Condors

I’m not an options trader.? Do I understand the math? Largely, yes.? Do I understand how they can benefit investors?? Also yes.? I occasionally use options to enhance income, but for the most part, I avoid using them for personality reasons.? I fear that I would make bad decisions while working at a higher level of leverage.? I don’t trust myself.

As for the books, they are clear and well-written, giving both the common view of options, and the view using the “greeks” a la Black-Scholes.? The chapters explain, and then offer tests at the end to see how well you have understood.? These could be textbooks in a business school.

The books explain how you can make money in any environment if your view of the world is correct.? That’s the catch, though.? Few of us get it right within the length of time before an option expires.? Be wary of the correctness of your opinions.

Now, my opinion is not of the highest value here.? Better to consult Adam Warner or Bill Luby, who have far more practical experience on a retail level.? My experience is largely institutional with respect to options.

Book Review: When Giants Fall

Posted on 22 April 2009 by David Merkel

I’m behind on my book reviews.? You should see two more in the near term.

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I try to resist doom-and-gloom literature.? Some of it finds its way to my door anyway.? When Giants Fall covers many of the issues that I have covered at my blog with an even more dour slant.? It contemplates the demise of American hegemony in the world.

Though I’m not crazy about the US Dollar, and the US in this economic environment, I’m not sure what can replace the US and its flexbile economy, which allows the rest of the world to shed its excesses here in exchange for buying our debts.? Yes, it is not sustainable.? But something not being sustainable does not tell us when it will end.? Nations like China following non-economic goals typically have to go through an experience where they eat so much of something bad for them and then they throw up.

Um, that’s not scientific-sounding, but I think it is a fair way to describe how a large unstable equilibrium gets destroyed.? The non-economic provider of liquidity (China) to the parasite in question (the US) must choke.

Who Would Benefit from this Book

Hmm… back to the book.? If you get easily dismayed, this is not the book for you.? Michael Panzner paints an “end of the era” picture for America, with the nation as a whole less well off.

For those that are willing to look at the pessimistic side of what is possible, When Giants Fall is a reasonable account of what could happen.? Warning: the book is long on description, and short on solutions, both personal and national.

You can buy it here: When Giants Fall: An Economic Roadmap for the End of the American Era.

PS ? Not many book reviewers read the books that they review.? They read the summary that the PR flacks send, and rely heavily on that.? I throw away those summaries, and read the books.? That takes time, but I like reading books, and when I wrote for RealMoney, I often missed reading books.? Now I read them more, and you can benefit from that, because I don?t always endorse the books that I review.

I don?t have a tip jar, but if you buy anything through Amazon, after entering through a link on my site, I get a small commission, and your costs don?t go up.? I like taking? the fees out of Amazon, and not out of my readers.

Book Review: Margin of Safety

Posted on 22 January 2009 by David Merkel

This book review is different.? I liked this book a lot, but I don’t want you to buy it.? Why?? I’m a value investor, that’s why.? More on that in a moment.

What commends this book to our attention?? It is a well-written book on value investing by one of its leading practicioners, Seth Klarman.? I love reading books on value investing written by the experts who have done it so well.? It is useful to get their differential insights.? It sharpens you.

What I found in Margin of Safety was a very good basic book on value investing.? It contains the usual warnings against speculation, which most retail investors do, and how Wall Street frequently overcharges and misleads retail investors.? Even institutional investors get cheated by focusing on relative performance, rather than absolute performance, according to Mr. Klarman.? As an absolute value investor, he wants to make money all the time, not just beat the market.? (A word here, if stocks beat safe bond investments on average, then there may be some validity to relative value investing.)

The book was written in 1991, after the junk bond market collapse, and contains a decent amount of criticism of the era.? Buying high yields is not enough, those yields be realizable from companies that can produce cash flows to support the price of the bonds.

The book also reflects the author’s early career in the investment shop founded by Max Heine, and run by Michael Price, until it was sold to Franklin Resources.? The Mutual Series Funds did ordinary value investing, but they also bought special situations, did deal arbitrage, bought distressed debt, and more.

The eponymous and key idea of the book is Ben Graham’s concept of a margin of safety.? Invest in assets where your likelihood and severity of loss is low, given your purchase price.? Don’t take risks unless you are handsomely paid to take them.? If you buy enough of them cheap enough, you will do well in the long run.

All in all, a very good book on value investing.? Why not buy it?? Too expensive.? The book is good, but very basic.? You can do better for free with:

So how much would it cost to buy a copy?? $900-$2000.? You can see the results at Ebay and Amazon.? Put on your cost-sensitive sunglasses before viewing.

It’s a very good book, but relative to what is available for free or at nominal (<$30) cost, it doesn’t make sense to buy it, aside from bragging rights.

So, how did I end up with a copy?? I don’t have a copy.? I borrowed it via Interlibrary loan and quickly read it, sending it back to the nice library in Florida that lent it to my library.? I recommend that you do that as well, if you want to read the book.? If you are game, I also ask that you write Seth Klarman at:

THE BAUPOST GROUP
10 St. James Avenue – Suite 1700
Boston, MA 02116

617.210.8300

Write a nice letter, asking him to do a second edition of the paperback version for a new generation of young value investors.? At least a reprint…

For those just wanting to know what he holds for clients, the 13F is available here.

PS — No link to buy it here, but remember, I do book reviews of all sorts of books, not just new ones.? Often the old stuff is better, like today’s book.? If you enter Amazon through any link on my site and buy anything there, I get a small commission.? It is my version of the tip jar, and the best thing is, it comes out of Amazon’s pocket, and not that of my readers.