Investing Demystified 1 – Markets and Portfolios
Today’s post is our first visit to a book that is popular with passive investors in the UK – Lars Kroijer’s Investing Demystified.
Lars Kroijer
I first came across Lars Kroijer on the Monevator site, but his book is increasingly popular on the UK finance subreddits (perhaps second only to Tim Hale’s Smarter Investing).
- Lars is Danish, but lives in London.
- He has an economics degree from Harvard, and an MBA from the business school there.
Until 2008, Lars was a hedge fund manager (market neutral special situations, since you ask) and he wrote a book about that (Money Mavericks).
- He now works at Alliedcrowds.com, which “aggregates alternative capital into the world’s lower-income countries”.
Lars claims to invest his own money along the lines discussed in the book.
Investing Demystified
Regular readers will know that I am not a 100% passive investor.
- From what I have read prior to this book, Lars is – so I don’t expect to agree with everything he writes.
He also pushes what I would call a “Lazy Portfolio” of only two funds.
- See my series of posts on this subject for my detailed position on these.
The one-liner is that they are suboptimal, particularly for investors with larger portfolios.
- I also struggle to see how such a simple approach can fill a 250-page book.
So don’t expect a ringing endorsement from me for this book.
- But in the spirit of education, I will look for common ground where possible.
Efficient markets
Lars starts the book with the premise that markets are quite efficient, and the majority of people are not able to outperform them.
- I will take issue with this, but first, we need to define terms:
For now, I will assume that by “markets”, Lars means the market-cap weighted indices, like the FTSE-100 or the S&P 500.
- These are by definition averages, and 50% of market participants should beat them (before costs).
They are also inappropriate as benchmarks for private investors.
- You need your own benchmark that reflects the likely composition of your ideal and practical portfolio.
That won’t be 100% local stocks for anyone.
Further, market cap weighting is a poor way to construct an index or to weight a portfolio.
- If you want a simple alternative, equal weighting is better.
If you can tolerate the (relatively simple) maths, then risk parity or volatility parity is even better.
- This applies across assets and geographies as well as within a single stock market.
As to efficiency, truly efficient markets would not exhibit simple outperformance factors like Who is the book for?
Lars provides a few examples of people who might get something from the book: Lars calls the rational investor someone who does not think than he can outperform the markets, or pick funds than can do that for him. Lars wants people to “embrace that we do not have an edge”. Lars also stresses the importance of costs and taxes, which is good to see. Lars is against active funds because they are too expensive. These tend to be cheaper than active OEICs, and have a good long-term track record, particularly in esoteric and illiquid markets. Lars says that the only equity investment you need is a global equity tracker. There’s no doubt that this portfolio is cheap and simple to include in tax wrappers. Saying that active funds can be beaten is not much of a claim – they are a bit of a straw man. The comparison reminds me of the way that robo-advisors compare themselves to the most expensive options in the market (St James’ Place, Hargreaves Lansdown etc). In the same way, Lars’ two-fund portfolio will do nicely against the average active fund. But will it beat my volatility parity portfolio, with factor and trend overlays? Chapter 2 of the book is about edge, which Lars thinks that most people don’t have. He opens the chapter with a challenge to beat the S&P 500 with a subset of the 500 stocks “or even the 500 stocks weighted differently from the index”. The next step is to compare “little old us” with the might of a unit trust research department. Lars also thinks that most people can’t time the markets. Chapter 3 is about the key components of the rational portfolio. We already know what they are: Foreign government bonds and corporate bonds are also allowed. It’s worth discussing the minimum risk asset a little. Lars prefers a local currency government bond of the appropriate maturity to match the investor’s time horizon. But bonds have risks too, principally counterparty risk (risk of default), interest rate risk and inflation risk. You can avoid counterparty risk by choosing bonds from your own government (assuming you live under a stable regime and have your own currency). Ideally, something like US Treasury bills (of 1 year and less to maturity) would be ideal, but they don’t exist in the UK. So you might consider easy access savings accounts or government products like premium bonds, or inflation-linked certificates (not available at present) as risk-free. When you have a small allocation to bonds and cash (say 20% of your portfolio) this is not a serious problem. Lars chooses five risk levels to drive stock allocation: He makes no attempt to map these risk levels to investor profiles. The three risk levels I normally discuss in portfolio construction are: Most investors should target one of the first two portfolios. Lars is not a fan of home bias, but I am. In contrast, Lars’ portfolio suffers from what I call Away Bias. That’s it for today. We haven’t found much common ground today: Lars thinks that markets can’t be beaten by most people. Volatility parity portfolios with factor and trend-following overlays will outperform on a risk-adjusted basis. Lars thinks that we need only two assets – stocks and bonds. I’ll be back in a few weeks with the next section of the book, which looks at assets in more detail. Share this with Twitter, Pinterest, LinkedIn, Tumblr, Reddit, StumbleUpon and WhatsApp. Article credit to: https://the7circles.uk/investing-demystified-1-markets-and-portfolios/
The rational investor
Active funds
Edge
Risk
Home bias
Conclusions