How to Make Money
SEGAL, HARVEY H.
How to Make Money Capital Ideas: The Improbable Origins of Modern Wall Street By Peter L. Bernstein Free Press. 340 pp. $24.95. Reviewed by Harvey H. Segal Author, "Corporate Makeover" In...
...Bernstein was mistaken, I think, to cut a planned "long section on the bond market...
...This explains why it is so difficult to beat...
...Thus, whether a corporation borrows a lot or a little has virtually no impact on its long term cost of capital...
...For more than 20 years Bernstein combined investing other people's money— he was, he says, one of "the social workers to the rich"—with sound, highly readable writing about economic problems...
...That year three Americans, Harry M. Markowitz of the City University of New York, William F. Sharpe of Stanford University, and Merton H. Miller of the University of Chicago were awarded the Nobel prize in economics for their contributions to portfolio theory...
...Because lemmings in hundreds of other financial institutions throughout the country had joined the dash over the cliff, a realization grew in the mid-'70s that the fate of the lucrative capital management business turned on devising radically different strategies for selecting assets...
...What stunned me was the group chief's smugly confident review of the common stock holdings...
...Benjamin Graham (1894-1976), another early innovator in Bernstein's pantheon, was the father of modern asset strategy and a spectacularly successful investor...
...Had Bernstein done little more than elucidate the ideas of the 1990 laureates, he would have given us a highly useful book...
...He proposed that an optimally efficient portfolio is one that maximizes expected returns at an acceptable level of risk, and he rigorously demonstrated that the overall riskiness of a group of securities depends not on the average risk of its components, but on the degree to which their prices move independently of one another...
...In 1964 Sharpe, a Markowitz student, came up with what is known as the capital asset pricing model...
...Then came a sharp slump...
...But the market values of both companies, measured by the prices of their stocks and bonds, are still principally determined by anticipated earnings...
...After struggling with only a modicum of success to improve an abysmal reputation, Citibank sold off its investment services sector in the late 1980s...
...Moreover, in greatly simplifying Markowitz' methods for building an optimally performing portfolio, Sharpe devised what is now called the beta, a much used summary measure of an asset's risk...
...The average share price was a heady 39 times earnings, more than double the multiple for the market as a whole...
...The professionals were wont to dismiss the professors as "academia nuts," but Bernstein did much to close the culture gap by founding and for years editing an intellectually serious journal that published submissions from both camps...
...These were heavily concentrated in a handful of so-called growth issues, favorites drawn from the "nifty fifty" list of approved securities that account managers were confined to...
...The growth stock fiasco of the 1970s aptly illustrates his point...
...His shocking conclusion was that the stock market in its entirety is really a superefficient portfolio...
...Betas show how the prices of individual assets fluctuate in relation to the overall market: The higher the beta, the wider the relative fluctuation and the greater the risk...
...To be sure, shareholders of a heavily debt-laden company are in a more precarious position than owners of one that borrows nothing...
...The laurels were, perforce, bestowed in belated recognition of past achievements...
...Several of his pension boards even took to taping his remarks and derisively playing back his failed forecasts at subsequent meetings...
...At the time, it controlled about $22 billion worth of stocks, bonds and real estate, most of it owned by corporate and union pension plans...
...For a friend who oversaw a big bundle of union funds, every periodic review became an inquisition...
...Bernstein's account of recent developments centers on the study of options and warrants...
...As Bernstein observes, U. S. stock prices during the last 60 years moved within a range of 5.9 per cent of their monthly averages...
...In 1973 he quit money management to take up consulting work and to serve as an intermediary between two sets of antagonists: practicing portfolio managers, whose conventional preconceptions had been shaken by adversity, and university-based strategists, whose policy formulations were often barrenly abstract and incomplete...
...That is roughly equal to 3.5 times the average monthly range, and the square root of 12 is 3.46...
...A portfolio of stocks that rise and fall in lockstep, therefore, is much riskier than a selection of high-risk issues that are systematically diversified across industries, company size and vulnerability to government regulation...
...In this elegant and insightful book, Peter Bernstein traces the development and adoption of policies designed to better serve this country's pension plan members—who now number nearly 65 million and own more than half of all common stocks—as well as individual investors...
...Despite disappointments in the October '87 market crash, the outlook for breakthroughs in coping with risk is bright, thanks in large part to the splendid work of Robert C. Merton, a brilliant theorist currently at Harvard who is certain one day to become better known to the public...
...Decades before the contests between dart throwers and stock pickers, Bachelier analyzed share prices on the Paris bourse and noted that their fluctuations were random...
...From this he postulated that "the mathematical expectation of the speculator is zero," that one has an equal chance of winning or losing...
...Once complacent pension trustees turned ugly...
...An imaginative French mathematician, he unfortunately offended the great Jules Henri Poincare in 1900 by submitting a doctoral dissertation entitled "The Theory of Speculation.' The committee at the Sorbonne gave him only a mention honorable, a cut below the mention tres honorable required for a good academic post, and he was thereafter banished to obscurity in provincial universities...
...Bachelier also formulated a set of equations proving with remarkable accuracy that the fluctuations increased proportionally with the square root of time...
...These rights to buy or sell securities at specified prices in the future pro vide a means of hedging against risk...
...In 1958 the third prizewinner, Merton Miller—in collaboration with Franco Modigliani, himself a subsequent Nobel laureate—advanced the controversial proposition that "the market value of any firm is independent of its capital structure...
...General readers became aware of the analytical underpinnings of the new investment approaches in October 1990...
...Capital Ideas is the offspring of an ideal union between author and subject...
...Over a year, though, the range increases to about 20 per cent...
...His most notable achievement was Security Analysis, a classic treatise co-authored with David L. Doddin 1934 that established an interpretive framework essential for theorizing about portfolio selection...
...By expanding the scope of his inquiry to include portfolio theory's intellectual roots in the late 19th century and its progress since the '60s, he has produced an indispensable volume on the subject...
...The most neglected significant precursor of the new concepts was Louis Bachelier...
...It was 28 years ear her, Bernstein points out, that Markowitz made his initial conceptual breakthroughs...
...I hope his next book will treat not only bonds but other domestic and foreign assets—commodities, currencies, derivative securities backed by bundles of mortgages—that today are established fixtures of sophisticated portfolios...
...Notwithstanding taxes and transaction costs, arbitrage over time will enforce "the law of one price," and any disparity in the prices of securities from companies differing only in their mix of debt and equity capital will thereby be eliminated...
...The value of Citibank's portfolio plummeted, and by the end of 1974 the price-earnings ratio was about eight...
...Reviewed by Harvey H. Segal Author, "Corporate Makeover" In the spring of 1972 I listened in on a press conference staged by Citibank's investment management group...
Vol. 75 • March 1992 • No. 4
