Review
&The strength of this book is its technical rigour& --
Investment and Pensions Europe, November 2003&the book explains some investment management techniques used by GSAM& --
Pensions Management, October 2003"a state-of-the-art exposition of modern investment techniques, full of brilliant analysis..." --
Financial Times, September 29, 2003“… valuable resource for any market practitioners interested in or working in the asset management field... one of the better books.” (
Risk, April 2004)
With names ranging from Alford to Zangari, but led by Bob Litterman, an academy of 23 authors has produced the 600-page Goldman Sachs Asset Management textbook entitled Modern Investment Management: An Equilibrium Approach*. This is a state-of-the-art exposition of modern investment techniques, full of brilliant analysis but oddly detached from the real world.
A briefcase-busting volume may be an unusual marketing tool to distribute to clients, but GSAM's focus is conventional enough. After all, US pension plans have a daunting problem: their sponsors are typically projecting 9 per cent investment returns even though the risk-free US Treasury bond yield has recently been below 4 per cent (though it is now rising quite fast).
Even GSAM does not think the equity risk premium is more than 3.5 per cent (and many others say it is much less). So where can a 9 per cent expectation come from, other than the end of a rainbow?
One response would be to cut the targeted return to, say, 6 per cent, which could be achieved through a reasonably cautious mix of bonds and equities.
But such a capitulation would plunge many pension plans into serious deficit, and force sharp rises in contributions.
Companies like General Motors would not be able to borrow on the bond market and invest the proceeds in securities at a "profit".
Enter GSAM with an array of active risk opportunities, information ratio assumptions and derivatives strategies.
Uncorrelated hedge funds and private equity products add alpha, while interest rate and currency overlays can contribute extra return while hedging liability risks. This is the world of "active alpha" - the return generated by active deviations from the benchmark as distinct from beta, the market return.
The positive appeal lies is in GSAM's treatment of risk. In today's markets, fund managers can only outperform if they accept an appropriate amount of risk: not too much, not too little.
This applies across the spectrum from asset allocators to specialist portfolio managers.
Investors, however, tend to be apprehensive about the dependence of the sophisticated investment theories on historical data. In a crisis, these can malfunction badly. A "three standard deviation event" - which, mathematically, is supposed to be almost impossible - is, in fact, all too common.
Moreover, GSAM appears to inhabit an unreal world where the information ratio - the active return per unit of active risk - is 0.75 and a higher active risk therefore reliably generates higher returns.
This is fine if the investors consistently select brilliant fund managers.
But, in the real world, the average information ratio is zero (or negative, after costs) and portfolio risk is hard to measure with precision over any length of time.
There is a problem of lack of scalability too. "The best hedge funds are closed," admits GSAM. Managers of niche funds can select unusually profitable opportunities in inefficient markets (Japanese small cap equities being an oft-quoted example).
Moreover, alpha can then be "ported" into a mainstream asset class, using derivatives. But it is unlikely that big pension plans can thread their way nimbly through such investment minefields without triggering explosions.
What GSAM is in effect saying is that simple investment in mainstream equities and bonds is not going to generate the required returns. In particular, the soft option of index-tracking, which has been adopted by so many pension funds and other institutional investors, is a trap. The age of risk and skill is here.
There is little or nothing here about economic fundamentals, corporate governance or costs, the kind of subjects which dominate conventional investment committee meetings.
Fans of Warren Buffett definitely need not apply, although Bob Litterman observes that "there might be a little bit of extra reward for those armed with the most thorough, efficient and disciplined investment processes, even though competition will certainly quickly eliminate most such opportunities".
For Goldman Sachs, the attractions of active alpha are crystal clear. But although some investors may be ready to move along the quantative route, many pension fund trustees will wonder whether the game is becoming too hazardous and opaque. (Financial Times, September 29, 2003)
“…this is a state of the art exposition of modern investment techniques, full of brilliant analysis…” (Financial Times (FTfm))
“…the book explains some investment management techniques used by GSAM…” (Pensions Management, October 2003)
“…The strength of this book is its technical rigour…” (Investment and Pensions Europe, November 2003)
From the Inside Flap
There are many approaches to investing, but for Bob Litterman and Goldman Sachs Asset Management’s Quantitative Resources Group, the equilibrium approach has been the most rewarding. In any dynamic system, equilibrium is an idealized point where forces are perfectly balanced. In economics, equilibrium refers to a state of the world where supply equals demand. And although perfect equilibrium is never actually reached in financial markets, this modern investment framework provides guidance for informed investment decisions in a world where random shocks constantly create new opportunities.
Modern Investment Management: An Equilibrium Approach outlines the modern investment theory used by the Quantitative Resources Group at Goldman Sachs Asset Management to achieve strong, consistent investment returns. Through in-depth analysis and expert advice, you’ll learn how the insights of an equilibrium framework help you to structure a portfolio that maximizes expected returns within a limited risk budget. You’ll also learn how to identify and take advantage of deviations from equilibrium.
Tremendous progress has been made in both the theory and the practice of investment management over the past fifty years, and our understanding of the science of market equilibrium and of portfolio theory has developed with it. Through six information-rich sections, Modern Investment Management will show you how to understand these changes and how to implement them in your own investment endeavors.
- Part One presents a simple, practical introduction to the theory of investment management that has been developed in academic institutions over time
- Part Two focuses on the problems faced in the largest institutional portfolios
- Part Three discusses the various aspects of risk, from defining a risk budget to estimating covariance matrices
- Part Four looks at traditional asset classes such as equities and bonds, as well as the challenge of manager selection
- Part Five considers nontraditional investments such as currency and other overlay strategies, hedge funds, and private equity
- Part Six explores the particular prob-lems of private investors, such as tax considerations and estate planning
Today, you have an opportunity to invest more intelligently than previous generations of investors. The possibilities of creating a portfolio that will deliver consistent, high-quality returns are better than you may think. With Modern Investment Management as your guide, you’ll quickly learn how this can be accomplished.
