QUOTE FOR QANTS.

[squiffy]

Here is a quote from Peter Lynch, one of the best stock pickers in the history of the Universe.

p. 49 One Up on the Street

"As I look back now it's obvious that studying history and philosophy was MUCH BETTER preparation for the stock market than, say, studying statistics. Investing in stocks is an art, not a science, and people who've been trained rigidly to quantify everything have a big disadvantage. If stockpicking could be quantified, you could rent time on a Cray computer and make a fortune. But it doesn't work that way. All the math you need in the stock market you get in the fourth grade."

I agree. What say you quant personages?

[bigpooch]

Lynch and Buffett were excellent stock pickers/investors
but what about the best traders? Some of them have much
better returns than most succesful investors but they're not
going to share their methodology with anyone! I agree that
an eclectic approach should work well but the mathematics
(not necessarily the statistics) simply can not be ignored.

[squiffy]

Hmmm. If they're not willing to share their methods, then how can we figure out what their methods are? Or use them to our benefit? Or figure out whether they are as successful as they claim to be.

Buffett and Lynch have proven track records. Buffett is a billionaire. If I had a choice between studying their methods and studying the methods of unknown and unnamed "trader" whose success I cannot verify, I can tell you who I would choose.

[crazy canuck]

Read Wall Street Wizards. As soon as a trading method is published it's advantage is eliminated. Some traders have much better returns (or risk adjusted returns) than Buffet or Lynch. Also, I'd guess the effectiveness of Buffet's and Warren's have been considerably decreased since investors have been better educated. Also, just becasue a fundamental or quantitative strategy has good performance it doesn't mean it's ideal. Just becasue Lynch's methods work well, it doesn't mean you can't improve on it by adding quantitative analysis.

[Ray Zee]

lynch was probaly very lucky. with millions throwing darts soon a monkey with the right formula emerges. he does reason well though.
buffet made tons with hedge funds, thats different from stock picking. but even in stock picking his formula was great. buy undervalued stocks and hold them until you get your value back. but since he had so much money he took huge positions. it would seem he couldnt sell without hurting the prices. partly true. but when you have such a large position you sell at your price to other large buyers and can get concessions from the company itself.

[bigpooch]

Although most would contend that "One Up On The Street"
by Lynch is a good book, "Wall Street Wizards" is a book
that indicates that there are several ways to skin the cat.
Both books are worthwhile reading.

[adios]

[ QUOTE ]
lynch was probaly very lucky. with millions throwing darts soon a monkey with the right formula emerges. he does reason well though.

[/ QUOTE ]

This is great point. How many times do they drag someone on TV who made a prediction that was right on. If you think about it though, make enough predictions about the market and eventually one will probably be right. Doesn't mean that that person knows more than the next guy though. This is one aspect in buying and selling securities that is similar to poker in my mind. Some wild man in a poker game plays hands like 65s in all the wrong situations and takes down the money for a short period of time and it appears that he might be a winning player when all they were was lucky.

[ QUOTE ]
buffet made tons with hedge funds, thats different from stock picking. but even in stock picking his formula was great. buy undervalued stocks and hold them until you get your value back. but since he had so much money he took huge positions. it would seem he couldnt sell without hurting the prices. partly true. but when you have such a large position you sell at your price to other large buyers and can get concessions from the company itself.

[/ QUOTE ]

I'd add that Buffet buys entire companies that he perceives as undervalued thus can realize the cash flows from the undervalued companies he buys and doesn't need to have the market recognize that they're undervalued. When Berkshire trades at a premium to the market because of Buffet then he gets a double whammy so to speak i.e. Berkshire's earnings look that much better and they value of the stock goes up inline with the premium on Berkshire.

[squiffy]

Now Buffett buys entire companies. He started off buying individual stocks and even while buying individual companies has also bought individual stocks. Though it's true he has always had huge leverage by investing OPM.

Having a great track record over 20 - 30 years could be luck. But I think there is a logic behind their success based no reading their books and books about them.

Buffett's argument is that a high percentage of successful stock pickers are value investors on the Graham/Dodd/Fischer model.

[squiffy]

I read the New Wall Street Wizards and don't remember it being helpful at all. I will take a look at Wall Street Wizards. Again, without some specific description of technique or approach, it doesn't help me too much to hear that someone made billions in currency trading. Those traders often lose hundreds of millions in currency trading.

Are they really net profitable? And are they making a bet on AA preflop or are they just betting on 2,3 offsuit and getting lucky.

If Buffett and Lynch make less but have a lower risk of ruin, I would rather follow their approach.

Though I agree, there may be more than one way to skin a cat, it would be nice to have specifics about what those ways are, risk involved, approaches, techniques.

[adios]

I was pointing out that it's one aspect of Buffet's success. I've learned the hard way that the approach advocated by Buffet is probably right.

[Ray Zee]

yes, buffet does things right. same as george soros. two of the best to follow. but way of our league to capitalize on their stuff.

one great play to watch for is the big premium on berkshire hathoway stock. buffet is getting old and will die in the future. when that happens a short on the stock is a no brainer. we wont get to know he is sick until after the first tank of the stock but more will be to follow.

[adios]

[ QUOTE ]
one great play to watch for is the big premium on berkshire hathoway stock. buffet is getting old and will die in the future. when that happens a short on the stock is a no brainer.

[/ QUOTE ]

Well I'm not going to get too deep shorting it maybe only 100 shares of the class A /images/graemlins/smile.gif.

[IlliniRyRy]

You can't ignore the fact that there are thousands of companies (hedge funds, prop trading firms, I-banks) out there that employ quantitative analysts to exploit the hell out of whatever mathematical edge they've found in the market. And believe me, there are lots. You don't hear about them because they wouldn't exist anymore if enough too many people used them. Arbitrage is a perfect example.

[Robk]

[ QUOTE ]
lynch was probaly very lucky.

[/ QUOTE ]

Actually he posted a fantastic alpha for like 12 years. So he was probably very good.

[crazy canuck]

I agree with you that Wall Street Wizard's doesn't give you a strategy that you can implement but I did learn a few important things. First of all, as several posters said before there are many successful approaches, some purely technical and some fundamental based. Secondly, finding a strategy that beats the market is not easy (it's not in the book but an average mutual fund manager doesn't beat the market). So pretty much most published strategies are useless by themselves. This means that an aspiring trader has to develop their own techniques to find inefficiencies. It also means, the stock market might be not the best place to trade.

[squiffy]

I agree Rob!!! And what he says in his books makes sense to me.

[squiffy]

Well, the existence of a large bureaucracy does not justify the expense or smoke and mirrors. For example, many of the so-called "experts" were telling people to buy Amazon at 200, because it would soon go to 300 or 400, even though Amazon had never made a profit. Why did the quants support the recommendations of the "experts?"

And where were these incredible number crunching quants when we needed them to uncover BILLIONS of dollars in fraud at ENRON and WORLD COM-MCI????

Quants are mainly bean counters. They are paid to justify whatever outcome the "experts" and investment bankers pay them to justify. If they knew anything about stock market analysis or investing they wouldn't be crunching numbers for a living.

It's not about numbers. It's about cause and effect.

If it's raining, people will buy lots of umbrellas. If oil prices are high, oil companies and oil drillers will have tons of business and make tons of money. If we are in a cold war with the Soviet Union or engaged in war in Iraq under a Republican president, defense spending will be high and defense industry stocks will do well.

It's simple. Quants cannot see the forest for the trees.

[bigpooch]

That is probably true for most of the quants, especially
those new Ph.D.'s or most of those employed in the financial
industry. But obviously a number of independent traders do
use quantitative methods to beat the market; and you can't
tell me that those that trade the indexes ignore the
numbers!

In any case, quants aren't exactly bean counters; on the
other hand, isn't Chris Moneymaker one? :-)

[J_V]

what's an alpha rob?

[adios]

From the article at the following URL:

The Nitty-Gritty: How to Do the Math (http://www.businessweek.com/2000/00_03/b3664118.htm)

HOLY GRAIL? Another way to determine how well a fund or stock stacks up is to look at its alpha. Alpha measures whether an investment is producing better or worse results than expected, given its risk. Consider a fund with a beta of 0.5. If the market rises by 20%, it would be expected to gain half as much, or 10%. If the fund instead increases by 15%, its alpha is 5, meaning it beat expectations by five percentage points.

Although many consider low betas and high alphas the Holy Grail of investing, both measures are subject to the same distortions. Like beta, alpha reveals little unless a fund closely resembles its benchmark. Plus, high alphas do not predict future performance, says Thomas Schneeweis, finance professor at the University of Massachusetts at Amherst. Indeed, when it comes to forecasting, very low alphas are more valuable: They sometimes signal poor performance ahead because as investors yank money from lagging funds, it's that much harder for the managers to keep up, Schneeweis says.

For those interested that don't want to use the link here's the entire article:

The Nitty-Gritty: How to Do the Math


How can you figure out how much downside risk an investment exposes you to? Answering this critical question can be tricky: There are so many ways to calculate risk. On top of that, many risk measures have their own limitations. And then there's the separate question of how you should use the risk barometers you pick. But there is one rule you should always follow. Although it is easy to get a separate risk reading on each of your investments, you should care only about how your portfolio rates as a whole.

It's important to go for the big picture because a diversified portfolio carries less risk than the sum of its parts. The reason is that in a diversified portfolio, individual components--such as stocks and bonds--are unlikely to move in sync, especially over the long term. Thus, each can offset some of another's risk. The volatility of stocks, for instance, could be balanced out by the fixed interest and principal payments of bonds.

LOTS OF BASKETS. It's hard to grab a calculator and arrive at a figure that reflects the overall risk in a portfolio. Still, a back-of-the-envelope reckoning provides a rough--though inflated--gauge, says Judith Ward, a certified financial planner at T. Rowe Price Associates Inc. in Baltimore. Just research the risk scores discussed below on each investment and multiply by their percentage weightings in your portfolio. Then, calculate an average. ''It's not ideal,'' says Ward, who notes that this fails to account for diversification's risk-reducing magic. ''If you are diversified, your risk is probably going to be less.''

For something more accurate, you can hire a financial adviser. Or you can use a free Web service such as Financialengines.com to assess how risky your portfolio is, compared with that of the average investor. To define risk, Financialengines uses the measure known as standard deviation, which it expresses as a numerical score. For instance, if your rating is 1.4, then you are taking 40% more risk than the average of 1.0.

Whatever approach you take, the results will be easier to interpret if you have a grasp of how professionals measure financial risk. When it comes to stocks, investors confront two types of risk. One is posed by market downdrafts, which can punish even the most worthy investments. The other consists of problems specific to companies, such as mismanagement or obsolete products. For mutual funds, there is a third variety of risk, which is posed by ''a bad manager who charges high fees and doesn't make enough to recoup that cost,'' says Martin Gruber, finance professor at New York University's Stern School of Business.

TOO CRUDE? Happily, about 96% of company-specific risk can be eliminated simply by owning a diversified portfolio of 40 to 50 stocks, Gruber says. The risk that remains--a loss due to a market sell-off--is captured in a measure called beta. Beta compares the magnitude of an investment's price swings with the market's overall fluctuations. To see how it works, look at the Internet Fund. With a beta of 2.24, it is deemed more than twice as risky or volatile as the market, which is always assigned a beta of 1.0. So, if the market drops by 10%, the fund should fall by 22.4%. Fidelity Magellan Fund, in contrast, nearly matches the Standard & Poor's 500-stock index: Fidelity is 1.02.

Appealing because of its simplicity, beta is sometimes too crude to be useful. For one thing, it is often calculated compared to the S&P 500, a big-cap measure that is a poor yardstick for other asset classes. To find out whether you can trust beta to give you an accurate picture of an investment's risk, look up another statistical measure, R-squared. This tells you the degree to which an investment's price rises and falls at the same time as the benchmark it is being compared to. An investment's beta can be considered reliable only if its R-squared falls between 85 and 100, meaning that it closely tracks the index. Thus, the Vanguard Gold & Precious Metals Fund's R-squared of 0.08 compared with the S&P signals its beta of 0.70 is a poor measure of the fund's true riskiness.

When confronted with a low R-squared, find a beta based on a better benchmark. For mutual funds, Morningstar.com publishes betas that use both the S&P and the most appropriate index. For stocks, Personalwealth.com tailors betas to peer groups, such as computer hardware stocks. But be wary of beta when a company or fund specializes in fast-changing technologies. ''The beta is also going to change rapidly,'' Gruber says. Of course, if your holdings are not diversified, it can be dangerous to rely on beta at all. Gruber notes that when it comes to individual stocks, beta explains only 35% of the risk. The rest is due to company-specific developments.

GO FIGURE. For an all-inclusive picture, look at standard deviation, which compares the range an investment's price fluctuates over time to its average price. A fund with a standard deviation of 4 and average annual gains of 24% over the past three years can be expected to deliver returns that fall within four percentage points of its average two-thirds of the time. In other words, you can generally expect to see gains that range between 20% and 28%.

It's possible to calculate standard deviation yourself (table, page 103). But Microsoft Corp.'s Excel program has a standard- deviation calculator that makes the task easier. Still, standard deviation has flaws, foremost of which is that it is often calculated using 36 months of returns. As the market's hot gains over the past three years indicate, short time horizons may not be representative of the long run, says Ken Fuller, vice-president at T. Rowe Price. To avoid this problem, Morningstar provides standard deviations of 3, 5, and 10 years.

Standard deviation is also often faulted for penalizing funds that soar just as much as those that plummet. Of course, most investors complain only when they lose money. In part to respond to this criticism, Morningstar came up with ''Morningstar Risk,'' which ranks funds by how often they underperform the returns of three-month Treasury bills, a nearly risk-free asset. The higher the score, the riskier the fund. Take the Oberweis Emerging Growth fund. Its five-year rating of 2.32 means that the fund has 132% more downside risk than the typical U.S. stock fund, which is assigned a value of 1.0. Such volatility is also reflected in the fund's annual returns, which range from a loss of 8.55% in 1997 to a gain of 87.06% in 1991. A shortcoming of the Morningstar system is that it can be used only to compare similar funds. For example, while a bond fund with a score of 1.3 is 30% riskier than the average bond fund, there's no way to tell if it is less risky than a stock fund with a score of 1.0.

Three other commonly used risk measures gauge risk-adjusted performance. The most well-known, the Sharpe ratio, is the brainchild of Nobel laureate William Sharpe, a Stanford University professor and the chairman of Financial Engines Investment Advisors. Sharpe's formula measures the extra return investors receive for each unit of risk they take. The beauty of the Sharpe Ratio is that it allows for an apples-to-apples comparison of different assets. ''If the Sharpe ratio is higher for one fund than another, I am getting a little more expected return for taking that expected risk,'' Gruber says. That is certainly true of Legg Mason Value Trust, which returns 1.09 for each unit of risk, compared with 0.55 for the average U.S. stock fund, according to Morningstar.

A similar result is furnished by M-squared, the creation of Leah Modigliani, a U.S. stock strategist at Morgan Stanley Dean Witter, and her grandfather, Nobelist Franco Modigliani. M-squared adjusts an investment's risk level to match that of a benchmark, such as the S&P 500. How? To reduce the standard deviation of a volatile technology fund, for example, the Modiglianis' computer adds risk-free Treasury bills to the portfolio until it matches the S&P 500. For a conservative fund, they use leverage--or borrowed funds--to simulate more exposure to stocks.

When adjusted for risk, some top performers look decidedly less attractive (table). Take the Internet Fund. Over the past three years, it has returned an average of 89.2% annually. But on a risk-adjusted basis, its performance falls to 28.2%, says Leah Modigliani. Although you can crunch the numbers yourself, it's easier to ask your fund manager or investment adviser for figures.

HOLY GRAIL? Another way to determine how well a fund or stock stacks up is to look at its alpha. Alpha measures whether an investment is producing better or worse results than expected, given its risk. Consider a fund with a beta of 0.5. If the market rises by 20%, it would be expected to gain half as much, or 10%. If the fund instead increases by 15%, its alpha is 5, meaning it beat expectations by five percentage points.

Although many consider low betas and high alphas the Holy Grail of investing, both measures are subject to the same distortions. Like beta, alpha reveals little unless a fund closely resembles its benchmark. Plus, high alphas do not predict future performance, says Thomas Schneeweis, finance professor at the University of Massachusetts at Amherst. Indeed, when it comes to forecasting, very low alphas are more valuable: They sometimes signal poor performance ahead because as investors yank money from lagging funds, it's that much harder for the managers to keep up, Schneeweis says.

Understanding risk will help you build a better portfolio, but getting a handle on risk doesn't eliminate it. If the market falls 10% and your fund is down 8%, you might feel a little smarter than your neighbor. But you have still lost money. The trick is to use the tools that are now so widely available to minimize damage during downturns and make sure your long-term goals jibe with the risk you are comfortable taking.

By ANNE TERGESEN

[BadBoyBenny]

Buffet dying does nothing to the value of the underlying businesses, which he has little input into managing and where most of the cash flows are coming from. Berkshire has a great collection of cash cows and I would see a significant drop on his death as a buying oppportunity. Also Buffet is old but pretty healthy. Market perception will probably drive Berkshire down in this event but IMO it will probably be short lived ans the cash keeps rolling in. I think there are easier companies to bet against

[Ray Zee]

i didnt advocate shorting it now. but you are wrong. there is a big premimum on the stock because of buffet. that will go away at some point after his death. like in the first few minutes or perhaps days. if the stock comes back a big short is in order.

[crazy canuck]

I agree with you that financial analysts are full of sh*t including many quants. However, quants also do advanced risk management, option pricing and credit risk.

[adios]

"Well, the existence of a large bureaucracy does not justify the expense or smoke and mirrors. For example, many of the so-called "experts" were telling people to buy Amazon at 200, because it would soon go to 300 or 400, even though Amazon had never made a profit. Why did the quants support the recommendations of the "experts?""

Not sure quants did, can you give any examples?

"And where were these incredible number crunching quants when we needed them to uncover BILLIONS of dollars in fraud at ENRON and WORLD COM-MCI????"

Why would you lay this on quants i.e. why should quants be expected to have discerned these frauds? If you ever got into the nitty gritty of these two cases you'd see that it wasn't obvious at all what was going on. Basically in the World Com case accountants who suspected wrong doing at the firm got a lucky break in uncovering the fraud. I refer you to the WSJ stories on this. In the Enron case the financial transactions were complicated and hard to discern and in my mind Citigroup and J.P. Morgan facilitated the fraud although they more or less got a slap on the wrist. It's obviously not easy to make the cases as the government is taking time to make them.

[Ray Zee]

also remember before all the big scandals broke, there were some people out there saying that the new accounting rules and the way the companies were treating things were making their numbers artificially high. but with the market going up nobody cared till it took a break then everyone shouted foul. face it. the people in charge have no real incentive to be honest with the best interests of the stock holders in mind. so when picking companies this should be foremost in your mind. pick companies that the ceo's have major exposure and are long term owners. without ambitions to hit the moon.