Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Politics : Ask Michael Burke -- Ignore unavailable to you. Want to Upgrade?

To: David Rosenthal who wrote (55069)	4/7/1999 10:41:00 PM
From: BGR	Read Replies (2) \| Respond to of 132070

David, My main argument has been that Michael was trashing Modern Portfolio Theory w/o providing an iota of rationale or evidence but rather by engaging in various levels of chest thumping, hand waving, insults and humor. Also, I am not advocating any investment strategy and have no comments about Michael's acumen as an investor. He may very well be a brilliant one for all I know. However, his arguments against MPT make no sense. This is in a nutshell the concept of adjusting returns for risk. Consider two corporate bonds, one from Microsoft and another from Fly by Night, Inc. In general, the later is riskier than the former, in that the holder of the bond has less chance of getting repaid. Hence, investors demand grater interest rates for the later than the former. W/o going into how you calculate the relative riskiness, let's say it is 3:1 in favor of MSFT and hence, say, you demand a 10% interest from MSFT and 20% from Fly by Night, where the t-bil is at 5% (I am making these numbers up). Now suppose that you invest in the MSFT bond and Michael in the FBN bond. Also, let's suppose that at the end of the year, FBN actually doen't default. So, your returns are less than Michael's. But does that mean that Michael is a better investor? Certainly not, as he just assumed more risk and could have lost his capital outright. In fact, if the original risk adjustment and interest rate settings are accurate, both of you have exactly the same acumen as an investor. Hence, returns always need to be adjusted for the riskiness of the underlying security. Assuming sovereign nations never default, sovereign bonds are least risky, hence they pay least interest rates. Then comes blue chip corporate bonds, then risky corporate bonds, and then securities, which have greater returns and are more risky. The additional interest expected of securities over the t-bill is called the risk premium. Options, being riskier, have an even higher risk premium (i.e possibility of return). IYO, w/o adjusting for risk, these returns are meaningless. MPT claims that over time on average the market accurately calculates these risk premiums. Hence, adjusted for risk, returns of all protfolios are about the same as the market index. Hence, all portfolios can be simulated using the market index portfolio and appropriate amount of leverage (or cash). If in fact an investor's long term risk adjusted returns are shown to be greater than the market average (consider Warren Buffet, for example), that person is indeed a superior investor. I can recommend some books on finance if you want. -BGR.