One of the most important things I am here to teach readers is that there is no such generic concept as risk.  There are risks, and they must be handled separately.  Generic measures of risk such as standard deviation of returns, beta, etc. are unstable.  This was driven home to me when I heard a presentation from endowment investment advisors, where they talked about their models, and how the models translated current economic statistics into investment decisions.

I’m sorry, but the models can not be that good.  The financial markets are only weakly related to the real economy in the short-run, though the tie gets strong in the long-run.

Economies are unstable; get used to it.  The concept of equilibrium is also not useful, and it holds economics in thrall, because it makes the math work, even though equilibrium never occurs.

It is far better to look at your investment in an oil refiner and ask “What are the possibilities for where crack spreads will be a year from now,” than to look at the beta, correlations to anything, standard deviations, etc.  The coefficients aren’t stable.

Risks, Not Risk, Again: No Generic concept Exists

Many advisors would rather follow a false certainty, than have to think for themselves, and have to deal with the complexity of the markets.

I am a quantitative analyst, and a very good one.  That is why I pay attention to the limitations of models, and the possibility that past data might be special, and not so relevant to the present.  It is far better that you pick over your portfolios, and ask what risks they are subject to, than to look at standardized risk measurements that describe the past or present.

Be forward looking.  What can go wrong?  Analyze each company.  Find the three most pertinent risks — read the 10-K if you are having a hard time.  See if you think the risks are worth taking.

But be assured of this.  Merely by looking at market price derived variables for stocks, you won’t learn anything valuable about the risks of what you own, or might own.  You need to think like a businessman, a sole owner, and ask whether the risks can be ably faced.

To the Consultants

Your models are garbage.  You need to review your managers at the holdings level, or you are doing no good at all.  All of the aggregate statistics hide the instability.  Far better to understand the qualitative methods of managers, and analyze whether they have a durable competitive advantage or not.

That may not seem so scientific, but science is put to bad ends in areas where there is no good science.

If I were hiring managers, I would spend a lot of time on process and people, and ignore a lot of other items.


Mathematics is of limited use in analyzing investments and investment managers.  It is far better to look for those that have good business sense, and invest with them.

By David Merkel, CFA of Aleph Blog