Murray Stahl On Problems With The MPT

Murray Stahl On Problems With The MPT

FRMO Corp. 2014 third quarter conference call was just posted on the company website. Comments from Murray Stahl, Chairman and Chief Executive Officer of FRMO Corp

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I can talk about some of the investments we’re making. The problem with the modern-day investment world, viewed through the lens of modern portfolio theory, is that it has an unspoken presumption. The unspoken presumption is that people are not really satisfied with the securities—I mean all the securities, the aggregation of securities, the tens of thousands of securities that exist in the world— they’re not really satisfied with them. They have too much volatility; they have too much risk.


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What people seek to do is, by combining them in different ways, meaning different forms of diversification and/or selling short and/or inclusion of different asset classes, et cetera, et cetera, they can change the risk/reward profile of the securities in some way to make them less volatile. Because basically, in sum, they want less risk. They can’t get less risk. They’re trying to achieve less risk, even at the cost of a lower rate of return.


The objective itself is very reasonable—you might even say it is noble—but the methodology I don’t think is appropriate. Because the real question is if you’re creating a portfolio, however it is you control the risk and however it is you diversify it, by basically either hedging or removing from the portfolio the high-risk elements, somebody, at the end of the day, has to take the risk. So, the critical question is: What is that someone—you might call that someone a speculator—what is that someone going to charge, not just in absolute numbers, but as a percent of the return you might get in a security?


For example, say you own Security A and you expect a 10% per annum rate of return, but you don’t want to take the risk associated with that, and you buy a put option or you sell another security short against it. The question really is—since you’re really trying to put the losses, if they occur, on someone else’s books—what are they going to charge you? Because, when you do that, they’re effectively going to be long that security, even though in book entry form you’re long that security.


What we believe is happening in the world is that the clearing price for taking that risk is very high, because virtually everybody wants to sell, and nobody wants to buy. Over the last year or so, we’ve been creating different instruments to take advantage of the other side. One product is the Virtus Wealth Masters Fund, which now, as of the most recent reckoning, has about $121 million in it. That is one of those instruments.

We’ve talked about it before, so I won’t belabor it. Essentially, we believe that for companies that are controlled by people who have virtually all of their net worth in that one security, those people are taking a lot of risk. In turn, as investors try—because it logically follows in the way they build indices— to eliminate, or at least underweight, those securities in the portfolio, someone has to be long those securities. The question is: what are you going to get if you’re willing to take the risk?

Full conference call with Murray Stahl can be found here

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