Fixing Capm

Others are attempting to refine or improve CAPM rather than tossing it out. Jeremy Siegel, author of Stocks for the LongRun (New York McGraw-Hill, 1998), and retired hedge fund manager Michael Steinhardt joined Wisdom Tree Investments to help market new exchange-traded index funds. These funds weight stocks according to dividend yields rather than market capitalization. Siegel's review of historic data indicates that dividend-weighted portfolios would have earned higher returns than...

The Dark Side Of Index Funds

Though one need not invest solely in index funds to follow CAPM, most advocates of CAPM recommend investing in index funds instead of actively managed accounts and mutual funds. A rich body of research backs the preference for index funds. Numerous studies have concluded that a minority of mutual funds earn returns exceeding those of the market indexes over long periods of time. The general conclusion is that a broad-based market index earns higher returns than about two thirds of mutual funds....

The Dark Side Of Derivatives

Derivatives are considered highly risky and even dangerous investments by most investors. This view was developed by a couple of public events, as well as anecdotes of which everyone seems to have a version. The first public incident involved portfolio insurance and the stock market crash of October 1987. In the 1970s and 1980s, as derivatives markets developed beyond commodities, a couple of academic researchers developed the concept of portfolio insurance. The idea was that an investor could...

Fundamentals Of Rational Beliefs

CAPM teaches that all investors are rational, right, and in agreement all the time. Rational Beliefs says all investors are rational but not necessarily correct or in agreement. Each investor has his or her own theory about which investment regime is the current one, how long it will last, and what the next regime will be. Some investors are always bearish some are always bullish most investors swing between the two. Each investor selects investments based on his or her outlook and the expected...

The All Weather Strategy

He was the founder of a successful money management firm for institutional investors, such as pension fUnds. He had established plans and trust funds for his loved ones, and he was managing the assets. But he worried what would happen to these funds in the future. Dalio had seen and heard of too many cases in which inherited funds were taken over by new trustees or money managers who subsequently lost a large share of the wealth. He sought a way of ensuring that the...

Criticisms Of Capm

CAPM gradually captured much of the investment world during the 1980s and 1990s. The factors discussed earlier were important in spreading the adoption of CAPM. Another important factor was the bull market in stocks that ran from 1982 to 2000. CAPM is ideal for a bull market. Buying and holding a portfolio of market indexes can maximize returns during an extended bull market. Yet the bear market that began in 2000 exposed shortcomings in CAPM that had received some attention from researchers...

The Valuation Cycle

It is the dynamics of investor beliefs that cause market cycles. Figure 4.1 is a tongue-in-cheek view of a market cycle and the changing views of investors during that cycle. As stated in Rational Beliefs Theory, investors range from different degrees of optimism and pessimism during a cycle. We can understand this cycle using Rational Beliefs Theory. An investment is neglected by investors because it has not had good returns for some time. It has been in a secular, or long-term, bear market....

Modern Portfolio Theory

Before Markowitz and MPT, investment strategies tended to focus primarily on returns and also on individual securities. The academic research and publications on the subject were relatively sparse. MPT introduced several additional concepts that seem obvious today but were novel at the time. MPT asserts that risk is at least as important to the investor as returns or potential returns. The typical academic investment research at the time focused on the process of analyzing securities to...