Product Description

PRAISE FOR Modern Investment Management

"This powerful book brilliantly discovers the routes to superior investment results in the roots of economic theory. In the process, it combines elegance of presentation with the highest levels of lucidity. The authors offer lessons that neither the scholar nor the investor-in-action can afford to ignore."
–– Peter Bernstein, bestselling author of Capital Ideas: The Improbable Origins of Modern Wall Street and Against the Gods: The Remarkable Story of Risk

"In Modern Investment Management: An Equilibrium Approach, Bob Litterman and his colleagues at Goldman Sachs Asset Management provide the reader with a gentle introduction to modern financial theory and a survey of their own monumental contributions to theory and practice. The role of the late Fischer Black is amply noted."
–– Harry M. Markowitz, 1990 Nobel Prize Laureate in Economics

"This comprehensive guide to equilibrium investing is perhaps the finest demonstration of the relevance of financial theory to investment practice. Both the academy and industry owe a huge debt to this exceptionally talented team for reuniting their paths. Study this book carefully and keep it close at hand if you are serious about investing or teaching about it."
–– Mark Kritzman, Managing Partner, Windham Capital Management Boston and Research Director, The Research Foundation of the Association for Investment Management and Research (AIMR)

"This book develops a powerful framework for making better investment decisions. The equilibrium approach frees you up to focus on what you know, without being blinded by what you don’t know."
–– Andre Perold, Professor, Senior Associate Dean, Faculty Director
Harvard Business School

"An invaluable investment manual ably supported by the highest-quality financial theory, but well peppered with common sense. The fund manager and the institutional investor ignore this book at their peril. It will be a key reference book for our pension plan."
–– David Morgan, Chief Executive, Coal Pension Trustees Services Ltd.

"This novel and ambitious book breaks new ground in demonstrating how modern investment theory can be refined and adapted to practice. The authors’ experience as investment professionals in a sophisticated institutional setting lends much credibility to their skillful blending of rigorous analysis, intuition, and real-world application."
–– Robert F. Stambaugh, Ronald O. Perelman Professor of Finance
The Wharton School, University of Pennsylvania

Product Details

• Amazon Sales Rank: #271728 in Books
• Published on: 2003-07-03
• Original language: English
• Number of items: 1
• Binding: Hardcover
• 624 pages

Review
&The strength of this book is its technical rigour& -- Investment and Pensions Europe, November 2003

&the book explains some investment management techniques used by GSAM& -- Pensions Management, October 2003

"a state-of-the-art exposition of modern investment techniques, full of brilliant analysis..." -- Financial Times, September 29, 2003

“… valuable resource for any market practitioners interested in or working in the asset management field... one of the better books.” (Risk, April 2004)

With names ranging from Alford to Zangari, but led by Bob Litterman, an academy of 23 authors has produced the 600-page Goldman Sachs Asset Management textbook entitled Modern Investment Management: An Equilibrium Approach*. This is a state-of-the-art exposition of modern investment techniques, full of brilliant analysis but oddly detached from the real world.
A briefcase-busting volume may be an unusual marketing tool to distribute to clients, but GSAM's focus is conventional enough. After all, US pension plans have a daunting problem: their sponsors are typically projecting 9 per cent investment returns even though the risk-free US Treasury bond yield has recently been below 4 per cent (though it is now rising quite fast).
Even GSAM does not think the equity risk premium is more than 3.5 per cent (and many others say it is much less). So where can a 9 per cent expectation come from, other than the end of a rainbow?
One response would be to cut the targeted return to, say, 6 per cent, which could be achieved through a reasonably cautious mix of bonds and equities.
But such a capitulation would plunge many pension plans into serious deficit, and force sharp rises in contributions.
Companies like General Motors would not be able to borrow on the bond market and invest the proceeds in securities at a "profit".
Enter GSAM with an array of active risk opportunities, information ratio assumptions and derivatives strategies.
Uncorrelated hedge funds and private equity products add alpha, while interest rate and currency overlays can contribute extra return while hedging liability risks. This is the world of "active alpha" - the return generated by active deviations from the benchmark as distinct from beta, the market return.
The positive appeal lies is in GSAM's treatment of risk. In today's markets, fund managers can only outperform if they accept an appropriate amount of risk: not too much, not too little.
This applies across the spectrum from asset allocators to specialist portfolio managers.
Investors, however, tend to be apprehensive about the dependence of the sophisticated investment theories on historical data. In a crisis, these can malfunction badly. A "three standard deviation event" - which, mathematically, is supposed to be almost impossible - is, in fact, all too common.
Moreover, GSAM appears to inhabit an unreal world where the information ratio - the active return per unit of active risk - is 0.75 and a higher active risk therefore reliably generates higher returns.
This is fine if the investors consistently select brilliant fund managers.
But, in the real world, the average information ratio is zero (or negative, after costs) and portfolio risk is hard to measure with precision over any length of time.
There is a problem of lack of scalability too. "The best hedge funds are closed," admits GSAM. Managers of niche funds can select unusually profitable opportunities in inefficient markets (Japanese small cap equities being an oft-quoted example).
Moreover, alpha can then be "ported" into a mainstream asset class, using derivatives. But it is unlikely that big pension plans can thread their way nimbly through such investment minefields without triggering explosions.
What GSAM is in effect saying is that simple investment in mainstream equities and bonds is not going to generate the required returns. In particular, the soft option of index-tracking, which has been adopted by so many pension funds and other institutional investors, is a trap. The age of risk and skill is here.
There is little or nothing here about economic fundamentals, corporate governance or costs, the kind of subjects which dominate conventional investment committee meetings.
Fans of Warren Buffett definitely need not apply, although Bob Litterman observes that "there might be a little bit of extra reward for those armed with the most thorough, efficient and disciplined investment processes, even though competition will certainly quickly eliminate most such opportunities".
For Goldman Sachs, the attractions of active alpha are crystal clear. But although some investors may be ready to move along the quantative route, many pension fund trustees will wonder whether the game is becoming too hazardous and opaque. (Financial Times, September 29, 2003)

“…this is a state of the art exposition of modern investment techniques, full of brilliant analysis…” (Financial Times (FTfm))

“…the book explains some investment management techniques used by GSAM…” (Pensions Management, October 2003)

“…The strength of this book is its technical rigour…” (Investment and Pensions Europe, November 2003)

From the Inside Flap
There are many approaches to investing, but for Bob Litterman and Goldman Sachs Asset Management’s Quantitative Resources Group, the equilibrium approach has been the most rewarding. In any dynamic system, equilibrium is an idealized point where forces are perfectly balanced. In economics, equilibrium refers to a state of the world where supply equals demand. And although perfect equilibrium is never actually reached in financial markets, this modern investment framework provides guidance for informed investment decisions in a world where random shocks constantly create new opportunities.

Modern Investment Management: An Equilibrium Approach outlines the modern investment theory used by the Quantitative Resources Group at Goldman Sachs Asset Management to achieve strong, consistent investment returns. Through in-depth analysis and expert advice, you’ll learn how the insights of an equilibrium framework help you to structure a portfolio that maximizes expected returns within a limited risk budget. You’ll also learn how to identify and take advantage of deviations from equilibrium.

Tremendous progress has been made in both the theory and the practice of investment management over the past fifty years, and our understanding of the science of market equilibrium and of portfolio theory has developed with it. Through six information-rich sections, Modern Investment Management will show you how to understand these changes and how to implement them in your own investment endeavors.

• Part One presents a simple, practical introduction to the theory of investment management that has been developed in academic institutions over time
• Part Two focuses on the problems faced in the largest institutional portfolios
• Part Three discusses the various aspects of risk, from defining a risk budget to estimating covariance matrices
• Part Four looks at traditional asset classes such as equities and bonds, as well as the challenge of manager selection
• Part Five considers nontraditional investments such as currency and other overlay strategies, hedge funds, and private equity
• Part Six explores the particular prob-lems of private investors, such as tax considerations and estate planning

Today, you have an opportunity to invest more intelligently than previous generations of investors. The possibilities of creating a portfolio that will deliver consistent, high-quality returns are better than you may think. With Modern Investment Management as your guide, you’ll quickly learn how this can be accomplished.

From the Back Cover
PRAISE FOR Modern Investment Management

"This powerful book brilliantly discovers the routes to superior investment results in the roots of economic theory. In the process, it combines elegance of presentation with the highest levels of lucidity. The authors offer lessons that neither the scholar nor the investor-in-action can afford to ignore."
–– Peter Bernstein, bestselling author of Capital Ideas: The Improbable Origins of Modern Wall Street and Against the Gods: The Remarkable Story of Risk

"In Modern Investment Management: An Equilibrium Approach, Bob Litterman and his colleagues at Goldman Sachs Asset Management provide the reader with a gentle introduction to modern financial theory and a survey of their own monumental contributions to theory and practice. The role of the late Fischer Black is amply noted."
–– Harry M. Markowitz, 1990 Nobel Prize Laureate in Economics

"This comprehensive guide to equilibrium investing is perhaps the finest demonstration of the relevance of financial theory to investment practice. Both the academy and industry owe a huge debt to this exceptionally talented team for reuniting their paths. Study this book carefully and keep it close at hand if you are serious about investing or teaching about it."
–– Mark Kritzman, Managing Partner, Windham Capital Management Boston and Research Director, The Research Foundation of the Association for Investment Management and Research (AIMR)

"This book develops a powerful framework for making better investment decisions. The equilibrium approach frees you up to focus on what you know, without being blinded by what you don’t know."
–– Andre Perold, Professor, Senior Associate Dean, Faculty Director
Harvard Business School

"An invaluable investment manual ably supported by the highest-quality financial theory, but well peppered with common sense. The fund manager and the institutional investor ignore this book at their peril. It will be a key reference book for our pension plan."
–– David Morgan, Chief Executive, Coal Pension Trustees Services Ltd.

"This novel and ambitious book breaks new ground in demonstrating how modern investment theory can be refined and adapted to practice. The authors’ experience as investment professionals in a sophisticated institutional setting lends much credibility to their skillful blending of rigorous analysis, intuition, and real-world application."
–– Robert F. Stambaugh, Ronald O. Perelman Professor of Finance
The Wharton School, University of Pennsylvania

Customer Reviews

Oldschool
Nicely written from a journalistic perspective but rather old fashioned. Many mistakes and deliberate false claims in order to suit product interests of Goldman Sachs. Examples:

In the chapter on asset liability management there is always an analytical case for equities. However the only reason is that GS does not allow duration as a choice variable. Otherwise beta (in their formula) would become one and the optimal equity allocation is zero. Accidental? I doubt it.

They also claim to have found (earlier) a better method than Stambaugh on dealing with missing data. However either you publish or you shut up.

Waste of time for serious quants

All Blather and No Substance
The boys at GSAM clearly wrote this book as an "alternative" to Grinold and Kahn and to help promote the group as the seek to raise assets.

Grinold and Kahn work at Barclays Global Investors, GSAM's biggest competitor, and they wrote a first-rate book on how to do quantitative management. Their book has become the standard, the must read, and is required by the CFA exam. This obviously bugged them to no end. It's no fun to see your biggest competitor getting tons of accolades. So they did what anyone with a big ego does: they wrote their own book, this book.

Only problem is this book STINKS. What's the matter with it you ask? It has no content. The boys at GSAM were so scared about divigulging anything that could help a competitor (or the market) that they didn't really want to SAY anything.

Now how do you not say anything but still write a book, you ask? Excellent question! The answer is you talk in infuriatingly broad generalities about very general topics.

For example, on the topic of how do you actually trade the portfolio, they come up with such gems of wisdom as:

"Tradomg is the process of executing the orders derived in the portfolio constrution step. To trade a list of stocks efficiently, investors must balance opportunity costs and execution price against market impact costs." [page 431]

This knowledge anyone who has ever thought for 2 seconds about trading knows. The real value might come if they gave you some cool way to think about measuring opportunity costs, ex-ante. Or a nice way of estimating market impact costs. Do they do either? Of course not! Just more and more banal talk.

The book is filled with millions of other examples. One should use a decay weight in estimating covariance matrices. How should we choose that decay weight is of course never mentioned or discussed!

They tell us when choosing between factors to predict returns, "the real challenge is to winnow down the list of factors to a parsimonious set." Okay, how might I do that you GSAM gods? They never ever tell you [see page 420]

You get the point, just lots of blather and really no content.

Save your money and don't buy this book. They don't need your money they have enough already. And it's not like you are getting knowledge or anything valuable in return.

Ignore the Bad Reviews Below
I am quite shocked by all of the poor reviews below. This text is actually very good, in that it address several topics that Grinold and Kahn do not, mainly utility theory (and its role in investor decision making), the international CAPM, and the Black-Litterman model. First, the presentation of the investment decision making process by Litterman from an economics (utility maximization) view point is right on target. Too often portfolio theory is simply presented in a pure mathematical finance format that, while teaching the mechanics, leaves the end user incapable of understanding the implications of the analysis they are performing. Additionally, Litterman's presentation of the international CAPM and universal hedge models are very well done and extremely important. Finally, the Black-Litterman model has become mainstream (it is incorporated into the Ibbotson software) and is completely ignored by Grinold!

I own both Litterman and Grinold, and if you can afford both I would buy both because Grinold does a nice job simply presenting the mathematics, but then so do so many other texts.