From the Silk Road to Wall Street, author William Bernstein finds that investors react to economic factors in similar ways.
You might think that a presentation titled "Investing 501 with Bill Bernstein" would be a dry, graduate-level lecture full of financial calculus. You'd be wrong. In a casual Q&A format with Morningstar's John Rekenthaler at this month's Morningstar Conference, William Bernstein will discuss why the study of world history from a financial perspective should make investors, and their advisors, skeptical about most of what the investment industry believes.
Bernstein is the well-known author of The Intelligent Asset Allocator (McGraw-Hill, 2000), a mathematical treatise on modern portfolio theory, and The Four Pillars of Investing: Lessons for Building a Winning Portfolio (McGraw-Hill, 2002), an entertaining do-it-yourself manual for individual investors. But his session at this year's conference is not really about portfolio design or modern portfolio theory. It is his other two books that provide a clue to the insight he will be sharing with the audience. The Birth of Plenty: How the Prosperity of the Modern World Was Created (McGraw-Hill, 2004) explains the four conditions necessary for sustained economic progress and how these will shape the future of our global economy. A Splendid Exchange: How Trade Shaped the World from Prehistory to Today (Atlantic Monthly Press, 2008), which was published this spring, is a timeline of how trade and globalization have slowly evolved from the stone age to the vast riches of today. The book is a sweeping view of human history from a financial perspective.
I recently spoke with Bernstein about his appearance at the conference. Our conversation was full of historical anecdotes that explain why today's investment climate looks the way it does.
Helen Modly: How will you relate the insights that you have developed from your studies to the activities of investment professionals?
Bill Bernstein: It is important for them to realize that knowing the math of investing is not enough. They need to know and understand the history behind the math. For example, 10 years ago, you and I could have been at a cocktail party and everyone in the room would have been discussing the latest dot-com IPO. If you wanted to know who in the room had been snookered by the bubble and who hadn't, you could have surveyed them to see who knew the major players in the last investment bubble. Those who could name a few of them would probably fare better than those who had no idea what the last investment bubble was.
HM: Do you think that an ignorance of financial history leads to overconfidence?
HM: What do you hope advisors learn from your session?
BB: An appreciation for how much understanding you can gain about today's economic climate by studying the past. Investors are people, and they have been reacting in similar ways to various economic stimuli for eons. By studying this history, or listening to people who have, you can glimpse how these factors will shape the future.
HM: What other topics will you discuss?
BB: The importance of rebalancing. Appropriate rebalancing, whether determined by period or by threshold, can help advisors deal with bubbles as well as less extreme instances of momentum in the markets. We all somehow "know" that rebalancing works, but after a lot of research, I've been able to come up with the math that proves it.
HM: How much return do you think appropriate rebalancing adds to a portfolio?
BB: At least 100 basis points a year.
HM: Any other nuggets that you have been able to tease out of the history books?
BB: My favorite lesson reveals that economic growth is not synonymous with stock growth. Economists and others have been telling us that when economies are growing their stock markets are growing also. There have been too many exceptions to this going back in time to really be valid, so I decided to figure out what the true relationship was.
HM: What are some examples of these exceptions?
BB: Let's take China for example. Their economy is no doubt growing at a very robust clip. When compared with their stock prices, China's GDP is growing much faster than its stock prices would suggest. Can you guess the reason?
HM: Not a clue.
BB: Dilution. The Chinese have very little protection for minority shareholders, so more and more shares are simply printed and sold rather than maintaining proportional ownership. This is simply not an investor-friendly approach. By contrast, consider the example of Great Britain. They entered the 20th century as masters of the sea with one of the healthiest economies in the world at that time. They finished out the century as an economic has-been. Yet, their stock prices have grown while their economy has stalled. Can you guess why?
HM: I'll pass.
BB: Shareholder protections have been a traditional priority in Great Britain, tracing back to their early days of exploration and exploitation. To an investor, this protection is attractive.
HM: What is the implication to advisors of this observed disconnect between GDP and stock appreciation?
BB: It helps to explain why the fastest growing economies may not be the best investment opportunities. I know it runs contrarian to what most advisors believe, but that is how you usually make money, by avoiding the herd.
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