Book Review: Equity Management
If the fact that the authors of Equity Management: The Art and Science of Modern Quantitative Investing collaborated with Nobel Laureate Harry Markowitz on several articles contained in this book is not sufficient to establish their credentials, then the 12 pages of praise and critical acclaim from luminaries of the investment management profession will remove any doubt. They include Mark J.P. Anson, Cliff Asness, Elroy Dimson (who rightly dubs the rich collection a menu dégustation of investment ideas), Andrew Lo, and Frank Fabozzi, CFA.
Experts at writing for practitioners, market veterans Bruce I. Jacobs and Kenneth N. Levy, CFA, have produced a well-resourced compilation of articles they have published in various academic journals. Their work is a robust treatment of the multifaceted discipline of equity management. This second edition expands on the first, retaining all of the original articles and contributing new thinking on various elements of quantitative stock investing in an effort to make practitioners current on the state of research in this domain of professional investment. As such, the work provides fodder and invaluable insight for the professional equity investor, analyst, performance measurement analyst, compliance specialist, and risk manager. Academics could selectively parse the work for portions of a course curriculum, and CFA charterholders and CFA Program candidates could consume various selections to reinforce concepts critical to their work as investment professionals.
At almost 900 pages, Equity Management brings together a body of work 30 years in the making that attests to the growing specialization not only of the investment management profession generally but also within established areas of research. Rather than merely ordering the authors’ research chronologically, the volume organizes it thematically, affording the practitioner ease of reference. This approach provides convenience for the reader and captures the history and evolution of equity evaluation, thereby telling an intriguing story. The prose is clean and lends itself to relative ease of understanding. (To be sure, some topics are a bit more recondite than others.) Practitioners can also read individual selections, depending on the nature of their specialization and research interests. Indeed, the authors suggest as much in the introduction.
Granularity of focus and practicality of exposition permeate the tome. The newest new thing, smart beta, comes in for robust examination, as do the trade-offs inherent in market-neutral strategies and approaches for the leverage-averse investor. The work is at once an education and a debunking. Well-researched and written in plain language, the chapter “20 Myths about Long–Short” seeks to allay investor misconceptions about the strategy. The second edition of the book replaces the old subtitle, “Quantitative Analysis for Stock Selection,” with “The Art and Science of Modern Quantitative Investing.” This reflects the authors’ belief that successful quantitative investing is as much about applying qualitative assessment and human judgment to the investment process as it is about the hard science of it. The new volume reflects the evolution of the marketplace embodied in the heightened popularity of factor-based strategies and financial leverage. Properly executed, portfolio optimization can allow an investment portfolio to maximize opportunities to profit from the factors that the researcher identifies and to manage risk. A strong grasp of how asset prices react to these factors is essential. Otherwise, valuations can fail to capture inherent value and risks can escalate.
An entire segment of the book, “Shifting Risk Can Lead to Financial Crises,” addresses the unintended and undesirable consequences of certain investment approaches. Some models are elegant in theory yet break down in practice. As an example, risk-shifting products have been on the authors’ radar for some time. Considering all of the attention given to smart beta strategies, their antennae are raised again. Several varieties of risk are embedded in these approaches. Investors’ price insensitivity and herding into a small number of popular factors can make their portfolios fragile and lead to excessive valuation. Indeed, the authors’ skepticism evokes the dark side of portfolio insurance, similarly hyped and with consequences that investment historians and practitioners of that technique would like to forget. Investment fads of this sort are the stuff of financial instability and market disturbances. The market debacles of 1987, which witnessed the failure of the aforementioned, seemingly well-intentioned portfolio insurance, and 2008, which arose from subprime mortgage contagion, attest to the dangers of overreliance on models without considering the attendant risks.
This particular subset of articles should be required reading for all practitioners and particularly for risk management and compliance officials at the large insurers, money-center banks, and investment firms. Finance is cyclical, seemingly fated to revisit catastrophe, not anticipating the result because “this time is different.” To quote Talking Heads front man David Byrne, it is the “same as it ever was.” By the same logic, the book should be on the bookshelves of regulators and policymakers as well. Will Jacobs and Levy’s observations and counsel prevent another 1987 or 2008? Probably not, but that does not exempt market actors from understanding at a deeper level how well-intended bets can go awry. The authors have contributed meaningfully to this debate.
Academics in practice since 1986, Jacobs and Levy recognize that equity markets are intricate systems driven as much by human emotion and irrationality as by various quantitative factors. The study of these markets is the study of complexity, requiring intellectual rigor and discipline. The gradient is steep but worth the ascent for those of cerebral and emotional fortitude. Equity Management represents a decades-long distillation of the authors’ thinking and experience. While modern portfolio theory endeavors to capture the fickle nature of markets in all of their complexity and interconnectedness in an effort to identify and capture the drivers of stock returns, it is nevertheless a work in progress. As research has evolved, so too have the tools needed to harness and place it into action. Computers and statistics are the sine qua non to accompany the intellectually curious and the driven. Practitioners have at hand a compendium of thought that bridges theory with practice. The authors remind us that the former should not overshadow the latter.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.