Bizna brings you the first installment of our two part series on investment ideas that will help you make money from trading at the Nairobi Securities Exchange. We sample insights from finance professors with proven success rates in matters investments to help you get rich or at least protect the wealth you have.
Finance Professor, Andrew Lo: “It’s unrealistic to say buy and hold. It’s like telling teenagers to abstain from sex,” quips Lo. The Hong Kong-born and Yale-and Harvard-educated Lo is hardly the first to observe that many investors hold on too long when markets are going down, finally panic and sell, and then wait way too long to get back in. What’s novel is the way he mixes behavioral economics and artificial intelligence to design programs that allow for human emotions while minimizing their wealth-destroying impact, an approach he dubs “artificial stupidity.” Simple example: There’s a threshold of pain–say, a 25% dive in the stock market–beyond which most normal humans can’t resist dumping stocks and going to cash. Fine. But when market volatility subsides, some start buying again, long before most people would have the stomach to get back in.
Lo offers this free advice: Accept you are a mortal who can panic, and adjust your portfolio to the risk in the marketplace, moving to bonds and cash when volatility goes up and moving back to equities when it subsides. The case for this approach is stronger since the increased tendency of different asset classes to move downward together in a crisis has weakened the power of diversification as a sleep-at-night prescription. “We all live in a world of diversification-deficit disorder,” says Lo.
Lasse Pedersen, Finance Professor: Momentum investing is nothing new–instead of fighting the tape, you buy stocks that are going up and dump (or short) those going down. All sorts of individual securities in different countries display a sort of momentum effect, where they tend to keep going in the direction they’ve been going for, say, a year. From stocks to commodities to currencies, it doesn’t matter what you’re trading, just the direction it’s been going lately.
Trading strategies that look good on paper can fall apart when the humans who actually buy and sell securities panic and liquidity evaporates, he notes–the very sequence of events that took down Long-Term Capital. But wait. If you’re more of a Warren Buffett value investor than a day trader, Lasse suggests an answer to the mystery of why boring value stocks return more than their flashy growth counterparts.
Some academics say it’s because boring companies are actually more risky, since they tend to be in older industries that could fade away. Pedersen sees something else going on: Most investors can’t or won’t use leverage to goose their returns (as some academics predict they should), yet they still want to get rich quick. So they pay too much for stocks that offer the promise of Google-type returns, just as people pay too much for lottery tickets.
For those with an eclectic investing approach, you can combine a diversified portfolio of momentum investments with low-priced value stocks to get nicely balanced returns. “If you take value and momentum, they almost sound like they are opposites,” he admits. “The fact that they’ve both worked together historically is quite remarkable.”