How to allocate assets, manage risk and select stocks
Wesley Gray is a new star in investment analysis with a very interesting background. He was raised on a cattle ranch in Colorado (USA) and graduated magna-cum-laude in economics from the Wharton School of the University of Pennsylvania. He enrolled at the University of Chicago but, in 2004, took a four-year sabbatical to serve as an intelligence officer in the United States Marine Corps. He spent two years as an intelligence officer in Asia and then served in Haditha (Iraq) as an embedded officer providing advice and support to the Iraqi Army. After leaving the army, Gray wrote Embedded: A Marine Corps Adviser Inside the Iraqi Army, based on 1,000 pages of personal notes that he took to share with his wife and daughter, which came out in April 2009.
In 2010, Gray obtained both, an MBA and a PhD in finance, from the University of Chicago’s Booth School of Business. In December 2012, he co-authored Quantitative Value: A Practitioner's Guide to Automating Intelligent Investment and Eliminating Behavioral Errors
(reviewed in Moneylife
, Issue 21 March 2013). That book is a tour de force showcasing rigorous tests on various value investing approaches. It proved that buying stocks, which are ranked low in value and high in returns, offers the best returns, an approach similar to Joel Greenblatt’s whose book The Little Book that Beats the Market has also been reviewed in Moneylife
. Gray and Carlisle claimed to have improved upon Greenblatt’s approach. Gray is now an assistant professor of finance at Drexel University’s LeBow College of Business and runs Alpha Architect (AA), a money management firm. AA’s work is striking in its methodological rigour of testing different investment and trading approaches. The blog posts of AA showcase the intellectual firepower of Gray.
This basic premise of DIY Financial Advisor: A Simple Solution to Build and Protect Your Wealth is that you do not need professional help to manage your investments. The book has two clear parts. Part one questions the society’s reliance on ‘expert’ opinion. Expert opinion on anything, other than hard sciences, has been proven to be highly overrated, most spectacularly by Philip Tetlock in his book Expert Political Judgement: How Good Is It? How Can We Know? We have reviewed Tetlock’s latest book Superforecasting: The Art and Science of Prediction (Moneylife, Issue 1 April 2016). Even in hard sciences, like medicine and chemistry, Nobel Prize winners have been proven wrong subsequently. In finance, they are wrong more often than not, because experts are not disinterested observers, but interested players, are prone to the same biases that affect other humans and, often, rely on stories, not facts. We can beat the experts and manage our own investments quite nicely. What we need “is an evidence-based systematic decision-making process.” Part Two of the book outlines how to do it. According to Gray, individual investors need to be aware of three things: asset allocation, risk measures and security selection.
Asset Allocation: Asset allocation is simply spreading your investments across different kinds of financial assets. Experts go to great lengths to make asset allocation complex by including different kinds of domestic and international equities, a wide variety of fixed assets and alternative asset classes. But Gray says simply staying invested in bonds, stocks and real estate is good enough.
Risk Management: Managing risk is being aware of significant price declines which can come from studying price patterns, but is frowned upon by fundamental analysts. Gray advocates using simple priced-based rules, such as simple moving averages or time-series momentum or, better still, combining both these which will reduce losses and fetch the upside completely.
Security Selection: As mentioned, Gray and Carlisle had already shown that the best results come from buying stocks ranked low in value and high in returns. In this book, he has also introduced the price momentum of stocks as another important factor for security selection. Gray’s studies show that combining value and momentum can increase risk-adjusted returns.
This book is a terrific resource for the serious investor. Gray has generously shared his research on what works, including momentum, which is shunned by most fundamental investing approaches. However, it will require access to data, some deft Excel work and several hours of study every weekend to stay on the ball. If you are up to it, look no further.