Introduction

Guide to Investment Strategy is an investment book. This book aims to address the concerns of retail investor. I would like to learn about the recommendations of two economists on investing.

Author

Peter Stanyer is an economist and strategist at a London-based private wealth manager. He was previously chief investment officer of a US-based investment firm, a managing director at Merrill Lynch and investment director of the UK’s Railways Rail Pension Fund. He has also worked as an economist for the Bank of England and the IMF. He won the Adam Smith prize for economics when he was at Cambridge University.

Stephen Satchell is Economics Fellow at Trinity College Cambridge, and is a Professor at the University of Sydney. He is The Reader in Financial Econometrics (Emeritus) at Cambridge University, and is an Honorary Member of the Institute of Actuaries. He is an academic advisor to numerous financial institutions.

Contents

Guide to Investment Strategy has a total of 11 chapters which are divided into 2 parts. It also has an introduction (Back to basics, again) and 2 appendices.

Part 1 is The Big Picture. There are 6 chapters here. These chapters are 1) Setting the scene: What is risk for a personal investor?, 2) Understand your behaviour: “Hope for riches and protect yourself from poverty”, 3) The personal pension challenge, 4) Investment returns, 5) Advice and investment strategy, and 6) Are you in it for the long term?

Part 2 is Implementing More Complicated Strategies and contains the remaining 5 chapters. The chapters are 7) Setting the scene, 8) Equities, 9) Credit, 10) Alternative investments, and 11) Art and investments of passion.

The appendices are Glossary, and Sources and recommended reading.

Review

Guide to Investment Strategy is mostly about managing risk. It states that the two things that investors need to understand are risk and uncertainty.

Risk is about the chance of disappointing outcomes. It can be managed but disappointing outcomes cannot, and we have to remember that surprising things sometimes do happen. Investors should think about how investments might perform in bad times as the key to understanding how much risk they are taking.

According to the authors, investment is a preparation for future expenses, especially in retirement. The most important thing in investment is the extent to which obligations or spending plans are hedged and future income secured.

The challenges in retirement are in essence a choice between self-insurance and paying insurance companies to insure your risk. Self-insurance ties up personal resources in excessive precautionary saving and reduces potential spending (and standard of living) in retirement. Thus, it is not the preferred way for the authors. However, I have some doubts over the viability of annuities and think that everyone still needs some degree of self-insurance in order to live well during retirement.

The risk of failing to meet reasonable future spending needs is best measured by the extent to which those future needs have been hedged, for example, by government bonds or insurance policies, rather than supported by risky or mismatched investments. The starting point of any pension plan should be a comparison with the income offered by lifetime annuities from highly rated insurance companies. I do agree with this point of view.

There is an old saying that to become wealthy, it is necessary to concentrate expertise, but that to conserve wealth, it is necessary to diversify. But risk concentration where there is no information advantage is a recipe for ruin. Financial markets should be seen as a place to protect and grow wealth, not as a place to grow wealthy.

Uncertainty related to the performance of investment portfolio should be considered when designing investment strategy. This is because the actual experience from time to time can be a lot worse than would be suggested by the past average statistics for overall returns and volatility. Expectations set at the outset for an investment can be as important as the subsequent performance in determining whether an investment is judged to be successful.

The authors advise that bond portfolios do not need to be complicated and they do not recommend private equity and hedge funds. As for real estate, the returns from real estate investment are determined by the performance of the market, the skill of their advisers, and the degree of leverage involved in the vehicle they use to access the market. Leverage is in turn influenced by the level of interest rates and whether the rent generated by the properties can cover the the debt interest payments. If an investor can get all these three factors right, real estate investment would be fruitful.

In the book, the authors suggest higher volatility international investments such as equities do not need to be hedged for currency risk because currency hedging will simply alter the pattern of returns, not materially increase or decrease the magnitude of volatility.

In my opinion, Guide to Investment Strategy seems to be written for financial advisers. The discussion regarding each asset class is detailed but there is no clear strategy being outlined in the book. Thus, we have to devise our own investment strategy. This book provides the knowledge that we need, and the rest is up to us as each of us has different circumstances.

Quotes

1. Financial decisions are a mix of risk and uncertainty.
2. What matters for setting strategy is what we expect for the future.
3. The purpose of wealth, however large or small, is to fund expenditure in the future.
4. All investors need to be responsive to changes in the structure, risk and opportunities of the marketplace.
5. In the presence of uncertainty, the prudent approach is to err on the side of caution.

Rating

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