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Monday, 16 April 2012
Unconventional Success: A Fundamental Approach to Personal Investment is written by the head of Yale endowment fund.

Like “Smarter Investing” this is no “get rich quick” guide to investment book, it differs from that book in that it is focused on USA rather than the UK. The book similarly advocates investors hold a diversified portfolio - generally preferring government bonds, property and stock market trackers. Investors are advised to avoid the high fees associated with the active investment fund management industry. Where the book is strongest is in examining agent-principle issues. This occurs when the investors aims differ from the managers of the asset or their owner.

Developed World Shares - The management are supposed to be operating for the benefit of shareholders and are often remunerated to increase the returns to shareholders.
Government Bonds (Gilts) - Generally government lend to their own citizens and so are broadly neutral. In developing countries most Gilts are held domestically and in a democracy default is very unlikely.
Company Bonds – Interest payments on bonds are a cost for companies and so they will seek to minimise them. There is a downside risk of default and complex contractual arrangements that can allow bond issues to buy back Bonds if interest rates fall, but unlike shares the potential upside is limited. This leads him to prefer Gilts.
Property - Investments in commercial real estate which have a predictable revenue stream (like bonds) and a residual value at the end of the lease. This makes them operate a bit like a cross between Bonds and Shares.
Developing World Shares – These offer potentially returns are higher, but political factors may limit potential for shareholder as returns are diverted to workers, governments or managements.

He recommends avoiding asset classes where the cost of information are too high for private investors – such as high yield bonds(junk bonds), private equity, hedge funds and asset backed securities. These do tend to form part of his professional portfolio, but he has more resources to evaluate these asset classes than a private investor. A problem with this is that much of his returns are generated from these assets as the high barriers to entry presumably offer the potential for higher profits.

The book argues that professional advisors suffer from a severe agent-principle issue. These professionals as agents seek to maximise their fees. The structures of the industry mean there is often little incentive for these to be aligned with the interest of investors. The result is complex and overly large fee structures (“Where are the Customers’ Yachts?” as another book asks).

The writing feels like it is written by an academic economist and the issues are considered rigorously. What it does not do is offer much in the way of example portfolios or concrete advice for the UK investor. Instead it is more a call to be careful on costs and consider how the interest of the person issuing or managing an asset is aligned with the interest of investors.

The author also guest lectures on the Yale finance lectures with Robert Shiller, this is available from iTunesU.