Table Of Content

“Many investors have substantial business expertise, and experience in specifi c capital markets. But such knowledge is not enough. Success requires an integrated view of the investment problem, and of the full range of investment products. Peter Stanyer’s excellent guide to investment strategy provides exactly this, summarising the latest thinking in a concise, readable format.” John Campbell, Professor of Economics, Harvard University “Peter Stanyer uses both his practical investment experience and recent developments in fi nancial economics to tackle many of the more important and complex decisions faced by investors. Don’t expect to fi nd simple answers; do expect to be stimulated.” Richard Brealey, Emeritus Professor of Finance, London Business School “This book provides a thoughtful and incisive appraisal of the optimal approach to long-term investment, drawing on historical data, the latest academic studies and best practice among institutional investors. It will be essential reading for investment advisers and private bankers as well as individual investors seeking to preserve and grow wealth.” John Calverley, Chief Economist and Strategist, American Express Bank “Investing today grows more complex by the day, and it is important to take a step back and simplify the foundation of the principles that guide the desired results. This guide does just that in a practical and accessible manner.” Christopher Hyzy, Investment Strategist, U.S. Trust “Peter Stanyer has used the full breadth of his experience to construct a guide which is practical but also insightful. The style is that of a knowledgeable friend, telling interesting stories, patiently explaining diffi cult points, but never talking down. Both the professional investor and the interested amateur will quickly fi nd much useful and relevant information in this book.” Chris Hitchen, Chief Executive, Railways Pension Trustee Co Ltd “Wealth management has been traditionally associated with expensive lunches, bespoke tailoring and not much else. Peter Stanyer’s excellent, accessible guide brings the techniques of quantitative fi nance to wealth management, giving the subject a structure and content that has been sorely needed.” Dr Steve Satchell, Reader of Financial Econometrics, Cambridge University; Fellow, Trinity College, Cambridge Peter Stanyer is one of the most knowledgeable investment professionals I encountered during my three decades at Merrill Lynch. Peter has utilised sound academic research, but he has also listened to investors over the years. The result is a clear, practical and authoritative book on investing in today’s markets that will be useful for both high net worth investors and their fi nancial advisers. I highly recommend it. Winthrop H. Smith Jr, Chairman of the Advisory Board of Overture Financial Services, former Executive Vice President of Merrill Lynch & Co. and Chairman of Merrill Lynch International, Inc. Gde Invest Strat.indb i 11/10/06 15:35:03 “Peter Stanyer is one of the most perceptive investment thinkers in the industry and his sharp-end experience is revealed in this book. Clear and concise, and always to the point, this guide to investment strategy covers all the key issues that investors need to consider when deciding how to invest their assets for the long-term.” Roger Urwin, Global Head Investment Consulting, Watson Wyatt Limited “In this excellent guide to investment strategy, Peter Stanyer sets out to explain the nature and characteristics of the world’s investment markets. Most importantly, he relates this analysis to the different objectives and preferences of investors. The book should prove to be an invaluable reference for wealth managers.” Chris Cheetham, CEO, HSBC Halbis Partners “Peter Stanyer has produced an elegant and well-crafted “how to” manual that can serve trustees, investment managers and high net worth investors well, in their quest for solid investment results at sensible risks. Unlike many books on investing, he begins with the all-important dictum: know thyself.” Robert D. Arnott, Chairman, Research Affi liates; Editor, Financial Analysts Journal “Essential reference for anyone with an interest in investment markets. From the discussion of the importance of planning and separating one’s ‘safety fi rst’ portfolio, such as a well-constructed bond ladder, from ‘investment lottery tickets’ to the review of new ways of thinking about the risk of small cap and value stocks, it is an invaluable addition to the fi nance books of any investor.” Joe Moglia, CEO, TD AMERITRADE “An excellent primer on investment strategy that is written in a highly accessible fashion for the lay as well as the experienced reader. Unlike many who write on this topic, Peter Stanyer takes full account of behavioural fi nance fi ndings in addition to traditional fi nance. He explains the jargon, acknowledges what can’t be known or is the subject of debate, and provides the tools for investors better to understand their portfolio investment choices and associated risk levels. I would recommend this guide to investment strategy to anyone looking for a candid, plain-English explanation of the world of investing.” Thomas Sowanick, Wall Street strategist Gde Invest Strat.indb ii 11/10/06 15:35:04 GUIDE TO INVESTMENT STRATEGY Gde Invest Strat.indb iii 11/10/06 15:35:04 OTHER ECONOMIST BOOKS Guide to Analysing Companies Guide to Business Modelling Guide to Business Planning Guide to Economic Indicators Guide to the European Union Guide to Financial Markets Guide to Management Ideas Numbers Guide Style Guide Dictionary of Business Dictionary of Economics International Dictionary of Finance Brands and Branding Business Consulting Business Ethics Business Miscellany Business Strategy China’s Stockmarket Dealing with Financial Risk Economics Future of Technology Globalisation Headhunters and How to Use Them Successful Mergers The City Wall Street Essential Director Essential Economics Essential Investment Essential Negotiation Pocket World in Figures Gde Invest Strat.indb iv 11/10/06 15:35:04 GUIDE TO INVESTMENT STRATEGY How to understand markets, risk, rewards and behaviour Peter Stanyer Gde Invest Strat.indb v 11/10/06 15:35:04 THE ECONOMIST IN ASSOCIATION WITH PROFILE BOOKS LTD Published by Profi le Books Ltd 3a Exmouth House, Pine Street, London ec1r 0jh www.profi lebooks.com Copyright © The Economist Newspaper Ltd, 2006 Text copyright © Peter Stanyer, 2006 All rights reserved. Without limiting the rights under copyright reserved above, no part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form or by any means (electronic, mechanical, photocopying, recording or otherwise), without the prior written permission of both the copyright owner and the publisher of this book. The greatest care has been taken in compiling this book. However, no responsibility can be accepted by the publishers or compilers for the accuracy of the information presented. This publication contains the author’s opinions and is designed to provide accurate and authoritative information. It is sold with the understanding that the author, the publisher and The Economist are not engaged in rendering legal, accounting, investment-planning, or other professional advice. The reader should seek the services of a qualifi ed professional for such advice; the author, the publisher and The Economist cannot be held responsible for any loss incurred as a result of specifi c investments or planning decisions made by the reader. Where opinion is expressed it is that of the author and does not necessarily coincide with the editorial views of The Economist Newspaper. Typeset in EcoType by MacGuru Ltd To Alex Gde Invest Strat.indb vii 11/10/06 15:35:04 This page intentionally left blank Contents Foreword xix Introduction xi Part 1 The big picture 1 Setting the scene 3 Think about risk before it hits you 5 Know your niche 7 Box Base currency 10 2 Understand your behaviour 1 Insights from behavioural fi nance 11 Investor biases 13 Investor preferences 15 Loss aversion Mental accounting and behavioural portfolio theory Investment strategy and behavioural fi nance 18 Parameter uncertainty and behavioural fi nance 20 Traditional fi nance, behavioural fi nance and evolution 21 3 Market investment returns: will the markets make me rich? 23 Sources of investment performance 23 Safe havens that provide different kinds of shelter 25 Which government bonds will perform best? 25 Box Is the break-even infl ation rate the market’s forecast? 27 What premium return should bond investors expect? 29 The equity risk premium 31 Equity risk: don’t bank on time diversifying risk 35 4 The time horizon and the shape of strategy: start with no frils and few thrils 40 Short-term investment strategies 40 The chance of a bad outcome may be much higher than you think No all-seasons short-term strategy Gde Invest Strat.indb ix 11/10/06 15:35:04