Debunking Beta

By Mark Barnicutt on October 3, 2010

One of the Financial Planners that we work with recently highlighted to me that in the September 2010 issue of Forbes magazine, there’s an article by David Dreman of Dreman Value Management, in which he makes the case that it’s time to delete the CAPM (Capital Asset Pricing Model) from the business school text books as it’s done more harm than good for investors.

Dreman’s article “hits home” with HighView as we believe that the global wealth management industry desperately needs to move away from “black box, theoretical investing” and get back to the basics where concepts such as price/value, dividends/yield, and quality actually mean something as it relates to sustainable long-term investing.

Unfortunately, the insanity that is currently prevailing in the “ETF Global Mass Production Game” is not helping our industry and in fact, I believe, will end-up eventually being a contributor to a future global capital markets disaster, just as the excessive proliferation of hedge funds during the 1995 – 2007 period did two years ago.  It’s interesting to note that our research shows that some of the “hedge fund black box quant geniuses” that facilitated the global capital markets meltdown in 2008/9 are resurfacing in some of the global ETF shops by creating all sorts of concentrated/high risk/levered/quant driven ETF strategies.  This is not to say that we don’t believe in the use of ETFs — as we do — but for specific areas of the capital markets and typically in a broadly diversified, non-levered form.

For many retail investors, the acronym “ETF” has an historical meaning of “passive & diversified” investing.  Unfortunately, despite the extensive investment legal & investment language that appears in prospectus documentation, many retail investors – and advisors – have no/limited idea of the concentrated, and in a growing set of cases, levered investment risks that they’re assuming.  Over my career, I’ve never seen a corporate finance creation that is carried to the extreme that doesn’t ultimately end in disaster for investors!  In the past decade alone, remember: income trusts, structured products, hedge funds, and asset backed commercial paper.

Question: So what should investors do? Answer: Stick to the basics!  A quote from the Dreman article summarizes our view well:

The New Testament of investing is actually a return to the Old Testament. I’m talking about Ben Graham and David Dodd’s Security Analysis, first published in 1934. They warned investors to stay away from excess leverage, illiquidity and other risks that CAPM ignores. They recommended buying firms with strong, identifiable earning power and stressed the importance of stockholder dividends.

Mark Barnicutt
See Beyond

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