The Long and the Short of It: Finance and investment for normally intelligent people who are not in the industry
The Erasmus Press £11.99
There is a certain irony in being asked to review a book that makes valid charges against my own profession. But as I have found John Kay's column in the Financial Times a worthy read during the course of the past 13 years, I was prepared to give his latest business tome a go.
Focusing on the relationship between economics and business, Kay has managed to pack in a good deal to his distinguished career, aside from journalism: academic work, think tanks, business schools, company directorships and stints at investment companies. Such experience suggests he is more than qualified to explain the ins and outs of investment.
The rambling title might put you off at first: The Long and the Short of It: Finance and investment for normally intelligent people who are not in the industry. It certainly does not pass the airport bookshop requirement for a catchy heading. So does a dry and tortuous read await? With an author as sensible and well informed as John Kay, however, I opened this book anticipating some sound principles sprinkled with new thinking.
I was slightly disappointed. Bookshop shelves are groaning with investment books, from the likes of Hedge Funds for Gardeners to Complex Hybrid Hypotheses for Very Bright People. Kay's effort falls between two stools: it is neither an academic exposition of financial economics, nor is it a practical guide for the switched-on potential investor.
This is not to say that it is devoid of wisdom. Kay provides a guide to the complexities of modern finance, taking us back to the basics of investment and then leading us towards the sophisticated but flawed innovations of the modern financial system - all too evident in the current credit crunch.
I have never read a book whose author encourages skipping over substantial chunks of text. In his foreword, Kay suggests that readers with prior knowledge of the financial services industry omit chapters 1, 2, 3 and 9. He's right to give such advice. Allthough they are a sound introduction to investing, the sophisticated investor or investment professional would soon tire.
The book takes a well-aimed, but now well-worn, tilt at the theoretical underpinning of modern investing. The Efficient Market Hypothesis, he says, is illuminating but not true, and neither does the Capital Assets Pricing model stand up, and both should be used to the investor's advantage. Certainly, professional investors are too often caught out by being slaves to a model. But he fails to explain exactly how the intelligent investor should capitalise on this information.
Benefiting from the imperfections of these theories is one of the supposed endgames of this book. Yet the reader is not supplied with the tools to do so, and in Chapter 13 is rather vaguely entreated to transfer money into a group of exchange-traded funds, closed-ended funds and real-estate trusts on substantial discounts.
Chapter 7 merits the closest attention. It is by far the longest and most complex, but describes his key investing recommendations: pay less, diversify more and be contrarian. He outlines a probabilistic approach to investing, where risk outcomes should be judged only by their subjective expected value.
Rightly, the risk that is pertinent to you is the risk that should be attributed to your whole investment portfolio, not the aggregated risk associated with the individual securities it contains. He stands up for diversification as a method of ensuring good portfolio performance. But as virtually all asset classes have gone down together in response to recent market events, diversification is no guarantee of good returns. Strangely, he is pretty silent on that point.
In his concluding chapters, Kay's view that the financial services industry is bloated and has spun out of control is hardly revelatory, given recent events and reactions from governments and investors. Still, he makes an interesting analogy. It is a casino attached to a utility - where the activities of the casino have become so bloated that they have jeopardised the everyday banking needs of consumers and business (the utility).
His opinion as to how to prevent a breakdown recurring is valid: close regulation and supervision, though tempting, is not the answer, he says. What is required is a firewall to protect the utility customers, not rigid rules to ensure good practices. He eschews the reintroduction of Glass-Steagall, US banking-style regulation. It is difficult to disagree with this logic, but it is not clear what Kay is proposing to erect in its place. He criticises without suggesting any solution, which is disappointing.
Perhaps worryingly for an already battered and demoralised investment community, his premise is to take matters into your own hands. Be your own investment manager, he advises. Identify the investment options open to you, distinguish fact from fiction, understand principles of and strategies for sound investment, and acquire the tools to manage risk.
Ultimately, Kay's premise that you are on your own when it comes to investment holds some water. Although I cannot subscribe wholeheartedly to this thesis, it is true that investors - whether they invest alone or with guidance - have to take ultimate responsibility for their decisions. However, this book does not quite make it in to the category of essential reading. It's interesting but unlikely to become an indispensable, practical companion on the intelligent investor's personal journey.
Keith Jones is chairman of Sourcecap International