Index

Absolute return, 16, 121

Accredited investors, 3–4, 11

Active investment management, 17, 62

abandoning, 127–128

Active Portfolio Management. See Fundamental Law of Active Portfolio Management

Alpha stocks, 17, 55, 68

buying, 56

seeking, 56

Apple company, 95

Arbitrage, 11–12, 21–22, 31, 113

convertible, 115

equity, 115, 116

fixed-income, 114, 115, 116

statistical, 22

Ask price, in stock trading, 25, 28

Asset-based valuations, 36–37, 42–43

Assets under management (AUM), 4, 10

fee, 122

Back end load funds, 13

Backtesting trading strategy, 93, 105–106

cautions about, 106–107

components of, 105

cross validation of, 107

Bankruptcy, 37

Benchmark

defined, 17

versus return, 16–18

Berkshire Hathaway, 65–66, 95

The Bet, 138

Beta stocks, 55

balanced portfolio of, 58–59

buying, 56

Bid price, 25, 28

The Big Short, 5

Biggs, Barton, 103–104

Black, Fisher, 114

Black–Scholes formula, 114

Bogle, John, 17, 51, 127

Book value, of firm, 36–37, 42

Breadth, of portfolio strategy, 66–67, 71

as diversification, 67–68

as trading, 68–70

Brokerage firms, 25, 28–29, 127

Buffett, Howard, 32

Buffett, Warren, 22, 31, 65, 66–67, 129

education of, 32–33

Buy orders, 26

Buy to close orders, 27

Capital asset pricing model (CAPM), 19, 51

alphas, betas, and correlations of, 53–56

hedge fund strategies in, 56–59

implications of, 51, 56

overview of, 52–53

Capital, defined, 9

Capitalism, defined, 98

Cash flow–based valuations, 42–43

Charting. See Technical analysis

Cigar butt approach, 32, 33

Circle of competence, 72

Cohen, Steven, 23–24

Company valuation

asset-based, 36–37, 42–43

cash flow–based, 42–43

dividend-based, 37–40

dividend discount model, 40

growth-based, 42

introduction to, 35–44

long-term ownership of asset, 41–42

used by hedge funds, 47–48

Compound annual growth rate (CAGR), 15–16

Constraints, for portfolio optimization, 81

Contingent orders, 27

Convertible arbitrage, 115

Correlation coefficients, 53–56

Cost–benefit analysis, 19

Creative destruction, 98

Cumulative returns, 15, 18, 105

Dalio, Ray, 85–86

Dark pools, 29, 127

Data mining, 107

Data sources, of stock price data, 99–102

datafeeds, characteristics of, 99

information feeds

InsiderInsights, 100–101

StarMine, 100

Thomson Reuters Machine Readable News, 100

Datafeeds, characteristics of, 99

Derivatives, 115, 116, 125

Discount rate, defined, 39

Discounting, defined, 37–38

Diversification, breadth as, 67–68

Dividend-based company valuation, 37–40

Dividend discount model, 40

Dividends of stock, 39, 40, 95–96

Dodd-Frank financial reform, 125

Dow Jones Industrial Average, 18

Drawdown, 19

ratios of, 20

Economic moat, 33

Efficient frontier, 78

and portfolio optimization, 82–83

Efficient markets hypothesis (EMH), 51, 87, 88, 107

debates over, 63

three versions of, 62–63

Ehrlich, Paul, 129

Einhorn, David, 22, 49–50

Equity strategy, for hedge funds, 11, 12

Event-driven strategies, of hedge funds, 12

Event studies, on stock prices

affecting stock price, 47–48

assessing and using, 90–91

conducting, 89–90

overview of, 87–89

Exchange traded funds (ETFs), 4, 6

Fama, Eugene, 62

Fill backward missing values, 97

Fill forward missing values, 97

Finance, 11, 51, 69

quantitative, 12

Financial markets, 35, 106, 126, 130

Fixed-income arbitrage, 114, 115, 116

Flash Boys, 5, 29, 126

Forward testing trading strategy, 105

Free ride stocks, 27

Front end load funds, 13

Front running trades, 29, 125–127

Frontier markets, 26, 62

Fundamental analysis, 36

Fundamental Law of Active Portfolio Management, 65–72

breadth, 66–67, 71

as diversification, 67–68

as trading, 68–70

implications of, 72

information coefficient, 71

information ratio, 70–71

performance of, 66–67

skill, 66–67

Funds of hedge funds, 13

Gate Capital, 122

Going long, in stock market, 26–27

Graham, Benjamin, 31–32, 35, 43, 44

Grinold, Richard, 66

Growth-based firm valuations, 42

Hedge Fund Research, Inc., 17

Hedge funds, 31, 51

active management, abandoning, 127–128

benchmark (relative return)

versus return, 16–18

betting, 129

case study, 113–117

company valuation, using, 47–48

conclusion, 130

evaluating, 14–19

event studies, assessing and using, 90–91

fee structure of, 13–14, 122–123

front-running, 125–127

funds of, 13

history of, 10

insider trading, 124

institutions retreat from, 128–129

introduction of, 3–6

macro, 48

managers, 12

momentum or direction of, 12

versus mutual funds, 11

opportunities and challenges for, 121–130

performance of, 121–122

private exchanges and dark pools, 127

registration and marketing of, 123–124

returns, 14–16

versus benchmark (relative return), 16–18

risk, 18–19

Sharpe ratio, 19–20

strategies of, 11–12

in CAPM framework, 56–59

explanation of, 21–22

systemic importance of, 125

Hedging, 56, 71

HFRI index, 121–122, 128

HFRX index, 17

High frequency trading (HFT), 29, 126–127

How The Eggheads Cracked, 113

Human ingenuity, versus resource depletion, 129

IBM, actual and split-adjusted stock price, 25, 26, 94–95, 96

Information coefficient (IC), 71

Information feeds, illustration of, 100–101

Information ratio (IR), 70–71, 106

Insider trading, 61, 124

InsiderInsights, 100–101

Institutions, retreat from hedge funds, 128–129

Intangible assets, 36

Intellectual property, 11

The Intelligent Investor, 31, 35

Intrinsic value, of firm, 22, 31, 32, 36

dividend-based valuation, 37–40

Investing

economic role of, 9–10

framework for, 51–59

short, 22

value, 22, 31–33, 35–36

Investment Company Act of 1940, 10, 123

Investment management, 62

Investment managers, 17, 62

Jones, Albert Winslow, 10, 56, 121

Journal of Economic Literature, 87

Jumpstart Our Business Startups (JOBS) Act, 123

Kahn, Ronald, 66

Liabilities, 36

Limit order, 26

Liquid markets, 26, 63

Load funds, 13

Long-term capital management (LTCM), 3, 113

aftermath of, 116–117

fall of, 115–116

rise of, 114–115

MacKinlay, A.C., 87, 90

Malkiel, Burton, 51, 63, 127

Margin of safety, 35, 43, 44

Market

capitalization, 36

conditions, changing, 107

defined, 25

efficiency of, 47, 48, 61–62, 99

impact costs, 105

liquidity, 26

makers, 25, 26

making mechanics, 25–29

milliseconds, advantage of, 28–29

neutral strategy, 121

order, 26

book, for XYZ stock, 27–28

types of, 26–27

spreads, 25–26, 28

value, of firm, 36

Markowitz, Harry, 77

Mean reversion, 89

Meriwether, John, 3, 113–114

Merton, Robert, 114

Miller, Merton, 51

Modern portfolio theory (MPT)

dynamic process of, 83

efficient frontier, 82–83

limitations of, 83–84

low correlation, 79–81

optimization basics, 81–82

overview of, 77

portfolio optimization, 82–83

risk and return trade-off, 77–79

Modigliani, Franco, 51

Money, time value of, 37–40

More Money Than God: Hedge Funds and The Making of the New Elite, 5

Mortgage-backed securities (MBS), 125

Mullins, David, 114

Munger, Charles, 33

Mutual funds, 4, 10, 123, 124

expenses, 13

versus hedge funds, 11

NASDAQ stock price, 25

three-hour break in, 96–97

New York Federal Reserve Bank, 115–116

New York Stock Exchange (NYSE), 25, 62, 96

Niche markets, 26, 62

Opportunity cost, 38, 39

Optimization. See Portfolio optimization

Orders, in market

book, for XYZ stock, 27–28

types of, 26–27

Ownership, of asset, 41–42

Paired trade, 114

Paper trades, 105

Payout ratio, of stock, 96

Perpetuity payments, 41

Portfolio construction, 78, 83–84

Portfolio management. See Fundamental Law of Active Portfolio Management

Portfolio optimization, 78

algorithm for, 82

basics, 81–82

constraints for, 81

decision variables for, 81

objective function of, 81

search procedure for, 82

dynamic process of, 83

and efficient frontier, 82–83

goals of, 81

limitations of, 83–84

Portfolio’s return, 16, 56–58

Present value cash flows, 38–39, 41, 47

Price-to-book ratio, 37

Private exchanges, 127

Quant arbitrage, 113, 130

Quant hedge funds, 6, 65

Quant strategies, 6, 113

Quantitative finance, 12

The Quants, 5

Quantum Capital, 3

A Random Walk Down Wall Street, 51, 63, 127

Rebate fees, 26

Regression to the mean, 22

Relative return. See Benchmark

Renaissance Technologies (RenTec), 65–66, 67

Resource depletion, versus human ingenuity, 129

Returns, in hedge funds, 14–16

versus benchmark (relative return), 16–18

risk-adjusted, 69, 72, 77, 80, 91, 106

and risk, combining, 19–20

Risk, in hedge funds, 18–19

adjusted returns, 69, 72, 77, 80, 91, 106

and return trade-off, 77–79, 80

and returns, combining, 19–20

Robertson, Julian, 3

Rule of 72, 15–16

SAC Capital, 124

Savings, defined, 9

Scholes, Myron, 114

Securities Analysis, 31

Securities and Exchange Commission (SEC) regulations, 10, 11, 123

Seides, Ted, 129

Sell orders, 26

Sell to open orders, 27

Selling short, in stock market, 26–27

Semi-strong form of EMH, 62–63

Shareholders, 95–96

Sharpe ratio, 19–20, 70, 80–81, 82, 91, 106

Sharpe, William, 19, 51

Short investing, 22

Simon, Julian, 129

Simons, Jim, 73–74

Soros, George, 3, 119–120

Sortino ratio, 19, 20, 84

Specific risk, of asset, 67

Standard deviation, 18–19, 67, 69, 79, 84

StarMine, 100

Statistical arbitrage, 22

Steinhardt, Michael, 109–110

Stock market index, 17, 51, 121, 127–128

Stock price data

actual versus adjusted, 93

breaks in, 96–97

data sources of, 99–102

dividends of, 95–96

events affecting, 47–48

splitting of, 93–95

reverse, 95

ticker symbols, missing, 97–98

Stop loss orders, 27

Stop orders, 27

Strong form of EMH, 62–63

Summers, Larry, 125

Sun Microsystems, 97

Survivor bias, 98, 99

Systematic risk, of asset, 67

Tangible assets, 36

Technical analysis, 36, 63

Thomson Reuters Machine Readable News, 100

Ticker symbols, missing, 97–98

Tiger Fund, 3

Time value of money, 37–40

Trading

breadth as, 68–70

strategies

actual versus adjusted stock price data, 93

backtesting, 105–107

breaks in series and missing data, 96–97

conclusion, 98

dividends of, 95–96

forward testing, 105

stock splits, 93–95

ticker symbols, missing, 97–98

systems, automated, 91

Trailing stop orders, 27

Troubled Asset Relief Program (TARP), 125

Unit investment trusts. See Mutual funds

Value investing, 22, 31–33, 35–36

Vanguard Balanced Index Fund, 51, 122

Variance. See Standard deviation

Volatility, 18, 67, 126

Wall Street, 3, 6, 13, 16, 44, 83, 113, 114, 115, 117

Weak form of EMH, 62–63

When Genius Failed: The Rise and Fall of Long-Term Capital Management, 5, 113

XYZ stock, order book for, 27–28