Thursday, November 23, 2006

Be with you shortly

There's an opinion piece in the FT by Arne Alsin that says, in a nutshell, that long term investors shouldn't short-sell the market, and he takes a swipe at the shorting funds. A few years back Guambat did a paper, mainly for himself, which he got into in answer to a friend's question, in which Guambat reckoned that buy and hold was a capital idea for the long haul, and that a leveraged buy and hold scheme using derivatives would amplify the returns. So Guambat has some affinity with the idea.

But Guambat finds that too boring and that it is really entertaining to be more active, which leads into trading. There is a cost to this kind of entertainment, not unlike gambling.

So, without intending criticism of the Alsin piece, I want to point out at least one error in his assessment. He says, "The reason they [short-sell funds] lose investors’ capital over the long term is owing to the insurmountable structural impediments in their path.... Another impediment is the relentless upward bias of the market. The combined companies in the Dow Jones Industrial Average have been unprofitable only once in the past 80 years. That was a small loss in the midst of the Great Depression in 1932."

We need reminding that this is a rigged criterium. The DJIA has only one stock in it, General Electric, that has been in the index from the start. Loosers get dropped out, and there have been some mighty big ones over time.

A simpler way to look at it is that the broad capital market reflects returns on money, over the long term, that approximates interest rates plus a bonus for taking on additional risk. It's a bit like backing the horse instead of the bookie. And almost nobody goes to the track to back the bookie. And that's where the trading trouble starts.

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