Saturday, 26 March 2016

Music to benchmarked ears

20:00 Posted by The Thalesians (@thalesians) No comments

There are some days, which I never thought would come. An example of one such day arrived years ago. It was the day, when I simply had no idea which artist was at the top of the music charts. This state of affairs has persisted to the current day: today, I have absolutely no idea who is at the top of either the Billboard 100 or the UK Top 40...

It would however, be wrong to equate this is to a lack of interest with music. I love music just as much as I did a decade ago. Browsing my main playlist, which I have unoriginally called the "Thalesians Mix", which I periodically add my favourite tracks, I see the names Taylor Swift and Ed Sheeran, juxtaposed with David Bowie and Bob Dylan, with a modicum of Tom Petty, The Beatles and topped by a hint of Green Day, interspersed with all manner of musical genres. Is this a "right" playlist? Well, it seems right for me, judging by the fact that I seem to gravitate towards listening to this playlist in its entirety at least several times a week. Whether it is right for everyone else, is an entirely different question, I am quite sure there are some tracks on my playlist, which you the reader, would not like. 

I strongly suspect, that my taste in music seems far more eclectic when judged against the "benchmark" of the music charts. I don't feel the "benchmark" of the current music charts is right for me. Of course, I might like one or two current tracks, but I can never see myself listening entirely to purely new songs and dispensing with the old.

The notion of benchmarks in finance is a fraught subject. Whenever you invest, what should be the yardstick for how you judge your performance? Should investors be purely judged by how they beat (or miss) a benchmark which is the "market"? A recent paper, Curse of the benchmarks, by Dimitri Vayanos and Paul Woolley attempts to answer this question (thanks @george_cooper__ and @PolemicTMM for tweeting this paper to my attention). They suggest that trying to use market cap weighted benchmarks (which is often considered as the market) ends up causing

the inversion of the relationship between risk and return so that high volatile securities and asset classes offer lower returns than low volatile ones

A far better way of judging investors, they suggest, is to try to compare them with their peer group adopting a similar trading strategy, rather than the approach of using market cap benchmarks. More broadly, the matter of precisely how to create targets for your investment, will differ between investors. What is an acceptable drawdown is not acceptable for one investor might well be too much for another. The idea of how much risk a trader should take will differ between mandates. I wrote a chapter on both the matter of risks and investment targets in my book, Trading Thalesians, if you'd be interested in reading more.

So whether it's music or investing, if you do have a benchmark, we first need to consider this: is it the right one? Most important does having the wrong benchmark end up changing your strategy for the worse! In the meantime, I keep listening to the music.

Like my writing? Have a look at my book Trading Thalesians - What the ancient world can teach us about trading today is on Palgrave Macmillan. You can order the book on Amazon. Drop me a message if you're interested in me writing something for you or creating a systematic trading strategy for you! Please also come to our regular finance talks in London, New York, Budapest, Prague, Frankfurt, Zurich & San Francisco - join our group for more details here (Thalesians calendar below)

14 Apr - New York - Lawrence Glosten - Limit Order Book Tail Expectations (Thalesians/IAQF)
20 Apr - London - Jacob Bartram - Can option trading strategies enhance CTA/trend following
12 May - New York - Luis Seco - Are Negative Hedge Fund Fees on the Horizon?
13 May - Budapest - Saeed Amen/Paul Bilokon - Thalesians workshop on algo trading at Global Derivatives
20 May - London - Martin Bridson - Knots and what not


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