Competitive Advantage in Investing. Steven Abrahams
part of Bear's fixed income research team. My job let me range across different markets and talk to different investors in the US and abroad. It had been the case throughout my Wall Street career that advantages and disadvantages mattered in investing, and the crisis made it especially clear. When Bear collapsed, I decided to try to relay some of what I had learned to a new generation.
Glenn Hubbard, dean at the Columbia Business School, and Galen Hite, who organized the adjunct faculty for him, warmed to the idea of a course that would focus on ways that different institutional portfolios dealt with markets. They gave me the chance to design and offer the course, and I took it. I've been grateful ever since.
From that first semester, the students at Columbia Business School taught me as much as I taught them. There was no precedent for the course, much less a book, so I started doing the background work and developing the materials that evolved over the years into these pages. The students contributed excellent ideas, challenged me to hone my own, and taught me that a good lecture is as much a performance as anything else. I thank them for the education.
The clients and colleagues that explained the way different portfolios work, or just showed me by analyzing the same markets in such different ways for such different reasons, also deserve thanks. My list of contacts, which I've kept carefully since my first day on the Street, runs into the thousands. They all deserve some credit. The job of analyst has always seemed an extraordinarily good place to satisfy curiosity. Morgan Stanley, Bear Stearns, Deutsche Bank, and Amherst Pierpont have given me the opportunity. I've taken full advantage.
Some friends in the business deserve specific mention for carefully reading sections of this book and offering thoughtful comments. Richard Dewey, Albert Papa, Glenn Perillo, and Robert Thompson kindly read parts of the manuscript on tight deadline. Of course, any shortfalls or errors in this book are entirely mine.
Kevin Harreld, Michael Henton, and Richard Samson at John Wiley & Sons have encouraged me throughout the drafting of this manuscript and worked with me patiently to get all the details right for publication. To my partners at Wiley, thank you.
As for my family, I thank them for the time on nights and weekends I needed to work through the book, for their support and encouragement, and for the beautiful spot by the lake in New Jersey where much of the writing took place and where all good things happen.
Steven Abrahams
September 9, 2019
1 Welcome, Harry Markowitz
In the Beginning
Imagine a simple beginning. You have some spare cash. You have covered your daily cost of living and other bills, and it's rattling around in your pocket. You start thinking about what you might do with it. Other than spend it, that is. That is the beginning. With that thought, you have become an investor.
Or imagine that you are sitting at a bank or insurance company or mutual fund. Or a hedge fund or some other place that invests professionally. In front of you is a number with the cash you have to invest. You have work to do.
You start penciling out a list. It's short at first. Maybe you think about putting the money in a drawer just because it's convenient. Perhaps you think about putting the money in a bank. Or you think about making a loan to someone or some company somewhere in the world. You think about investing as an owner of a business or several businesses. You imagine a budding international empire of businesses. The list has only started.
You could buy a bond from a government or from a company somewhere in the world. You could buy stock. You could buy an option, where someone takes a payment today and agrees to either buy or sell something at a certain price in the future. You could buy insurance or a contract that works like insurance, where someone takes a payment today and agrees to cover losses or damage in the future. You could buy gold or silver, wheat or orange juice, oil or other commodities. You could buy an apartment or an apartment building, an office building, or other commercial property. That's a lot to consider, but the list goes on.
You could buy shares in funds managed by professional investors—even if you are a professional investor yourself. The fund would invest on your behalf in any or all of the available markets. You could buy shares in funds that make loans, buy and sell private companies, buy and sell bonds or equity, own options or commodities or real estate, or any combination of these and other things. You could own funds that trade their investments all the time or almost never. The list continues.
It you printed this list out and watched the pages tick off of the printer and slide onto the floor, it would likely run longer than the longest list you have ever seen. It would fill up the room, spill into the hallway, out the front door, and down the street. It would keep going from there. You could follow it to the ocean and watch it start to fill up the deepest parts. The list would literally be endless.
Now that you have this infinite list, choose. Build your portfolio.
Choose Wisely
The challenge of investing becomes a challenge of choice and choosing wisely.
If you avoid the temptation to put the infinite list aside and do nothing, you may start to notice something common to all of these investments. Something that unifies them. Something that simplifies them. Something that enables you to compare each item on your infinite list to every other.
Start with the money in the drawer. You put the money there, and time passes. One day, you open the drawer and take the money out. You spend it.
Consider another simple investment: depositing money in a bank. You put the money in the bank, and time passes. The bank pays interest on your deposit. One day, you take the deposit and the interest out of the bank. You spend it.
Now consider another investment: a loan. You give the borrower cash. The borrower makes interest payments on a certain schedule and then returns the cash. The investment ends. You spend it.
Consider a related investment: a bond. You buy a bond with cash. The cash goes to a government or company. The government or company pays interest on a certain schedule and then repays the cash. The investment ends.
Consider buying a company or making an investment in common stock or some other form of ownership. The investor buys the stock or the ownership stake with cash. The company uses the cash to operate its business, taking in revenues and paying expenses. Whatever is left over after expenses either gets reinvested in the business or returned to investors as a dividend. The investor never gets back the original cash, although the investor can sell the stock or the ownership stake to another buyer.
Then consider options, insurance, commodities, real estate, and funds. It's a couple of lifetimes' worth of considering.
One thing unifies all of these investments: cash flow. All investing in all of its various forms starts and ends with cash flowing in and cash flowing out of an investment. The world has endless notes, articles, books, and guides to the particular ways that cash flows in and out of different kinds of investments. The investments may seem very different, but underneath the complexities and nuances of different investments is the flow of cash or value into and out of an investment over time. Look through the different names and details to the cash flow. Cash flow is investing stripped to its essentials. Cash flow is all that matters.
Different forms of investment simply entitle investors to different cash flows. The money in the drawer only generates cash in and cash out. A bank deposit generates cash and interest. A loan or bond typically gets principal and interest. Equity gets whatever cash flow is left after a business pays expenses. An option gets the chance to buy debt or equity or something else at some future date. Premiums paid for insurance get the right to recover future damages or losses.
Even when investment advice never mentions cash flow—when it focuses on buying low and selling high, or timing or not timing the market, or momentum or value investing, or the like—it still