By DAVID MOON, Moon Capital
Management August 14, 2005
In 250 A.D., Arab scholars had an advanced understanding
of mathematics that was unmatched anywhere else in the world. Most historians
acknowledge that the Middle East was, at that time, the mathematical center
of the universe. In the middle of the third century, an Egyptian mathematician,
Diophantus, invented a system of new symbols to represent numerals. Until then,
the cumbersome Roman numeral system was used worldwide.
Roman numerals had two significant
shortcomings, however. The lettering system did not lend itself easily to simple
math functions, like addition and subtraction. And the Roman numeral system had
no concept of zero, hence it didn't accommodate negative numbers. Eighteen
hundred years ago, the primary purpose of numbers was for counting; there was
little need for negative numbers or the concept of zero. Who wants to buy zero
calves or sacrifice negative 6 virgins?
But the Arab mathematicians never took the
next step and used their knowledge of numbers to develop the field of statistics
and probability analysis ' that is, a quantifiable understanding of
risk.
Why? It probably had a lot to do with their
core beliefs. The doctrine of alqada wa
alqadar ('the divine decree and the predestination') teaches that God has
measured out the fortune of every individual. For a people who believed in a form of
predestination, it was incomprehensible that you could calculate the
expected value of a decision with multiple, unknown possible outcomes. Their
core beliefs could not even comprehend the notion of probabilities. They
believed their fate was not in their own hands; it was already decided by Allah.
How then could their own decisions play a role in determining outcomes? The
development of the field of statistics would have to wait another 1,400 before
being explored ' not by Arab scholars but by a Franciscan monk, Luca
Paccioli.
Our core beliefs and the way we think affect the way we
invest. The basic premise of socalled Modern Portfolio Theory is that
individual security analysis has no value. Since investors can't outperform some
arbitrary equity benchmark, why even try? Why not just buy the entire stock
market? If that's not a predestination theology, I don't know what is. 'It
doesn't really matter what I decide, so I won't decide anything. I'll just let
the market make my decisions for me.' (Investors who let 'the market' make their
investment decisions usually turn to index funds to execute their fatalistic
investment strategy. Those who use an S&P 500 index fund are actually
letting a committee at McGrawHill make their decisions. McGrawHill, a book and
magazine publisher, also publishes the Standard & Poor's
indices.)
A new client came into our office after dismissing his investment
manager. His portfolio contained almost 100 stocks, representing more than 60
percent of the market capitalization of the S&P 500. Do you think the
manager who bought all those stocks really believed that his stock selection
decisions had any impact on overall portfolio performance? If he did, he was
kidding himself. The client's portfolio and fortune were not in the hands of the
investment adviser. They were in the hands of fate, or some higher power. In
this case, the higher power was a committee at McGrawHill.
The adviser who bought those stocks didn't trust his own decisionmaking
ability. Either that, or he didn't think his decisions really mattered. His
method of thinking was little different than the Muslim scholars who, for more
than 1,000 years, sat on the other side of the door from one of the great
discoveries of the Renaissance. And like those Arab mathematicians, the
investment manager was content to sit beside that closed door, unable or
unwilling to grasp that something better was on the other side.
David Moon is president of Moon Capital Management, a
Knoxvillebased investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).
