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Get up, see what's on the other side of the door | ||
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By DAVID MOON, Moon Capital
Management 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 al-qada wa al-qadar ('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 so-called 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 McGraw-Hill make their decisions. McGraw-Hill, 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 McGraw-Hill.
The adviser who bought those stocks didn't trust his own decision-making 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 Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).
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