Applied Investment Theory How Markets and Investors Behave, and Why
Institutions now dominate trading in equities around the world. Mutual funds are the most prominent, and doubly important as custodians of retirement savings. Despite this, there is no comprehensive description of fund manager behaviour, much less a match
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How Markets and Investors Behave, and Why
Les Coleman
Applied Investment Theory
Les Coleman
Applied Investment Theory How Markets and Investors Behave, and Why
Les Coleman University of Melbourne Parkville, Victoria, Australia
ISBN 978-3-319-43975-4 ISBN 978-3-319-43976-1 (eBook) DOI 10.1007/978-3-319-43976-1 Library of Congress Control Number: 2016957298 © The Editor(s) (if applicable) and The Author(s) 2016 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made. Cover Design by Liron Gilenberg Printed on acid-free paper This Palgrave Macmillan imprint is published by Springer Nature The registered company is Springer International Publishing AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland
For Millie, and her siblings and cousins. Yours will be the best generation yet.
Preface
Summary of Applied Investment Theory Applied Investment Theory (AIT) explains how mutual fund managers invest in equities. This is one of modern finance’s most important questions because mutual funds are the largest investor group in most developed economies, where their management of individuals’ retirement savings is a critical agency relationship. AIT builds on core principles of standard investment, namely efficient markets and rational investors, and overlays real-world conditions so that: markets are subject to frictions; rationality is conditional on restricted foresight; and risk becomes aversion to loss and uncertainty. AIT also relies on well-recognised finance concepts: equity value is contingent on state of the world; and equities have attributes of real options, multiple components to their value, and are ranked according to opportunity costs. In addition, mutual funds form a global oligopoly and their revenue is linked to funds under management. These structural influences from markets and the investment management industry combine with moral hazard and agency theory to explain fund managers’ behaviour. Understanding the
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