For years, academia has been selling the idea that share prices represent the discounted rational expectations of future cash flows. But if something had been learned since the mid 1990s, it was that there are long periods during which emotion is a much more important component of price than rationality. Empirical observation shows that prices often deviate from what is predicted by the Efficient Market Hypothesis and that deviations sometimes last for long. Sentiment is then an important ingredient of price.

Unlike what happens in almost every other market, in financial markets, higher prices often attract more buyers. This contributes to increase the euphoria until some day everyone realises prices are just wrong. By then, it’s too late for most and a the bust cannot be avoided. Sometimes with huge financial and real consequences. The 2000s house bubble that ended in a huge financial crisis in 2007-2009 is good evidence for it.

Staying rational is the biggest challenge of investing. It requires the use of quantitative metrics to uncover value, and the courage to oppose the crowd.

But, investing is not only about picking the right securities. It is also about managing risk. Fifty years ago, it was relatively easy to find uncorrelated securities. But in today’s fast-paced world, where capital moves freely from the UK to New Zealand in a few seconds, the global financial market can be seen as a big pond where each small water drop represents a different security. The question arising is:

How much different is a water drop is from any other?

If securities are all exposed to the same risk factors, we are unable to manage risk effectively. We need to use new ways to identify the key characteristics of a security. Instead of asset classes, we now use factors like value, size, volatility, among others.

Managing risk is the second biggest challenge of investing. We want to build a portfolio of securities in a way that the risk of the securities taken together is less than the weighted risk of the individual securities.

The goal of the Macro Investor is to address the two biggest issues faced by investors: staying rational and being able to manage risk. It is about identifying macroeconomic trends, analysing securities using a quantitative approach and building portfolios. The Macro Investor is not a share tips website though. It’s about translating the state-of-the-art knowledge from academia into improvements in the way individual investors manage their investment portfolios. It’s about identifying mistakes, learn with them, and improve the future action. It’s about giving tools to individual investors to invest on their own.

For now, the Macro Investor is a one-man band, developed by just myself.

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