OMAHA, Neb. — A theme that keeps cropping up from Warren Buffett and Charlie Mungerat the Berskire Hathaway meeting is their complete disdain for modern portfolio theory and the use of higher-order mathematics in finance.
Mr. Buffett talked about efficient-market hypothesis. EMH is a key part of modern portfolio theory. Broadly the theory is about how math shows that investors should diversify because it reduces risk. EMH says you can’t beat the broader market because it’s always perfectly priced.
Here, a few select variations on the mathematics theme from the meeting:
Mr. Buffett: “There is so much that’s false and nutty in modern investing practice and modern investment banking, that if you just reduced the nonsense, that’s a goal you should reasonably hope for.”
Mr. Buffett said he was once asked by a student from the University of Chicago, a hub of modern portfolio theory, “What are we learning that’s most wrong?” To which Charlie Munger quipped, “How do you handle that in one session?”
Mr. Buffett on the efficient market hypothesis, the idea that all information is instantly priced into the market: “There’s this holy writ, the efficient market theory. How do you teach your students everything is priced properly? What do you do for the rest of the hour?”
Mr. Buffett on complex calculations used to value purchases: “If you need to use a computer or a calculator to make the calculation, you shouldn’t buy it.”
Mr. Buffett on the use of higher-order math in finance: “The more symbols they could work into their writing the more they were revered.”
Mr. Munger on the same theme: “Some of the worst business decisions I’ve ever seen are those with future projections and discounts back. It seems like the higher mathematics with more false precision should help you but it doesn’t. They teach that in business schools because, well, they’ve got to do something. ”
Mr. Buffett adds: “If you stand up in front of a business class and say a bird in the hand is worth two in the bush, you won’t get tenure…. Higher mathematics my be dangerous and lead you down pathways that are better left untrod.”
Mr. Buffett on the persistence of bad ideas in finance: “The famous physicist Max Planck was talking about the resistance of the human mind, even the bright human mind, to new ideas…. And he said science advances one funeral at a time, and I think there’s a lot of truth to that and it’s certainly been true in finance.”
Sunday, May 03, 2009
The Oracle gets it.
It is apropos that my alma mater is mentioned in the article, as I have wasted many, many hours of my life embroiled in arguments with fellow classmates regarding the Efficient Markets Hypothesis and Modern Portfolio theory. My position always attempted to demonstrate the poverty of holding on to such positivistic positions given the obvious fact that information management is a central business model of investment banks and funds.