Chapter 10: Barclays Global Investors: “It Was an Evangelical Undertaking”

Ø Grossman enjoys discussing the role of basic finance theory in the development of BGI products and in their implementation: “I think the heritage of our product line goes back directly to the original theories of Markowitz, Sharpe, Modigliani-Miller and Black-Scholes.”

Ø When we developed the whole idea of separating alpha strategies from beta strategies like indexing related only to market forces, we were drawing directly to on CAPM for understanding what was involved and how to put it to good use.

Ø Much of what we do also draws on Barr Rosenberg’s innovation of multifactor models, in which Barr went beyond beta in the search for the drivers of return and for shaping risk control structures.

Ø Jack Treynor: “CAPM is about expectations. All the other asset pricing models are about surprise.”

Ø Grossman agreed: “CAPM is about what should hold in equilibrium, whereas multifactor models like Fama and French’s models incorporate the size effect and the value/ growth effect”

Ø Grossman added: “Much of the work, especially by practitioners, is not as much as theory, but it is about ways to capture what is priced or not priced in the marketplace.”

Ø Bill Sharpe agreed: “The optimal situation involves theory that proceeds from sensible assumptions, is carefully and logically constructed, and is broadly consistent with the data. You want to avoid empirical results that have no basis in theory and blandly say, ‘it seems to have worked in the past, so it will work in the future’”

Ø Grossman: “The constraint of theory, have as significant impact on investment results, often for the worse, but we would not understand that if we did not have capital market theories to explain the fundamental drivers of investment returns and risk exposures.”

Ø Grossman talking about bubble: “Over time, I observe that bubbles are more often made by clients than by managers, because it is scary for a manager to remain steadfast when long time clients start walking out the door. Only the most tough-minded can resist that kind of pressure.”

Ø Grossman talking about the future:

n The market is now even difficult to beat than it was in the first place. Alpha does not grow on trees, ripe for the picking, even for management organizations as sophisticated as BGI

n BGI is turning to new approaches à and application of behavioral finance, by studying the accounting data with fresh viewpoints to assess the quality and sustainability of earnings and to understand where the real drivers of earnings come from.

n BGI has found vast quantities of data and is uncovering many different sources of growth other investors are ignoring. The trick now is to discover how – or whether – the market prices these facts.