Book Review: Smart(er) Investing by Elisabetta and Tommi

It’s not often I get the opportunity to write a book review for our fellow teammates and the best authors on our website — Elisabetta Basilico and Tommi Johnsen!

If you haven’t read Elisabetta and Tommi’s mountain of blog posts on our site you’ve been hiding under a rock somewhere (or clearly not spending enough time on the Alpha Architect website).

I believe that rigorous academic research is the foundation for understanding and implementing successful investing strategies. At the core, I firmly subscribe to the idea of turning academic insights into investment performance.

But as many readers know, it is almost impossible to keep up do date on the latest peer-reviewed journal articles and working papers coming out of the financial economics research community, even with Tommi and Elisabetta’s weekly updates on our site.

Elisabetta and Tommi solve this problem in their book: Smart(er) Investing: How Academic Insights Propel the Savvy Investor.

• Elisabetta Basilico and Tommi Johnsen
• The book can be found here.
• Want to see all our book reviews?

The aim of the book is to democratize research by making it transparent, understandable, and digestible by the non-academic. Finally, the book seeks to identify the research that is most applicable and important for investors in the modern investing environment.

What did I like about the book?

I like this book because it simplifies my life and helps me get up to speed on areas of the market that matter today and will likely matter in the future. Elisabetta and Tommi have identified a number of cutting-edge investment ideas in the following categories:

• Index Investing
• Factor Investing
• Multi-Asset Investing
• Tail Risk Hedging
• Responsible Investing
• Equity and Rewards Based Crowdfunding
• Big Data and Artificial Intelligence Based Investing
• Cryptocurrencies
• Women in Finance

Elisabetta and Tommi survey decades of academic literature on these topics and identify those that represent the “best in class” for each respective category. Tommi and Elisabetta have a unique gift to help clarify what research is relevant, why it’s relevant, and give practical examples to implement in portfolios.

For a quick preview of the book I’ve included a short summary of a few of the main chapters:

• In the Index Investing chapter, they review an article that challenges the anti-passive movement by discussing the research that documents the impact of index investing on active management: it makes it better! For example, active funds have a higher active share and lower shareholder costs in countries where indexers are relatively more prevalent and are less costly to boot.
• In the Multi-Asset Investing chapter, Elisabetta and Tommi review a compilation of more than twenty papers on various aspects of asset allocation including the definition of an asset class; common pitfalls of mean-variance models;  a new measure of risk that will determine the probability of maximum drawdowns on a continuous basis; and approaches to rebalancing the multi-asset portfolio.
• In a world where alpha has proven to be scarce, investment professionals believe that AI-based investing will be the next wave of financial innovation. In the Big Data and AI chapter, we review the research on whether new and novel datasets and statistical techniques create value and add alpha. Specifically, we focus on sentiment related datasets covering news, social media, accounting textual information, and macro-economic text.

Plus three bonus chapters:

• What Constitutes Good Investment Research
• A Roadmap to Reading an Academic Article
• Women in Finance

The first two bonus chapters are great because both Elisabetta and Tommi are PhDs with years of experience reading, writing, and educating students on the insights from academic research. I believe these are the most important chapters in the book because they teach the reader how to fish as opposed to simply giving them fish (I know, a cliche, but seems appropriate. Sorry!). These chapters arm readers with some basic knowledge on how to identify the potential pitfalls of academic research (e.g., look-ahead or survivor bias) and how to read an academic paper (sounds easy, but it’s not!)

The third topic on women in finance is also interesting because Elisabetta and Tommi have lived in the male-dominated quantitative finance realm their entire lives. This experience puts them in a unique position to help challenge the status quo and provide an informed perspective on the situation.

Constructive criticisms

We typically have a constructive criticism section for our book reviews. But the first few chapters of this book reminded me that all researchers have bias/conflicts that should be acknowledged up front. So let’s be honest here — I wrote the foreword for the book and I am a huge fan of both Elisabetta and Tommi — I’m not in a position to critically review this book without some serious bias :-)

Summary

In a world where alpha has proven to be as scarce as Big-Foot and new investment ideas are coming out on what seems to be a daily basis, the ability to get a quick assessment of the ideas that matter is really important. In addition, the ability to access evidence-based opinions on these new ideas and the respective benefits/costs is even more valuable. In situations where narratives are powerful and data is relatively weak, we are most susceptible to poor decision-making. Elisabetta and Tommi will help readers minimize this risk after they read this book.