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A Few Notes on The Bible of Compounding Money

| | Posted in: Investing Expertise

Andrew Abraham, founder of Abraham Investment Management, prefaces his 2013 book, The Bible of Compounding Money: The Complete Guide to Investing with World Class Money Managers, by stating: “I wrote this book because I wanted to separate the snake oil from reality when investing. …By investing with world class money managers I have compounded money and thus been able to live my dreams and enjoy this with my family. I have a complete set of rules for investing in and identifying world class money managers. It is both a quantitative approach as well as qualitative approach full of due diligence. I want to ‘try’ to buy the best managers, diversify among them and make sure they are liquid and transparent. Nothing is held back. Everything is disclosed.” Using examples of successful investors and drawing upon his own experience as a trader and investor, he concludes that:

From Chapter 1, “Are You Sure You Want to Invest with Warren Buffett?” (Page 30): “I have first-hand experience seeing investors’ compound money to shocking amounts. However what most people forget was how hard it really was. They went through long drawdowns and periods of time of elusive profits.”

From Chapter 2, “Compounding is the Key” (Page 44): “There are two catches in the compounding process. The first is clear; compounding involves sacrifice (you can’t spend it and still save it). Second, compounding is boring.”

From Chapter 3, “Investing with World Class Commodity Trading Advisors” (Page 89): “This chapter proves with various examples that world class money managers exist and have compounded in the range of 15% on average over long periods of time.”

From Chapter 4, “Inflation” (Page 112): “So how does one position themself in an inflationary environment? …My bet is with commodity traders and futures trading.”

From Chapter 5, “Trend Followers Lead the Pack” (Page 117): “The vast majority of the traders of managed futures are trend followers.”

From Chapter 6, “Why Invest in Managed Futures?” (Pages 125-126): “…there is a low correlation to the stock and bond markets and this gives you the chance to build absolute returns. This ability to post ‘absolute returns,’ paired with low correlation makes investing in a managed futures vehicle a perfect candidate for portfolio diversification. …One caveat however is that the commodity trading advisor will charge you fees on the notional balance…, and those will be a much higher percentage of your actual balance… The norm in the industry is a 2% management fee and 20% incentive fee.”

From Chapter 7, “World Class Trading Program” (Page 151): “My goal for you is that you become objective and have patience and discipline with world class money managers, even when they go through their inevitable drawdowns. This is where the vast majority fail. …Money is made by sitting, not by jumping. …Your money will be made over a long series of time. No single trade of any manager means anything. No month or any year of any manager means anything.

From Chapter 8, “Common Investor Mistakes” (Page 155): “One of the most typical mistakes that investor’s make is that they chase returns. They look at the ‘best money manager’ who had a good run in a particular category and blindly invest with him/her. They do not understand the strategy or the risks.”

From Chapter 9, “Money Manager Blow Ups” (Page 181): “The golden rule is never allocating more than 5% of your trading capital to any one idea.”

From Chapter 10, “Doing the Uncomfortable: Buying the Drawdown” (Page 185): “The common theme amongst successful investors is having a long term focus, riding out the drawdowns as well as using drawdowns as entry points to invest.

From Chapter 11, “Transparency and Liquidity” (Pages 189-190): “I avoid managers who have lock ups of more than two months… Smart investors always ask to see a daily equity run from a manager. This type of transparency really can give you a good feeling of anticipated volatility.”

From Chapter 12, “Buying the Drawdowns of Commodity Trading Advisors” (Page 201): “When managers are in a drawdown they are more flexible to reduce fees. I always try to reduce fees. Sometimes it works and sometimes it does not. I do not make it a deal breaker if I want to invest with a manager when my goal is to compound money over long periods of time. What I try to do is to negate the 2% management and out of fairness gladly play the 20% incentive fee.”

From Chapter 13, “Due Diligence” (Page 203): “The due diligence that needs to be ascertained includes the structure of the organization, critical backup policies, the managers and key personal, the methodology, its implementation, how the manager approaches risk, fee structure, high water mark…”

From Chapter 14, “The First Question: Are the Returns REAL?” (Page 214, 221-222): “If the returns are real and audited you need to verify and confirm everything. …If the returns are not audited you should ask for monthly statements. You want these statements to come from the brokerage firm directly… Believe it or not, there are managers that will show hypothetical returns or back tested returns. Clearly we are only interested in an actual track record…”

From Chapter 15, “Risk Management” (Page 231): “Three questions can give you the quick litmus test on how a manager approaches risk. These questions are imperative to your trading success. 1. What is your risk per trade? 2. What is your maximum risk per sector? 3. What is your maximum risk on the entire portfolio?”

From Chapter 16, “How to Find the World Class Trend Followers” (Page 249): “Networking is the key to finding world class money managers. Many do not hold themselves out. Conferences are one of the best places to interact and find world class money managers.”

In summary, investors may discover useful tips for selecting and dealing with Commodity Trading Advisors from The Bible of Compounding Money.

Cautions regarding arguments/findings include:

  • The subtitle is more descriptive of the book’s content than is the title.
  • The general approach in the book is screened examples/stories, rather than statistical analysis, of success. This approach is susceptible to non-representative sampling and retrospective biases.
  • The successful money managers cited in Chapter 3 may not identifiable a priori, so citing their past performance as an achievable level of future performance may mislead. Testing should instead: (1) use past performance only to identify all top performers (10 years of at least 15% annual compound returns); and, (2) measure achievable returns based on subsequent out-of-sample (beyond 10 years) performance of identified top performers.
  • When (per Chapter 7) “no month or year of any manager means anything”, testing a manager’s performance generally requires many years of data (more than 10 and perhaps more than spanned by the careers of many manager).
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