Impact Podcast | Smarter investing: Building your own philosophy for an uncertain world

KANINA BLANCHARD

Exclusive insights, actionable strategies and ideas that ignite change. You're listening to the Ivey Impact Podcast from Ivey Business School.

JULIAN BIRKINSHAW

Hello and welcome to Dialogue with Dean, the inaugural series on the Ivey Impact Podcast. I'm Julian Birkinshaw, Dean of the Ivey Business School. On today's episode we explore the art, science and psychology of investing. Financial markets have always been volatile, but in our current era of economic uncertainty and political instability, what some might call stock market mayhem, investors are desperately searching for sound strategies and trusted in voices. To help us navigate this landscape, I'm joined by Steve Foerster, finance professor at Ivey and author of two recent books, In Pursuit of the Perfect Portfolio and Trailblazers, Heroes and Crooks Stories to Make You a Smarter Investor. These books offer a blend of biography, behavioral finance, and practical wisdom, featuring Nobel laureates, financial legends, historical intrigue, and modern-day cautionary tales.

Steve, welcome to Dialogue with the Dean. It's a pleasure to have you with us.

STEVE FOERSTER

Thank you. Julian. Pleasure to be here.

JULIAN BIRKINSHAW

Thanks. So, let's get to know you a little bit better just to take us through your academic, your professional journey. What led you to writing these types of books?

STEVE FOERSTER

Well, I'm first of all, I'm Ivey through and through. I first, stepped foot in the old Ivey building 48 years ago, in 1977, when I started my, undergrad degree, did, an Ivey HBA, went to Wharton for a PhD., and since 1987, I've been, back here teaching and researching. I got interested in terms of, book writing and, and, writing stories as, as well - I started as the traditional, academic doing the research for top tier journals and was successful at that. But found that, as, as I'm sure you noticed with your work, the more specialized area you're in, the audience, is pretty, pretty small. So, I expanded, and, and, just around 2002 wrote a textbook, which was, which was great. And these books are meant to then, get into a broader audience. And when I think about our teaching pedagogy, cases, what's a case? A case is a story. So it's just really an extension of, instead of, telling stories, writing stories as well.

JULIAN BIRKINSHAW

So, you're actually one of the few faculty still at Ivey who was on the faculty when I was doing my MBA.

STEVE FOERSTER

Absolutely.

JULIAN BIRKINSHAW

All those years ago. So. No, it's I mean, it's great that you're still, you know, hugely active as a as a researcher, as a writer. And I think it's completely right in some way is that you try to gradually over your career broaden the market that you're trying to reach with your research.

MUSICAL BREAK

JULIAN BIRKINSHAW

So, I think what we're going to do is we're going to dig into these two books. The first one, In Pursuit of the Perfect Portfolio, which you wrote with Andrew Lo, who's a well-known American, finance professor. I think he's at MIT.

STEVE FOERSTER

Is that correct? Yes.

JULIAN BIRKINSHAW

Let's just dive in and then perhaps come back to why did you write the book? You talk about historical versus modern investing. I guess you're just trying to remind is that there's nothing new under the sun that investing was happening, you know, back at the dawn of time as well. Is that right? Tell us a bit about that.

STEVE FOERSTER

And in fact, in the first chapter, before we get into the ten luminaries that we, that we interviewed, our first chapter is, is a very brief history of investing going back, thousands of years, Mesopotamia and so on. The demarcation is really 1952. In finance and investing, we have a particular date. Prior to that date, we would talk more about the art of investing versus the science of investing. While there were some, some people, Benjamin Graham, for example, in 1934 wrote, Security Analysis, which was a pretty thoughtful book and talked about a systematic approach for a certain way of investing called value investing. But there really wasn't much of that until 1952. In March of 1952, a paper appeared in the Journal of Finance, a very short paper called Portfolio Selection, and it was written by one of the people we interviewed in in our book, Harry Markowitz. And what was so unusual about that article for the Journal of Finance at the time, it had mathematic equations in it. And so this was just a very, a very different paper.

JULIAN BIRKINSHAW

Let’s do it Harry Markowitz, I've heard of him, but that's kind of my job, but most of the audience I've never heard of this guy. And it's very unusual that an academic paper kind of has such a huge influence. So tell us what the big idea was in Harry Markowitz’s famous paper.

STEVE FOERSTER

Sure. Well, it's surprisingly simple for a Nobel Prize winning idea. And Julian it’s probably something your mother told you - don't put all your eggs in one basket. And that's what Harry Markowitz came up with. Maybe life is not fair. Why didn't your mother get a Nobel Prize for that? But what Harry did is he always told people, call me Harry, call me Harry. What Harry did was he came up with a process, a very simple but powerful process to think about risk and return. So his simple models was what do investors care about? Two things. What's my expected return? All else equal, I would like a higher expected return to a lower expected return. And secondly, how much risk exposure do I have? All else equal, we would like to have less risk exposure than more. And so with that simple premise and also, recognizing that there's a relationship between, any two stocks, we call that, a correlation covariance, taking that into account as, as well. What he was able to show that if we take the whole sum of securities, let's suppose there are 2000 securities out there. He was able to show that that we can boil this down to a subset of what he called efficient portfolios. His definition of efficient portfolios. Of all the choices you have out there, these are portfolios that have the highest level of expected return for a given a level of risk, or flip that around the lowest level of risk for a given level of expected return. And so the key insight that he had is that there is a free lunch. There's one free lunch and that free lunch is diversification. If you're diversified, you can improve your return to risk relationship. That was a profound, way that he did that in a mathematical setting.

JULIAN BIRKINSHAW

So obviously we're not going to get into the math. We I wouldn't understand it. I’m sure the listeners wouldn't either. But conceptually, you're saying, as an investor, all of us, some of them are investing ourselves is we should buy ourselves a diversified portfolio of stocks. And somehow the risks kind of cancel each other out. Is that is that the right?

STEVE FOERSTER

Correct.

JULIAN BIRKINSHAW

There always be something which is going up. Something else is going down.

STEVE FOERSTER

Precisely. Unless by chance, you had two stocks that were moving in lockstep, and generally that just doesn't happen. Right. And so as long as you don't have a perfectly correlated stocks that are going exactly the same, then you get these benefits from diversification. And so, I mean, we'll transition into Bill Sharpe in a few minutes, but, what Harry Markowitz said is be diversified, and that's sort of the extent he didn't describe how to diversify, but just be diverse.

JULIAN BIRKINSHAW

Does this mean just stocks of this, including my bonds and my gold in my property portfolio as well?

STEVE FOERSTER

That's a great question. And, he just called these securities. And so it really is generic. And you've hit on something that's really important because while we tend to talk narrowly in terms of stocks, really we're talking about all securities.

JULIAN BIRKINSHAW

Right. So, a US Treasury is is a is a security wise. Yeah. It has an interest. It has a yield, which is a little bit different, and obviously there's risk associated with that which yeah we'll get to that's all other securities rates, in a, in a few minutes no doubt. Markowitz kind of really kind of shapes the field because from that point on, people are bringing mathematical modeling correct to portfolio analysis. Was there a kind of a an optimum or sort of minimum number of securities you needed to get at least decent level of….?

STEVE FOERSTER

So, so this is where subsequent researchers did look into that, and if by definition, we were just randomly choosing these, you get the greatest amount in once you've diversified to call it 20 to 30 stocks, as long as those are randomly chosen.

JULIAN BIRKINSHAW

Right, but 20 or 30 companies in mining is not diversification, right? Yeah. We've got to take the entire portfolio. Yeah. Okay. So we'll get to William Sharpe. Now, who's again a name that some people might remember, but most probably do not. Who was William Sharpe and what was his big idea?

STEVE FOERSTER

Well, given that you were through the MBA program, 1991, I believe, you were probably exposed to the capital asset pricing model.

JULIAN BIRKINSHAW

CAPm as we called it in those days.

STEVE FOERSTER

Actually, Bill Sharpe himself calls it the C.A.P.M. He never calls it CAPm. Interestingly, a little bit of tidbit tidbit there. So what Bill Sharpe did, he actually was, a protege, of Markowitz. And so there was a key connection there. Bill Sharpe asked one simple question. What if we take Markowitz’s, his model that we just described? And what if everybody acted as if they were trying to form these kind of portfolios?

What would the world look like? In other words, what would be an equilibrium situation? And that's where he came up with the capital asset pricing model. He made one additional assumption. So with Markowitz, we were talking about securities, broadly defined. Bill Sharpe said, what if we could also borrow or lend at some kind of risk free rate and combine that with all of these, all of these risky securities? So, Markowitz said, of all the securities out there, there's a subset that are the efficient ones that have the best return for a given level of risk. Bill Sharpe narrowed it down to once we combine that with, have a risk free investment like a Treasury bill, then there's only one of those Markowitz risky portfolios that we would all want to hold. And therefore, if we all want to hold it, then that has to be the, quote unquote, the market portfolio. The portfolio weighted by market weights that everyone would want to hold. So, this had a profound practical implication that it took decades. And we're still in this revolution that we can talk about. But this simple model, equilibrium model, said you should not only just be diversified, but you should buy the market portfolio. And that got both Markowitz and Sharpe Nobel prizes.

JULIAN BIRKINSHAW

And, so for an individual investor buying the market portfolio and we'll get into tracker stocks and stuff in a second, but is actually the smart thing to do. But obviously there are many investors who are trying to pick individual stocks. I mean, my vague memory, I'm going to look foolish in a second, was that we used the capital asset pricing model as a way of valuing individual companies. Is that right?

STEVE FOERSTER

Yes, absolutely. And to this day, our graduates, other graduates, virtually, I'm going to go out on a limb and say virtually every MBA commerce program teaches the capital asset pricing model. A lot of graduates of programs become analysts, and they have to do discounted cash flow models to value companies. What would they use for the discount rate?

It would come out of the capital asset pricing model.

JULIAN BIRKINSHAW

Oh, I see. Okay. So we're going to talk about one more person. His name is John Bogle, before we move on to the other book. Who was John Bogle and what was his contribution.

STEVE FOERSTER

So John Bogle, or Jack Bogle was a practitioner. So, he was not an academic. But when he was at, Princeton in, in the early 50s, he wrote a thesis, an undergraduate thesis on mutual funds. Mutual funds  were pretty boring kind of investment. There were a few large, fairly diversified mutual fund companies, but he, put some ideas out there in terms of what mutual funds, and what the direction mutual fund industry might be. He was a traditional fund manager. He rose to the top, in his, in his 30s with the Wellington Fund. This was the time, of the so-called Go-Go years, not unlike the dotcom, years where it was these high growth or even more recently, The Magnificent Seven. It's these high growth stocks, and that's all that that matters. His firm tried to resist, but then, then they were getting outperformed by these other managers. So he hired a slew of these go-go managers and it was a disaster. It was so bad that, he was basically fired from his firm and had to start all over. He had to figure out a different way, a different approach. One thing led to the other, partly inspired by academics, he decided to start what then was the world's first index mutual fund. Rather than trying to outperform, create a fund that replicates the S&P 500 in the US. This was the Vanguard fund and it took a while. But, where we are now, trillions and trillions of dollars are flowing into what we refer to as passive investments.

JULIAN BIRKINSHAW

So, I do need to just push a bit here because, as you say, many people, whether they do it actively or passively, they are buying into some of these funds and those funds and the mechanics of them don't matter, but essentially, they are created in a way that they will more or less mirror the S&P 500, or whatever it is. And we know that in the long term, that will be a very solid investment. And yet there are hundreds of thousands of people out the world running active funds. And they are basically asking investors, people like you and me, to give them essentially, what, 2% or whatever the fee is for the right to chance their luck with beating the market and yeah, the evidence, almost by definition, is that while some of them do, some of them don't, and that, you know, they shouldn't have bothered, so how does that active fund investment industry, which is, you know, many of our graduates, how does it persist? I mean, why why just why do we end up with more and more of the world just simply playing the passive game?

STEVE FOERSTER

Well, the trend is clearly and has been, in terms of the passive world, is a winning world. And so that has grown tremendously. It is, admittedly much, much tougher to be an active manager now. And as you point out, the big difference is in terms of costs Vanguard really led the way, continues to lead the way in terms of, of bringing down those costs for these passive funds. So it's minuscule. It's only a few fractions of a percent. So even if the active managers are charging 1%, that means they have to outperform by more than 1% to recoup those. Actually Bill Sharpe has a delightful, very short but famous paper called the arithmetic of active management. Just the logic you described - if active managers are more costly than passive collectively after fees, they have to be doing worse than the passive. Nash. So why are there still active managers? You have to believe that I know how to pick those active managers who are going to outperform. I know the Warren Buffett's well, we can look at Warren Buffett as an exception. But the challenge is, Julian, can you name who is the next Warren Buffett and who will be that person for the next 30 years?

JULIAN BIRKINSHAW

If I could name that person, I'd just be buying in….

STEVE FOERSTER

And you wouldn't you wouldn't be telling your audience…

JULIAN BIRKINSHAW

No, I mean, it's I mean, it's it's such a well-known paradox that perhaps we shouldn't spend any more time on it. But, but it seems to me that we do need to, of course, some people who are actively trying to beat the market, otherwise the market doesn't work.

STEVE FOERSTER

You're absolutely right on that. And there have been a lot of theoretical discussions of that. If everyone went passive, we wouldn't have a functioning market because, thanks to the active managers, they played an important role in terms of incorporating new information that they find through their through their work.

JULIAN BIRKINSHAW

So, we actually need these people beavering away trying to, as you say, come up with new theories, new reasons why Tesla is, you know, overvalued. Well, I think we all know that that is the case. But getting the timing is the challenge, so that, others can then form their opinions and stocks can eventually find that they're right level, I guess. Good. So just before we finish on that book, I mean, you actually interviewed these people yourself.

STEVE FOERSTER

Yes, myself and Andrew Lo.

JULIAN BIRKINSHAW

So I mean, just a quick insight into your dealing with people who become, you know, within their industry, world famous. But these are just humble academics like you and me, I guess. What was what were they like? Perhaps some were, perhaps some were…

STEVE FOERSTER

Some were more humble. And then than others I would say. To a tee, they are some of the brightest people that that I've, I've met. And what's fascinating, I think in terms of, you know, what are some common elements, it's amazing, especially among the academics, how they got into the area that they got into Luck and serendipity played such a big role. Harry Markowitz, to give a quick example, was struggling in his PhD program in an area called Operations Research, what we would now call management science.  He wasn't sure of a topic, so he went to see his advisor. He knew the tools he wanted to use, linear programing and so on. His advisor was busy, so he was, sitting in the anteroom waiting for his advisor, and another person was waiting for his advisor. Anyway, they got to talking and this person happened to be, the, advisors’ stockbroker. So, when Markowitz went in to see his, advisor, he said the guy out there said I should, apply these techniques to the stock market. What do you think? And that's how Markowitz got into this. So it's so much serendipity in in all of these people.

MUSICAL BREAK

JULIAN BIRKINSHAW

So let's turn to the second book, Trailblazers, Heroes and Crooks: Stories to Make You a Smarter Investor. And I actually read some of this, and there's some very quirky stories in here. I mean, it's a little bit of there is a little bit of that which is kind of fun. We'll just pick up on a couple of them. So, Ronaldo and Coca Cola, just tell us what that chapter is about.

STEVE FOERSTER

Well, a lot of your viewers might be familiar with this event that took place in 2021 at the Euro Cup. Ronaldo, of course, the big star was at a press conference. Coca-Cola, big sponsor and there are two bottles of Coca-Cola prominently displayed.As you would have it in this press conferences. Ronaldo comes in, sits down, takes these two bottles, puts them out of sight, and then says, agua, no Coca Cola, drink water, don't drink Coca Cola. And this is a major sponsor. So the headline of Washington Post and others, the next day was, Ronaldo snubs Coca Cola, stock drops by $4 billion that day. The story was about Ronaldo, who actually, to this day is the biggest, has the most followers on Instagram. Half a billion followers, on Instagram. So, the story was look at these influencers and what impact they would have. It turns out that's not the story. That's not the real story. So did the stock lose $4 billion in value that day? Yes, it did, but it had nothing to do with Ronaldo. There was an actual technical reason having to do with an upcoming dividend that Coca Cola had announced. And if you owned the stock on the Friday, this was a Monday, you got the dividend. If you buy it on the Monday, you don’t get the dividend. So naturally this happens all the time, the stock falls by approximately the amount of the dividend, right? That all that happened before the press conference. And so in fact, Coca-Cola stock went up the rest of the day after that. So, the whole theme and the lesson from that story is let's not confuse correlation with causation.

JULIAN BIRKINSHAW

Got it. And so when we see big stock market moves, I mean, we always want to kind of make sense of it. We want to provide a causal effect.

STEVE FOERSTER

Yes, exactly.

JULIAN BIRKINSHAW

But you're saying a lot of this is nonsense basically…?

STEVE FOESTER

it certainly makes for a much better headline to say Ronaldo snubbed Coca-Cola stock dropped, versus Coca Cola had an ex-dividend day and the stock dropped is not an exciting headline.

JULIAN BIRKINSHAW

I remember that book Fooled by Randomness. That was again a similar sort of approach. You got a chapter on mastering inactivity, the wisdom of doing nothing Let's explore what that means.

STEVE FOERSTER

So mastering inactivity is not about laziness. So the term really is the art of knowing when to do nothing. It goes back to, two centuries, BCE with a Roman dictator, Quintus Fabius. He had the unenviable task of trying to stop Hannibal, who was, bringing his elephants across the Alps and taking territory in Italy. When, Hannibal met up with, Fabius, he tried to draw him into battle. But, Fabius knew that he wasn't quite ready, so he chose to do nothing when Hannibal was trying to say, okay, let's fight. And he said he just didn't engage. He waited and timed things once he had built up enough force and then surprisingly defeated Hannibal. So that's one example. Another example in the sports realm, in boxing, probably the world's most famous boxer, Muhammad Ali, in 1974, the famous rumble in the jungle against, George Foreman. At the time, Muhammad Ali was a has-been. He was way past his prime. Foreman had knockout after knockout and, the odds were something like 40 to 1 that Foreman would beat, would beat Ali. What did Ali do? This was the famous rope a dope, where he just protected himself. When went against the ropes absorbed all the punches until Foreman was exhausted and then he knocked him out. So this was a classic, mastery of activity.

JULIAN BIRKINSHAW

And so this then plays into the world of investing, in other words, nd perhaps we can bring it to the present day briefly. But, when you see all this frantic stuff happening in market, yes. You know, you don't know whether Donald Trump is going to raise or drop tariffs. Just ignore it. Wait for that noise to let it go past. Is that right?

STEVE FOERSTER

Exactly. And in investing, it goes back to Jack Bogle. And, buying and holding an index fund might be boring, but it's mastering inactivity. It's doing nothing. And Bogle had a famous saying, when the markets are going crazy and your broker calls you and says, you've got to do something, you've got to do something. He said, well, tell your broker that, don't just do something, stand there. So mastering inactivity.

JULIAN BIRKINSHAW

And I know I do have a few friends who are brokers. They're investing somebody else's money, usually. And it's remarkable how little work they ever seem to do, but of course they are. They are working by monitoring what's going on. And then they learn when to make that big decision to make a trade, to buy, to sell whatever. Beautiful. It sounds like a good way of earning a living. So. Absolutely. One more, from the book, the power of keeping emotions in check. You say a bit more about.

STEVE FOERSTER

Sure. There's a few different ways we could we could go with this. Actually, one that I'll talk about is Sir Isaac Newton. Back in the 1720s. What people don't know about Newton is he was, he was big, in investing at the time. And the one hot stock then was, the South Sea Company. Newton had invested in the South Sea. Stock price went up, he made a ton and he sold. He made a huge profit. The equivalent of, of at least hundreds of thousands of dollars, if not if not millions of dollars. South Sea stock after he sold kept going up. Newton had, one of the earliest documented cases of FOMO, the fear of missing out.

So, what did he decide to do? He decided to get back in and buy back in the South Sea, probably at the worst time, right when it was at its peak. its stock had gone up by ten times in about six months. And it just dropped right down after. So this is a classic case of, we've seen we've seen this more recently with meme stocks, you know, keep your emotions in check just because everybody else is going after this fancy new thing doesn't mean you have to.

JULIAN BIRKINSHAW

When your friends are making a fortune in Bitcoin, don't do it. Okay. Look, let's take all this back to the present day. And, you know, we live in a time of absolute chaos in the markets where, you know, one person's utterances, you know, moves the markets by huge amounts. We've made the very simple observation that the smart investor at the moment is probably just sitting on the sidelines and watching, but what more can you say in terms of how we make good investment choices through this period?

STEVE FOERSTER

Sure. So the common theme to both of those books is that, it's important for all investors to come up with their own investment philosophy. So, for example, my investment philosophy might be that either I believe or don't believe in efficient markets. If I believe in efficient markets, then I think that it's hard to beat the market. Therefore, I'll just buy and hold an index fund, right? So that's an example of developing your own investment philosophy. You might try your stock picking and you might learn from the lessons from that. But, whatever it is, and try to make that investment philosophy evidence based. And that's why I try to tell some stories, so at least if you're if you're not investing, you can be aware of what happened on October 19th, 1987 where the stock market dropped by over 20%. So that's one thing. The second thing, let's go back to Harry Markowitz. Diversify. Diversification is so powerful, not just diversifying within stocks, but across different asset classes as well. We talked about bonds and other different kind of assets. Another thing is, is investing for, the long term, that's really important. And the last thing would be, to check your emotions, watch what biases, that you would have.

MUSICAL BREAK

JULIAN BIRKINSHAW

Look, we must we must wrap up, I hear you're working on a new book. Just tell us briefly what that is.

STEVE FOERSTER

It's a really fun project. It's the authorized biography of Bill Sharpe, who talked about the capital asset pricing model. So it's a delightful, it's a delightful story because his story is really the story of investing. It's, it's going to be a life and times, so it'll be a story about investing. And, maybe I'll give you four things that graduates of our program and other programs who have taken finance and know about the capital asset pricing model, what do they not know about Bill Sharpe? Bill Sharpe is an amazing jazz musician. He used to play the bass. So he, got started in that way. He's the co-founder of, a company that, originally called Financial Engines, that, went public on Nasdaq and at its peak was worth something like, 2 to $3 billion. Not many Nobel Prize winners, found successful companies like that. In 1959, he co-authored while he was at the Rand Corporation, he coauthored a paper, one of the first papers to come up with the idea of a carbon tax. It was trying to deal with the smog problem they had in the Los Angeles basin. And the last thing he has a colorful ancestor. He had, one ancestor, Jonathan Buck, who, founded, Buck Sports, who legend has it, and I'll tell more of the story in the book, and again, I want to stress this is legend, that Jonathan Buck, may have had a mistress who, he accused of being a witch who burned her at the, at the stake and she came back and put a curse on him. So that's a colorful story. I don't know whether you have ancestors as colorful as that…

JULIAN BIRKINSHAW

Not I'm aware of that’s for sure. And this is authorized meaning you are interviewing his family and his friends and stuff like that.

STEVE FOERSTER

That's a delightful person.

JULIAN BIRKINSHAW

We must wrap up now. Thank you very much, Steve, for your time today.

STEVE FOERSTER

It's been a pleasure.

JULIAN BIRKINSHAW

Thanks. You've been listening to Dialogue with Dean from Ivey Business School. A big thank you to my guest, Steve Foerster for sharing his time and insights. And of course, thank you for tuning in. Until next time, goodbye.

KANINA BLANCHARD

This was Dialogue with the Dean an Ivey Impact Podcast series. For more insights from Ivey, including thought leadership on critical issues and additional podcast episodes, visit Iveyimpact.ca or subscribe on your preferred podcast platform. Thanks for tuning in.