Capital Ideas Evolving

During the last three decades of the 20th century, a revolution in the theory and practice of investing swept over Wall Street. The bold innovators who carried out this revolution were scholars toiling in the ivory towers, far away from the heart of the financial world in New York City.

Some of them had never even owned a share of stock. Hence, the title of my 1992 book, Capital Ideas: The Improbable Origins of Modern Wall Street.

But the products of those improbable origins have been evolving since Capital Ideas appeared 15 years ago. Beginning with the simple notions that risk is at the center of all investment decisions, that diversification is essential to successful investing, and that markets are hard to beat, the products of the ivory towers are now the intellectual core of numerous powerful innovations in active investing and in risk management.

Both form and function are undergoing radical changes, involving concepts and tools no one could have conceived of in the old days. This process of change is what my new book, Capital Ideas Evolving, is about.

The book begins by facing upfront the attack on "capital ideas" by the proponents of behavioral finance -- and especially on the idea of the efficient market hypothesis. The next chapter describes the current views of Paul Samuelson, one of the great sages about market behavior and portfolio formation.

Samuelson takes a dim view of efforts to outperform the returns of the market as a whole or, in a more practical sense, to outperform mutual funds indexed to some primary benchmark like the S&P 500.

Later pages offer the views of other well-known academics, including four winners of the Nobel Prize -- all of whom, in one way or another, are involved in developing practical applications for their core ideas of finance theory in new and exciting formats.

We then turn to a series of chapters that relate the startling success of a few institutional investors -- Barclays Global Investors, the Yale Endowment Fund, and Goldman Sachs -- and we shall see how those investors developed their strategies from a base composed of the principles of capital ideas.

That is just the beginning. As investors increasingly draw on capital ideas to shape their strategies, to innovate new financial instruments, and to motivate the drive for higher returns in relation to risk, the real world itself is on a path toward an increasing resemblance to the theoretical world described in Capital Ideas.

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