Fundamental value is an inexorable tide that pulls on the price of markets and currencies over longer-term time horizons. While the calculation of fundamental value is still necessary as an investment tool, it’s no longer sufficient in and of itself.

This is especially true in today’s geopolitically unstable world, which, unlike the Cold War era, comprises a plethora of overlapping game theaters, such as the eurozone crisis, periodic U.S. debt ceiling negotiations, and the perpetual conflict in the Middle East.

Applying game theory to investing can help. Here’s how our Dynamic Allocation Strategies team uses game theoretical constructs to identify, quantify, and analyze these global macro forces.

With game theory, we improve the organization and interpretation of information, and that means we’re more likely to discern truth than see what we want to see.

1. Assess Initial Conditions

We begin by determining the objectives and dimensions of net influence  for each player. Understanding their cultures, interests, incentives, and powers helps us understand their potential actions and reactions. That’s not to say this allows us to predict specific actions or outcomes, but it does add to our understanding of potential displays of power, especially brinkmanship maneuvers that are particularly troubling to market participants.

We then position our portfolios to potentially benefit from or protect against these displays of power.

2. Adjust Risk Exposures Based on Players’ Actions and Reactions

As players act and react, we shift portfolio exposures in an attempt to benefit from market misinterpretation. Misunderstanding of the negotiating process, especially when it gives rise to the deliberate creation of risk, can lead to unwarranted panic or euphoria. This creates short-term opportunities, so we modify the timing and magnitude of investment positions, seeking to benefit from the inevitable medium- and long-term reversion of market and currency prices to fundamental values.

3. Gauge Discrepancies During the Negotiating Process

At each step of the negotiating process, we evaluate fundamental opportunities to gauge whether they afford adequate compensation for the risk the negotiation presents over the coming weeks, months, or even years. If our understanding of the negotiation is sufficient, risk is adequately compensated, and strategies are consistent with our fundamental value signals, we position our portfolios to take advantage of the opportunity or to eliminate the risk.

Game theory doesn’t eliminate risk. The soul of strategic negotiation is risk, created and responded to by players who are human and, thus, fallible.

But, with game theory, we improve the organization and interpretation of information, and that means we’re more likely to discern truth than see what we want to see.

If you’re looking for an easy-to-understand example of many of the principles of game theory, read my recent post: Rocky, Bullwinkle, and Game Theory.

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Please carefully consider the Funds’ investment objective, risks, charges, and expenses before investing. This and other information is contained in the Funds’ prospectus and summary prospectus, which you may obtain by calling +1 800 742 7272. Read the prospectus and summary prospectus carefully before investing. Investing includes the risk of loss.

Any statements or opinions expressed are those of the author as of the date of publication, are subject to change without notice as economic and markets conditions dictate, and may not reflect the opinions of other investment teams within William Blair Investment Management, LLC or the Investment Management Division of William Blair & Company, L.L.C.

This content is for informational and educational purposes only and not intended as investment advice or a recommendation to buy or sell any security. Investment advice and recommendations can be provided only after careful consideration of an investor’s objectives, guidelines, and restrictions.

Factual information has been taken from sources we believe to be reliable, but its accuracy, completeness or interpretation cannot be guaranteed. Investments are subject to market risk. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Statements concerning financial market trends are based on current market conditions, which will fluctuate.

William Blair does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax questions and concerns.

Distributed by William Blair & Company, L.L.C., member FINRA/SIPC.

Copyright © 2019 William Blair & Company, L.L.C. "William Blair” is a registered trademark of William Blair & Company, L.L.C. No part of this material may be reproduced in any form, or referred to in any other publication, without express written consent.

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Please carefully consider the Funds’ investment objective, risks, charges, and expenses before investing. This and other information is contained in the Funds’ prospectus and summary prospectus, which you may obtain by calling +1 800 742 7272. Read the prospectus and summary prospectus carefully before investing. Investing includes the risk of loss.

Any statements or opinions expressed are those of the author as of the date of publication, are subject to change without notice as economic and markets conditions dictate, and may not reflect the opinions of other investment teams within William Blair Investment Management, LLC or the Investment Management Division of William Blair & Company, L.L.C.

This content is for informational and educational purposes only and not intended as investment advice or a recommendation to buy or sell any security. Investment advice and recommendations can be provided only after careful consideration of an investor’s objectives, guidelines, and restrictions.

Factual information has been taken from sources we believe to be reliable, but its accuracy, completeness or interpretation cannot be guaranteed. Investments are subject to market risk. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Statements concerning financial market trends are based on current market conditions, which will fluctuate.

William Blair does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax questions and concerns.

Distributed by William Blair & Company, L.L.C., member FINRA/SIPC.

Copyright © 2019 William Blair & Company, L.L.C. "William Blair” is a registered trademark of William Blair & Company, L.L.C. No part of this material may be reproduced in any form, or referred to in any other publication, without express written consent.

Statement of Financial Condition | NMS Rule 605 & 606 | Business Continuity Plan | UK Stewardship Code
Cookie Policy | Social Media Disclaimer | Privacy & Security | FINRA’s BrokerCheck

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