Wikipedia opens its description of degrees of freedom as “the number of values in the final calculation of a statistic that are free to vary.” If ‘statistic’ is defined as a concept that we wish to describe, or a problem seeking an optimal solution, degrees of freedom transcend the world of pure statistics and enter the universe of ideas.
The Investment Universe
Degrees of freedom may be thought of as the number of values which are free to vary in achieving a desired investment outcome. The degrees of freedom represent the critical pathways between cause and effect when translating the future.
Though a particular investment opportunity occupies a single position along the degrees of freedom spectrum at any given moment it also remains in a universal state of flux, thus change. Investment opportunities confined to oscillating within the low end of the spectrum translate into fewer critical pathways between cause and effect, between investment intention and investment outcome.
The question one must ask is whether lesser or greater degrees of freedom is preferable given one’s objective?
Capital Growth
As long-term growth is the most common objective, it serves to highlight the degrees of freedom concept when applied to the investment universe. With this as the stated objective, an optimal solution to the opportunity set will be found in the high degrees of freedom end of the spectrum.
This is not to say that opportunities with low degrees of freedom are not valuable in achieving long-term growth objectives. For example, many cyclical opportunities have been attractive growth options in recent times. As discussed in the International Paper and FedEx reports, it was their lower degrees of freedom and thus lower risk that created each opportunity.
When degrees of freedom are low, timing becomes the critical dimension for achieving growth objectives. In contrast, in regard to capital growth herein, I am referring to the ideal vehicle when one is seeking long-term growth.
As degrees of freedom translate into degrees of potential change, and the space-time fabric of the investment universe is one of flux, the optimal frequency on which to operate is located at the high end of the spectrum.