Below is the paper that won the $10k Wagner Award from NAAIM for best paper. You can download it from the website. (And I’m happy to hear that the author heard about the competition from the blog.) I’ve haven’t read it yet but plan to over the long weekend.
Alpha Generation and Risk Smoothing using Volatility of Volatility by Tony Cooper
I will be in Charlottesville, VA next weekend (June 4-6). If you are nearby (Richmond, DC, etc) and want to get together shoot me an email.
Just out from my friend Peter Mladina of Waterline is a fun paper coming out in the upcoming Journal of Wealth Management Summer Edition. He splits the Yale allocations into much more granularity than I did in my book (and also adds leverage and factor tilts) with some interesting results and conclusions.
I don’t see it up on the web or SSRN yet anywhere for free, but you can buy it here for (gulp) $45.
Abstract
In this article, the authors examine the underlying factors that drove the outsized performance of the Yale University Endowment over the past two decades. With the aid of the Endowment’s published asset allocation targets and their own “Proxy Portfolios” designed to replicate the Endowment’s exposure to common risk factors, they were able to delve fairly deeply into the drivers of the Endowment’s returns. As the authors observed the Endowment’s gradual transition from a conventional public markets strategy to one capitalizing on alternative investments—notably private equity, real assets, and hedge funds—it became apparent that much of the putative case for the Endowment’s performance, the skill of its active managers, was not entirely correct. This article suggests that heavy exposure to common equity risk factors and manager skill in private equity drove the Endowment’s sizable returns. These key findings have significant implications for investors who are seeking manager skill across asset classes.
Below is a table with the suggested allocations, and the percentages those indexes would receive with the current Yale allocation.
The second table sums a few of the repeats, then lays out some sample ETFs one could use. The big difference with my book is that I exclude Private Equity and Hedge Funds then normalize the allocation. The result is that Mladina’s allocation is higher in US equity and real estate, and lower in bonds, foreign equities, and energy. (He also applies some factor tilts to the portfolio.) I also added the .5% cash allocation into the bonds.
What I am reading this week:
I Want to Break Free – Montier
Electica Manager Commentary – Hendry
Global Strategy Weekly – SocGen
The Holy Grail of Macro – Koo
Koo’s Good News – welling@weeden
US State Pensions Becoming Federal Issue – FT.com
Educational Endowments and the Financial Crisis - Tellus
800 Years of Financial Folly – Reinhart
With most equity-like asset classes putting in some terrible numbers for May, I thought we would dredge up some old research on returns following terrible months in asset classes.
I have written about this subject a number of times. For background you can check out some earlier posts linked at the end of the article.
My research has shown that negative returns 2 and 3 years ago produce approximately 6% outperformance in the current year. If you are lucky enough to have 3 down years in a row, the outperformance jumps to well over 10%. (Supported heavily by the academic literature.)
On the monthly time frame, I examined asset class performance after a really bad month.
The take-aways from this study were:
- It does not pay to buy an asset class after a really bad month for the following 1 month.
- 12 Months later the return is not much different than average.
- 3 and 6 month returns, however, are stronger. You pick up on average about 3-4% abnormal returns buying after a terrible month.
A simple strategy would be:
After an asset class has a terrible month, wait a month then take a 2 month position. i.e. after this (probably) terrible month, buy July 1 for a two month hold. Those with a little longer time frame could move out to a 5 month hold.
It looks like a good “trigger” for equity like asset classes is around -10%, and for bonds around -4%. That equates to about the worst 2% of all months. The worst 5% of all months is around a -7% trigger for equities and -3% for bonds.
Below is a summary chart of this strategy for the five asset classes I mentioned in my paper. The returns are simply the excess returns (nets out the average monthly return over the entire time period) to a strategy of buying an asset class a month after a really bad month, with a two month hold.
Note that this does not work for the commodity index, and one could speculate that is due to differing risk premiums and sources of return to that asset class.
Here are the real time results for all the occurences in 2008 and 2009, not bad!
I imagine if you broke out the asset classes into further subdivisions (sectors, countries, etc.), the same principles would apply but the triggers would widen due to the increases in volatility.
Time to Put Money to Work
When is the Time to Buy Homebuilders?
When to Buy Japan?
Idiocracy and Mean Reversion
Down two years in a row in 07 and 08:
Argentina
Austria
Belgium
Estonia
Ireland
Italy
Japan
Latvia
New Zealand
Spain
Sri Lanka
Sweden
Switzerland
I was taking the Amtrak from SF to Sacto last night and sped through Redleaf’s book Panic: The Betrayal of Capitalism by Wall Street and Washington. (You can find more info on Redleaf and his fund Whitebox here on Hedge Fund Letters.)
There are two chapters that are fantastic, and I will have to revisit them after a few days spent mulling them over.
If you have any of Redleaf’s investor letters send them over.
Some great quotes:
“The moral defenders of capitalism have repeatedly staked the system’s legitimacy on the notion that those who take great risks deserve great rewards. It is this combination of an appealing intuitive notion (investors who risk more must be paid more) with a thrilling moral tale (the capitalist knight wins the kingdom not by counting the beanstalks but by slaying the dragon and leveraging the damsel) that surely explains why the notion of risk as the source of return remains so powerful.
Powerful, persuasive, deeply intuitive but wrong, dangerously and destructively wrong. We believe that the reign of risk is at the root of the repeated crises in modern financial markets and that overthrowing it is the key to successful investment….risk is not the foundation of profit but its most dreaded enemy.
…Risk is not the source of wealth in securities markets or anywhere else. The notion that risk equates with reward is worse than a myth – it is a mass delusion, a mass delusion that in our time has cost investors of trillions of dollars that we can measure…It has lulled an entire generation of financial advisors into complacency about the risks to which they expose their clients.
At every turn of economic life, the reduction of risk is the key to prosperity. Except in financial markets? Why should it be so?”
Klarman, Tepper, Grantham, Einhorn, Zell, etc.
The Benefits of Tax Harvesting
Insights Into the Global Financial Crisis
Profile of Tyler Cowen of Marginal Revolution:
“With books, Cowen is even more brutal. If a book is bad, he often throws it away, so it doesn’t waste anyone’s time. “What if the next book they were going to read is ‘Moby-Dick’?” But if a book is good, he might give it away — to libraries, friends or, if he’s on a plane, total strangers (he leaves them in the seat-back pocket for the next passenger to discover). “He drives the flight attendants crazy,” his wife says.”
Is there a mutual fund (or ETF) that decrease their management fee as total assets increase? I’ve heard Magellan does it but have not read the prospectus.
Leave a comment if you know of any.
