World Beta Blog

Hope Is Not a Strategy – John West, Research Affiliates

In related news, the French Senate just passed their pension reform bill.  Here are some great pics from The Big Picture.  Can you imagine US citizens protesting like this on pension reform?  Wait, can you imagine US HIGH SCHOOL STUDENTS protesting on the topic?

“Weeks of strikes, protests and demonstrations have brought much of France to a standstill as workers, students and others voice their strong opposition to a government proposal to raise the age for a minimum pension from 60 to 62. A quarter of the nation’s gas stations were out of fuel, hundreds of flights were canceled, long lines formed at gas stations and train services in many regions were cut in half. Protesters blockaded Marseille’s airport, Lady Gaga canceled concerts in Paris and rioting youths attacked police in Lyon. The unpopular bill is edging closer to becoming law as the French Senate is preparing to vote on it today. Collected here are recent images of the unrest around France.”

“Because I believe that all criteria for investing (that is, good betting strategies) should have a logic that isn’t time specific, I believe that the alpha generators that make up the ultimate alpha generator should be timeless and universal. By that I mean that they should have worked over very longtime horizons and in all countries’ markets.” Ray Dalio, Founder Bridgewater

Any trading system that is based on uncovering alpha, at least to me, must have a fundamental reason why the strategy works.  If you cannot explain why the inefficiency exists, or understand the fundamentals behind a technical strategy then you are likely just data mining.  I can get on board with the Presidential Cycle (source: NDR) as there are possible monetary reasons that strategy would work (artificial election year stimulus).  We are currently in the most favorable year (3) of the cycle being the pre-election year. Also Crossing Wall St.

One popular system many people discuss is the “Sell in May and Go Away” (also known as the Halloween Indicator) strategy.  The system simply invests in the stock market from November – April, then moves to cash from May – October.  This strategy popularized by Yale Hirsh (who writes the informative and entertaining Stock Trader’s Almanac 2011), has its origins in the U.K. market as far back as 1935 (see must read paper “Are Monthly Seasonals Real?“).

The paper finds very strong evidence of abnormal performance in the UK since the 1600s, and Bouman and Jacobson (2002) find that the strategy works in 36 of the 37 countries they tested.

This strategy has performed mightily since 1950 in the US as the chart below indicates. This is what is great about the investment blogosphere – the velocity at which an idea whips around and lots of people can comment on it and share their input…Lots and lots more chatter here on: Abnormal Returns, Hulbert, and CXO.

If you take the strategy back to 1900 in the US, the results do not confirm for the first half of the century.  You have to ask yourself “What is the fundamental reason this strategy works?”  Some offer Seasonal Affective Disorder, holiday good tidings, pension flows, summer vacation, and tax season in April…

In any case, the new period starts Monday!

Long time readers know I love thumbing through 13F hedge fund filings on AlphaClone as both an idea farm and a way to piggyback on top investment managers.  I’ve written extensively about Seth Klarman at Baupost, and by simply tracking his top 10 holdings this year an investor would be up a whopping 40% (some winners being ADCT and THRX).    Sidenote:  It looks like his book Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor has come down to a “reasonable” $895 from the normal $1500 asking price.

Who else is killing it with their long book this year?  Mohnish Pabrai (up 45% with winners like HNR, POT, and CRESV) and ValueAct (up 27% with winners like IT, SNA) are both way ahead of the S&P500…

MarketFolly has a great post today that talks about little known hedge fund Kleinheinz and their Russia thesis.  The fund is up 18% YTD through the end of Sep and the AlphaClone Top 10 Holdings is up 19% YTD through yesterday.  Check out the Kleinheinz equity curve since 2002 below – beat the market by an impressive 20% a year.

Check out Hedge Fund Letters for archived letters and the VIC for manager presentations.

Happy Halloween!

Source: AlphaClone

The three biggest questions most investors face are 1) How much of their portfolio they place in risky assets, and 2) how they allocate their portfolio across those assets, and 3) if they use risk management or other active strategies.  (Well, #1 is really how much they pay in fees and taxes but let’s ignore that area for now.)

I got a ton of emails asking me “what do you think of XXX allocation?”.  Everything from Swensen, to Tobias, to the Texas Double Down.

Some popular allocations (or “lazy portfolios”) are here and here.  I typed up a few of the more famous ones at the end of the post.

Anyways, I get a lot of emails asking what I think of the Permanent Portfolio (25%  US Stocks, 25%  Cash (T-Bills), 25%  US Long Bonds, 25%  Gold) and what I think of applying risk management or market timing to the portfolio.

Below is the equity curve of the buy and hold, timing on the portfolio, and the S&P500 (all total returns rebalanced monthly).  Even though PERM is 50% in bonds and cash the timing helps due to the highly volatile gold and US equity components.

And because I know I am going to get the question, here is the IVY allocation with timing compared to the PERM allocation with timing.  The point of this post is not that there is an ideal allocation (well there is of course but it is unknowable as the future is inherently uncertain), but rather that risk management has worked across various allocations.  One of the difficulties with the PERM portfolio, certainly today, is that there is a very high allocation to cash (yielding 0%) and long bonds (yielding 3.8%) – which implies that half of your portfolio is targeted to return less than 2%!

Some other famous allocations:

Swensen Portfolio (Source:  Unconventional Success, 2005)

30% US Stocks

20% REITs

20% Foreign Stocks

15% US Govt Short Term

15%  TIPS

El-Erian Portfolio (Source: When Markets Collide, 2008)

15%  US Stocks

15%  Foreign Developed Stocks

12%  Foreign Emerging Stocks

7%  Private Equity

5%  US Bonds

9%  International Bonds

6%  Real Estate

7%  Commodities

5%  TIPS

5%  Infastructure

8%  Special Situations

Arnott Portfolio (Source: Liquid Alternatives: More Than Hedge Funds, 2008)

10%  US Stocks

10%  Foreign Stocks

10%  Emerging Market Bonds

10%  TIPS

10%  High Yield Bonds

10%  US Govt Long Bonds

10%  Unhedged Foreign Bonds

10%  US Investment Grade Corporates

10%  Commodities

10%  REITs

Permanent Portfolio (Source: Fail-Safe Investing, 1981 )

25%  US Stocks

25%  Cash (T-Bills)

25%  US Long Bonds

25%  Gold

Andrew Tobias Portfolio (Similar to Bill Shultheis & Scott Burns’s 3 Fund portfolios)

33%  US Stocks

33%  Foreign Stocks

33%  US Bonds

William Bernstein Portfolio (Source:The Intelligent Asset Allocator, 2000 )

25%  US Stocks

25%  Small Cap Stocks

25%  International Stocks

25%  Bonds

Ivy Portfolio (Source: Ivy Portfolio, 2009)

20%  US Stocks (S&P 500)

20%  Foreign Stocks(MSCI EAFE)

20%  US 10Yr Gov Bonds

20%  Commodities (GSCI)

20%  Real Estate (NAREIT)

UPDATED: Link to audio is here.

Getting ready to do a segment on Bloomy Radio, listen in!

The Cambria Global Tactical strategy is now live (ticker:GTAA).  The press release is here.

Due to the launch of this public product I need to be extra careful about my wording as well as what and how I post.  Compliance also wants to do away with the comments, so they have come down as well (boooo).  Please feel free to email me with questions and comments going forward and I’ll do my best to respond.

There have been more and more hedge-like funds coming to market lately through either ETFs or mutual funds.  I didn’t know that Altegris launched a managed futures offering until I was searching for another managed futures ETF (WisdomTree).  Unlike some funds that are running the strategy internally (like AQR, AQMIX) Altegris is allocating to the underlying managers.  The upside is that they have some top names in the space (Winton, Abraham, and QIM).  The downside is that you are paying 2% fees (roughly, there are four share classes) on top of the roughly 1% and 20% the funds charge.

Hatteras also has a mutual fund (ALPHX) that allocates to hedge-like strategies (although the names are less well known).  AlphaTitans and Chapwood are trying to do something similar (but was private placement to RIAs etc).  There have been others that have not been successful (Geronimo).

Again, at the end of the day it all comes down to returns after all fees, or, “returns you can eat”.  At 2% and 20%, then another 2% management fee you need the underlying managers to return 17% after all trading costs to return a 10% return to the final manager.  That is a lot of alpha that needs to be created just to get to 10%…(Not saying that it isn’t possible, just difficult.)  BUT, overall I like the trend of more alternatives available to the investor.

Great paper “Rules of Prudence for Individual Investors” by Mark Kritzman of Windham Capital.  Table below:

GTAA ETF launch is official for next Tuesday.

Have a great weekend, finally getting some blue skies in LA!

John Hussman is one of the best portfolio managers around.  His ability to take complex topics and distill them down to simple readable articles makes his weekly commentary a must read (although he does go off on PhD level rants on occasion).

I thought I would build some Excel sheets that tracked his stock market valuation models in some of these posts:

Estimating the Long Term Returns on Stocks

The Likely Range of Market Returns in the Coming Decade

Anyone with a few hours and the inclination can re-create these (I used the Shiller dataset).  The charts all look similar (though I took them back to 1900).

The summary from the models is that equities are looking at pretty subdued returns for the next decade.  At a terminal PE Ratio of 15 you are looking at about 2% a year.  Even at a PE of 20 you are looking at a little of 5% returns.  And those are nominal returns.

Real returns are negative or only slightly positive (I included terminal inflation of 3%).

And his dividend model:

I know I post a lot of pictures from The Big Picture but I can’t help it!  They are always stunning:

“Isn’t it enough to see that a garden is beautiful without having to believe that there are fairies at the bottom of it too?” -Douglas Adams

From Small Worlds (a picture of a bee’s abdomen with grains of pollen attached):

Our GTAA ETF is set to launch this Friday or the following Tuesday (should find out in the next day or two)!!

In the meantime I thought I would answer a question as it relates to the construction of portfolios that I get all the time.

Q:  ”Does it make sense to simply use your 5 asset class model as published in your 2007 paper, or portfolios with more holdings as suggested in your book (10 and 20) and your upcoming ETF (50 – 100)?”

I think the two biggest decisions an investor can make are 1) how much of their wealth to put at risk and in what asset classes, and 2) whether to actively or passively manage those risks.  I think these two decisions get you most of the way there, but I also think there are some dials one can tweak to improve the risk adjusted returns further.

As long as the underlying assets are not perfectly correlated then it makes sense to break out the allocation into further granularity.  An example I always give is the commodity space.  While we used the generic GSCI (which is about 70% energy) in the paper, it makes sense to me to split out the commodity allocation along groups such as energy, base metals, precious metals, and agriculture.  Corn and wheat may be flying through the roof while copper or oil make be going sideways or declining.  (This is just an example of course, as we could get into a much longer conversation about how best to tackle commodities whether long/short, momentum based, or with contago/backwardation considerations but that is not the point of this post.)

The point of the post is to demonstrate how breaking out an asset class into more granularity works empirically.  In the below example we are going to create an artificial MSCI EAFE index.  Here is a fact sheet on the index.  We will take the top 5 countries that are in the index by market cap (Australia has since jumped into the top 5 in the past year but I went with an old fact sheet but the results should be identical):

Japan 21%

UK 21%

France 10%

Germany 8%

Switzerland 8%

As you can see in the below chart, the countries had varying performance since 1973 with France being the best performer at 11.72% and Japan being the worst at 6.8%.  The red line is a simple buy and hold of the 5 countries, equal weighted and rebalanced monthly, and from the perspective of a US investor.

Then, if you apply the timing model on this “index” like in the white paper, you get a nice reduction in volatility and drawdown similar to the published paper (using the 10-month simple moving average).

However, what if instead of timing the whole index (our synthetic EAFE), you timed the individual components separately?  Below is an equity curve as well as the table that details the additional bump in both return as well as reduction in risk you see here.

Now, you can envision how extrapolating this granularity to other asset classes and styles would be even more beneficial and could be one of the improvements that are possible on top of the published model.  It is unrealistic to try and trade 50-100 ETFs in certain portfolios due to the complexity and trading costs (per share vs. per ticket) and this is one of the many reasons we are launching the GTAA ETF this week (or next).