World Beta Blog

I’ll be in NYC all week (to ring the bell on the 2nd) and around Pittsburg for a few days early next week.

Drop me a line if you want to meetup!

Wonderful article by Lahart from WSJ. (HT: BB)

There are a lot of people debating the value of stock picking events like the recent charity Ira Sohn Conference.  Felix Salmon and David Gaffen debate the usefulness (Felix responds here)  and Joe Weisenthal chimes in here.

There is so much misinformation in the 13F space, and most comments are simply not based in a firm understanding of what works and what doesn’t, but rather guesses.   But that is what most financial commentary is, guesses (ie all of the commentary surrounding buy and hold and market timing, what drives stocks, often has the feel of debating religion or politics).  I like reading David, Joe, and Felix but if you want to know what works and what doesn’t in 13F tracking you should be listening to people that have spent many years getting their hands dirty with the data and truly understand what works (and what doesn’t) like Jay at MarketFolly or Maz at AlphaClone.

There is also reams of academic papers on the subject including this paper from my friend Wes Gray at Empirical Finance that demonstrates ability to follow managers and disclosures.

Some of the comments:

Gaffen:  ”Some of them (following hedge funds) work and some of them don’t…the more complicated you get and the more derivitives you get involved in the less you can follow…the ones that are slightly more straightforward you can follow.”  David is spot on here.

Felix:  ”Trying to chase hedge fund managers is a fools errand…my big problem in all of this is that you and I have no ability to pick stocks and if we have no ability to pick stocks then what on earth makes us think we have the ability to think we can pick hedge fund managers.”  Clearly I disagree.

I am a quant.  I used to pour through these filings by hand a number of years ago (take a look at the blog archives back in 2006 and 2007), but being a quant I could never get comfortable with following these managers until I tested them.  I had an inkling that it worked but I wasn’t sure.  Like Fama says, “if it is in the data”…

…so my intern and I went and backtested 10 funds (Buffett, Blue Ridge, Greenlight, etc) and what we found is that there is huge value in tracking the funds that have lower turnover and derive most of their value from their long stockpicking book.  Like Gaffan says, there are some things that work and some that don’t – SAC doesn’t make sense to follow (too active), Rentec doesn’t make sense to follow (derivatives), and if you want more information there is an entire chapter on 13F tracking in my book.  The benefits, the drawback, what works and what doesn’t.

But like Salmon mentions, 13F tracking rests on two questions:

Can anyone beat the market?

Can you pick a manager ahead of time that will beat the market in the future?

Most of the academic literature suggests no to both answers (on aggregate).  But does that mean someone cannot answer yes to both questions?  Of course not.

We can all backtest until the cows come home but all that matters is real time performance of course.  We profiled three funds in the book, and taking their top 10 holdings, and rebalanced quarterly, 2/3 outperformed the S&P since publication (using beginning of 2009).  On average the three outperformed the S&P by 3.5% a year.

That is solid alpha.

S&P500 since book publication:  54%

Blue Ridge since book publication:  92%

Greenlight since book publication:  44%

Berkshire since book publication:  63%

FOF approach since book publication (top 5 holdings from each):  66%

All data courtesy AlphaClone.

Later in the chapter I included a list of 54 funds that I thought would be interesting funds to follow.  Out of that 54, 8 were never added to the database.  Excluding the  never added, the other 46 funds beat the S&P 500 by an average amount of 15 percentage points per year. (Historical research shows that following Buffett since the 1970s would have resulted in >10% outperformance per year – and he has beaten by 8% per annum since ’00.  So much for all those detractors that say he isn’t a good stockpicker!)

Roughly 80% of the funds beat the S&P500 over the time period.  Impressive real time results!  To be fair a lot of that outperformace came in the 2009 rebound, but the funds outperformed by 7% on average in 2010 as well (2011 a wash so far).

(Not to mention 13F tracking would have kept you out of Galleon.)

So, at the end of the day would you rather listen to Seth Klarman or your local broker when picking stocks?

Funds included in analysis:

I have basically seen Twitter up to this point as a pleasant distraction.  One of the effects however of this real time newsstream is the instant newsflow, and I was immediately saddened to hear about Mark Haines passing away yesterday. Lots of people are offering up their experiences with Mark as a tribute so I thought I would mention mine, albeit brief meeting with Mark.

Mark and Erin were my favorite team at CNBC, and I was estatic when I had the chance to sit down with them at the NYSE a few years ago.  I remember getting warned by the staff that Mark could be just a little bit gruff and ornery, so to be prepared.  They make you sit on this little pulpit waiting for your turn to go on air, and there are a few minutes during commercial where you get to sit down before going on.

Mark introduced (more of a kind of half acknowledgement rather) himself with what I would describe as a skeptical “who is this young kid and WTF does he know about markets?”.  He then proceded to continue a rant he was having, now transferred to me, about how these guys come on air and think they are somehow going to get Erin Burnett’s telephone #.  I responded with a serious “would it be ok if I could get it then?” to which Mark responded with a “I am going to cut your f&king head off and eat it” look of total distain.  I burst our laughing, and after that we kidded around a bit and (hopefully) broke down his guard a little.

The interview was over in a few minutes, but I will say the world has lost a great reporter.  I’m headed back to NYSE to ring the bell for GTAA and am truly sad Mark will not be there and to Mark’s family, he will truly be missed!!

I am finally back home after three weeks on the road (made more interesting by not having a photo ID for the last five flights).  While exhausting to say the least, one of the major benefits of travel is getting to connect with other money managers, writers, and friends to share ideas and swap stories.  I hope to share some of the research ideas that grew out of these meetings in the coming weeks and months.  Now that summertime is fast approaching I’m ready to put my writing hat on and get some of this long overdue research out…

One such lunch meeting was over gyros in Washington D.C. with Eddy Elfenbein from Crossing Wall St.  We got to chatting about asset allocation, and more specifically what economic conditions (factors) drove returns.  And of course, the discussion meandered towards everyone’s favorite precious metal (now that silver has taken a tumble), gold.  Eddy has a great post here titled “A Possible Model for the Price of Gold“.

In it he takes a look at how real interest rates drive gold:

Whenever the dollar’s real short-term interest rate is below 2%, gold rallies. Whenever the real short-term rate is above 2%, the price of gold falls. Gold holds steady at the equilibrium rate of 2%. It’s my contention that this was what the Gibson Paradox was all about since the price of gold was tied to the general price level.

Now here’s the kicker: there’s a lot of volatility in this relationship. According to my backtest, for every one percentage point real rates differ from 2%, gold moves by eight times that amount per year. So if the real rates are at 1%, gold will move up at an 8% annualized rate. If real rates are at 0%, then gold will move up at a 16% rate (that’s been about the story for the past decade). Conversely, if the real rate jumps to 3%, then gold will drop at an 8% rate.

My intern and I have built (still in progress) an Excel sheet that analyzes market returns for asset classes based on any factor.  Below is a look, since 1972 at a few of these factors.  Below is a similar study as Eddy’s but split into quartiles for real rates (90day – CPI) for a whole host of asset classes.  As you can see our numbers are very similar…

(click to enlarge)

Below are assets segregated by deciles for each indicator.  While we have a lot more factors built in, we are demonstrating two below – the yield curve and real interest rates.  We take the next month average returns and then annualize them.  For the second table, we take the returns net of inflation (real returns).  We also have the data for sectors back to the 1920s.

I haven’t decided what to do with the findings yet (publish in some form, likely), but I think it is a very useful exercise for taking a broad economic litmus test for “where are we now?”

It looks like, at least according to these two indicators, that small caps and emerging equities, long duration and high yield bonds, and real estate and gold are the best asset classes to own.

I think there is a big need for a newsletter that focuses on public alternative and actively managed funds for the professional (and hobbyist/active individual) investor.  Most people have a difficult time making sense of the hundreds of offerings that are coming out on a daily basis in the ETF and mutual fund space.  Morningstar has the best research offering I have seen so far, although it is limited to the ETF space (ETF Investor:  disclosure – I am a subscriber and our fund GTAA was featured in the last piece.)

The managed futures space is a good example.  It is an area that historically was difficult for most to understand, was/is (ridiculously) expensive, and there have been few public choices available.  I mentioned awhile back that my intern built a killer Excel sheet that could update and report performance for any publicly traded list of funds/stocks.  I wasn’t quite expecting the overwhelming response for the Excel sheet, but instead of emailing out the Excel sheet (which is a rather complicated install and I don’t want to have to offer software support for the file) we have considered just building it as a website.  Stay tuned and we will post updates to the blog when available.

Anyways, here is a look at the various managed futures funds and their performance over the past few periods, as well as performance for some asset classes updated last nite:

(click to enlarge)

Kind of like the VIC, but instead of a $ prize you get a hedge fund job with base of $125K + bonus.

Capitalist Collective

HT:NG

We already had a blog reader win the $10,000 NAAIM prize, so maybe we can have another one win the chance to present your idea in front of hundreds of hedge fund managers and gazillions in assets under management.  (Both semi and finalists get free tix to the event.)

I’ve never been but it has been on my to-do list for years…just be careful what you submit, as your judges will be Ackman, Price, Greenblatt, Einhorn, and Klarman!

Register here.

Ok, so I finally am starting to crank out all of these research pieces I have been meaning to write for months/years, and the newest issue of CQR Monthy (err, should be called CQR Quarterly or CQR whenever…) should be out soon.

In the meantime, a nice read from the folks at Vanguard, The Case for Indexing.

While the % of active funds underperforming indexes was not surprising (consistently over time around 70-80% and something like 95%+ after-tax), the relatively small size of index funds as a % of total assets (13%) at registered investment companies was (I assumed much, much larger).

My friend likes to call online and magazine articles “toilet reading” (well that is the SFW description), and he passed along enough reads for all of 2011.  Just as I was coming up for air from all the books I’ve finished, thank you very little friend (HT: AF)

The Atlantic 100 Great Pieces of Journalism