World Beta Blog

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.

http://www.irasohnconference.com/

Kyle Bass on Japan and Europe

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.

With most risky assets taking a bit hit last week, I decided to show our Alternatives Update for just last week to see what, if anything, would’ve help diversify your portfolio.

Bonds, market neutral, some merger and l/s guys, managed futures, and of course the bear funds did well.

San Francisco and Sacramento Monday May 17th – Thursday May 21st.

Drop me a line if you want to meetup!

A couple potentially great books en route:

Buy–DON’T Hold: Investing with ETFs Using Relative Strength to Increase Returns with Less Risk – Masonson

Panic: The Betrayal of Capitalism by Wall Street and Washington – Redleaf

I can count the number of crash/crisis books I’m interested in reading on zero fingers, but this one is different.  For those that don’t know Redleaf is one of the best investors in the world.  He runs the multi-billion dollar hedge fund Whitebox Advisors.  You can find more info here on Hedge Fund Letters.

The rest of “What I’m Reading” can be found in the CQR Weekly Update.  If you don’t sign up you can to the right with the Timing Updates box.

Asset Allocation

• Asset Allocation by Roger Gibson
• All About Asset Allocation by Richard Ferri
• The Intelligent Asset Allocator by William Bernstein
• Mastering the Art of Asset Allocation by David Darst
• The Fundamental Index – Arnott and Hsu
• Index Funds – Hebner
• The Little Book of Common Sense Investing – John Bogle

Endowment Investing

• Unconventional Success and Pioneering Portfolio Management by David Swensen
• When Markets Collide by Mohamed El-Erian
• Foundation & Endowment Investing by Lawrence Kochard and Cathleen M. Rittereiser
• Trustee Investment Strategy for Endowments and Foundations by Chris Russell

History of Markets

• Triumph of the Optimists: 101 Years of Global Investment Returns by Elroy Dimson, Paul Marsh, and Mike Staunton
• 2008 GIRY – by Elroy Dimson, Paul Marsh, and Mike Staunton
• Stocks for the Long Run by Jeremy Siegel
• Reminiscences of a Stock Operator by Edwin LeFèvre
• When Genius Failed by Roger Lowenstein
• Capital Ideas, Capital Ideas Evolving, and Against the Gods by Peter Bernstein
• Ibbotson Yearbook by Ibbotson Associates
• The CRB Commodity Yearbook by Commodity Research Bureau
• The Essays of Warren Buffett by Warren E. Buffett and Lawrence A. Cunningham
• Fortune’s Formula by William Poundstone
• The Myth of the Rational Market - Justin Fox

Stock Distributions

• Why Stock Markets Crash: Critical Events in Complex Financial Systems - Didier Sornette
• The Misbehavior of Markets by Benoit Mandelbrot
• Fooled by Randomness and by Nassim Nicholas Taleb
• Finding Alpha – by Eric Falkenstein
• Market Volatility – Robert Shiller
• Optimal Portfolio Modeling – Philip McDonnell
• Fractal Market Analysis - Edgar Peters
• More Than You Know: Finding Financial Wisdom in Unconventional Places - Michael Mauboussin
  

Market Bubbles

• Manias, Panics, and Crashes by Charles Kindleberger
• Extraordinary Popular Delusions and the Madness of Crowds by Charles MacKay
• The Prize: The Epic Quest for Oil, Money, & Power by Daniel Yergin
• The First Tycoon: The Epic Life of Cornelius Vanderbilt by TJ Stiles
• Irrational Exuberance – by Robert Shiller

Behavioral Psychology and Evolutionary Biology

• Dr. Tatiana’s Sex Advice to All Creation by Olivia Judson
• Your Money and Your Brain by Jason Zweig
• Behavioral Investing: A Practitioners Guide to Applying Behavioral Finance by James Montier

Hedge Funds

• All About Hedge Funds by Robert Jaeger
• Absolute Returns by Alexander Ineichen
• Handbook of Alternative Investments by Mark Anson
• Rocking Wall Street by Gary Marks

Profiles of Fund Managers

• Hedge Hunters by Katherine Burton
• 20/20 Vision by Harry Liem
• The New Investment Superstars by Lois Peltz
• Market Wizards, The New Market Wizards by Jack Schwager
• Inside the House of Money by Stephen Drobny

Quantitative and Technical Analysis

• The Research Driven Investor by Tim Hayes
• Being Right or Making Money by Ned Davis
• The Little Book That Beats the Market by Joel Greenblatt
• The Handbook of Portfolio Mathematics by Ralph Vince
• Quantitative Investment Analysis by Richard DeFusco, Dennis McLeavey, Jerald Pinto, and David Runkle

Private Equity

• Private Equity as an Asset Class by Guy Fraser-Sampson
• J-Curve Exposure by Pierre-Yves Mathonet and Thomas Meyer

Research

Often, I link to research papers and other sites of interest.  They are categorized below:

Tactical Asset Allocation & Market Timing

• “Does Trendfollowing Work on Stocks?” – Blackstar Funds
• “On the Nature and Origins of Trendfollowing“ – Ostgaard
• “The 52-Week High and Momentum Investing” – George and Hwang
• “Global Tactical Asset Allocation” – Goldman Sachs “Manufacturing Alpha from Beta” – IntegraCapital “TAA Comes Back from the Dead” – Goldman Sachs
• “Evaluating a stock market timing strategy: the case of RTE Asset Managment” by Tezel and McManus [2001].
• “Equity Timing Models Explained” – FundAdvice.com
• “Modern Tactical Asset Allocation” – Harindra de Silva
• “Global Tactical Cross-Asset Allocation: Applying Value and Momentum Across Asset Classes” – Blitz and Van Vilet
• “Value and Momentum Everywhere” – Asness

Macro

• “The Next Decade” – Bridgewater
• “The First Day of the New Decade…” – Bridgewater
• The Perfect U.S. Economic Storm: Asset Deflation, Commodity Inflation and the Expiration of the “Greenspan Put” – Epoch Partners
• Our View of the World (and Oil) – Bridgewater
• What Makes Us Different – Bridgewater

Portfolio Theory

• “Attack of the Clones” – Man Investments
• “Adaptive Market Hypothesis” – Andrew lo
• Technical Analysis: An Academic Perspective – Andrew Lo
• “Emphasizing Low Correlated Assets: The Volatility of Correlation“, and “The Volatility of Correlation” – Coaker
• “The Biggest Mistake In Investing” – Bridgewater
• “Risk Parity Portfolios” – PanAgora
• Risk Parity PPT– PanAgora
• “The Evolving Relation between Earnings, Dividends, and Stock Repurchases” – Skinner
• “Engineering Targeted Returns and Risks” – Bridgewater
• The Ultimate Buy and Hold Portfolio – FundAdvice.com The Perfect Portfolio – FundAdvice.com
• Vanguard We Believe #1 Vanguard We Believe #2 Vanguard We Believe #3 Vanguard We Believe #4 Vanguard We Believe #5 Vanguard We Believe #6 Vanguard We Believe #7Vanguard We Believe #8 Vanguard We Believe #9
• “The Rewards of Multi-Asset-Class Investing” – Gibson
• “Models for Beating the Market” – Thorp
• “Multiple Alpha Sources and Risk Management” – Edward Qian
• “GFD Guide to Total Returns”
• “Ten Lessons for the Twenty-first Century Investor” by Dr. Bryan Taylor

Hedge Funds + Private Equity

• “Hedge Funds Levering Betas” – Bridgewater
• “Factor Modelling of Hedge Funds” – Partners Group
• (Hedge Funds: Risk and Return – Malkiel and Saha
• “Alternative Routes to Hedge Fund Replication” – Harry Kat
• “The Hedge Fund Elite” – New Yorker
• “100 Hedge Funds to Watch” – Financial Times
• “The Advantage of Persistence – How the Best Private Equity Firms Beat the Fade”
• Top 50 Private Equity firms.
• Alpha Hedge Fund Hall of Fame
• Alpha’s top 100 hedge funds.
• “Sharpe Ratios of Top Managers” – Ziemba
• “Negative Compounding” – Gogerty

Randoms

• “Congress and the Stock Market” – Ferguson and Witte
• “Does the “Dow-10 Investment Strategy” Beat the Dow Statistically and Economically?” – McQueen et al
• “Are Cover Stories Effective Contrarian Indicators?” – Arnold, Earl, North
• Why Do We Do What We Do? – Acadian Asset Management

Stock Picking

• “How Smart are the Smart Guys? A Unique View from Hedge Fund Stock Holdings” – John Griffin
• “Hedge Fund Activism, Corporate Governance and Firm Performance” – Brav et al
• “On the Importance of Payout Yield” – Boudoukh, Michaely, Richardson, and Roberts
• “Extreme Returns From Extreme Value Stocks: Enhancing the Value Premium” – Keith Anderson,Chris Brooks
• “Asset Growth and the Cross-Section of Stock Returns” – Schill, Gulen, and Cooper
• “Is Dividend Yield Dead?” – Acadian Asset Management
• “Stock Selection – A Test of Relative Stock Values Reported Over 17-1/2 Years” – Kirkpatrick

Commodities

• “Strategic Asset Allocation and Commodities” – Ibbotson Associates
• Q&A with Bob Greer from PIMCO
• “Facts and Fantasies about Commodity Futures“, Gorton and Rouwenhorst
• “The Strategic and Tactical Value of Commodity Futures“, Erb and Harvey
• “Evaluating a Trend-Following Commodity Index for Multi-Period Asset Allocation”, Mulvey, Kaul, and Sims
• Morningstar Commodity Indexes Fact Sheet
• Comparison of Commodity Indexes
• The Next Generation of Commodity Indexes
• Construction Rules for Morningstar Commodity Indexes

Price Distributions

• “A Tail of Two Worlds“
• “Skewing Your Diversification” – Mark Shore

Hedge Fund Managers

• Jim Simons
• “Manager Frets Over the Market, but Still Outdoes It” – New York Times on Seth Klarman
• The King of Quants GTAA Q2 Risk Parity Q3 Risk Parity Q2
• Bruce Kovner
• James Simons
• Julian Robertson
• George Soros
• Michael Steinhardt
• Kenneth Griffin
• Seth Klarman
• David Swensen
• Steven Cohen
• Leon Levy
• Jack Nash
• Louis Bacon
• Alfred Winslow Jones
• Paul Tudor Jones

Behavioral Finance

• Applying Behavioral Finance to Value Investing – Whitney Tilson Behavioural Finance – Martin Sewell
• Munger at Harvard
• “Psychology of Human Misjudgement” – Munger
• Seven Sins of Fund Management – James Montier

13Fs

• AlphaClone
• SEC EDGAR Database

Newsletters

• Formula Research
• Gloom, Boom, and Doom
• SuperInvestor Insight

Data

• Kenneth French’s data library

I love the new feature on AlphaClone that lets an investor view what fund has placed the biggest bet on a stock (as defined by % of their portfolio in the stock).  Who won in the recent BIDU and DNDN stock jumps?

Kleinheinz and S.A.C.

Kleinheinz Is an example of a fund most investors have never heard of.  Their firm is a Fort Worth, TX based hedge fund founded by John B. Kleinheinz in 1996. The firm has a global value oriented investment approach and their top 10 position clone has beaten the market by over 20% a year since 2000.  Top positions today include AAPL RIMM and LUKOV.

Below is an excerpt of a full interview from Hedge Fund News:

After graduating from Stanford University in 1984, John Kleinheinz started his career as an investment banker doing corporate finance and mergers and acquisitions work for Nomura Securities and Merrill Lynch in Tokyo, New York and London. In 1993, he became the second principal of San Antonio Capital Management, a hedge fund management company started in 1990 by Dana McGinnis. In February 1996, he hung his own shingle in Fort Worth where he launched the Global Undervalued Securities Fund, L.P. By the end of 1996, the fund was up 130% and had $25 million in capital. Since then, John¿s record has been nothing short of remarkable, multiplying the original dollar invested by a factor of more than 15 in 8 years. As the name indicates, the Global Undervalued Securities Fund focuses on value situations on a global basis. Over the years, the fund has shifted its focus to countries or industry sectors as varied as Russian equities, internet stocks, Japanese equities, healthcare stocks and emerging market debt. John’s conviction style of investing is not for the faint of heart, as he has occasionally suffered significant drawdowns. However, on a calendar year basis, he lost less than 4% in his only down year (2000). John has paid careful attention to matching his investor base with his investment style and limiting the amount of capital managed by closing to new investors (the fund is currently closed). Presently, he manages $750 million, of which half has come from Texas-based investors.