World Beta Blog

The Hidden Risks of Risk Parity Portfolios – Ben Inker GMO

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Forgotten Lessons of 2008 – Seth Klarman’s Annual Letter

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Interview with James Montier – Simolean Sense

Here is an old post  where we took at a look at investing based on the yield curve.  I updated the charts here with more and less granularity.  From the tables one could infer that stocks and especially REITs love a good ol steep yield curve like we have now.  Annualized average monthly returns from 1973-2009 (although it is missing the last two months of 2009).  Check out that commodity and gold performance when yield curve is negative.

Nice article about Paolo Pellegrini’s PSQR Fund over on Prag Cap (via Altucher).  Paolo is featured heavily in the very good book The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History.

Lots of media on PSQR over on Hedge Fund Letters.

Is anyone going to Andrew Lo’s presentation at the CFA Society here in Los Angeles next week?  If so come say hello.

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Betting on the Blind Side

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kaChing is requiring all Geniuses on their platform to register as RIAs – which I think is a great step in the right direction.  I still think the killer app for these guys is to morph into a technology/back office provider to outsource RIA duties which I posted about back in October.

But that also only makes sense for RIAs once kaChing has some decent AUM (and by decent I mean > $100mm).  Somewhat of a chicken/egg problem, but I like the direction they are moving.  Would also like to see them drop the silly “Genius” label.  Anyone willing to call themselves a genius in our field needs to go read my last blog post on the Folly of Forecasting and the must read Montier behavioral PDF the Seven Sins of Fund Management.

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This could be interesting but my first reaction is blah.   (CSLS Fact Sheet here, Index Fact Sheet here, Brochure here ).  If you recall from my book and numerous postings, these indexes are notorious about overstating returns vs. their liquid and investable versions (usually on the order of around 4% a year).

So for this fund you get:  no underlying hedge funds (rather a factor based replicator, but you want the ALPHA in hedge funds NOT the BETA), the credit risk of an ETN, possibly overstated hypothetical returns vs. the non-investable version, and active management fees – all for something that doesn’t really add anything to a diversified portfolio anyways.  I would much rather see an ETN on the actual foreign listed hedge funds with a bias towards those with the biggest discount to NAV.

Credit Suisse recently announced that for the first time, U.S. investors will be able to access the Credit Suisse/Tremont Long/Short Equity Hedge Fund Index strategy through an exchange-traded product.

The new Credit Suisse Long/Short Liquid Index (Net) ETN (NYSE Arca: CSLS) (the “CSLS ETN”) is designed to provide a more liquid alternative to hedge fund investing with lower fees. The Credit Suisse Long/Short Liquid Index (Net) seeks to replicate the performance of the Credit Suisse/Tremont Long/Short Equity Hedge Fund Index by tracking the performance of non-hedge fund, transparent market measures.

The CSLS ETN is designed to provide lower volatility than traditional asset classes with equity-linked returns. Plus, the CSLS ETN gives investors the freedom to buy and sell openly on an exchange. By providing real-time pricing, intraday liquidity and portfolio transparency, the CSLS ETN represents the next generation of alternative investing.

I was cleaning out some files and came across the fantastic James Montier PDF “The Seven Sins of Fund Management“. (If you want the Cliff’s note version check out his recent book The Little Book of Behavioral Investing.)

There was a great quote from Lao Tzu, a 6th century BC poet, “Those who have knowledge don’t predict.  Those who predict don’t have knowledge.”

This reminded me of a conversation I had with the Chief Economist of a major I-bank when I just graduated college.  We were out skateboarding (technically on a FlowBoard) down the paved streets of San Francisco.  The FlowBoard allows the user to basically snowboard down paved streets.  We would take a lift (car) back up then skate back down Rivera or Sloate streets.  Pretty amazing and one of those experiences you only get in the Bay Area.  Imagine going skateboarding with the head of Goldman in NYC…

Anyways, one of the simple questions I had was – “If people have such a rotten record of forecasting, specifically, why do we have a Federal Reserve Chairman/Committee adjusting interest rates at all?  Why not simply peg them to some basket of commodities, goods, or other inflation measure.”  He went on an hour long diatrtibe, and that debate is not the point of this post.  Rather, I wanted to point out a few of the great charts from the PDF highlighting the terrible record of forecasting in general.  From Montier:

The two most common biases are over-optimism and overconfidence. Overconfidence refers to a situation whereby people are surprised more often than they expect to be. Effectively people are generally much too sure about their ability to predict. This tendency is particularly pronounced amongst experts. That is to say, experts are more overconfident than lay people. This is consistent with the illusion of knowledge driving overconfidence.

Dunning and colleagues have documented that the worst performers are generally the most overconfident. They argue that such individuals suffer a double curse of being unskilled and unaware of it. Dunning et al argue that the skills needed to produce correct responses are virtually identical to those needed to self-evaluate the potential accuracy of responses. Hence the problem.

Why do we persist in using forecasts in the investment process? The answer probably lies in behaviour known as anchoring. That is in the face of uncertainty we will cling to any irrelevant number as support. So it is little wonder that investors cling to forecasts, despite their uselessness.

The first chart shows economists attempts to forecast the rate of inflation as measured by the GDP deflator. Sadly it reveals a pattern that will become all too common in the next few charts. Economists are really very good at telling you what has just happened! They constantly seem to lag reality. Inflation forecasts appear to be largely a function of past inflation rates.

The economists are bad, but what about bond forecasters?

Not only are bond forecasters bad at guessing the level of the yield, they can’t get the direction of yield changes right either. The table below (in PDF) shows that when yields were forecast to rise, they actually fell 55% of the time!

The same thing occurs for both equity strategists and analysts.  So, the question is, why forecast at all?

trying to figure out what in the world Currensee, the new social network for currency traders, could possibly spend their $8mm venture round on.  So far if I include free lunch Fridays I can only get to about $200k.

Press release here.

What academic study has the most historical data for momentum?  Most studies I see go back to the 1960s at the most.

Good listing of momentum papers here and here.

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Looks like 1866-1907 is the winner so far, but is there a gap between 1907 and 1960s?

2008 GIRY – by Elroy Dimson, Paul Marsh, and Mike Staunton

“On the Nature and Origins of Trendfollowing“ – Ostgaard

The appendix of Carr’s book.

Greenlight Capital Re (GLRE) hitting new all time highs recently.

Below is an updated equity curve from the global rotation strategy in the book.  Trying to decide if this is going to be a new section in my quant GTAA paper, or an entirely separate paper. . .

Long time readers know that I am fantastic with coming up with great ideas but less so at monetizing them.  Anyways, here is an obvious idea (Barclay’s/PIMCO are you listening?):

Start a suite of three public mutual funds or ETFs that focus on fat tail hedging including equity, credit, and inflation(deflation) protected funds.  One could also design them against other factors but these seem simplest.  All they do is buy out of the money options on those asset classes.  This is a perfect example of a strategy you should only be paying 50 bps for (Universa and Landmark charge hedge fund style fees).  Really, all they are doing at the end of the day is buying out of the money options so why charge alpha fees? (Note: This is not the same thing as 3X inverse funds – rather, this focuses on the optionality of using derivatives so it works almost like insurance.)

PIMCO does this within their Global Multi Asset Fund (PGMAX) but I am talking about someone that breaks it out separately.

Should be tons of demand for a product (ie insurance) like this.  Over/under until we see something?  I definitely think < one year.