Market Efficiency

I love it when people place creative names on otherwise boring academic papers (Katz is one of the best).

Case Closed by Haugen

Great review by Empirical Finance here.  The problem is that every quant with a FactSet subscription knows what factors outperform.  If you pull up a symbol of a highly rated multi-factor stock (say, CORE, AEA, etc) you see all the same holders – AQR, Rentec, DFA, LSV, etc.  So, what is the edge here?  Before it was unique acess to data, but now?  Hmmph.

This article provides conclusive evidence that the U.S. stock market is highly inefficient. Our results, spanning a 45 year period, indicate dramatic, consistent, and negative payoffs to measures of risk, positive payoffs to measures of current profitability, positive payoffs to measures of cheapness, positive payoffs to momentum in stock return, and negative payoffs to recent stock performance. Our comprehensive expected return factor model successfully predicts future return, out of sample, in each of the forty-five years covered by our study save one. Stunningly, the ten percent of stocks with highest expected return, in aggregate, are low risk and highly profitable, with positive trends in profitability. They are cheap relative to current earnings, cash flow, sales, and dividends. They have relatively large market capitalization and positive price momentum over the previous year. The ten percent with lowest expected return (decile 1) have exactly the opposite profile, and we find a smooth transition in the profiles as we go from 1 through 10. We split the whole 45-year time period into five sub-periods, and find that the relative profiles hold over all periods. Undeniably, the highest expected return stocks are, collectively, highly attractive; the lowest expected return stocks are very scary – results fatal to the efficient market hypothesis. While this evidence is consistent with risk loving in the cross-section, we also present strong evidence consistent with risk aversion in the market aggregate’s longitudinal behavior. These behaviors cannot simultaneously exist in an efficient market.

World Beta Value Masters

Wow – the World Beta fund group we have been tracking on the blog since Jan ’07 is beating the market by 30% this year through the weekend.  Real time out of sample results results below:

out samply

Simple Momentum Rotation

I was flipping though Mike Carr’s book again the other day, and decided to download the monthly data for the Fidelity Select Sector funds from Yahoo.  (Part of the reason was due to my frustration with the state of asset class testing software that I did a post on the other day).

I reran my simple rotation system on the universe of 23 funds that had data back to 1988.  Results were broadly similar as those in my book, albeit with higher drawdowns.  (These all are equity funds, so they lose the diversification benefit of including bonds, etc).  This test was meant to be instructive rather than exhaustive.

Simply taking the top fund, updated monthly, based on the average rolling 3/6/12 month performance resulted in compound returns of 18% per year, vs. 10% for the average fund.

Simply taking the top 3 funds , updated monthly, based on the average rolling 3/6/12 month performance resulted in compound returns of 16% per year, vs. 10% for the average fund.

Both systems had similar volatility  and drawdowns (54%, occurring in 08/09) as the underlying funds (average of 61%).

I think Fido has some screwy rules for holding their funds, but I see no reason why this wouldn’t work splendidly with a diverse portoflio of ETFs or mutual funds.  The sample 5, 10, 20 fund allocations from my book would be a good start.

fido rotate

Asset Allocation Backtesting Software

There are a lot of asset allocation software choices for the professional – Morningstar’s Encorr, MSCI Barra – but not many for the individual. Very few are web based, and most are very expensive.

What are some good sites out there besides AssetPlay?

(I’ll update this post with $$ and links as I get to it.)

Zephyr AllocationAdvisor ($5,000)  Mean-variance optimization (MVO), Black-Litterman, etc.

Pertrac Analytics ($5,500 – $8,300 /year)

Gravity Investments

SmartFolio ($600 – $6,000) Multi-period MVO, Black-Litterman, etc.

Morningstar’s Encorr ($10,000 / year)

MSCI Barra

Windham Portfolio Advisor ($12,000/year), Financial Planner ($6,000/year), Planner Express ($1,800/year)

Efficient Solutions ($70-$170 one time)  Single and multi-period MVO, Monte Carlo.

DynaPorte ($20,000 /year)  Macro factor based tactical asset allocation.

FastTrack ($400-$700/year)  Poor man’s version of FastBreak.

FastBreak ($500, Pro $1,800)  Mutual fund and stock trading system to test and trade strategies using fund rotation.  Pro version features genetic algos.

Quantext ($100 – $180/year) Portfolio simulation.

Anyone speak Italian?

Not sure if this article is a pan or praise:

Vuoi un guru? Te lo copiamo noi

Lazy Portfolios, or, The Revenge of 60/40

There has been some discussion around the blogosphere regarding returns from strategic asset allocation strategies.  Here is a post on the Yale endowment & Swensen’s allocation mix,

With the news that PIMCO is launching a real assets ETF, it now becomes possible to have a truly diversified portfolio with only 3 ETFs.  1 world equity, 1 bond, and 1 real assets.  Doesn’t get much simpler than that.

Anyways, I thought I would update an old post on the performance of some lazy portfolios.  You can do your own tests over on Asset Play with more granular asset classes, but I am presenting these below mainly to just be instructive. (Who runs this site btw?)

Completely unrelated but nice interview with Paul Samuleson.  Part 1 and Part 2.


US Stocks (S&P500)

Bonds (10 Year US Govt)

Foreign Stocks (MSCI EAFE)


Commodities (GSCI)


60% US Stocks

40% Bonds

Andrew Tobias Three Fund Lazy Portfolio (Also similar to Bill Shultheis & Scott Burns’s 3 Fund portfolios)
33% US Stocks
33% Foreign Stocks
33% US Bonds

Swensen model, from his book Unconventional Success
30% US Stocks
20% REITs
20% Foreign Stocks (He recommends emerging, but for simplicity we just used foreign developed)
30% Bonds (He recommends short term US and TIPS, but since TIPS only existed post 1997 we lumped them in with bonds)

El-Erian model, from his book When Markets Collide

(This is simplified from his longer allocation. )

15% Commodities

20% US Stocks
15% REITs
30% Foreign Stocks
20% Bonds

Ivy Portfolio (from our book – note this is the B&H allocation not the tactical)

20% US Stocks
20% Foreign Stocks
20% Bonds
20% Commodities
20% REITs

Some nice rules of thumb:

Most asset classes have a Sharpe of around .20 (over time).

A diversified portfolio gets you to around .3 to .4.

Active risk management can improve that to around .7 to .8.

Data from Global Financial Data.


and a few more asset classes:


People Suck at Investing Part II, the ETF Version

Least surprising data of the day.  Although this has nothing to do with the vehicle (ETFs, the same thing happends with mutual funds), and everything to do with investor behavior.


Great suggestion for what to buy Dad for Father’s Day!


Moving Averages:  Holy Grail or Fairy Tale, Part 1


Some new blogs added to the blogroll, including today’s addition:  Investment Linebacker


10 Rules for Investing


I haven’t seen a mean variance optimization with human capital.  Yet.


Speaking of mean variance, this author argues terminal wealth is more useful.  Link to the paper here: “A Geometric Mean Maximization: An Overlooked Portfolio Approach?


Birds hate me.  This bird is apparently dive bombing every passerby in San Fran’s financial district.  Video here from CNN.

Photo from Reuters:



And, one more Tuesday diversion, “Her Morning Elegance” :

Fund Manager Profiles

I was making a list of books that profile fund managers – are there any that I am missing?

Books below are reader links:

  • Money Masters, The New Money Masters, and Money Masters of Our Time – Train
  • The Global Investor Book of Investing Rules – Jenks
  • Julian Robertson – Strachman
  • Hedgehogging – Barton Biggs
  • When Supertraders Meet Kryptonite -Art Collins
  • New Market Mavericks-Cutmore
  • Investing With Young Guns-Morton
  • The Best:Conversations With Top Traders-Marder
  • Investment All Stars-Stern
  • Confessions of a Street Addict-Cramer
  • Education of a Speculator-Niederhoffer
  • The Mind of Wall Street-Levy
  • John Neff on Investing-Neff
  • The Lion of Wall Street-Dreyfus
  • Trading the Worlds Markets-Gough
  • Value Investing with the Masters-Kazanjian
  • Wizards of Wall Street-Kazanjian
  • The Bond King-Middleton
  • Pit Bull – Martin Schwartz
  • John Neff on Investing – Neff and Mintz
  • Running Money by Andy Kessler
  • Barnard Baruch – The Adventures of a Wall St Legend
  • Charlie D – The Story of the Legendary Bond Trader – William Falloon
  • Education of a Speculator – Vic Niederhoffer
  • What I Learned Losing a Million Dollars – Jim Paul & Brendan Moynihan

Active Fixed Income Investing

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