Becoming Asset Class Agnostic, or, A Golden Dilemma

People often get attached to their investments.  You will hear people described as a goldbug, or a stock guy, or perhaps a dividend income loving retiree.  I’ve never really seen the wisdom in falling in love with one asset class or another.  It seems to me from history that every asset class is great sometimes, and horrible other times.  On top of this layer in all the behavioral biases that people have once they like and/or own an asset class and you then start to really get emotions involved.

Lots of debate and inquiry raging about the shiny metals lately.  We have written about a lot of the fundamentals behind investing in metals on the blog in the archives, as well as some simple technical posts.  Here is one from 2009.  Here is a recent Hulbert piece on gold that summarizes this Erb and Harvey paper out recently: “The Golden Dilemma“.  From the Hulbert summary:  

“But to come up with an estimate of gold’s fair value, they calculate a ratio of gold to inflation going back as far as they were able to obtain data. They report that this ratio, when expressed in terms of the U.S. Consumer Price Index, has averaged about 3.2-to-1. Even at $1,400 an ounce, this ratio stands at 6.03-to-1, or nearly double this average.”

I thought I would update the chart in our earlier post, that simply looks at a long term trendfollowing approach to gold, and investing the cash in Tbills or 10 Year Bonds when below the long term trend as defined by 10 month SMA.  You would have exited the long gold position at the end of 2012.  This data doesn’t include March…


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The Golden Dilemma

Claude B. Erb

Campbell R. Harvey 

Duke University – Fuqua School of Business; National Bureau of Economic Research (NBER)

April 15, 2013


Gold objects have existed for thousands of years but for many investors gold has only recently become a tradable investment opportunity. Gold has been described as an inflation hedge, a “golden constant”, with a long run real return of zero. Yet over 1, 5, 10, 15 and 20 year investment horizons the variation in the nominal and real returns of gold has not been driven by realized inflation. The real price of gold is currently high compared to history. In the past, when the real price of gold was above average, subsequent real gold returns have been below average. Given this situation is it time to explore “this time is different” rationalizations? We show that new mined supply is surprisingly unresponsive to prices. In addition, authoritative estimates suggest that about three quarters of the achievable world supply of gold has already been mined. On the demand side, we focus on the official gold holdings of many countries. If prominent emerging markets increase their gold holdings to average per capita or per GDP holdings of developed countries, the real price of gold may rise even further from today’s elevated levels. As a result investors in gold face a daunting dilemma: 1) embrace a view that “those who cannot remember the past are condemned to repeat it”, there is a “golden constant” and the purchasing power of gold is likely to fall or 2) embrace a view that “this time is different” and the “golden constant” is dead.

Noteworthy for Two Reasons

iShares and an AZ pension fund are teaming up.  First, since iShares is launching their first active funds.  But more importantly, a real money fund is basically launching their own ETFs.  I am surprised this hasn’t happened sooner.  If I was a family office that pursued active management, why wouldn’t I just launch my own ETF to optimize my tax exposure?


Hussman Speech from Wine Country

Even though I left (and later sold) my car in Paso Robles on the way up, it was worth it to connect with some friends in Sonoma.  Here is a link to the presentations from a number of speakers, and I’ll link to the videos as they come online.  Highly recommend going next year! 

 ”If you like and appreciate hearing from these speakers, please consider making a donation to further ALS research and/or please plan on attending our 2014 Wine Country Conference in April 2014 where we will be raising money for Autism. You can enter your email address in the sidebar to receive periodic updates about the 2014 event.”


Another $10k Winner

Glad to hear that another blog reader won another big prize this year, the $10k Wagner Award.  Going to download it and the other interesting papers from the NAAIM website (they also have a conference coming up in Denver).:


Click here to view and download all submitted Wagner Award papers from 2009, 2010, 2011, 2012

Download a copy of all of the 2013 papers including the prize winning paper:


Quant Approach to TAA Paper Updated

I updated our 2006 paper “A Quantitative Approach to Tactical Asset Allocation”.  I am going to send it to The Idea  Farm list this Friday so make sure to signup!




This 70 page new update includes:

1.  Results are extended out-of-sample to include the years 2009-2012.

2.  Additional asset classes are included (from 5 to 13).

3.  Alternative cash management strategies are included.

4.  Additional conservative and aggressive approaches are included.

5.  Alternative allocations are included.

6.  FAQ Section with answers to over 20 common questions.

Countries & Sectors

Below is a dump of CAPE data from the subscription product.  Going forward these will only be on the Idea Farm so signup there if you want the CAPE updates.  

First up is the CAPE values for countries around the world:

The difficulty I have with a lot of indicators is just that, they are difficult.  If I can’t understand what the chart is saying within a few seconds it is usually too confusing and often makes me think you’re trying to smash a square peg in a round hole.

I’m not sure why I didn’t think of this before, but below is simply the average CAPE value across all countries since 1979.  As you can see, it does a great job of setting up secular and cyclical lows in the markets…

And one of the more interesting takeaways to me is that the current CAPE value correlates much better with drawdown than does the TTM E figure.

Lastly, here are the sector values.  Financials still pretty cheap relative to the consumer sectors…



Claim Your $

I do this post every year…let me know if you find anything!

Old post below for background:

Since it is tax time make sure to make your way over to the NAUPA site here and start your search for any unclaimed property.  As always I’ll post if anyone finds anything big and juicy, last year we had the largest single claim so far : $10,000, with total claimed by readers around $20,000…

As tax season rolls around, most people are busy trying to figure out how much they owe the government.  Most people don’t know that their (state) goverments likely are holding on to some of their cash as well (running total around $30 billion).  Did you know there is a website where you can go to search for unclaimed assets?  It is usually something simple related to moving (utility company owes you money) or relatives passing away (and forgot about those 1,000 shares of GE ).

Goto the NAUPA site here and start your search!

Report back if you find some lost assets and I’ll post the total found on the blog as well as the biggest.

Unfortunately for me I have three claims only worth a combined $2.

Inefficiencies in the Pricing of Exchange-traded Funds

This looks good – unfortunately will not still be in NYC…


Inefficiencies in the Pricing of Exchange-traded Funds


MONDAY, April 15, 2013 (5:30 PM – 7:30 PM)
The Cornell Club of New York (Fall Creek Room)
6 West 44th Street, New York  NY 10017

Antti Petajisto, Ph.D. 
BlackRock Multi-Asset Strategy Group

The prices of exchange-traded funds can deviate significantly from their net asset values, on average fluctuating within a band of 260 basis points, in spite of the arbitrage mechanism that allows authorized participants to create and redeem shares for the underlying portfolios. The deviations are larger in funds holding international or illiquid securities where net asset values are most difficult to determine in real time. To control for stale pricing of the underlying assets, I introduce a novel approach using the cross-section of prices on a group of similar ETFs. Nevertheless, the average pricing band remains economically significant at 150 basis points, with even larger mispricings in some asset classes. Active trading strategies exploiting such inefficiencies produce substantial abnormal returns before transaction costs, providing further proof of short-term mean-reversion in ETF prices. 


About the speaker: Antti Petajisto, Ph.D., is a Vice President in BlackRock s Multi-Asset Strategies group, where his team’s main responsibility is the development of active investment strategies for global tactical asset allocation.

Prior to joining BlackRock, Dr. Petajisto was an Assistant Professor of Finance at the Yale School of Management and a Visiting Assistant Professor of Finance at New York University Stern School of Business, where he taught MBA-level elective courses on investments and portfolio management as well as behavioral finance. Dr. Petajisto’s academic research includes topics such as active and passive portfolio management, performance evaluation of money managers, pricing inefficiencies in exchange-traded funds, and the price impact of passive indexing strategies. He also developed the Active Share measure which today is used by a number of practitioners. His research has been published and cited in academic journals and the popular press, and he has frequently presented his findings to both academic and practitioner audiences.

Dr. Petajisto has a Ph.D. in Finance from MIT Sloan School of Management and M.Sc. in Engineering Physics from the Helsinki University of Technology.

Registration Fees
SQA Members: $50 Regular or Academic; $30 Transitional; $30 Student
Non-Members: $70 IAFE, QWAFAFEW, or NYSSA Members; $90 Non-members

5:30pm Check-in & networking cocktail reception
6:00pm Speaker Presentation
7:00pm Networking reception continues
7:30pm Adjourn

Success Leaves Traces

That is a great John Templeton quote (that I plan to use as the title for an upcoming piece.) 

I was stuck in the Philly airport during the NYC ground stop on Wednesday, and started, then finished, the book The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success by Thorndike.  Buffett mentioned the book recently so I had ordered it but it sat on my shelf for some time and included in Chapter 1 was the above quote.  It’s absurdly cold here so will likely find a pub with a fireplace to cozy up to here in a bit.

(PS I also scraped together some of the reading lists from some hedge fund managers and uploaded them to AMZN here.)

The author  examines one of the more overlooked duties of a CEO, capital allocation, and argues it is as important, if not more so than operational abilities.  Considering all of the work we have done on how capital allocation affects stock prices ala Shareholder Yield, it was a natural fit.  Some quotes and excerpts below, a great read!


CEOs need to do two things well to be successful:  run their operations efficiently and deploy the cash generated by those operations.  Most CEOs (and the management books they write or read) focus on managing operations, which is undeniably important.  Singleton, in contrast, gave most of his attention to the latter task.

Basically CEOs have five essential choices for deploying capital – investing in existing operations, acquiring other businesses, paying down debt, or repurchasing stock – and three alternatives for raising it – tapping internal cash flow, issuing debt, or raising equity.  Think of these options collectively as a tool kit.  Over the long term, returns for shareholders will be determined largely by the decisions a CEO makes in choosing which tools to use (and which to avoid) among these varios options….In fact, this role just might be the most important responsibility any CEO has, and yet despite its importance, there are no courses in capital allocation at the top business schools. As Warren Buffett has observed, very few CEOs come prepared for the task:

“The heads of many companies are not skilled in capital allocation.  Their inadequacy is not surprising.  Most  bosses rise to the top because they have excelled in an area such  as marketing, production, engineering, administration or,  sometimes, institutional politics. Once they become CEOs, they face new responsibilities.  They now must make capital allocation decisions, a critical job that  they may have never tackled and that is not easily mastered.  To stretch the point, it’s as if the final step for a highly talented musician was not to perform at Carnegie Hall but instead, to be named Chairman of the Federal Reserve.”



The conventional wisdom was that repurchases signaled a lack of internal investment opportunity, and they were thus regarded by Wall St as a sign of weakness.  Singleton ignored this orthodoxy, and between 1972 and 1984, in eight separate tender offers, he bought back an astonishing 90 percent of Teledyne’s outstanding shares. 


As Chabraja described to me, “What drove me was the realization that the stock was trading at a significant premium to our historic norm:  twenty-three times next year’s projected earnings versus an historic average of sixteen times.  So what do you do with a high-priced stock?  Use it to acquire a premium asset in a a related field at a lower multiple and benefit from the arbitrage.”



Making Adjustments (ie What if 2008 Never Happened?)

One of the things that makes me really queasy as a portfolio manager is when people make “adjustments” to historical price data.  The classic example is excluding 1987 from the analysis as an outlier.  Why would you exclude something that actually happened?

My friend John Bollinger often says (paraphrase), “all of the interesting information is in the tails”.  A friend emailed me this morning asking about our CAPE research.  First of all, let me state there is nothing magical about smoothing earnings across 10 years.  In fact, using 1 year earnings (or Price/Book, P/cash flow, or P/sales all work, please see the appendix in our Global Value paper).  Most of the value indicators usually line up on the same side, and I think an ensemble method is a great idea.  

I really like Liz Ann Sonders at Schwab - she has a good piece on all things PE and makes a few comments:

“More recently, the move toward fair-value accounting standards resulted in security losses having a devastating effect on the reported earnings of financial institutions during the recent financial crisis. Yet that effect now appears to have been transitory. If an accounting item is deemed non-recurring, it’s common practice to ignore it when determining underlying earnings (i.e., using “operating” instead of reported earnings). But CAPE continues to reflect the effect of non-recurring items for the 10 years that follow their initial recognition in reported earnings.”

Anyways, the question from my friends was “We don’t like using the CAPE because it includes 2008-2009 earnings which distorts the PE since they are too low.” My response to this is, well, according to your logic, do you also exclude 1999 and 2007 as being abnormally high?  And then, if you make the adjustments, does it even matter?

Below we adjust the earnings series from Shiller to pretend like 2008/2009 never really happened.  We adjusted the earnings series so that it only declined a little bit as seen in the first chart below to reflect a normal recession.  The second chart is the adjusted CAPE series.  If you adjust the data it moves the CAPE from 22.9 to 20.9 (this was a month or so ago when I wrote this).  ie basically no difference and stocks are still slightly expensive, but not terribly so due to the mild inflation sweet spot we are in.

CAPE and other valuation methods are mildly interesting to me on a stand alone basis – but MUCH more important to me, is expanding the opportunity set to include all of the countries in the world and consistently buying the cheapest instead of the owning the most expensive and often biggest by market cap. 

You can download our JOI version of the CAPE paper here with much prettier graphs than the first version (and a ever so slightly different dataset, albeit with same takeaways and conclusions).

First chart is E, second chart is CAPE.



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