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.



cape 2

Important News – Freed Again

It has only taken a few weeks but I am very happy to announce that enough people have subscribed to The Idea Farm that I am ready to return the blog to free.  More people subscribed , and at a faster rate,  than I expected. In retrospect I should have just turned on the Idea Farm first before the blog.  But this has all been new to me and a bit of an experiment, as well as a learning experience.  (So too will be self publishing a book in two weeks.)  Instead of the six month period I was expecting it to take to reach a conclusion, it was only two weeks.

I’m going to refund all charges to the blog, which is a bit painful,  but a big huge thanks to the overwhelming support for the people that subscribed.  In general I prefer to have the content free, and never got comfortable placing the content behind a paywall.  I certainly don’t have a problem with charging for content (as I described to one reader, that is the beauty of capitalism – you only have to pay for what you consider to be of value). But, it is expensive to run a research organization and thankfully Idea Farm is helping to pay the freight of all of those costs…

If you want to support our efforts the easiest way is simply through a subscription to The Idea Farm.

All of the same privileges of subscription to the blog will now apply to subscribers on The Idea Farm – first look at publications, CAPE updates,  and free copies of all books.

Next up, GTAA 2012 paper update goes out to the Idea Farm list later this or next week depending on NYC travel schedule!

Thanks for the patience and support everyone!  


Sharks Circling

Interesting news tonite that Third Point is launching a Greek Hedge Fund to capitalize on opportunities in the beaten down stock market there.  Other big firms such as Baupost have been building stakes in stocks there, and you know I think they’re cheap!

Longer post from Josh on Third Point and their recent investment letter

Travel: NYC and Philly

I’m on the plane to NYC to sit in on the Barron’s ETF Roundtable, and should have a little free time in both cities.  Bummed the Mets and Phillies are out of town but may catch a Yanks game (somehow never been to any of the three stadiums).

Drop me a line if you want to meetup!

Asset Price Trend

Asset Price Trend Theory

Traditional portfolio optimization models implicitly or explicitly specify placement of capital as rather irrevocably and fully at risk through investment horizon(s) or continuously. Under this constraint, asset class allocation typically serves as primary mode of diversification, pursuing risk moderation by seeking to reduce portfolio variance. But investors adopting this construct find Risk Management inevitably failing to encompass risk containment, to limit negative variance, leaving drawdown risk unbounded to fully 100% loss. 

Here we turn to the little-discussed yet universally-held and most basic of assumptions in Finance – that asset prices tend to trend – and consider implications of constructs reframed in a consistent and corresponding manner. Most important among these is enabling of pursuit of risk containment which, through stop-loss protocols (i.e., loss-contingent exits), seeks to limit negative variance, to limit drawdown depth. Additionally, with risk containment centered on Exit protocols, pursuit of growth can proceed in relatively un-conflicted form via traditional modes of capital deployment and via now logically-enabled price and return trend-contingent alternatives. 

Within a more broadly-applicable capital allocation framework we illustrate how pursuit of risk moderation, such as through traditional asset allocation regimes, is logically and operationally subordinated to the objectively more pressing and critical matter of risk containment.

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