Better Indexing

I was going to do this post as an issue of The Idea Farm, but there is already a two week backlog of good pieces so I figured I’d just post it here.  Passive and active are meaningless terms to me since I’m a quant and everything is active in my mind.  You have rules for buying, selling, and rebalancing.  It is always ironic to me that likely the largest and most famous index, the S&P 500, is really an active fund in drag.  It has momentum rules (mkt cap weighted), fundamental rules (4Q of E, liquidity requirements), and a subjective overlay (committee input).  Does that sound passive to you?!

However, most of the early indexes were built to be representative of the marketplace.  So while indexing was revolutionary, it was not necessarily the best approach for managing money.  Over the past 30 years we have seen an amazing amount of research that has shown simple ways to construct mechanical portfolios, ie indexes, that outperform these market cap indexes.  Simple indexes that take into account value, momentum and trend, and carry have been applied within and across asset classes to form more robust portfolios.  Second generation indexes have improved upon the first generation (commodities are a great example here).  (For a recent piece of ours that details why market cap indexing is flawed, check out Global Value in the Journal of Indexing.)

Below the good folks at O’Shaughnessy put together a piece titled  ”Combining the Best of Passive and Active Investing” that is well worth your time.



We Live in a Real World

Below are two charts that I find highly useful.  The first looks at yields on various indexes (the red dot is where we are now and purple/green represent one standard deviation bands).  This chart poses the problem many investors complain about daily – where to find yield?  (Note: S&P500 is TTM PE yield.)

One would conclude, that with the exception of mortgage REITs and US stocks, everything else is highly unnattractive.  Bonds and REITs seem to be at their worst yields EVER.




However, if one looks at yields after inflation, so called real yields, the picture changes.  Most asset classes are in normal valuation ranges, and while bonds are still trading at low yields, stocks are even more attractive, and mortgage REITS too.  

The world doesn’t look so bad. (HT: DJ.)


Total Returns for ETFs

I know this is very basic but I have had a shocking amount of conversations lately with people (retail and pro) that seem to forget ETFs pay out income and dividends.  This matters more and more the larger the yield, but below is one of the older dividend ETFs, and the difference in returns is 23% vs. 67%!  While it may look like the price is flat for the blue line, you have to include the dividends!


What To Do About REITs?

REITs have been the best performing major asset class since the market bottom in 2009, up over 200%.  What are the current drivers of REITs saying now across trend, yield curve, and valuation?  I’ll write up a longer piece in the upcoming weeks on my thoughts but below is a very short clip from CNBC yesterday…



Five Million Dollar Investing Ideas (Part 4/5), Private Crowdfunded Research Boutique

Below is Part 4 in my series of ideas in the world of fintech.  

Part 1 – Public Alts newsletter

Part 2 – Quant Backtester

Part 3 - Tax Harvesting

4.  Investment research boutique focused on private crowdfunded companies on AngelList and The Funders Club.  Most people have no idea what they are investing in, and probably spend more time on researching buying a TV or a car than they do chipping $10k into these companies (which is one reason Wirecutter is so successful).  Start a website that reviews the news around all of these companies, etc, and make buy or pass recs on the ones that are available to invest in.

Five Million Dollar Investing Ideas (Part 3/5), Tax Harvesting

Below is Part 3 in my series of ideas in the world of fintech.  

Part 1 – Public Alts newsletter

Part 2 – Quant Backtester

3.  Tax Harvesting.  Setup a simple site that pulls portfolio info from ByAllAccounts or similar and emails you when to rebalance the portfolio based on tax implications.  The academic research shows that it can add about 1-2% per year post tax returns.  My buddy Richard Smith runs a similar site called Trading Stops, and I know Welathfront has added this feature (but have not seen it).  Shocked there isn’t anything here.  Here is a paper on the subject and there are a ton of posts in the archives.

Five Million Dollar Investing Ideas (Part 2/5), Quant Backtester

This post is 2/5 on ideas in fintech.  We have had to build everything custom in house as most online/public software is too limited…

2.  Website for backtesting and tracking quant models.  There have been a few entrants here (Turnkey AnalystNed DavisETFReplay).  We actually built one over two years ago at to track and receive emails for our quant models, but I don’t want to have to maintain it. (Ignore all the Latin placeholders for the text, all the guts and software works behind the scenes).  Let me know if you want to run with it!

Quantopian looks like another interesting entrant here, and they have an intro webinar coming up in a week to check it out… 

Below is a chart from Quantopian that backtests and reports on one of our published models…



Five Million Dollar Investing Ideas (Part 1/5), Public Alts

James did a fun post on new startup ideas (though I wish he would have just followed up on JungleSmash).  A couple buddies of mine give me a hard time about always giving away ideas for free, but I have plenty on my plate in the next few years trying to disrupt the traditional asset management space so in the coming weeks I’ll post five ideas I would love to see, many of which I would pay for as a subscriber (or fund as a partner).  Please reach out if interested!  

Here is the first one:

1.  Investment newsletter focused on publicly traded alternatives.  With hundreds of choices out there most advisors cannot separate the good from the bad across the mutual fund/ETF/CEF spectrum.   Most don’t know the difference between all of the managed futures funds (which is a Grand Canyon wide difference) ,or the difference between the FX, long/short equity, volatility, and triple levered who-knows-what funds.  I don’t blame the advisors, it’s simply too much info.  The likely suspects have not done much here (Morningstar and IndexU, although both have great newsletter services on the broad offerings) and therein lies the opportunity. 

A Few Hedge Fund Interview Stories (Including Meth and Stock Fraud)

I was joking with a friend the other day about some of our funnier interview stories (I’m not going to even get into work stories, just interviews).  Our investment management industry has a tendency to attract quite a few characters, as well as quite a few bastards and aholes.  

I’ve probably taken one of the windy-iest routes to running an investment management firm out there, but I thought I would share a few stories to give a little color to how strange (and funny) our world can be.  But also to show that sometimes, channeling a little Garth Brooks, sometimes you give thanks for unanswered interview offers.  These are just a few of the highlights..

-Interviewing in college with a hedge fund from a Myrtle Beach pay phone. Later showed up for interview in NYC realizing I didn’t know the name of the fund just the PMs name.  Learned that hedge funds don’t call to tell you that you didn’t get the job, they just never call you or respond to emails again.  Fund out of business few years later due to poor performance.

-Worked for a biotech fund and went to grad school at night at Hopkins in my year off before “going back to finish PhD”.  Too fascinated with investing world and PhD is (still) on hold.  First day on job got quoted in BusinessWeek as saying “I’ve been studying this stuff for years”.  To this day believe I never said that.  

-Interviewing with Soros funded hedge fund.  Suggested a biotech stock long, suggested my price target,  to which the PM suggested his price target of $0.50.  (I think he was close to correct it got bought for about $1.5).  Didn’t get job.  Both the PM and CFO went to jail for stock fraud for buying up 70% of the float of a few stocks and not disclosing it.

-Interviewed with PM who told me to work in his office for a week while he was gone.  Ran into him while skateboarding in the Presidio on a Flowlab skateboard.  Didn’t get job.  He closed fund a few years later.

-Applied for a sushi chef job in Tahoe and turned down on the spot.

-Interviewed with family office of probably the world’s top hedge fund.  Got asked a poker question and got the pot odds wrong.  Didn’t get job offer as PM said it was clear I wanted to be a CTA (becomes half true later).

-Interviewing with trading shop and probably 25 different people.  Spent all of lunch getting quizzed about my sports arb model at a table of probably 12 people.  After last interview and writing down equations for 30 minutes, two guys asked me what their names were.  No idea.  Didn’t get job.  Company in the news lately with HFT and buying Knight.

-Interviewing with wealth management shop.  Asked what books I had read on the shelf.  I replied all of them (wasn’t trying to humblebrag or be a total jackass but was actually the truth).  PM proceeded to take all the books down from the shelf and quiz me on the contents. Of. Each. One.  Got an offer but declined.

-Interviewing with quant hedge fund.  Talked about how I wanted to climb Aconcagua.  Later heard the PM referred to me with two words: ‘hubris’ and ‘gregarious’.  Didn’t get the job.  Fund involved in quant wreck a few years back.

-Interviewed for a fund where two of the partners are in or going to jail.  One for meth and one for stealing client funds.  

-Interviewed with an investment bank via the CEO finding my resume on Craigslist.  CEO was on Craiglist for the first time ever.  Company is now leading the charge in disrupting the asset management industry by launching actively managed ETFs.

What’s your best story?

A few reader stories below:

After months of trying to say the right thing in job interviews after tech bubble burst, I interviewed with (big name economist).  He asked me about various software like Bloomberg, Factset., etc.I just gave up, and said “they’re all just glorified video games. I’ll figure them out.”  Got the job next day.


Buy High, Sell Higher?

A classic example from my buddy Steve Sjuggerud on a Wall St “truth”, ie you have to buy low sell high…(reminds me of an olllld 2007 post here).



Should You Buy at New Lows? Or New Highs?

So we tested which strategy works better: Buying near 52-week lows… or buying at 52-week highs. We looked at nearly 100 years of weekly data on the S&P 500 Index, not counting dividends.
You might be surprised at what we found…
After the stock market hits a 52-week high, the compound annual gain over the next year is 9.6%. That is a phenomenal outperformance over the long-term “buy and hold” return, which was 5.6% a year.
On the flip side, buying when the stock market is at or near new lows leads to terrible performance over the next 12 months… Specifically, buying anytime stocks are within 6% of their 52-week lows leads to compound annual gain of 0%. That’s correct, no gain at all 12 months later.
Using monthly data, our True Wealth Systems databases go back to 1791. The results are similar… Buying at a 12-month high and holding for 12 months beats the return of buy-and-hold. And buying at a 12-month low and holding for a year does worse than buy-and-hold. Take a look… 
1791 to 2012 
All periods 
New Highs 
New Lows 
The same holds true for a more recent time period, this time starting in 1950… 
1950 to 2012 
All periods 
New Highs 
New Lows 
History’s verdict is clear… You’re much better off buying at new highs than at new lows.
You might not agree with it… but it’s true.
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