2012 Global Investment Returns Sourcebook

Get it while it’s hot! (HT: Abnormal Returns)

One of my top must reads of the year…

(PS If you are a CSFB client you can get the full/extended version in hardcover.)

Updated: How to Pick Mutual Funds: The Netflix Prize for Improving Morningstar’s Star Rankings

Thought I would update this older post with a few new studies that take a look at active share, and illiquidity and momentum.

While most mutual funds underperform a simple index (and the vast majority underperform after tax), does that mean one cannot build a metric that predicts fund performance better than random?

I was at the Morningstar ETF conference this past summer and learned a pretty amazing statistic: roughly all inflows into mutual funds go into 4/5 star rated funds or new funds.  That was astounding to me.  The Morningstar star ratings (background at the bottom of the post) have been measuring past risk-adjusted performance for over two decades.  What they DO NOT do is offer any clues to future performance.

Don Phillips, President of Fund Research at Morningstar, stated:

“The star rating is a grade on past performance. It’s an achievement test, not an aptitude test…We never claim that they predict the future.”

Morningstar, quite impressively, actually disclosed a few months ago that simply using expense ratios was a better metric for predicting future performance that their star ratings. “Investors should make expense ratios a primary test in fund selection,” Russel Kinnel, director of mutual fund research at Morningstar, said in an article about the study. “They are still the most dependable predictor of performance. Start by focusing on funds in the cheapest or two cheapest quintiles, and you’ll be on the path to success.”  (Older 2007 study here.)

It would be interesting to see Morningstar present this metric on gross and net-of-fee returns to try and isolate the impact of fees (their current ratings are net of fees so naturally include the expense ratio as a factor).

If I was Russ or Don, I would commission a study in house (or possibly with some cheap local U of Chicago PhD’s) or even open it up Netflix style to a competition.  There have been numerous studies that illustrate ways in which one can pick mutual funds (maybe call it SuperStars? ha).

I’m sure there are more (email the papers to me and I’ll add them), and some of these probably overlap (ie high fees and low Morningstar ratings).  A lot of these factors are successful in selecting hedge fund manages on AlphaClone as well.

Most of these links are from the fantastic blog CXO Advisory.  It would be interesting to see a white paper that combines these factors into one metric.


Ways to improve your chances when picking mutual funds:

-Favor funds holding illiquid and high momentum stocks:  ”Using Liquidity and Momentum to Pick Alpha Managers“ - Idzorek

-Favor funds with high active share:  ”Equity Allocations: Thinking Outside of the Box”  Larson

-Favor new funds.  Academic paper here: Performance and Characteristics of Mutual Fund Starts” Karoui and Meier

-Favor cheap funds.  Academic paper herePerformance and Characteristics of Actively Managed Retail Mutual Funds with Diverse Expense Ratios” Haslem, Baker, and Smith

-Favor funds with higher ownership stakes (manager skin in the game).  Academic paper here: Portfolio Manager Ownership and Fund Performance” Khorana, Servaes, and Wedge

-Favor funds with high “Active Share” (holdings very different from the benchmark).  Academic paper here:  How Active is Your Fund Manager? Cremers and Petajisto

-Favor funds with low assets under management.  Academic paper here: How Active is Your Fund Manager? Cremers and Petajisto

-Favor funds with recent momentum.  Academic paper here: How Active is Your Fund Manager? Cremers and Petajisto and here “The 52-Week High, Momentum, and Predicting Mutual Fund Returns” Sapp

-Favor funds with redemption fees.  Academic paper here: “Redemption Fees:  Reward for Punishment” Nanigan, Finke, Waller

-Avoid funds with low Morningstar Stars.  Academic paper here: Selectivity, Market Timing and the Morningstar Star-Rating System” Antypas, Caporale, Kourogenis, and Pittis

-High conviction picks outperform.  Academic paper here:  Best Ideas”  Cohen, Polk, Silli


Long Vol and Short Vol

Option selling has always been a fascination for me, and long time readers may recall a lot of the posts I used to do on the subject years ago.  (07 – Are option selling funds a blowup waiting to happen, and 2008 – Kablooey.)

I could never understand why most option sellers only traded one market (usually US stocks) rather than a portfolio of world markets.  In a project I did back in the early ’00s I found that writing options away from the direction of the trend on a diversified asset class basket created some great numbers.

Kudos to Jared at Condor Options for tracking such a strategy in real time - lots of merit in a short vol strategy with long vol trading rules!

Volatility-Responsive Asset Allocation

Fun paper from the good folks at Russell Research.  Although I would argue the volatility is an artifact of prices declining, and this could be called a trendfollowing approach….ie our paper on where the vol occurs:

Where the Black Swans Hide and the Ten Best Days Myth

Volatility Responsive Asset Allocation


Shiller CAPE for the G8

Most stock market valuation models are not that predictive in the short term.  However, value tends to work great on longer term timeframes.  We rebuilt Hussman’s valuation models (both the PE and dividend ones) with the Shiller data, and right now at future P/Es of 15 the US stock market should do about 5% a year nominal (so, net of inflation maybe 2-3% per year) over the next decade.  P/E contraction to 10 means -3% losses per annum, and a future PE of 20 implies around 8%.  (We also rebuilt the Arnott models on CAPE and inflation here.)

We couldn’t find much in the way of Shiller CAPE’s for foreign markets, so we have built a lot of these in house.  There is a lot of evidence showing sorting countries on value produces outperformance over time (section in the Tweedy Browne paper and an old post here:  sorting countries by dividend yield).

Source:  Global Financial Data



















Sentiment Update

For all the visual folks, source AAII:



Permanent Portfolio ETF to Launch

One of the trends in ETFland is launching funds that fall under the banner of what I call ‘investable benchmarks’.  Depending on your worldview and strategic asset allocation mindset, you may favor an endowment style portfolio (heavy in equties, global, with decent chunks in real assets).  Or perhaps you fall under the risk parity spell (examine asset classes on a vol adjusted basis or economic regime basis, basically ends up with more in bond and usually requires leverage).  Recent article on Dalio here.

In any case, after you come up with the initial allocation there is not a lot more to do with the portfolio than rebalance it every so often and upgrade funds when better or more representative ones come out.  I am generally in favor of these portfolios being available to investors, but in no way do I think they should cost any more than 0.5% for a buy and hold allocation.  And over time I expect them to converge to around 20 bps as the old high fee model dies a slow mutual death.  Lots of these funds have garnered a ton of assets this year, and I was interested to see a filing the other day for a Permanent Portfolio ETF.  If they are smart they will come in at a reasonable cost.  But in general one can replicate these funds for free (and is why we put sample portfolios in our book for the buy and hold investor.)

We’re putting together a piece on dynamic risk parity (permanent falls under this banner I think) and endowment portfolios.  Stay tuned!

8%? Try 4% (or 1.1%)

Long time readers know that we take issue with the arbitrary 8% return target for most real money funds.  We put out a paper in 2011 titled “What if 8% is Really 0%?”  With news that CalPERS returned 1.1% in 2011, I thought I would update a little chart that seemingly would give many investors pause.

Below is the rolling 7-year return of the average endowment from NACUBO  (data through 2010 as 2011 data comes out in February.  Also recall endowment year end is in June.)  Even though they have experienced years above 8% (1997-2000 all above), on a rolling basis they have YET to exceed 8%.  If you compare the returns to simple bond yields it seems obvious that benchmarking your return target to long term or corporate bonds would be more reasonable (but painful).  (This analysis also does not consider the exceptional outlier endowments such as Harvard/Yale.)

If you realize most real money funds are also heavily invested in equities, you can then even do a simple Shiller CAPE valuation model to predict equity returns (old post here on some of Hussman’s great work.)  We use a 60/40 allocation, and as recent as the summer of 2010 the model predicted meager returns of around 4.5% to the portfolio.

Better ideas than using an arbitrary 8%:

1.  Long Bond Yields

2.  Corporate Bond Yields

3.  Projected 60/40 returns (for those with equity like exposure, can tailor to their exact mix)

A few more good reads from the Barron’s crew here:  A High Cost of Low Interest Rates, and A Deep Money Pit

I predict

Twitter will implode this weekend when my Broncos take down the Pats!

Here is a gorgeous video of Teahupoo to take ease you into the weekend, HT:KP:

More Surfing Videos



7% Alpha

We published The Ivy Portfolio back in 2009, and honestly it probably should have been three separate books (investing like the endowments, global tactical approaches to investing, and picking stocks via the 13F tracking of hedge funds).  We went with the kitchen sink approach, and now the good news is that you can buy the $50 book for $9 on Kindle which is pretty cool.

I’ve got a good bit of totally new material coming out in the next few months so stay tuned (finally).

Anyways, we spent a chapter educating on 13F investing in Ivy, what works, what doesn’t work.  We then have done lots of follow up posts on 13F ideas, and we will update this post from last year with new stats:

The Value of Ira Sohn (Hedge Fund Stock Picks)

There are a lot of people debating the value of stock picking events like the recent charity Ira Sohn Conference.  Felix Salmon and David Gaffen debate the usefulness (Felix responds here)  and Joe Weisenthal chimes in here.

There is so much misinformation in the 13F space, and most comments are simply not based in a firm understanding of what works and what doesn’t, but rather guesses.   But that is what most financial commentary is (ie all of the commentary surrounding buy and hold and market timing, what drives stocks, often has the feel of debating religion or politics).  I like reading David, Joe, and Felix but if you want to know what works and what doesn’t in 13F tracking you should be listening to people that have spent many years getting their hands dirty with the data and truly understand what works (and what doesn’t) like Jay at MarketFolly or Maz at AlphaClone or John Heins at Value Investing Insight.

There is also reams of academic papers on the subject including this paper from my friend Wes Gray at Empirical Finance that demonstrates ability to follow managers and disclosures.

Some of the comments:

Gaffen:  ”Some of them (following hedge funds) work and some of them don’t…the more complicated you get and the more derivitives you get involved in the less you can follow…the ones that are slightly more straightforward you can follow.”  David is spot on here.

Felix:  ”Trying to chase hedge fund managers is a fools errand…my big problem in all of this is that you and I have no ability to pick stocks and if we have no ability to pick stocks then what on earth makes us think we have the ability to think we can pick hedge fund managers.”  Clearly I disagree.

I am a quant.  I used to pour through these filings by hand a number of years ago (take a look at the blog archives back in 2006 and 2007), but being a quant I could never get comfortable with following these managers until I tested them.  I had an inkling that it worked but I wasn’t sure.  Like Fama says, “if it is in the data”…

…so my intern and I went and backtested 10 funds (Buffett, Blue Ridge, Greenlight, etc) and what we found is that there is huge value in tracking the funds that have lower turnover and derive most of their value from their long stockpicking book.  Like Gaffan says, there are some things that work and some that don’t – SAC doesn’t make sense to follow (too active), Rentec doesn’t make sense to follow (derivatives), and if you want more information there is an entire chapter on 13F tracking in my book.  The benefits, the drawbacks, what works and what doesn’t.

But like Salmon mentions, 13F tracking rests on two questions:

-Can anyone beat the market?

-Can you pick a manager ahead of time that will beat the market in the future?

Most of the academic literature suggests no to both answers (on aggregate).  But does that mean someone cannot answer yes to both questions?  Of course not.

We can all backtest until the cows come home but all that matters is real time performance of course.

All data courtesy AlphaClone.

I included a list of 57 funds that I thought would be interesting funds to follow.  Out of that 57, 8 were never added to the database.  Excluding the  never added, the other funds beat the S&P 500 by an average amount of 7 percentage points per year. (Historical research shows that following Buffett since the 1970s would have resulted in >10% outperformance per year – and he has beaten by 8% per annum since ’00.  So much for all those detractors that say he isn’t a good stockpicker!)

Roughly 70% of the funds beat the S&P500 over the time period.  The average fund beat the S&P in 2009 and 2010 before losing about 5% in 2011.

Impressive real time results, and not to mention 13F tracking would have kept you out of Galleon.

So, at the end of the day would you rather listen to Seth Klarman or your local broker when picking stocks?

Top funds that did over 25% a year include:

Eagle, Pabrai, ValueAct, Newcastle, Abrams/Pamet, Baupost, Akre, Tiger, Icahn, Perry, Lone Pine, and Steel.

The worst funds were:

King Street, Tontine, Private, Glenview, Maverick, and Bridger

Here is a chart of all of the funds, and the black dotted line is the S&P 500.



Funds included in analysis:


Blue Ridge


Eagle Value Partners (Witmer)

Pabrai Mohnish

ValueAct Holdings

Newcastle Partners

Abrams Capital (Pamet)

Baupost Group

Akre Capital Management

Pershing Square Capital Management

Tiger Global Management

Icahn Capital LP

Perry Capital

Lone Pine Capital

Steel Partners

Fine Capital Partners

Relational Investors

SAB Capital Management

Jana Partners

Appaloosa Management


Chieftain Capital Management (BW)

Viking Global Investors

Pennant Capital Management

Atlantic Investment Management

Highfields Capital Management

Glenhill Advisors

Cobalt Capital Management

Second Curve Capital

SemperVic Partners (Gardner Russo)

Cannell Capital LLC

Eminence Capital

Trafelet Capital Management

T2 Partners Management

Third Point

Omega Advisors

Chesapeake Partners Management

Bridger Management

Maverick Capital

Glenview Capital Management

Private Capital Management

Tontine Associates

King Street Capital

Defiance Asset Management

Abingdon Capital Management

Alson Capital Partners

Scion Capital

Shamrock Activist Value


Barrington Partners


Lane Five Capital

Libra Advisors

Thames River

Wyser-Pratt Management

Yaupon Partners




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