This is a really interesting semi-annual report from Hussman. In it he shows the returns of his main fund, both hedged and unhedged. The take-aways are that a) his stock picking has added a lot of value over the broad indexes and b) the hedging has added value, not on an absolute level, but a lot on a risk adjusted level by reducing volatility and drawdowns over the past decade. Click on chart to enlarge.
We have presented a lot of hedging ideas over time, the main one being a momentum, or trend, based system (A Quantitative Approach To Tactical Asset Allocation). Most of the results of a moving average system have similar properties in that the they do not increase absolute return over buy and hold, but rather reduce volatility and drawdown. (One can use other methods such as momentum/relative strength and or leverage to increase absolute returns like Relative Strength Strategies for Investing.)
Hussman’s fund is interesting, as it essentially increases equity exposure as valuations come down, and decreases exposure or hedges as valuations increase. Reminds me a lot of GMO. So in some ways it is a bit of a dynamic short volatility fund based on valuation (I know not quite the right description but works for purposes of this post). Here is an older post we did on hedging using CAPE, and found that a simple method of investing when the CAPE was less than average generates equity returns with less risk and drawdown.
Anyways, I think it is instructive to demonstrate how pairing a fund like this with a long volatility strategy would have worked since inception. So, I’m going to include the GTAA strategy from my paper here, only using the hypothetical 5 asset classes and the 10-month simple moving average. I’m also going to lop off a very conservative 2.0% for fund expenses, trading friction, etc.
(I don’t think I have to say this for long time readers, but please realize this is a hypothetical exercise that is meant to be instructive, and this is not how I manage funds, etc. In none of our funds do we use these parameters, etc. My family is also a long time HSGFX owner, none in client accounts. I have 100% of my net worth in our funds.)
Ok, back to the simulation. Below is an equity curve of the strategies from 12/00 (Hussman inception) to end of Jan. What is interesting to note is that both strategies have delivered nice absolute and risk adjusted returns over stocks and a hypothetical 60/40 allocation. HSGFX and GTAA strategies both end up in roughly the same place, but note they have zero correlation to each other. (Also notice the 60/40 correlation to stocks, an often used argument for risk parity strategies.)
Both funds have chopped sideways in the past two years where their correlation has been -.6%. There are times where the strategies would be highly correlated (an uptrending low valuation market). I still think there is a huge need for a research piece or newsletter focused on public alternative funds. If no one gets on the ball we’re gonna have to start one here…
I am wrapping up my trip in Sydney (wonderful country, people, and beaches), and mentioned on Twitter yesterday that I thought the AUS $ was overpriced due to the prices of cocktails in the country. I was specifically referring to the Green Bison, which sounds a bit more manly than Green Destiny, but in any case they were made with Zubrowka which is a wonderful vodka. The last time I experienced prices that felt this out of whack was back when I was in London. Even the Panda Express stir fry is about $25 at the airport. Reminded me of the old Jim Rogers quote… “While I have never patronized a prostitute,” Jim Rogers writes, “I know that one can learn more about a country from speaking to the madam of a brothel or a black marketeer than from meeting a foreign minister.”
In a vaugely similar note, I really enjoyed this article on the carry trade. It takes a look at the carry trade but ranks currencies on real interest rates rather than just interest rates. I always hate it when journalists write an article about factor or approach X, then go on to state “no one know why X works.” I guarantee you there are people that understand why X works and are profiting handsomely (they just aren’t telling you about it). Currencies appreciating due to excess fear due to high inflation (and the subsequent risk premium built in to compensate the investor) makes sense to me. I’ll re-run the study on both G10 and emerging countries when I get back home from the airplane. Fingers crossed that there are bad movies, babies crying, and no internet so I’ll have 14 hours straight to write…
“There’s nothing to writing. All you do is sit down at a typewriter and open a vein.” -Walter Wellesley “Red” Smith
I look forward to meeting a few readers at the conference in Sydney tomorrow, and I’m chatting a bit about active ETFs. The active ETF space is still relatively small (about $5billion in the US), and is dominated mostly by currency and bond funds (about 50 funds). But if McKinsey is right, that is going to change and change quick (The Second Act Begins for ETFs – this is really a great PDF read from last summer):
“Consider that if active ETFs were to follow the same growth pattern that passive ETF products followed, they would constitute approximately 10 percent of all actively managed U.S. long-term mutual fund assets within a decade and exceed $1 trillion in AUM”
The new Gross fund out next week should do a bit to stir up the industry, and I think in general people are still slow to realize the tax benefits of the ETF structure, and possibly more importantly, the benefits of not following an index (and avoiding front running costs, up to 1.8% for small caps see Chen (2005) and Petajusto (2010).) which makes the active ETF structure perfect for active managers. (Also see ‘Indexing’s Dirty Little Secret.)
Chart below from my talk, Y-axis is millions of $.
Great read from Howard Marks in this months Chairman Memo.
“Thus timing – and in particular the selection of the beginning point and end point for studying a performance record – plays an incredibly important role in perceptions of success or failure”
We have been managing clients assets for five years (!) at the end of the month, and we publish our track record for all to see. In general it has accomplished our objectives, but that is also for a full investment cycle. We also have a fund that started in Spring 2009, and while it has much much better absolute performance, the relative performance isn’t as good. It has been really interesting to see the reactions of many investors, professional as well, to essentially the same portfolio, but with different start dates…
I’m in Sydney and Brisbane this week, lots of fun meetings set up including one in the ocean on a board at Bondi Beach!
aiCIO is quickly becoming one of my favorite reads.
Here is new article on a white paper examining the Norway pension funds vs. the endowment model popularized by Yale by a few of my favorite authors.
Abstract: The Norwegian Government Pension Fund Global was recently ranked the largest fund on the planet. It is also highly rated for its professional, low-cost, transparent, and socially responsible approach to asset management. Investment professionals increasingly refer to Norway as a model for managing financial assets. We present and evaluate the strategies followed by the Fund, review long-term performance, and describe how it responded to the financial crisis. We conclude with some lessons that investors can draw from Norway’s approach to asset management, contrasting the Norway Model with the Yale Model.
It is often very difficult to determine how geopolitical events will play out in markets. However, there are some cases where a structural change will have a very logical influence on a market and a substantial impact on investment strategies and outcomes.
Today there is news that in his recent budget proposal Obama outlines taxing dividends for top bracket earners as ordinary income up to 40% from the current 15%. How will this impact the investment landscape?
One structural change in the stock market is that companies pay out less in cash dividends than they have in the past. As seen in Figure 1, while companies have historically paid out, on average, 60% of their earnings as dividends, this figure has been declining for the past seventy years.
FIGURE 1 – Dividend Payout Ratio per Decade, 1880-2010.
Source: Shiller, Faber
Likewise, as shown in Figure 2, the number of companies paying dividends has been decreasing, as well. At one time, nearly all companies in the S&P 500 paid a dividend, but that figure has declined to roughly 70% today. (The shaded areas represent regimes where dividends were not tax disadvantaged to income.)
FIGURE 2 – Percentage of Companies Paying Dividends, S&P 500.
Source: Standard and Poor’s, Political Calculations blog
The combination of these two forces, less companies paying dividends and companies paying out less of their earnings as dividends, has resulted in the dividend yield on stocks declining to all-time lows levels in the past decade.
When examining any fundamental shift in markets, we must analyze why the change occurred. Why are fewer companies paying out cash dividends, and why has the amount of earnings paid out as cash dividends decreased?
One of the reasons that companies pay out less in dividends is due to the SEC instituting rule 10b-18 in 1982 – which provided safe harbor for firms conducting repurchases from stock manipulation charges. A noteworthy paper on trends in corporate payout policy is Dividends, Share Repurchases, and the Substitution Hypothesis (2002) by Grullon and Michaely. Once the government made it easier for companies to buy back their own stock, Figure 3, below, details how stock buybacks went from nearly nothing to either equaling or surpassing capital that was paid out as dividends in the late 1990s.
FIGURE 3 – Amount of Dividends and Buybacks, All Stocks.
Why might companies choose to buyback stock rather than payout cash dividends? While tax rates fluctuate with the political seasons, it has often been the case that dividends taxed as income have had inferior tax treatment to long-term capital gains that are taxed at lower rates. For over half of the past forty years, dividends have been taxed at higher rates than long-term capital gains, with the exception of 1988-1997, and 2003-present. While this disadvantage was slightly improved by the recent Bush tax cuts, and while there are some foreign countries that do not have inferior tax treatment for dividends (see table at the end of the post for dividend and tax rates by year), the number of companies paying dividends has, nonetheless, declined from nearly 100% to around 66% for the largest stocks in the U.S. The percentage of companies remained relatively stable during the shaded areas in Figure 2, representing the 1988-1997 and the 2003-present periods where dividends were not tax disadvantaged.
Investors shouldn’t care whether their returns come from dividends or capital gains (the so-called Modigliani-Miller theorem). This approach assumes a tax-neutral investor when, in reality, most investors are highly sensitive to tax treatment. A recent study finds plenty of empirical support for this argument (here is also a summary from Cowen at Marginal Revolution, Hat Tip:AF):
We compile a comprehensive international dividend and capital gains tax data set to study tax explanations of corporate payouts for a panel of 6,416 firms from 25 countries for 1990-2008. We find robust evidence that the tax penalty on dividends versus capital gains is statistically significant and negatively related to firms’ propensity to pay dividends, initiate such payments, and the amount of dividends paid. Our analysis further reveals that an increase in the dividend tax penalty raises firms’ likelihood to repurchase shares, initiate such repurchases, and the amount of shares repurchased. This is strong confirming evidence that when listed industrial firms globally design their payout policies, they take into careful consideration the relative tax implications of their payout choices.
How does this impact your investment decisions? Are dividend stocks going to become more or less relevant? Stay tuned, lots more to come in a future post soon…
Source: “How Tax Efficient are Equity Styles?” by Israel and Moskowitz.
Totally unrelated to markets, but lots of interesting lifestyle companies popping up. I am inherently skeptical about most of these (Groupon and sites like it are my worst nightmare – ie buying more things I don’t want). However, there are a lot of sites that simply reduce the costs or improve what you are already doing. A few of my favorites below – I use all of these.
Tripit: Tracks travel, updates flights, and tracks reward balances.
Taxi Magic: I don’t have cell service at my house, so this app lets you summon or schedule a cab and pay with credit card info stored on your phone. Uber is similar for a private driver (but not in LA).
FoundersCard: I was highly skeptical of this card, as I am for anything that charges a fee ($295) and especially for something that has “exclusive” invites that happens to be open to everyone. However, it has a few benefits that right off the bat pay for the card and more. I upgraded/booked an enormous hotel room in NYC for a week that probably saved me a few thousand dollars alone. Other benefits:
10% off AT&T bill, 33% off UPS shipping
Send someone $20 every month through Giftly (for free somehow. Reminds me of the old X Card Paypal bought)
$40 credit on Gilt
TaskRabbit 15% off and $20 credit (used this last wknd to unclog my sink)
All sorts of benefits on American, Virgin, Quantas, Hertz etc.
Refferral Code: FCFABER11 (I get reward points if you use my code)
Savored and BlackBoard Eats: These two are similar and focused on restaurants. BBEats gives you a code to give the waiter (a pain and has the downside of feeling like you are using a coupon), usually good for 25-33% off food at a restaurant, and they generally have about 2 or so offers per month that expire in a few month’s time. Savored is a much better offering where they give you 30% off all food AND drink if you book your reservation through the site (read: no coupons or codes to give the waiter, it’s automatic). That is a big deal if you like wine, etc. The catch is that it is $10 to make a reservation, but if you are a FoundersCard member they are all free.
Jetsetter and Hotel Tonight (phone app only): Jetsetter curates hotels and then offers discounts. Hotel Tonight gives you a choice of a hand full of hotels each nite highly discounted. In both cases they solve some problems for me – narrowing the list of possible hotels, and then giving a nice discount. FoundersCard members get a free $50 credit and 15% off Hotel Tonight bookings.
Any other cool sites or apps I’m missing?
Updated with a few readers sent in:
GrubHub: Online food ordering.
Seamless: Online group food ordering.
AutoSlash: Books you with cheapest car and automatically rebooks if fares go down.