National Geographic Picture Contest

Some great pics from the NatGeo photo contest (via Kottke)…my favorites (click to enlarge):

 

 

       

Risk Parity ETF to Launch

Interesting news that Global X is launching a risk parity fund.  (Filing here via Index Universe.)  Risk parity is certainly one of the big buzzwords/phrases/concepts in the investment community this year.  (Not surprising given the monster year in bonds.)  My speech in NYC was on some interesting risk parity extensions, and hopefully I can write it up before year end.

If Global X is smart they will list this with a really low fee (<50 bps) in which case it could be a great public alternative to all of the big private shops doing it (and a few mutual funds as well).  I haven’t spent much time teasing out all of the portfolio construction methodology yet so will reserve judgement.

As an amusing aside, I actually used to own the domain riskparity.com before selling it earlier in the year.  Of course I wish I knew I was selling it to a multi billion $ hedge fund when negotiating!

And a short history of risk parity from Mr. Wiki:

 

History

“The seeds for the risk parity approach were sown when economist and Nobel Prize winner, Harry Markowitz introduced the concept of the efficient frontier into modern portfolio theory in 1952. Then in 1958, Nobel laureate James “Bill” Tobin concluded that the efficient frontier model could be improved by adding risk-free investments and he advocated leveraging a diversified portfolio to improve its risk/return ratio. The theoretical analysis of combining leverage and minimizing risk amongst multiple assets in a portfolio was also examined by Jack Treynor in 1961, William Sharpe in 1964, John Lintner in 1965 and Jan Mossin in 1966. However, the concept was not put into practice due to the difficulties of implementing leverage in the portfolio of a large institution.

According to Joe Flaherty, senior vice president at MFS Investment Management, “the idea of risk parity goes back to the 1990s”. In 1996, Bridgewater Associates launched a risk parity fund called the All Weather asset allocation strategy which attempted to “achieve consistent performance” and equalize risk by correlating diversification (such as global inflation-linked bonds and global fixed income assets) with exposure to different economic drivers, such as inflation and economic growth.  The initial impetus for the All Weather fund was to establish a family trust for the founder of Bridgewater Associates.  Although Bridgewater Associates was the first to bring a risk parity product to market, they did not coin the term. Instead the term, risk parity was first used by Edward Qian, of PanAgora Asset Management, when he authored a white paper in 2005. The term was later co-opted by the asset management industry and evolved into a portfolio investment category.  In time, other firms such as AQR Capital, Aquila Capital (2004), Northwater, Wellington, Invesco, First Quadrant, Putnam Investments, ATP (2006), PanAgora Asset Management (2006), AllianceBernstein (2010) and the Clifton Group (2011) began establishing risk parity funds.”

 

Some risk parity mutual funds (that tend to be expensive):

 

Managers AMG FQ Global Essentials Fund (MMAVX)

AQR Risk Parity (AQRNX)

Diversified Risk Parity (DRPAX)

Putnam Dynamic Risk Allocation (PDREX)

Invesco Balanced-Risk Allocation Fund (ABRZX)

 

Huge listing of risk parity related literature below (most are PDFs).  If I missed any great ones send me a link and I’ll add: 

 

ai CIO website has a treasure trove of risk parity articles.  Sample from their great magazine here.

Diversification and Risk Management - First Quadrant

At Par with Risk Parity? - Kunz, Policemen’s Fund of Chicago

Balancing Betas - FQ

Counter-Point to Risk Parity Critiques - FQ

I Want to Break Free - GMO

RISK PARITY: IN THE SPOTLIGHT AFTER 50 YEARS - NEPC

Leverage Aversion and Risk Parity - Asness

The Biggest Mistake In Investing - Bridgewater Associates

The Hidden Risks of Risk Parity Portfolios - Inker GMO

Engineering Targeted Returns and Risks - Bridgewater Associates

Global Asset Allocation & Risk Parity - Richmond Retirement

Risk Parity White Paper - Meketa Investment Group

On the Properties of Equally-Weighted Risk Contributions Portfolios - Maillard et al 

Demystifying Equity Risk-Based Strategies: A Simple Alpha Plus Beta Description  - Carvalho et al

Chasing Your Own Tail (Risk) - AQR

Risk Parity Portfolios™: The Next Generation - PanAgora

PanAgora risk parity & Risk Parity Portfolios

The Risk Parity Approach to Asset Allocation - Callan

Now Long Greek Bonds

Although it looks like it is the 1898 issue, with only a,  pffft,  2 1/2% coupon. (Great parting gift for speakers from the SQA conference in NYC.  When I was giving talks on currencies the last few years I used to give out hyperinflated bills.)

Conference was great, but since they didn’t record it I’ll try and transform a few of the ideas into the next couple issues of CQR.  Goal will be to get both out by year end…

A couple of the speakers had some solid presentations and here are some of their published pieces out lately:

Wai Lee, “Risk on Risk Off” (PDF here).

Lars Nielson, Chasing Your Own Tail (Risk), (PDF here).

No other published materials for the other speakers, but if you are a member of the SQA I think you can access PPTs via website.

Conference Tomorrow

I’m chatting in NYC about risk parity (topic du jour) with a little trendfollowing, dividends, and black swans thrown in.  Hopefully they record the speech and I’ll post, but if not, I’ll see if I can do a webinar or such in the next month or two…

The Quant Stock Screening Bible

I just picked up a new copy of What Works on Wall Street, Fourth Edition: The Classic Guide to the Best-Performing Investment Strategies of All Time. If you are not familiar, O’Shaughnessy takes a look at all the factors that determine stock performance.

From size, to P/E, to momentum, to EBITDA/enterprise value, to multifactor models, to accruals, this is a wonderful book first published in 1996. The best part of this edition is that James includes all new CRSP data since 1929 were possible (Compustat really only begins in the 1960s).

One of my favorites! (I wonder if readers can guess what my favorite factor combo is…)

Some other good screening books are:

Quantitative Strategies for Achieving Alpha by Richard Tortoriello.

Greenblatt’s books.

Haugen’s The Inefficient Stock Market .

Chinicari’s Quant Equity Portfolio Management.

Stock Selection – A Test of Relative Stock Values Reported Over 17-1/2 Years - Charles Kirkpatrick.

The Handbook of Equity Market Anomalies: Translating Market Inefficiencies into Effective Investment Strategies  - Zacks.

Measuring the Performance of the Ivy Portfolio

I get lots of emails asking me to update my various models, and we will likely do so in the new year.  Doug Short, one of my favorite and most prolific blogs, has a nice piece here that demonstrates the real time (hypothetical) performance of the timing model we published in 2006.  He uses the great site ETFReplay and conducts the test with publicly traded ETFs.  ETFReplay has some really nice tools to test quant strategies with ETFs (now if they just added index data back to the 1970s….I know you guys are reading this ahem)…

The numbers are in the ballpark of what I would expect.  Great chart below, click to enlarge:

Intelligence for Chief Investment Officers

Wow, what a beautiful (and free) digital magazine.  Had not seen it yet:

AI CIO

Added to the blogroll under Institutional…

 

 

 

 

UVa Investment Conference

I will be in NYC but if any readers are attending let me know –  would love to hear a summary of the event.  Solid speaker including  here.

 

 

Interest Rates vs. Violent Crime

I was reading New Ideas from Dead Economists: An Introduction to Modern Economic Thought when I was in Berlin, and there were a few particularly interesting passages.  One commented on a proposed link between interest rates and violent crime.  Here is an except from his blog (and strangely enough he also worked at Tiger at one point):

“I argue that low interest rates fight crime waves.  Why?  Because low interest rates tell us that tomorrow is worth waiting for.   If the world were ending next year (where are those Rapture preachers?), even SNL’s Church Lady might be tempted to misbehave.  Think of those New Orleans looters swiping Cadillacs after Hurricane Katrina – they cared less about the consequences of tomorrow.  They let the good times roll right out of the broken plate glass of the showroom.

Here’s the logic:  As an economist, the best measure of time I can find is the prevailing interest rate.  When interest rates are high, it tells us that tomorrow counts for less.  It is not worth investing today.  From a business point of view, very few financed projects will pay off if interest rates are high (the “hurdle rate”).  However, when interest rates are low, it tells us that we should invest today because any return will be prized more in the future.  During the German hyperinflation of the early 1920s, prices and interest rates jumped higher each hour.  The price of a cup of coffee could go up as the waitress was pouring.  Teachers got paid at 10 am and brought their banknotes to the playground so their relatives could pick them up and then buy things immediately.

Likewise, the hyperinflation of Zimbabwe in recent years has acted like a neutron bomb on the economy.   Coincidentally, in 1919 when Yeats wrote “things fall apart; the centre cannot hold,” interest rates were jumping sharply, the British pound slid in value, and Europe was preparing for a terrible bout of post-War War I inflation.

The “Buchholz hypothesis” says that the crime rate is importantly a function of interest rates.  This solves the puzzle of the Great Depression.  Most commentators on crime say that a lousy economy leads to crime.  But during the Great Depression, crime rates fell, as they did in 2008-10.  Why?  Because interest rates fell, too.  People did not give up on tomorrow, even as they suffered economic distress.”

Why Use Book Value to Sort Stocks?

Did you know French and Fama hold a Q&A on their blog (though they call it a forum) ?  Text from a recent entry here:

Data from Ken French’s website shows that sorting stocks on E/P or CF/P data produces a bigger spread than BtM over the last 55 years. Wouldn’t it make sense to use these other factors in addition to BtM to distinguish value from growth stocks?

EFF/KRF: A stock’s price is just the present value of its expected future dividends, with the expected dividends discounted with the expected stock return (roughly speaking). A higher expected return implies a lower price. We always emphasize that different price ratios are just different ways to scale a stock’s price with a fundamental, to extract the information in the cross-section of stock prices about expected returns. One fundamental (book value, earnings, or cashflow) is pretty much as good as another for this job, and the average return spreads produced by different ratios are similar to and, in statistical terms, indistinguishable from one another. We like BtM because the book value in the numerator is more stable over time than earnings or cashflow, which is important for keeping turnover down in a value portfolio.

Nevertheless, there are problems in all accounting variables and book value is no exception, so supplementing BtM with other ratios can in principal improve the information about expected returns. We periodically test this proposition, so far without much success.

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