CHAPTER 8 – THE MARC FABER PORTFOLIO

This excerpt is from the book Global Asset Allocation now available on Amazon as an eBook.   If you promise to write a review, go here and I’ll send you a free copy.

—-

Marc Faber is a Swiss economist and fund manager, living in Asia, who writes the Gloom, Boom, and Doom market newsletter.  And before you ask, no we’re not directly related – although my father’s side is from Germany and France and so there is a chance we have some shared blood somewhere.) While he often contributes long and short investment ideas to the Barron’s Roundtable, he has stated numerous times his rough asset allocation is 25% each in gold, stocks, bonds and cash, and real estate.  Marc probably holds some bonds and real estate in foreign markets, but the simple portfolio will do for a general discussion.  While he doesn’t explicitly say that he would split his stocks into U.S. and foreign, we assume that to be the case.

This was a surprise to me, but Marc’s simple allocation is one of the most consistent we have reviewed.  The portfolio is one of the few that had positive real returns in each decade. Figure 35 displays the Marc Faber Portfolio.

 

FIGURE 35 – Marc Faber Portfolio

35

Source: CNBC

 

 

FIGURE 36 – Asset Class Returns, 1973-2013

 

 

35a

35b

Source: Global Financial Data

 


 

CHAPTER 7 – THE ROB ARNOTT PORTFOLIO

This excerpt is from the book Global Asset Allocation now available on Amazon as an eBook.   If you promise to write a review, go here and I’ll send you a free copy.

—-

Rob Arnott is the founder and chairman of Research Affiliates, a research firm that has over $170 billion in assets managed using its strategies.  He published over 100 articles in financial journals, as well as having served as the editor of the Financial Analysts Journal.  His book The Fundamental Index: A Better Way to Invest focuses on smart beta strategies.

Smart beta is a phrase that refers to strategies that move away from the broad market cap portfolio. (So in U.S. stocks, think the S&P 500 versus a portfolio sorted on dividends or perhaps equally weighted.)  The market cap portfolio is the market, and the returns of the market portfolio are the returns the population of investors receive before fees, transaction costs, etc.  However, market cap weighting is problematic.

Market cap weighted indexes have only one variable – size – which is largely determined by price.  (While not the topic of this book, market cap indexes often overweight expensive markets and bubbles – you can find more information in our book Global Value.)  Many smart beta strategies weight their holdings by factors that have long shown outperformance, including value, momentum, quality, carry, and volatility.  Here is a fun interview with William Bernstein on portfolio tilts.  We are big proponents of smart beta and factor tilts applied to a portfolio.

Below is one sample allocation from an article Mr. Arnott authored in 2008.  Another solid performer!  To be fair, there is a zero chance that he would have used market cap weighted allocations in his portfolio, but we’re trying to compare apples to apples for now.  We examine one smart beta portfolio in the appendix.

 

FIGURE 33 – Arnott Portfolio

33

Source: Liquid Alternatives: More than Hedge Funds, 2008

 

FIGURE 34 – Asset Class Returns, 1973-2013

 arn

a

Source: Global Financial Data


 

10 Bearish Charts, 1 Bullish Chart

Below are 10 charts or stats to mull over this fine weekend while I am on the plane to NYC after a long delay…Come say hello if you are in town or in Charlottesville!

Any other great charts I’m missing?  (You all already know my portfolio and plan for 2015 but old post if you have not read.)

Click to enlarge any.

1.  Buyback Authorizations

April 2015 highest amount ever

buybacks

 

2.  Value of M&A Deals

May highest ever: $242B

 

3.  Valuation of M&A Deals

The average EV/EBITDA multiple for global M&A stands at 12.4x in 2015 YTD, the highest full year level on record.

 

deal

via Economist

 

4.  % IPOS unprofitable

Near or at highest ever.

CGWPv6SUQAAc994

via Howard Lindzon

 

5.  Shiller CAPE

Highest except 2000, 2007, and 1929.

cape

via Shiller

 

6.  Median P/S Ratio

The Price-to-Sales ratio of the median stock in the S&P 500 is at an all time high at 2.1 since 1964. Median 0.89 .  Ditto for median price to book, earnings, and cash flow.

ps

via Ned Davis

 

7.  Allocation of Investors to Equities

With exception of 2000, near prior peaks.

Screen Shot 2015-05-31 at 4.10.28 PM

 

8.  P/E Ratio of Cheapest S&P 500 Sector

Highest ever.

cheap

Via Leuthold

 

9.  NYSE Margin Debt

All time high.

NYSE-margin-debt-SPX-since-1995

Via dShort

 

10. Yearlong Sentiment

Second highest ever.

Screen-Shot-2015-01-10-at-4.50.00-PM

Screen-Shot-2015-01-10-at-4.50.13-PM

Screen-Shot-2015-01-10-at-4.50.20-PM

via Leuthold

 

…And the 1 bullish chart……

The trend.

Is up.

And for now, the 1 bullish chart is more powerful than all the bearish charts…

trend

via StockCharts

 

Very Reasonable Advice

From a Robert Shiller interview with Goldman, via ZH:

Allison Nathan: What should investors do when so many assets look expensive?

Robert Shiller: I am not an investment advisor. But I would say that the main implication for most people is that they should save more because their portfolio probably won’t do as well as they imagined. And if they’re saving for some distant goal like retirement, they might be disappointed. People have learned about the power of compound interest. But what they don’t understand is that if interest rates are zero, you don’t get any compound interest. I think that there is complacency among investors today. People have seen how well the stock market has done over the last century. But the market might not do so well the next time. So you have to consider whether you are saving enough.

And as a general principle, I think people should diversify across assets and geographies because there is no way to predict what any one asset will do with any accuracy. I’ve been talking down US stocks because of their high valuation, but I would invest something into US stocks; I would just put a heavier contribution in stocks around the world, where CAPE ratios look lower. I keep coming back to the theme that there are lots of places outside of the US to invest. And I would also own bonds, real estate and commodities. Commodities are overlooked by many investors but they are an important part of an investing portfolio.

The reality is that people are not very good at diversifying. This has been documented in studies. They tend to be distracted, and focus too much on one sector or one thing that they have heard. They also tend to focus on their own country. There’s no reason why one should invest only in one’s own country. Quite the contrary, some people make the extreme statement you should short your own country and invest only elsewhere. I wouldn’t go to that extreme, but it is a plausible argument.

Allison Nathan: But is the strong US growth story relative to elsewhere enough to warrant buying US stocks?

Robert Shiller: The US looks pretty good and in some ways brilliant. The exciting news about technology seems to come largely from the US. For example, fracking, which is predominantly a US technology, transformed the energy market, and just within the last five years or so. And many electronics and IT advances are also coming from the US. So there is reason to believe in this country.

But I think that we also have to understand that we tend to be biased. One sees and appreciates one’s own country; that’s human nature that one has to correct for. Amazing things can happen elsewhere as well. You see that in much of the developing world; over the last half-century, there’s been remarkable economic progress and growth. And we’re going to see more and more advancement in those countries. So maybe the high US CAPE ratio is partly justified. But I think we have to nourish a healthy skepticism as investors and not get swayed too much by the idea that we’re living in a new era here.

CHAPTER 6 – THE GLOBAL MARKET PORTFOLIO

This excerpt is from the book Global Asset Allocation now available on Amazon as an eBook.   If you promise to write a review, go here and I’ll send you a free copy.

—-

“We have a passion for keeping things simple.” – Charlie Munger, Vice-Chairman Berkshire Hathaway

Why not just invest along the weightings of the global market cap weighted portfolio?  The main difficulty is that it is hard to determine exactly what the exact weightings are, but a number of researchers have come pretty close with a ballpark estimate.

A paper titled “Strategic Asset Allocation: The Global Multi-Asset Market Portfolio 1959-2011” breaks out the broad world market portfolio.

Credit Suisse also looks at the global portfolio, and Figure 30 breaks out their allocations.

 

FIGURE 30 – The Global Market Portfolio, (“GMP”)

aa

Source: Credit Suisse, Global Wealth Databook 2014

 

We simplify this to the below allocation (Figure 31), labeled “GMP” for Global Market Portfolio, to see how this portfolio performed.  Note:  This does not reflect the exact global market portfolio over time since it is estimated from today’s weightings – but it should be a close approximation.  It is interesting to note that the true global market portfolio would never rebalance – talk about a lazy portfolio.

 

FIGURE 31 – The Global Market Portfolio, (“GMP”)

31

 


 

FIGURE 32- Asset Class Returns 1973-2013

 

32

 

32a

Source: Global Financial Data

We don’t include commodities in this portfolio since it is difficult to estimate market composition, but we believe they provide a vital portfolio diversification element.  So what if you altered the above global market portfolio to include commodities?  In this case, we’re ball-parking a reasonable number, and we add a 5% allocation each to commodities and gold, and reduce the other allocations proportionally. We will call this portfolio the Global Asset Allocation or “GAA” portfolio.  The results were not hugely different, though risk-adjusted returns did improve, as did the consistency.


 

FIGURE 32b- Asset Class Returns 1973-2013

 32b

32bb

 

Source: Global Financial Data

CHAPTER 5 – THE PERMANENT PORTFOLIO

This excerpt is from the book Global Asset Allocation now available on Amazon as an eBook.   If you promise to write a review, go here and I’ll send you a free copy.

—-

Harry Browne was an author of over 12 books, a one-time Presidential candidate, and a financial advisor.  The basic portfolio that he designed in the 1980s was balanced across four simple assets, and you can see Harry explain the theory here:

For the money you need to take care of you for the rest of your life, set up a simple, balanced, diversified portfolio. I call this a “Permanent Portfolio” because once you set it up, you never need to rearrange the investment mix— even if your outlook for the future changes. The portfolio should assure that your wealth will survive any event — including an event that would be devastating to any individual element within the portfolio… It isn’t difficult or complicated to have such a portfolio this safe. You can achieve a great deal of diversification with a surprisingly simple portfolio.”

Although the portfolio underperformed stocks, it was incredibly consistent across all market environments with low volatility and drawdowns.  This presents a classic dilemma for investors, particularly professional advisors.  What is the trade-off for being different?  Despite the incredibly consistent performance there are many years this portfolio would have underperformed U.S. stocks or a 60/40 allocation.  Can you survive those periods even if you believe this portfolio to be superior?  See Figure 28.

FIGURE 28 – Permanent Portfolio

28

Source:  Browne

 

FIGURE 29– Asset Class Returns, 1973-2013

 29b

29

 

Source: Global Financial Data

Next to Marc Faber’s allocation that we profile later in the book, this allocation has the highest weighting to gold.  Gold is an emotional topic for investors, and usually they fall on one side or another with a very strong opinion for or against.   We think you should learn to become asset class agnostic and appreciate each asset class for its unique characteristics.  Gold had the highest real returns of any asset class in the inflationary 1970s but also the worst performance from 1982 – 2013.  However, adding gold (and to a lesser extent other real assets like commodities and TIPS) could have helped protect the portfolio during a rising inflation environment.  Gold also performs well in an environment of negative real interest rates – that is when inflation is higher than current bond yields.

The next portfolio we look at just aims to be average, and it turns out that isn’t a bad thing.

CHAPTER 4 – THE RISK PARITY AND ALL SEASONS PORTFOLIOS

This excerpt is from the book Global Asset Allocation now available on Amazon as an eBook.   If you promise to write a review, go here and I’ll send you a free copy.

—-

“I know that there are good and bad environments for all asset classes.  And I know that in one’s lifetime, there will be a ruinous environment for one of those asset classes.  That’s been true throughout history.” – Ray Dalio, founder Bridgewater Associates

“Today we can structure a portfolio that will do well in 2022, even though we can’t possibly know what the world will look like in 2022.” – Bob Prince, co-CIO Bridgewater Associates

Risk parity is a term that focuses on building a portfolio based on allocating weights based on “risk” rather than dollar weights in the portfolio.  While the general theory of risk parity isn’t something particularly new, the term was only coined within the past decade and became in vogue in the past few years. Risk is defined in different ways but volatility is a simple example.  As an illustration, the 60/40 stocks and bonds portfolio doesn’t have 60% of total overall risk weighted to stocks,  rather,  more like 90% since stock volatility dominates the portfolio’s overall total volatility.

Risk parity has its roots in the modern portfolio theory of Harry Markowitz. While introduced in the 1950s, it eventually earned him a Nobel Prize.  The basic theory suggested the concept of an efficient frontier – the allocation that offers the highest return for any given level of risk, and vice versa.  When combined with the work of Tobin, Treynor, Sharpe, and others the theory demonstrates that a portfolio could be leveraged or deleveraged to target desired risk and return parameters. Many commodity trading advisors (CTAs) have also been using risk- or volatility-level position-sizing methods since at least the 1980s.

Ray Dalio’s Bridgewater, one of the largest hedge funds in the world based on assets under management, was likely the first to launch a true risk parity portfolio in 1996 called All Weather.  Many firms have since launched risk parity products.  While the underlying construction methods are different, the broad theory is generally the same.

We are not going to focus too much on risk parity since Bridgewater and others have published extensively on the topic, and you will find several links at the end of this chapter.  Three primer papers to read are “The All Weather Story,” “The Biggest Mistake in Investing,” and “Engineering Targeted Returns and Risks”— all of which can be found on the Bridgewater website.

Bridgewater describes the theory in their white paper “The All Weather Story”:

“All Weather grew out of Bridgewater’s effort to make sense of the world, to hold the portfolio today that will do reasonably well 20 years from now even if no one can predict what form of growth and inflation will prevail. When investing over the long run, all you can have confidence in is that (1) holding assets should provide a return above cash, and (2) asset volatility will be largely driven by how economic conditions unfold relative to current expectations (as well as how these expectations change). That’s it. Anything else (asset class returns, correlations, or even precise volatilities) is an attempt to predict the future. In essence, All Weather can be sketched out on a napkin. It is as simple as holding four different portfolios each with the same risk, each of which does well in a particular environment: when (1) inflation rises, (2) inflation falls, (3) growth rises, and (4) growth falls relative to expectations.”

In another piece, “Engineering Targeted Returns and Risks”, Dalio refers to the simple building blocks he calls market betas (such as U.S. stocks or bonds): 

“Betas are limited in number (that is, not many viable asset classes exist), they are typically relatively correlated with each other, and their excess returns are relatively low compared to their excess risks, with Sharpe ratios typically ranging from 0.2 to 0.3. However, betas are reliable – we can expect they will outperform cash over long time horizons.”

Investors need not view any single asset class in its prepackaged form, meaning, leveraging any single asset class, like bonds, can result in higher returns along with volatility similar to stocks. Many asset classes come with embedded leverage already, and adjusting to a risk level by leveraging or deleveraging assets is neither good nor evil – it just is. (A simple example is that many companies carry debt, so one could view stocks as leveraged already.) More from The All Weather Story”:

“Low-risk/low-return assets can be converted into high-risk/high-return assets. Translation: when viewed in terms of return per unit of risk, all assets are more or less the same. Investing in bonds, when risk-adjusted to stock-like risk, didn’t require an investor to sacrifice return in the service of diversification. This made sense. Investors should basically be compensated in proportion to the risk they take on: the more risk, the higher the reward.”

Combining assets with similar volatility into a portfolio results in a total allocation with more in low-volatility assets (like bonds) and less to high-volatility assets (like stocks).

Many other firms now offer risk parity strategies, and you can track a risk parity index from Salient Partners.  There are a handful of risk parity mutual funds from firms such as AQR, Putnam, and Invesco, although most are very expensive.  A risk parity ETF was filed by Global X but never launched.  The theory is well accepted and adopted by a large cadre of the investment community, but the key question is – “has this strategy simply ridden the wave of a secular trend downward in interest rates?”  Only time will tell.

Below we examine two variations of risk parity.  The first is a risk parity portfolio we proposed back in 2012 while giving a speech in New York City that reflects a broad risk parity style of investing (Figure 25).

 

FIGURE 25 – Risk Parity Portfolio

25

Source: Faber PPT, 2012

Why try to divine the actual risk parity allocation when we can just go straight to the source and let Mr. Dalio construct it for us?  The second allocation is the “All Seasons” portfolio Dalio himself suggested in the recent Tony Robbins book Master the Money Game (Figure 26).

 

FIGURE 26 – All Seasons Portfolio

26

 

Source: Master the Money Game, 2014

So how did these two portfolios perform?  Almost identically, which isn’t surprising due to the similar nature of the allocation.

 

FIGURE 27 – Asset Class Returns, 1973-2013

27b

27

 

 

Source: Global Financial Data

 

In general, the theory behind risk parity makes a lot of sense with one caveat – the biggest challenge to a risk parity portfolio now is that we are potentially near the end of a 30-year bull market in bonds.  The returns of the actual All Weather fund are better than the allocations above since Bridgewater uses leverage (which is essentially borrowing money to invest more thus magnifying both gains and losses).  You can find a blog post comparing the returns of All Weather to a leveraged Global Asset Allocation portfolio in my article “Cloning the Largest Hedge Fund in the World.”

 

More background reading:

Diversification and Risk Management, Balancing Betas, Counter-Point to Risk Parity Critiques, – First Quadrant

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

“I Want to Break Free, The Hidden Risks of Risk Parity Portfolio’s – GMO

Risk Parity – In the Spotlight after 50 Years” – NEPC

Leverage Aversion and Risk Parity”, “Chasing Your Own Tail (Risk)” – AQR

“The Biggest Mistake in Investing”,” Engineering Targeted Returns and Risks” – Bridgewater

Risk Parity White Paper” – Meketa

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.

Risk Parity Portfolios™: The Next Generation”, “PanAgora risk parity” – PanAgora

The Risk Parity Approach to Asset Allocation” – Callan

Risk Parity for the Masses” – Steiner

Risk Parity in a Rising Rates Regime” – Salient

April Tweets

Performance of Ira Sohn Presenters

I’ve been to a few Sohn conferences over the years, and while a lot of fun & for a good cause, my crazy schedule has led to my pumping the brakes a bit on traveling.  I’ve written about hedge funds and their stock picks more than I care to admit on this blog and in my books.  Below are a few summaries we’ve included from The Idea Farm (data source: AlphaClone) on how tracking today’s presenters through their public stock picks would have performed since 2000.  Not bad!

Click to enlarge

 

GREENLIGHT

Screen Shot 2015-05-04 at 9.07.36 AM

JANA

Screen Shot 2015-05-04 at 9.13.18 AM

 

GLENVIEW

Screen Shot 2015-05-04 at 9.14.34 AM

LONE PINE

Screen Shot 2015-05-04 at 9.15.13 AM

APPALOOSA

Screen Shot 2015-05-04 at 9.15.55 AM

Schwab vs. WealthFront vs. Betterment

I attended a fun evening dinner with my friends from FirstTrust this week.  They had a guest speaker who was a political consultant – usually this isn’t my favorite topic – but I joined to have a few glasses of wine then sneak out.  Fast forward a few hours later and I was fascinated with the speaker, who was able to weave policy, investing, and economics into a sort of mash-up of House of Cards and George Soros.  At one point I was asking about the historical tax rates and Republican versus Democrat hair pulling over the subject.  It is interesting to me that taxes as a % of GDP have ranged between 14 and 20% of GDP since 1950.  But politicians are not making bold proposals for 50% or 10% of GDP, but rather very very minor alterations.  The speaker referenced how Obamacare and Keystone pipelines were likewise very minor components of total spending and supply – but essentially it gives politicians something to fight about.  How else will you distinguish yourself from your opponent when you are so similar?

This reminds me of the state of the roboadvisors.  Even though I believe asset allocation ETFs are superior to these separate accounts, the development of the roboadvisors has been a big positive for investors (mainly due to fee compression for the managed account space).   While most of their innovations have been around for awhile, the ability to wrap them in a beautiful offering that people will use is a great benefit to investors.

I wrote a big about this last month in the piece “What a Great Time to be an Investor!“.  I was a little surprised that some of the companies were getting into a catfight over some of the specifics of their offerings, when in my mind they were on the same side of the good fight.  What I failed to realize, was that in a world of very, very similar business models, they need to create the appearance of big differences – otherwise how will they be able to distinguish themselves in a world of cutthroat competition?

A nice article was published today from Liz Moyer at the WSJ looking at the very different allocation proposed by the various advisors when she went through the questionnaire.  While the allocations look very different (one has 9% in cash, another zero,  one has 5% in gold, others zero…you get the drift) how do they perform?

Does it even matter?

Below are the returns and equity curves for the allocations historically back to 1972. (Similar older post here.)  As you can see, it is a rounding error what allocation you choose!  I mean, a total CAGR difference of 0.22%!  I do think that someone eventually will offer tactical roboadvisors instead of everyone just doing MPT, which could seriously stand out from the competition.  Also, what’s up with none of the robos tracking their performance through GIPS?  In a world of expensive US stocks, when is someone going to include managed futures or liquid alts?

If you want to read some more on the subject, I’m happy to send you a free copy of my new book Global Asset Allocation.  Just sign up here and I’ll send you one on Amazon – you just have to promise to write a review when finished!

Click to enlarge below charts

 

returns

 

sch

 

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