Webinar and NYC Travel

Tune in tomorrow and come ask some questions! Free webinar with my friends at S&P Dow.


I’ll be in NYC twice in March to speak at QuantCon on March 14th and the MTA Conference on March 27th.  If you want to schedule a meeting let me know!



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. It is also available as a printable PDF on Gumroad.  To celebrate the launch of the new book, my last two ebooks (Global Value and Shareholder Yield) are free on Amazon for five days ending March 6th …


Let’s start with a history lesson.  Many people begin investing their money without a true understanding of what has happened in the past, and often bias their expectations toward their own personal experiences.  My mother always told me the way to invest was to buy some stocks and then just hold on to them.  But her experience, living in the United States and investing particularly in the 1980s and 1990s, was very different from her parent’s generation, which lived through the Great Depression.  Both of these experiences would be vastly different from those of the average Japanese, German, or Russian investor.

So what is possible and reasonable to expect from history?  We should begin with a discussion about the value of money.

A few years ago, my father and I were talking and he decided to demonstrate a real world example of inflation.  A couple weeks later, I received a letter with a check inside written by my great grandfather in the 1910s for $0.50.  He was a farmer who immigrated from Les Martigny-Baines, Voges France and ended up in Nebraska.  That $0.50 is equivalent to about $13 today and shows a very simple example of inflation.  As a side note, look at that penmanship!


FIGURE 1 – Real World Inflation


Source: Faber


A more familiar example is the oft-used phrase, “I remember when a Coca-Cola cost ten cents.” (Another fun example is “Superhero Inflation.”) Inflation is an emotional topic.  It usually goes hand-in-hand with a discussion of The Federal Reserve, and there are not many topics that incite more vitriol in certain economic and political precincts than “The Fed” and the U.S. dollar.

One of the most famous charts in all of investing literature is the one below that illustrates the U.S. dollar’s purchasing power since the creation of The Federal Reserve in 1913.  The description usually goes along the lines of this ZeroHedge post:

“This is the chart they don’t want you to see: the purchasing power of the dollar over the past 76 years has declined by 94%. And based on current monetary and fiscal policy, we have at least another 94% to go. The only question is whether this will be achieved in 76 months this time.”

The above statement is factually true – $1.00 in 1913 is only worth about three cents in current dollars due to the effects of inflation (which have averaged about 3.2% a year).  But that is all the chart tells you – the U.S. has had mild inflation this century (with fits of disinflation, deflation, and high inflation mixed in):


FIGURE 2 – U.S. Dollar Purchasing Power, 1913-2014


Source: Global Financial Data, Shiller


The chart is then used to justify any number of arguments and conclusions, usually laden with exclamation points!!!, bold text, and CAPITALIZATIONS.  Cries to end the Fed, buy gold, sell stocks, and build forts stocked with guns, food, and ammunition usually follow in a stream of rants and raves. These articles are written like this for a reason.  They elicit an emotional response (who doesn’t enjoy grumbling about the government?) and they certainly make for great headlines.

The problem that most miss is that investors have to do something with those dollars. Pretend you were an investor in 1913.  You could choose to put your dollars under a mattress, in which case your purchasing power would decline as indicated in the chart above.  You could also spend the money on consumption, such as vacations, entertainment, clothes, or food.  Or you could invest in Treasury bills, in which case the dollar was a perfectly fine store of value, and your $1 would be worth $1.33 today (for a real return of about 0.26% per year).

So you didn’t really make any money, but you were not losing any either.

Note that “real returns” refer to the returns an investor receives after inflation.  If an investment returned 10% (what we call nominal returns) but there was inflation of 2% that year, the real return is only 8%. Real returns are a very important concept as they make comparisons across timeframes more relevant.  A 10% return with 8% inflation (2% real) is very different than a 10% return with 2% inflation (8% real). It is helpful to think about real returns as “returns you can eat.”  That $1 Coke likely costs about the same as the $0.10 Coke, you are just paying with inflated dollars (and probably getting corn syrup instead of real sugar).

If you had decided to take on a little more risk, you could have invested in longer duration bonds, corporate bonds, gold, stocks, housing, or even wine and art—all of which would have been better stores of value than your mattress.

Figure 3 shows the real returns of stocks, bonds, and bills.  While $1 would be worth only three cents had you put your hard-earned cash under the mattress, it would be worth $1.33 had you invested in T-bills, worth $5.68 in 10-Year Treasury bonds, and worth a whopping $492 in U.S. stocks.


FIGURE 3 – Purchasing Power, 1913-2014


Source: Global Financial Data, Shiller


For those looking for a beautiful coffee table book on the topic of historical market returns, check out my all-time favorite investing book, Triumph of the Optimists: 101 Years of Global Investment Returns. (There are also free yearly updates of the book from Credit Suisse here.  All of the yearly updates are highly recommended.)  This fantastic book illustrates that many global asset classes in the twentieth century produced nice gains in wealth for individuals who bought and held those assets for generation-long holding periods.  It also shows how the assets went through regular and painful drawdowns like the Global Financial Crisis of 2008.

Unfortunately for investors, there are only two states for your portfolio – all-time highs and drawdowns.  Drawdowns for those unfamiliar are simply the peak to trough loss you are experiencing in an investment.  So if you bought an investment at 100 and it declines to 75, you are in a 25% drawdown.  If it then rises to 110, your drawdown is then 0 (all-time high).

For some long-term perspective, set forth below are some charts based on data from the book Triumph of the Optimists (available through Morningstar as the Dimson, Marsh, and Staunton module but requires a subscription).  They represent the best-, middle-, and worst-case scenarios for the main asset classes of sixteen countries from 1900-2014. They have since updated their database to include 23 countries with results in the Credit Suisse reference link above.  All return series are local real returns and displayed as a log graph (except the last one).   U.S. dollar based returns are near identical.

First, here are the best-, middle-, and worst-cases for returns on your cash.

Figure 4 shows that leaving cash under your mattress is a slow bleed for a portfolio. Germany is excluded after the first series as it dominates the worst-case scenarios (in this case, hyperinflation).   Inflation is a major drag on returns. When it gets out of control, it can completely wipe out your cash and bond savings. So you mattress stuffers – on average you would have lost about 4% a year by keeping your money at home.


FIGURE 4 – Cash Real Returns, 1900-2014

Best-Case: -2.2% per year

Middle: -3.9%

Worst-Case: -100%


Source: Morningstar, Elroy Dimson, Paul Marsh, Mike Staunton, Triumph of the Optimists, Princeton University Press, 2002, Credit Suisse Global Investment Returns Sourcebook 2015


Next up are real returns for short-term government bills. These instruments do all they can just to keep up with inflation.  You’re not usually going to make any money, as Figure 5 shows, but at least they don’t lose 4% a year like the mattress does. We also include the “World” which is the global market capitalization weighted portfolio which weights the portfolio based on size of each country’s stock market.


FIGURE 5 –Short-term Government Bills Real Returns, 1900-2014  

Best-Case: 2.1% per year

Middle: 0. 7%

Worst-Case: -3.5%
(Real Worst-Case, Germany -100%)

World:  0.9%


Source: Morningstar, Elroy Dimson, Paul Marsh, Mike Staunton, Triumph of the Optimists, Princeton University Press, 2002, Credit Suisse Global Investment Returns Sourcebook 2015


In Figure 6, adding a little duration risk doubles the historical returns of bills for our 10-year bonds, but that is still a pretty small return.  You’re not going to get rich with 1.7% real returns, and you still have to sit through a 50% drawdown, as we will show later.


FIGURE 6 –Long-term Government Bonds Real Returns, 1900-2014

Best-Case: 3.3% per year

Middle: 1.7%

Worst-Case: -1.4%
(Real Worst-Case, Germany -100%)

World: 1.9%


Source: Morningstar,  Elroy Dimson, Paul Marsh, Mike Staunton, Triumph of the Optimists, Princeton University Press, 2002, Credit Suisse Global Investment Returns Sourcebook 2015


And finally, we have the real returns for stocks.  Much better! Over 4% real returns per year is far superior to returns of the bond market.  While these are great returns, realize that it would still take over 15 years to double your money!


FIGURE 7 –Stocks Real Returns, 1900-2014

Best-Case: 7.4% per year

Middle: 4.8%

Worst-Case: 1.9%

(Real Worst-Case, China, Russia -100%)

World: 5.2%


Source: Morningstar,  Elroy Dimson, Paul Marsh, Mike Staunton, Triumph of the Optimists, Princeton University Press, 2002, Credit Suisse Global Investment Returns Sourcebook 2015


And in Figure 7a, the same chart is presented with a non-log y-axis.  We do this to demonstrate to readers the importance of viewing charts that have percentage changes over long time frames with a log axis.  Otherwise the chart is almost unreadable and definitely not useful.  Perhaps importantly, you can now distinguish between unscrupulous money managers advertising their services with the below style of chart which can be misleading, as the gains look much more dramatic.


FIGURE 7a–Stocks Real Returns, 1900-2014, Non-log Axis



Source: Morningstar,  Elroy Dimson, Paul Marsh, Mike Staunton, Triumph of the Optimists, Princeton University Press, 2002, Credit Suisse Global Investment Returns Sourcebook 2015


Let’s look at the entire series across all countries to visualize some of the best and worst-case scenarios.  It looks like a simple conservative rule of thumb may be to expect stocks to return around 4% to 5%, bonds 1% to 2%, and bills basically zero.  Note that the United States had one of the best performing equity and bond markets for the 20th Century.


FIGURE 8–Asset Class Real Returns, 1900-2014


Source: Morningstar,  Elroy Dimson, Paul Marsh, Mike Staunton, Triumph of the Optimists, Princeton University Press 2002, Credit Suisse Global Investment Returns Sourcebook 2015


One would think that the math above would make the decision easy – just put all your money in stocks!  While stocks outperformed the returns of bonds and bills, stocks are not without their own risks.  At least two countries had their equity markets wiped out when the government shut down the capital markets.  No wonder people are so wary of investing in Russia and China even today.

Another risk is that stocks can go for a really long time underperforming other asset classes, such as bonds.  It is easy to look at the data and assume you can wait out any stock market underperformance—at least until it happens to you.

In his 2011 “The Biggest Urban Legend in Finance,” Rob Arnott discusses a 30-year underperformance of stocks vs. bonds:

“A 30-year stock market excess return of approximately zero is a huge disappointment to the legions of “stocks at any price” long-term investors. But it’s not the first extended drought. From 1803 to 1857, U.S. equities struggled; the stock investor would have received a third of the ending wealth of the bond investor. Stocks managed to break even only in 1871. Most observers would be shocked to learn there was ever a 68-year stretch of stock market underperformance. After a 72-year bull market from 1857 through 1929, another dry spell ensued. From 1929 through 1949, stocks failed to match bonds, the only long-term shortfall in the Ibbotson time sample. Perhaps it was the extraordinary period of history—The Great Depression and World War II—and the spectacular aftermath from 1950–1999, that lulled recent investors into a false sense of security regarding long-term equity performance.”

A 68-year long stock underperformance is almost the same as a human’s current expected lifespan in the U.S.  Bonds outperformed stocks over an entire lifetime (really, more than a lifetime, since life expectancy in the 1800s was around 40 years in the U.S.).  When talking about stocks for the long run, then, it must mean something other than a human lifetime.  For a tortoise, deep sea tubeworm, or sequoia tree perhaps?  To be fair, the longer you go back in history the more suspect the data is, so we confine our analysis below to the post 1900 period.

Other countries experienced large drawdowns, and even in the United States, an investor lost about 80% from the peak in the 1929-1930s stock bear market.  The unfortunate mathematics of a 75% decline requires an investor to realize a 300% gain just to get back to even – the equivalent of compounding at 4.8% for 30 years! Even a smaller 50% drawdown would require 15 years at that rate of return to get back to even.

Large drawdowns are why many people choose to invest in bonds, but bonds are risky too.  While stocks typically suffer from sharper price declines, bonds often have their value eroded by inflation.  The U.S. and the U.K. have both seen real bond drawdowns of over 60%. While that sounds painful, in many other countries (Japan, Germany, Italy, and France), it was worse than 80%.  Some countries that faced hyperinflation resulted in a total loss, and Business Insider has a slideshow that examines a few of the worst examples in the past 100 years.

Figure 9 shows that both stocks and bonds have had multiple large drawdowns over the years.  The first chart uses monthly data (we don’t have monthly for the U.K.), and monthly data only increases the drawdown figure.


FIGURE 9 –Asset Class Real Drawdowns, 1900-2014


Source: Morningstar, Bloomberg, Elroy Dimson, Paul Marsh, Mike Staunton, Triumph of the Optimists, Princeton University Press 2002


The same principle occurs in the U.K., but bond investors had to wait even longer to get back to even – almost 50 years!  Below is Figure 10 looking at yearly real returns and drawdowns.


FIGURE 10 –Asset Class Real Drawdowns, 1900-2014


Source: Morningstar, Bloomberg, Elroy Dimson, Paul Marsh, Mike Staunton, Triumph of the Optimists, Princeton University Press 2002


This is one of the problems with investing in just one security, country, or asset class.  Normal market returns are extreme.  Individuals invested in various assets at specific periods—U.S. stocks in the late 1920s and early 1930s, German asset classes in the 1910s and 1940s, Russian stocks in 1917, Chinese stocks in 1949, U.S. real estate in the mid-1950s, Japanese stocks in the 1990s, emerging markets and commodities in the late 1990s, and nearly everything in 2008— would reason that holding these assets was a decidedly unwise course of action. Most individuals do not have a sufficiently long time to recover from large drawdowns from any one risky asset class.

So what is an investor to do?  The next step lies in what is called the only free lunch in investing – diversification.


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. It is also available as a printable PDF on Gumroad.  To celebrate the launch of the new book, my last two ebooks (Global Value and Shareholder Yield) are free on Amazon for five days ending March 6th …


To help put the reader in the right mindset for this book, let’s run a little experiment.  We want to make sure you’re paying attention, so turn off the TV, close your email, and grab a cup of coffee.

Below is a test.  It is simple, but requires your utmost concentration.  Here is a video for you to watch.  So click on this link and then come back to this book after watching – it’s only about 20 seconds long so we’ll wait.

Selective Attention Test Video

Did you watch?

Okay, do you have your number? If you do your job correctly, you learn that the ball is passed 15 times.  Did you get the number correct?  Congratulations!

But, of course, that’s not the whole story.

In this particular experiment, which many of you have probably seen already, while you were fastidiously counting basketball passes, what you might have missed was someone dressed in a gorilla costume walk into the frame, pound his chest, and walk off.  Don’t feel bad – most participants in the experiment don’t notice the gorilla at all.  While they kept their eye trained on what they assumed to be the most important task—the passing of the basketball—they simply failed to notice anything else.

Go back and watch again and be amazed that you would have missed this very obvious intruder. What the research actually finds is that when we narrow our focus to one specific task, we tend to overlook other, significant events.

What does this have to do with investing and this book? Conventional wisdom tells us that, as investors, we have to keep our eyes trained on our asset allocation.   However, how much time do you spend thinking about the following questions:

“Is it the right time to be in stocks, or should I sell?”

“Should I add gold to my portfolio?  If so, how much?”

“Aren’t bonds in a bubble?”

“How much should I put in foreign stocks?”

“Are central banks manipulating the market?”

With all of our focus on assets – and how much and when to allocate them – are we missing the gorilla in the room?

Our book begins by reviewing the historical performance record of popular assets like stocks, bonds, and cash.  We look at the impact inflation has on our money.  We then start to examine how diversification through combining assets, in this case a simple stock and bond mix, works to mitigate the extreme drawdowns of risky asset classes.

But we go beyond a limited stock/bond portfolio to consider a more global allocation that also takes into account real assets. We track 13 assets and their returns since 1973, with particular attention to a number of well-known portfolios, like Ray Dalio’s All Weather portfolio, the Endowment portfolio, Warren Buffett’s suggestion, and others. And what we find is that, with a few notable exceptions, many of the allocations have similar exposures.

And yet, while we are all busy paying close attention to our portfolio’s particular allocation of assets, the greatest impact on our portfolios may be something we fail to notice altogether. In this case, the so-called “gorilla” are the fees that we often fail to consider. In one shocking example, we find that the best performing strategy underperforms the worst strategy when we tack on advisory fees. Ultimately, smart investing requires that we not only monitor asset allocation, but of equal weight, we focus on the advisory fees associated with the investment strategy.

Global Asset Allocation – New Book!

So my new book is finally done!  Sorry that took longer than expected but sometimes life just intervenes.  Publication date is officially next Monday, March 2nd but you can go here and pre-order a copy of the eBook on Amazon here.  Starting Monday, to celebrate, I will also make my last two books on Amazon free to download for 5 days…


Global Asset Allocation with border


As with the last two books, my goal was to keep it short enough to read in one sitting, evidence-based with a basic summary that is practical and easily implementable.  Like my other books, this is not meant to be a moneymaker, rather, I just want to get it in as many people’s hands as possible that want to read it.  And since many often ask about the ins-and-outs of self-publishing, below is a long post with lots of links and comments on the whole process. (You can find my case study on publishing my first eBook here to see what has changed.)

Pick up a copy, or, if you promise to write a review I’ll even send you a free one on Amazon – just sign up here and expect to receive one in a few days after request.



1.  WRITING– Like my last three books, I go a bit manic when writing and editing.  Months of writer’s block/dread are followed by an intense period where it all comes out over the course of a month or so and then I promise to never write again.  Book #5 is actually also 90% done, though I had a little help on that one with some background research and look for it in 3-6 months time.  But after both of these, I’m done!

2.  EDITING –   Going self-published means you no longer have a professional team behind you to edit and design the interior and exterior.  I used Kibin to do a first edit for spelling, grammar ($200 or so).  Then, I offered a sneak peak to Twitter followers that were willing to give comments and suggestions.  The funny thing here is that no matter how many people edit your book, someone ALWAYS finds an error, and surprisingly, they are rarely the same.  I owe a huge debt to the people that helped edit, you know who you are, and THANK YOU.

3.  INTERIOR DESIGN – My last two books I did this myself with Vook, which seems to be discontinued for personal use but still open for outsourcing.  A number of other sites now offer outsourced interior design including Nook Press (new to me) for $250 – $500.  I would have tried Nook had I known ahead of time, but had also contacted the folks at BookinaBox about their contractors.  They passed along a few people and resources such as Command Z Content and BubbleCow for editing and The Book Designers for interior design.  I ended up using a fellow named Ian Cladius for the design and he was great.  Budget a month lead time to get all the edits done (which is why the book was delayed a bit).

4.  EXTERIOR DESIGN – Once again I used 99Designs for the design contest.  I think the general designs were pretty good, and usually this type of contest works better if you have an idea of what you want or at least give some guidance.  As usual, I picked the 5 best and let the readers decide – and overwhelmingly, they picked the above cover which has grown on me.  Eventually there will be a paperback once we finish the interior design there as well.

6.  AVAILABILITY – Like the last two books I’m tossing this one up on Amazon for $2.99.  Eventually there will be a paperback to follow that will be priced at break-even.  Below is a picture from Amazon on maximizing revenues for an eBook.  Since I don’t care about the variable but rather the # of people reading it, we went with a lower price.



The quality of the paperbacks from Createspace are still not as good as the traditional publishers but I expect that to change sooner than later.  Amazon is oddly not that user friendly to authors – for example you can’t even find the total number of books sold without downloading monthly Excel files and compiling all the data yourself. Nor can you gift the ebook to anyone – you actually send them a gift card which seems absurd since they can go buy a pair of socks instead of the ebook.  A new site called AppAnnie seems like a good work around that I’m trying out.

So, knowing there are a lot of people that would still like to read and or print the book out, I’m listing it on Gumroad as a PDF that is priced slightly more than Amazon to not run afoul of any Amazon rules.  I also tossed some sample chapters on Bitorrent Bundles but I don’t really think that is my core audience, but who knows.

I am going to publish most of the content over the next few weeks here as well.  I didn’t go down the rabbit hole of active and tactical too much, but will follow up with a bonus blog post or two at the end of this…

7.  MARKETING – You can find lots of ideas from James AltucherRyan Holliday, and OkDork via case studies they have done about marketing their books.  They are experts at getting the word out and I have adopted some of their ideas in this go-round.  However, being super self-promotional isn’t really my style so many I don’t include.  My goal isn’t to sell books for revenue, but rather to have as many people read them as possible.

We still use Dukas PR firm out of NYC, and they are outstanding.

I’ll update this over the next few weeks as the process is completed, and as usual, let me know what you think!

Below is the Table of Contents of the upcoming blog posts of the book…


CHAPTER 1 – A History of Stocks, Bonds, and Bills

CHAPTER 2 – The Benchmark Portfolio: 60/40

CHAPTER 3 – Asset Class Building Blocks

CHAPTER 4 – The Risk Parity and All Seasons Portfolios

CHAPTER 5 – The Permanent Portfolio

CHAPTER 6 – The Global Market Portfolio

CHAPTER 7 – The Rob Arnott Portfolio

CHAPTER 8 – The Marc Faber Portfolio

CHAPTER 9 – The Endowment Portfolio: Swensen, El-Erian, and Ivy

CHAPTER 10 – The Warren Buffett Portfolio

CHAPTER 11 – Comparison of the Strategies

CHAPTER 12 – Implementation (ETFs, Fees, Taxes, Advisors)

CHAPTER 13 – Summary


APPENDIX B – The Tobias Portfolio

APPENDIX C – The Talmud Portfolio

APPENDIX D – The 7Twelve Portfolio

APPENDIX E – The William Bernstein Portfolio

APPENDIX F – The Larry Swedroe Portfolio


#1 Read of the Year

I sent this to The Idea Farm last week – this is always my #1 read of the year,  the CSFB Global Investment Returns Yearbook!  This is the annual update to my favorite investment book,Triumph of the Optimists.  Included this year is a near 100 year backtest on industry rotation based on value and momentum.


First person to replicate their returns with French Fama data below gets a free sub to The Idea Farm.


industries market cap weight, also equal weight

industries sorted by momentum quintile

industries sorted by valuation quintile

industries sorted by valuation/momentum combo quintile

returns, volatility, drawdown stats and equity curves

How to Hedge Your Business

Note: I’m holding a cover design contest for my new book out next week, feel free to enter!

This is normally something I would send to The Idea Farm, but since we started the conversation here I wanted to follow up.  One of the best parts of writing is getting feedback.  I posted an article the other week on hedging the biggest risk in the BUSINESS of asset management.

Sure enough, a thoughtful reader emailed in a fun paper from SSgA titled, “A Comparison of Tail Risk Protection Strategies in the U.S. Market“.  Lots of the strategies are somewhat costly, but you know what isn’t?  Two of my favorites – managed futures and a simple long/short trend strategy.  A chart and a quote:

Screen Shot 2015-02-03 at 8.35.16 AM

“As a reminder, our tactical equity strategy uses a simple trading rule and is long the S&P 500 index when above its 10 month moving average and short the index when below. Remarkably, of the 24 months with greater than 5% loss in the S&P 500 between March 1990 and March 2011, 17 of them (or 71%) occurred with the S&P 500 below its 10-month moving average.”


Everything Old is New Again

Reading old investment books is somewhat of a hobby of mine (I know probably need a better hobby).  Glancing up on my bookshelf there are titles most have never heard of such as Once in Golconda, The Zurich Axioms, and Supermoney.  I was flipping through another book new to me that I found when thinking about titles for my new book (coming in a week or so, promise!)  It was called Diversify and was published in 1989.

Anyways, I was surprised to see the author propose the “All-Weather Portfolio” that consisted of 30% stocks, 15% foreign stocks, 15% US bonds, 20% international bonds, 5% gold, and 15% T-bills.  That portfolio obviously has the same name as Ray Dalio’s fund which launched five years later in 1994.  I’m not suggesting Ray copied this book obviously, as it is a very common phrase, but I just thought it would be fun to compare Dalio’s recently suggested portfolio from Tony Robbin’s new book to this portfolio proposed over 25 years ago!

Below are the stats.  I named the Diversify portfolio ALLW2.  As you can see, they are near clones of each other.  That is a good thing in my mind, as a solid diversified portfolio should be very “average” in a sense.  But remember, if you’re only doing 5% real a year, fees are your greatest enemy.  But what do you spend most of your time on?  The asset allocation.




IMG_2263 (1)


Why Don’t Asset Management Companies Hedge Their Biggest Risk?

I had a great time this week catching up with old and new friends at the annual ETF conference in Florida.  I think I’ve been to just about every one of the eight or so conferences they have had, and it has been interesting to watch the growth from a small venue to about 2,000 people.  We are certainly in boom times for the ETF industry – I think about four firms have been purchased in the past year and there was even a giant 30 foot ski machine in the middle of the booth room – another sign of a seven year bull market as well. (PWC has a new report detailing they expect the ETF space to hit $5T by 2020.)

I was thinking about our booming industry while dipping my toes into the Atlantic, and it reminded me of an old question (and idea) from a blog post way back in 2009 called “A Quant Approach to Private Equity“.  Ironically, you can also read my thoughts on the roboadvisory space six years ago when Wealthfront was still a trading game on Facebook called kaChing.

I posed this question in a blog post, and will quote from it below:

“I always wondered why big investors of private equity (like the endowments and pension funds) don’t hedge their portfolio at all?  If they assume that they are top quartile, which they have to assume becuase otherwise they should be buying SPY and QQQQ, then they are assuming they’re generating alpha returns.  So why not hedge out some of that risk through a static, or better, dynamic hedge?  Hedging against long bear markets is a great idea because not only are their holdings going down in value, but their exits disappear.  Anyways, ping me if anyone does this I’d like to chat with them.  Is there such a thing as a market neutral private equity investor?

We talk a lot about private equity in the book, and a lot about why using the ETFs (ETNs) in the US doesn’t make any sense.  Anyways, below is the 10 month SMA on the not-recommended PE ETF.  Looks like you would have sold somewhere in the 20’s and bought back somewhere around 8.  Not too shabby.”

So while my old post focused on the end investor for private equity (say CALPERs or the endowment funds), this one is going to focus on the actual operating companies themselves.

So follow my thinking for a minute.  Airlines hedge their biggest risk (the cost of fuel), as do food companies (commodity prices, etc).  A recent book titled The Secret Club That Runs the World: Inside the Fraternity of Commodity Tradershighlighted some of these companies and hedging programs.

So, what is the biggest risk to an asset management firm (or PE firm too), especially one that is highly exposed to long only holdings in stocks?  The biggest risk is stock losses, particularly a long bear market.  Assume a nice fat 50% bear market in stocks – that results in the asset management company losing 50% of revenues due to fees declining, but also potentially people selling at the bottom etc.

So why don’t large asset managers hedge not their portfolios, but their business risk?  This could be done simply by a) buying puts or other long-term LEAP style out of the money options on a consistent basis or b) doing the same on a trendfollowing basis?  This would be an insurance style cost in good times, but would help to smooth revenue and ensure the firm survives in a challenging environment the same way hedging fuel ensures Virgin or Southwest could stay in business if oil did goto 150 (or, err, 60).

This situation is particularly timely and personal for me as my firm, while small and growing fast, is mostly exposed to long assets currently (which for a tactical/macro guy like me makes me squirm!)  This seems like a much more anti-fragile way to run your company…

Anyone ever heard of a Legg Mason, Fido, or other such firms hedging their company-wide revenue stream in the financial markets?

The Most (Not) Hated Bull Market

I look forward to reading Leuthold’s Green Book every month and the most recent one was great.

I asked permission to share the following study as I thought it was revealing.  They looked at sentiment levels as published by Investor’s Intelligence – specifically they averaged all of the values for each year to get a yearly reading. Below is a chart of the values.


Screen Shot 2015-01-10 at 4.50.00 PM

But does sentiment help with stock market returns?  Below are the 10 highest and lowest sentiment years and the returns of the stock market the following year.  Not surprisingly high sentiment results in low returns of 0.1% per year.  Low sentiment results in whopping 17.4% returns per year.  What was average sentiment in 2014?   2014 was the second highest value ever at 76.3%


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The Agony and the Ecstasy of Being a Trendfollower

This one chart shows almost everything – the whipsaws & false breakouts, but also the monster gains.  The emotions are just as difficult for trendfollowers as they are for the buy and hold crowd, they are just at different times and for different reasons…



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