I am excited about my new job with ERS. If this works as expected, it could be a great long term thing. I am disappointed that Long Capital didn't make it.
Bitter sweet.
Moving on.
New chapter in life and career.
Friday, September 4, 2015
Monday, August 3, 2015
HTH conference call
Generalized comments from the Hilltop Holdings 2Q conference call with relevance to the broader economy:
Oil & gas service firms are toast.
Houston is slowing. Austin is hot.
Refi mortgage companies are toast.
Oil & gas service firms are toast.
Houston is slowing. Austin is hot.
Refi mortgage companies are toast.
Tuesday, July 14, 2015
M&A - They're Going To Keep Dancing Until After The Music Stops
M&A activity is hot, hot, hot. Don't expect it to cool off before any correction. They are going to keep dancing right through the decline. Pipelines are full and you can't stop things once they get put in motion.
Many mistakes and bad deals will be done before and after the top.
They just can't help themselves.
When you're paid to dance, what do you think is going to happen. They're going to dance. And they going to keep dancing even when the music stops.
That is just the way the game is played.
The investment bankers are the last guys to call the top. Their job is to feast at the trough as long as they can. 'tis the nature of the beast.
Many mistakes and bad deals will be done before and after the top.
They just can't help themselves.
When you're paid to dance, what do you think is going to happen. They're going to dance. And they going to keep dancing even when the music stops.
That is just the way the game is played.
The investment bankers are the last guys to call the top. Their job is to feast at the trough as long as they can. 'tis the nature of the beast.
Making The Case For Active Management
The key to making the case for active management is to acknowledge at the outset that you are likely to underperform (potentially quite substantially) the markets over the long term. The reason for this is you are likely to sell either too early or too late into a market correction and are likely to either buy too early or too late after a recovery. Timing entries and exits to and from the markets is incredibly imprecise and highly inefficient from a long term investment management perspective.
That having been said, what you are advocating with active management is that you are going to try and reduce your downside by actively taking money off the table when you think the odds are in your favor. The basis for this activity is managing clients emotional wellbeing. The cost of this exercise is reduced upside because you know you are unlikely to time exits and entries perfectly.
You are offering clients the peace of mind of knowing and believing that they have someone out there trying to actively protect their assets. They are willing to forgo some upside because they are happy knowing/believing that the downside is somewhat capped.
A problem occurs when the manager fails to set a stop loss or floor and follows the market down. Usually because of their own behavioral foibles.
I don't think it is unreasonable advocating active management to clients who want to believe they have some semblance of downside protection and realize that it comes at the cost of upside potential.
The problem is clients want it both ways. They want downside protection and unlimited upside potential.
Other issues related to active management are overactive management, ie. chopping and changing market position repeatedly in response to news, and operating within a probability based framework.
Active management is a not unattractive framework for wealthy UHNW investors. The reason is they should want to earn a reasonable return on their wealth in order to preserve its purchasing power and derive a risk premium but they should also want to make sure they don't expose themselves to substantial capital destruction which can happen when markets collapse. Wealthy investors should be more focused on preserving their wealth as compared to growing their wealth. Whether they are or not depends upon the individual and their risk profile.
The irony is that wealthy investors often take more risk than they should because they are 'greedy' for returns. They think because they have been successful the markets somehow owe them greater returns. This is a dangerous trap that many fail to realize until it is too late. The irony is that they seek out active management not to protect their downside but to enhance their upside. And for the most part, they are likely to be sorely disappointed.
That having been said, what you are advocating with active management is that you are going to try and reduce your downside by actively taking money off the table when you think the odds are in your favor. The basis for this activity is managing clients emotional wellbeing. The cost of this exercise is reduced upside because you know you are unlikely to time exits and entries perfectly.
You are offering clients the peace of mind of knowing and believing that they have someone out there trying to actively protect their assets. They are willing to forgo some upside because they are happy knowing/believing that the downside is somewhat capped.
A problem occurs when the manager fails to set a stop loss or floor and follows the market down. Usually because of their own behavioral foibles.
I don't think it is unreasonable advocating active management to clients who want to believe they have some semblance of downside protection and realize that it comes at the cost of upside potential.
The problem is clients want it both ways. They want downside protection and unlimited upside potential.
Other issues related to active management are overactive management, ie. chopping and changing market position repeatedly in response to news, and operating within a probability based framework.
Active management is a not unattractive framework for wealthy UHNW investors. The reason is they should want to earn a reasonable return on their wealth in order to preserve its purchasing power and derive a risk premium but they should also want to make sure they don't expose themselves to substantial capital destruction which can happen when markets collapse. Wealthy investors should be more focused on preserving their wealth as compared to growing their wealth. Whether they are or not depends upon the individual and their risk profile.
The irony is that wealthy investors often take more risk than they should because they are 'greedy' for returns. They think because they have been successful the markets somehow owe them greater returns. This is a dangerous trap that many fail to realize until it is too late. The irony is that they seek out active management not to protect their downside but to enhance their upside. And for the most part, they are likely to be sorely disappointed.
Saturday, July 11, 2015
Model Dictates
The results of my modeling generally dictate my attitude toward investing in a company. This makes sense because presumably your best guesses about the future of that company go into your models.
The problem is that in general when I model a growth stock, I generally model a contracting multiple and when I model a value stock I generally model a stable to expanding multiple.
It doesn't take a rocket scientist to work out that usual outcome there wrt recommendations.
The problem is that in general when I model a growth stock, I generally model a contracting multiple and when I model a value stock I generally model a stable to expanding multiple.
It doesn't take a rocket scientist to work out that usual outcome there wrt recommendations.
The Systemic Mistakes Of Bias and How It Infuses A Process (Disposition Bias)
As a value oriented analyst I find that 'disposition bias' infusing my whole process.
Whether it is using a higher discount rate than appropriate, or discounting growth and margins more than is likely.
I have found myself over the years moving from a 12% discount rate (or expected rate of return) to a 10% discount rate to recently using an 8% discount rate.
I have found myself moving from a normalized PE of 18x down to 15x and contemplating moving it up to 18x. I use the normalized PE to base relative PE's off for each stock.
As a value investor with the implicit cautious nature of that disposition, I tend to use growth rates and margins less than what is embedded by the current consensus.
I am sure the reverse goes for a growth oriented analyst. They are likely to use lower discount rates and higher growth rates and margins than what the current consensus has embedded into the price.
What does this all mean? It means (1) You need to know the bias of your analyst, and (2) You've got to compare your assumptions with the consensus.
Note: In a world where the current WACC or discount rate is probably somewhere around 5%, growth is king. If you use a normalized discount rate of 8%-10%, then current stock prices are not going to look so bueno. But if the game is played using a 5% discount rate, rightly or wrongly, shouldn't you get with the system and play the game the way it is currently being played? Ans. No. Because when the discount rate normalizes, then stock prices will be re-rated to a normalized discount rate.
Whether it is using a higher discount rate than appropriate, or discounting growth and margins more than is likely.
I have found myself over the years moving from a 12% discount rate (or expected rate of return) to a 10% discount rate to recently using an 8% discount rate.
I have found myself moving from a normalized PE of 18x down to 15x and contemplating moving it up to 18x. I use the normalized PE to base relative PE's off for each stock.
As a value investor with the implicit cautious nature of that disposition, I tend to use growth rates and margins less than what is embedded by the current consensus.
I am sure the reverse goes for a growth oriented analyst. They are likely to use lower discount rates and higher growth rates and margins than what the current consensus has embedded into the price.
What does this all mean? It means (1) You need to know the bias of your analyst, and (2) You've got to compare your assumptions with the consensus.
Note: In a world where the current WACC or discount rate is probably somewhere around 5%, growth is king. If you use a normalized discount rate of 8%-10%, then current stock prices are not going to look so bueno. But if the game is played using a 5% discount rate, rightly or wrongly, shouldn't you get with the system and play the game the way it is currently being played? Ans. No. Because when the discount rate normalizes, then stock prices will be re-rated to a normalized discount rate.
Friday, July 10, 2015
Investment Basics - Know Your Returns - The Return That Counts = After tax, after inflation, after costs
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Know Your Returns
Real Return: After tax, after inflation, after costs
The return that really counts is your after tax, after inflation and after costs return. Assuming a 20% capital gains tax rate, 2% pa inflation rate and 1% pa management fees. Your real after tax, after inflation, after costs return is:
Tax: $50 – 20% capital gains tax = $40 net after tax amount.
After tax gross return = ($140/$100) = 40%
After tax annualized return = {($140/$100)^(1/5)}-1 = 6.96% pa
Inflation: 2% pa = (1+.02)^5 = 1.104
After tax, after inflation annualized return = {(($140/$100)/1.104)^(1/5)}-1 = 4.86% pa
Cost: 1% pa = (1+.01)^5 = 1.051 After cost amount = ($150/100)/1.051 = $142
After costs, after tax, after inflation annualized return = {(($100+($42-20%))/1.104)^(1/5)}-1 = 3.98% pa
Gross Return
If you start
with $100 and earn $50 on that money over five years, your gross return is:
($150/$100)
- 1 = 50%
Annualized
Return
Your
annualized compound average return on that investment over time is:
{($150/$100)^(1/5)}-1
= 8.45% per annum (pa)
The return that really counts is your after tax, after inflation and after costs return. Assuming a 20% capital gains tax rate, 2% pa inflation rate and 1% pa management fees. Your real after tax, after inflation, after costs return is:
Tax: $50 – 20% capital gains tax = $40 net after tax amount.
After tax gross return = ($140/$100) = 40%
After tax annualized return = {($140/$100)^(1/5)}-1 = 6.96% pa
Inflation: 2% pa = (1+.02)^5 = 1.104
After tax, after inflation annualized return = {(($140/$100)/1.104)^(1/5)}-1 = 4.86% pa
Cost: 1% pa = (1+.01)^5 = 1.051 After cost amount = ($150/100)/1.051 = $142
After costs, after tax, after inflation annualized return = {(($100+($42-20%))/1.104)^(1/5)}-1 = 3.98% pa
Money is about more than money
Making money. Managing money. Saving money. Spending money. Giving money.
Money is about more than money.
The way we manage, think about, and act on acquiring and disbursing money is all about our values and priorities.
Money is an efficient mechanism for facilitating the exchange of value. What we do with it and how we make it and spend it is a reflection of our selves.
Money is about more than money.
The way we manage, think about, and act on acquiring and disbursing money is all about our values and priorities.
Money is an efficient mechanism for facilitating the exchange of value. What we do with it and how we make it and spend it is a reflection of our selves.
Principle # 2: Have A Plan
"Everyone has a plan 'till they get punched in the face." - Mike Tyson
“A good plan now is better than a perfect plan executed next
week.” - General
George S. Patton
Introduction
On
the face of it the value of a plan may seem self-evident, but whether you get
hit by an economic punch or have a sub-par plan, it bears repeating, because
according to the 2012 National Consumer Survey on Personal Finance, nearly 66%
of respondents did not have a financial plan. This is problematic, because in
the absence of a plan, how do you know where you are going? And, how do you
know how to get there? As Vanguard, the Valley Forge, PA fund giant puts it, “A
carefully conceived financial plan is a must-have for every investor. It’s the
blueprint that spells out the details of your short- and long-term financial
well-being.”
Purpose
Carl
Richards, author of “The One-Page Financial Plan” points out, “before you
plan…you have to know why you are planning.” Richards goes on to say, “the best
financial plan has nothing to do with what the markets are doing and everything
to do with what’s important to you – your life, your dreams, your goals.” The purpose of a plan is simple. It provides
a roadmap for your financial path. Planning is the process by
which you take stock of your life, organize your financial affairs and
better understand your values. It helps identify goals and aspirations, and
charts a course for the future. A well constructed plan reconciles hopes and
dreams with reality, imposes discipline upon the investment process, provides
peace of mind and is the basis for all future conversations. It
is your personal Rosetta Stone - the reference you return to over time.
Basic Issues
A
formal financial plan does
not need to be fancy, but it should provide an accounting of your assets,
liabilities, current and future income, risk tolerance, time horizon and goals.
Core issues addressed within the context of a financial planning conversation
are saving and spending habits, short term and long term financial goals, expected
life changes, taxes, charitable giving, de-cumulation and the passing of wealth
to heirs.
The Value Of
A Plan
A
plan communicates purpose and shows intent toward a goal, but it should also be
flexible enough to adapt to changing circumstance. It helps you to think about
the issues and align your life goals. A formal plan increases the chance of
making good decisions and decreases the chance of making bad decisions. A plan
helps remove emotion from the markets and imposes structure and discipline upon
the decision making process. A plan creates buy-in and commitment to a course
of action, and serves as something tangible against which to gauge progress. Above
all a good plan should match with your personal and emotional DNA (it is no
good having a plan if you can’t stick to it!).
Bottom-Line
A financial plan is about more than money. It is about why money is
important to you and how that translates to your life. It is an insight to the inner
individual. Having a plan is critical to establishing good financial habits
and setting a path to the future. A plan is something that moves you from being
reactive to events and circumstances, to something more measured in the
management of your financial affairs. As such, it is probably a good idea to
have a plan.
Friday, June 26, 2015
White Lies The Industry Tells Itself
The service we provide is valuable and worth every penny people pay.
Just wait till the next downturn. That is where we outperform.
I am a highly trained financial professional and deserve the money I am paid.
I control my outcomes.
We are investment focused (not sales/marketing focused).
Investments is what we are all about.
We can beat the market.
Costs don't matter when you beat the market.
This is an exclusive investment.
We have a differentiated product, process, people, approach.
We are active (not closet indexers).
We consistently produce alpha.
The quality and amount of our experts, technology, resources matters.
There is implied skill in our outcomes.
It is all about investing (not gathering funds).
Our costs and fees are fair. You get what you pay for.
Tricks of the trade: change the base year; change the benchmark; gross of fees; advertise only the winners; spin the departure of a manager; change the risk measure that works best; look at our fund rating (even though it has no predictive value); focus on a three year record; selectively choose which funds, criteria, which period to advertise.
Just wait till the next downturn. That is where we outperform.
I am a highly trained financial professional and deserve the money I am paid.
I control my outcomes.
We are investment focused (not sales/marketing focused).
Investments is what we are all about.
We can beat the market.
Costs don't matter when you beat the market.
This is an exclusive investment.
We have a differentiated product, process, people, approach.
We are active (not closet indexers).
We consistently produce alpha.
The quality and amount of our experts, technology, resources matters.
There is implied skill in our outcomes.
It is all about investing (not gathering funds).
Our costs and fees are fair. You get what you pay for.
Tricks of the trade: change the base year; change the benchmark; gross of fees; advertise only the winners; spin the departure of a manager; change the risk measure that works best; look at our fund rating (even though it has no predictive value); focus on a three year record; selectively choose which funds, criteria, which period to advertise.
Wednesday, June 24, 2015
Transformation and Change aka Jumping the Shark
It is amazing how quickly change can flow through an industry.
It was not more than a couple of years ago that active management and fundamental-based research was the core of the industry. Now, less than 6 years after the financial crisis, active management is in full retreat and human-based fundamental analysis is increasingly marginalized. If I had to put a date on when active management jumped the shark, I would tentatively place it at 2014. Of course, active management still dominates the industry and that is not going to change for quite some time. But the secular trends are clearly in place and the level of knowledge and understanding among the masses is growing.
Information and computers have transformed the industry and the research function, and will no doubt transform the advisor function in the next 5 years or so.
It was not more than a couple of years ago that active management and fundamental-based research was the core of the industry. Now, less than 6 years after the financial crisis, active management is in full retreat and human-based fundamental analysis is increasingly marginalized. If I had to put a date on when active management jumped the shark, I would tentatively place it at 2014. Of course, active management still dominates the industry and that is not going to change for quite some time. But the secular trends are clearly in place and the level of knowledge and understanding among the masses is growing.
Information and computers have transformed the industry and the research function, and will no doubt transform the advisor function in the next 5 years or so.
Friday, June 19, 2015
Philosophical Predilections
Was thinking. They teach you to be an analyst in college. Or at least they provide you with the tools to be an analyst. Everyone comes out with the same tools. But you take on an investment perspective/philosophy when you join a firm. Investment management is unique in that there are literally many ways to skin the cat - many paths to market beating nirvana (sadly none of them guarantee success). Some basic principles are essential, but after that you can seek to beat the market in any number of different ways. One reason for this is because there is no unified theory of investing. There is no one empirically correct way to beat the market.
And so, how important is the philosophical predilection of a shop? and, What effect (or bias) does that predilection have on the analyst's analysis?
Does a value oriented analyst in a value shop overly discount everything? Does a growth oriented analyst in a growth shop overestimate everything? [do they even do any analysis!!! my little joke]
Does it make any difference if you have a value-oriented analyst in a growth shop or a growth-oriented analyst in a value shop?
I would say Yes to everything.
And so, how important is the philosophical predilection of a shop? and, What effect (or bias) does that predilection have on the analyst's analysis?
Does a value oriented analyst in a value shop overly discount everything? Does a growth oriented analyst in a growth shop overestimate everything? [do they even do any analysis!!! my little joke]
Does it make any difference if you have a value-oriented analyst in a growth shop or a growth-oriented analyst in a value shop?
I would say Yes to everything.
Wednesday, June 17, 2015
Dealing With Hardship
Hardship befalls most people in their life at some point. Some deal with it on a much greater scale, others for a much greater time, but hardship is just a stones throw away. Life and success and happiness are fragile. And just like health, you don't appreciate what you had until you lose it.
And everyone deals with it differently. Some go into their shell, others roll up their sleeves. Some are embarrassed, some are prideful, some don't want anyone to know (even as everyone knows). Time keeps on slipping away making it harder and harder to change get out of one's quiet desperation.
And everyone deals with it differently. Some go into their shell, others roll up their sleeves. Some are embarrassed, some are prideful, some don't want anyone to know (even as everyone knows). Time keeps on slipping away making it harder and harder to change get out of one's quiet desperation.
Monday, June 15, 2015
Vanguard's Advantage Wasn't It Mutual Structure But It's Investment Philosophy
Vanguard's unique corporate structure is not why Vanguard is different and beating people. There is plenty of money to be made in Vanguard's corporate structure. Vanguard is successful because it's investment approach/philosophy conforms to financial theory (ie. it creates broad-based asset class products) and seeks to be the lowest cost producer. I guess not having to respond to profit pressures from shareholders is valuable, but a for profit company could have adopted the same strategy and been equally successful. In fact, Dimensional is an example of that as were Wells Fargo Nikko and Barclays Index which have since been subsumed. Mutual funds are in theory structured the same way as Vanguard, but when controlled by for profit entities are obviously not interested in doing everything in the client's/shareholder's best interests.
Serial Correlation Affecting Quality Large Caps In A Panic
Rusty was big on this and I think he was right (although I don't like the conspiracy allusions that are usually drawn with it), and it is not something that you see too much written or talked about.
During the crisis when everyone hit the exits at the same time, quality company large cap stocks got hit just as much, if not more, compared to low quality stocks. The reason being that they were liquid and provided an avenue to exit when other avenues were not as attractive.
In theory this should create an inefficient situation where information based investors (ie. value investors) step in to take advantage of the temporary oversupply in the market. Unfortunately, much of the oversupply was probably being created by value investors as much as any other type of investor and that is why the window of opportunity was so great and the time period for taking advantage greater than normal.
Timing is everything. Contrarians likely bought too soon. Value managers were so abused that they were stuck on the sidelines too long. Growth and momentum guys were just dazed and confused.
But the reality was in a panic, high quality large caps are hit just as much as any other segment precisely because they are a store of value and a ready source of funds.
During the crisis when everyone hit the exits at the same time, quality company large cap stocks got hit just as much, if not more, compared to low quality stocks. The reason being that they were liquid and provided an avenue to exit when other avenues were not as attractive.
In theory this should create an inefficient situation where information based investors (ie. value investors) step in to take advantage of the temporary oversupply in the market. Unfortunately, much of the oversupply was probably being created by value investors as much as any other type of investor and that is why the window of opportunity was so great and the time period for taking advantage greater than normal.
Timing is everything. Contrarians likely bought too soon. Value managers were so abused that they were stuck on the sidelines too long. Growth and momentum guys were just dazed and confused.
But the reality was in a panic, high quality large caps are hit just as much as any other segment precisely because they are a store of value and a ready source of funds.
Pet Peeve
I really hate (hate is proverbial and hyperbole...dislike is the more appropriate word) all the crap research that comes out matching S&P 500 performance or industry/sector performance or company specific performance with things like presidential election years, interest rate changes, currency changes, geopolitical crisis or any other market factor. I think it is junk science and junk information. It tickles the fancy, but is ultimately not worth much.
Taking Another Shot At Market Efficiency
The market is inefficient.
What I mean by this is that the market is always in a state of controlled chaos. Some may consider this equilibria, but it is equilibria in a very limited sense of the word. Equilibria is not the same as intrinsic or fundamental value (which is also in the eye of the beholder).
Because market prices are a function of consensus feelings, emotions, expectations and sentiment regarding earnings, interest rates, risk and the future (in other words they reflect the current zeitgeist of the day and embed some feelings for the future), they are necessarily wrong all the time. No one knows what the future holds. Of course as markets correct and swing from overvalued to undervalued and vice versa, they must by definition pass through some median or fair value point. The problem is they rarely trade at the fair value point for any steady state period of time.
Getting cyclical trend and momentum right are consequently the most important ingredients to long term active investing, while have a mean reversion contrarian disposition can help cut off the excesses of the tails. The problem is we never really know beforehand the timing, time or magnitude of any new cycle.
Therein lies the problem.
What I mean by this is that the market is always in a state of controlled chaos. Some may consider this equilibria, but it is equilibria in a very limited sense of the word. Equilibria is not the same as intrinsic or fundamental value (which is also in the eye of the beholder).
Because market prices are a function of consensus feelings, emotions, expectations and sentiment regarding earnings, interest rates, risk and the future (in other words they reflect the current zeitgeist of the day and embed some feelings for the future), they are necessarily wrong all the time. No one knows what the future holds. Of course as markets correct and swing from overvalued to undervalued and vice versa, they must by definition pass through some median or fair value point. The problem is they rarely trade at the fair value point for any steady state period of time.
Getting cyclical trend and momentum right are consequently the most important ingredients to long term active investing, while have a mean reversion contrarian disposition can help cut off the excesses of the tails. The problem is we never really know beforehand the timing, time or magnitude of any new cycle.
Therein lies the problem.
Thursday, June 11, 2015
Fed Rate Hike
Will they or won't they...hike in July, September...some time this year.
I don't think so. There is no reason to hike. Inflation is low. Growth is subdued. Other countries are cutting their interest rates. Why should the Fed raise rates. The only reason would be if the markets really take off.
I don't think so. There is no reason to hike. Inflation is low. Growth is subdued. Other countries are cutting their interest rates. Why should the Fed raise rates. The only reason would be if the markets really take off.
Friday, June 5, 2015
You Only Get One Chance...Can't Go Back To The Well
My experience has been that you only get one chance with people when you ask for their help. There is a short window after the initial meeting where they are willing to help, but you can't keep going back to them asking for help. They turn off.
Tuesday, June 2, 2015
ETFs Made Factor Investing
Factor investing has been around a long time, but it was not until the advent of ETFs and the regulatory requirements for approval that factor investing came to the fore.
Why Good News Is Bad News
Bad news has been good news for the markets for a long time now. The basic premise has been bad news spells more liquidity as the authorities fight any and all negative notions.
We may be entering a new stretch where the market (and the CBs) are finally able to feel better about life. When good news starts spelling bad news for the markets, this will be the sign that the market is calming down and beginning to clear, ie. equalize valuations.
We may be entering a new stretch where the market (and the CBs) are finally able to feel better about life. When good news starts spelling bad news for the markets, this will be the sign that the market is calming down and beginning to clear, ie. equalize valuations.
Thursday, May 14, 2015
The Weird Thing About Swing Thoughts
It is weird how there are times you are playing well on the golf course (or anywhere else for that matter) and you have a swing thought that is working for you. You feel it, it feels good and you believe it is making your game better.
I know that is the case with my golf game. There are times when I have a swing thought and it just works. The funny thing is if I took a video of my swing when I have the swing thought and I look at a video of my swing any other time, it would in all likelihood be no different.
I know that is the case with my golf game. There are times when I have a swing thought and it just works. The funny thing is if I took a video of my swing when I have the swing thought and I look at a video of my swing any other time, it would in all likelihood be no different.
Tuesday, May 12, 2015
Why Won't This Market Go Down?
The fundamental reason why this market may not go down (when for all intents and purposes it probably should) is because there are still plenty of investors still sitting on the sidelines just waiting for it to fall to get back in.
I hate the idea that the market level is in fact set by supply and demand rather than fundamentals. But you would argue that supply and demand are a part of fundamentals. Yes and no. Yes in the sense that the market is simply a market with prices set by supply and demand. But no in the sense that the market does not always reflect the fundamental economic reality of an asset.
When supply and demand are more a function of sentiment than economics, then perverse outcomes tend to happen.
I hate the idea that the market level is in fact set by supply and demand rather than fundamentals. But you would argue that supply and demand are a part of fundamentals. Yes and no. Yes in the sense that the market is simply a market with prices set by supply and demand. But no in the sense that the market does not always reflect the fundamental economic reality of an asset.
When supply and demand are more a function of sentiment than economics, then perverse outcomes tend to happen.
Inherently Distrustful Of Macro Commentary
I am inherently distrustful of macro commentary, especially if it tries to come up with some pseudo-conspiratorial explanation for what happened attributable to countries, actors, or politicians.
There is usually some truth to what they point to, but the attributing of such calculable intent when none was recognized previously is a stretch.
There is usually some truth to what they point to, but the attributing of such calculable intent when none was recognized previously is a stretch.
Friday, May 8, 2015
Incentive Structures - Moral Hazard and Behavior
The problem with most institutional incentive structures, ie. those promulgated by major corporations, is they overemphasize increasing revenues and maximizing profit to the detriment of customer experience/service. The reason is, they already have the customers, they are now just milking them with sales and marketing gimmicks and internal employee incentives to achieve their goal of profit maximization.
At some point they will go too far. But because these organizations are so large, the cost (in fines) or damage to reputation are not sufficient for customers to move away (they already have them locked in and switching costs are high).
The other thing about the incentive plans is they are invariably unbelievably complicated. That is because, as with most things bureaucratic, they are heaping performance measures on performance measures (when new ones come along, they usually don't scrap the old ones), which will also ultimately be self-defeating due to their complexity. A structural issue which can effect employee morale is when incentives and bonuses are based on unrealistic goals, then either behavior becomes severely distorted (really leverage and exploit the client) or employees lose motivation. Both circumstances are bad and should be watched out for.
Fines are other penalties are just considered a cost of doing business.
If there are so many things wrong with these plans/structures, why don't companies reform them or change?
One reason is that they are the most effective way to exact more money out of clients. Another reason is that senior management is served by these and this effect with bigger bonuses.
One of the real problems is employees become demotivated and begin seeing the absurdity of the company and its business.
At some point they will go too far. But because these organizations are so large, the cost (in fines) or damage to reputation are not sufficient for customers to move away (they already have them locked in and switching costs are high).
The other thing about the incentive plans is they are invariably unbelievably complicated. That is because, as with most things bureaucratic, they are heaping performance measures on performance measures (when new ones come along, they usually don't scrap the old ones), which will also ultimately be self-defeating due to their complexity. A structural issue which can effect employee morale is when incentives and bonuses are based on unrealistic goals, then either behavior becomes severely distorted (really leverage and exploit the client) or employees lose motivation. Both circumstances are bad and should be watched out for.
Fines are other penalties are just considered a cost of doing business.
If there are so many things wrong with these plans/structures, why don't companies reform them or change?
One reason is that they are the most effective way to exact more money out of clients. Another reason is that senior management is served by these and this effect with bigger bonuses.
One of the real problems is employees become demotivated and begin seeing the absurdity of the company and its business.
Thursday, May 7, 2015
Future Taxes
No one knows what future tax rates are going to be in the future. Everyone, however, knows the tax codes needs to be reformed.
It is no scholar who thinks that future tax rates are likely to be lower while deductions will be less.
How then should you plan for saving in your retirement accounts. Obviously it depends upon your current marginal tax rate vs your future marginal tax rate. One known, one unknown. The thing to remember is that current marginal tax rates are artificially low compared to what they will be in the future. Now while they may drop tax rate levels, with fewer deductions, I suspect future marginal tax rates will be on average higher than today. All of which pitches for the Roth over the tax deferred vehicle.
It is no scholar who thinks that future tax rates are likely to be lower while deductions will be less.
How then should you plan for saving in your retirement accounts. Obviously it depends upon your current marginal tax rate vs your future marginal tax rate. One known, one unknown. The thing to remember is that current marginal tax rates are artificially low compared to what they will be in the future. Now while they may drop tax rate levels, with fewer deductions, I suspect future marginal tax rates will be on average higher than today. All of which pitches for the Roth over the tax deferred vehicle.
Wednesday, May 6, 2015
Everyone Is Shy Of Calling A Top
Everyone is gun shy about calling a top in equities or bonds.
Too often in the recent past anyone who has called a top has been steam-rolled. As a result it is only ideologues and dogmatists who have been calling a top for years who are left to carry the flag.
I don't think we are in a bubble, but I do think the market is way overextended. The contrarian in me wants to take the under.
Too often in the recent past anyone who has called a top has been steam-rolled. As a result it is only ideologues and dogmatists who have been calling a top for years who are left to carry the flag.
I don't think we are in a bubble, but I do think the market is way overextended. The contrarian in me wants to take the under.
Monday, May 4, 2015
Saturday, May 2, 2015
Synthetic Deferred Annuity
Given that I have never dealt with annuities and given that I have never liked them (because investment texts degrade them because of their high cost and complexity), it has been really interesting for me to discover that academics love annuities. There seems like almost universal support for annuities as the solution to retirement income spending needs (at least deferred income annuities).
The initial investment for a lifetime deferred fixed annuity paying $1000/mo in 20 years is $26,894.
The PV of a deferred fixed annuity based on 20 years of monthly $1000 fixed payments is $57,108 (assuming 5% discount rate).
Looks like the annuity is a much better deal than trying to construct it yourself.
The initial investment for a lifetime deferred fixed annuity paying $1000/mo in 20 years is $26,894.
The PV of a deferred fixed annuity based on 20 years of monthly $1000 fixed payments is $57,108 (assuming 5% discount rate).
Looks like the annuity is a much better deal than trying to construct it yourself.
Return Myopia
Return myopia is the fixation on return to the neglect of risk.
A myopic focus on yield is a classic case of focusing on return and neglecting the risk side of the equation.
A myopic focus on yield is a classic case of focusing on return and neglecting the risk side of the equation.
Yield Chasing: There Is No Free Lunch
There is no free lunch.
The temptation to chase higher yielding securities is a ephemera.
Higher yields reflect greater risk. He who neglects that basic signal is subject to the laws of economics.
To the piper a price will be paid.
The temptation to chase higher yielding securities is a ephemera.
Higher yields reflect greater risk. He who neglects that basic signal is subject to the laws of economics.
To the piper a price will be paid.
Friday, May 1, 2015
Variant Perception and Edge: Value vs Growth
There are only two possible options for variant perception for both value and growth investors.
Both investor types are forecasting either higher growth rates or higher margins or a combination of those two factors compared to the market consensus and what is baked into the stock price today.
It is as simple as that. One other possible variant perception relates to the realm of undervalued/hidden/latent assets which occurs more on the value side of the divide (although effectively that is the implied assumption also on the growth side).
So for a growth investor when they come across a growth company trading at 30x forward earnings, implying 30%pa 5 yr growth and 20% operating margins, to have a variant perception they are either forecasting growth greater than 30% and/or operating margins greater than 20%. Implicitly they are also forecasting the future multiple to be 30x or greater. Lots of moving parts in that equation and lots of hope (the future) embedded in todays price. As long term holders the odds are usually not in their favor. Although if they hit the jackpot and get a genuine emerging leader that turns into a market leader then all their misses are likely to be made up by that one single hit.
For a value investor, looking at a company trading at 10x forward earnings with consensus growth of 0%pa for 5 years and operating margins of 5%, the variant perception hurdle does not appear all that great. The risk in this space is a company going the way of the dinosaur.
Both investor types are forecasting either higher growth rates or higher margins or a combination of those two factors compared to the market consensus and what is baked into the stock price today.
It is as simple as that. One other possible variant perception relates to the realm of undervalued/hidden/latent assets which occurs more on the value side of the divide (although effectively that is the implied assumption also on the growth side).
So for a growth investor when they come across a growth company trading at 30x forward earnings, implying 30%pa 5 yr growth and 20% operating margins, to have a variant perception they are either forecasting growth greater than 30% and/or operating margins greater than 20%. Implicitly they are also forecasting the future multiple to be 30x or greater. Lots of moving parts in that equation and lots of hope (the future) embedded in todays price. As long term holders the odds are usually not in their favor. Although if they hit the jackpot and get a genuine emerging leader that turns into a market leader then all their misses are likely to be made up by that one single hit.
For a value investor, looking at a company trading at 10x forward earnings with consensus growth of 0%pa for 5 years and operating margins of 5%, the variant perception hurdle does not appear all that great. The risk in this space is a company going the way of the dinosaur.
Friday, April 24, 2015
The Difference Between Then and Now
I read stuff from young commentators today and wonder how they could write such insightful commentary. It is hard for me to remember the quality and depth of insight I had when I was a similar age.
But as I reflect upon some of my writings and insights from when I first entered the industry, the quality and depth of those insights were not all that much different from the good stuff I see from young commentators today.
What has changed for me is a more honed approach toward investing (stripping away the dross) and a greater skepticism toward smart people based on those 25+ years of experience. Whereas I was trying to work out what works and what doesn't back then, today I have a greater appreciation for messiness of life.
But as I reflect upon some of my writings and insights from when I first entered the industry, the quality and depth of those insights were not all that much different from the good stuff I see from young commentators today.
What has changed for me is a more honed approach toward investing (stripping away the dross) and a greater skepticism toward smart people based on those 25+ years of experience. Whereas I was trying to work out what works and what doesn't back then, today I have a greater appreciation for messiness of life.
Tuesday, April 21, 2015
Peak China
I am not saying China has peaked. Far from it. China will do nothing but continue to grow in size and influence throughout the 21st century. The 21st century is the Chinese century (22nd century is India's).
What I am saying is the current reverence and awe for China and its seeming infallibility in the face of Western incompetence and decline reminds me of peak Japan back in the 80s. On the face of it China appears to have pulled off a seemingly perfect emergence.
Beneath the surface there are many cracks (overcapacity, overindebtedness) and with increasing commitments both at home and worldwide, China will be found to be fallible.
Just sayin!
What I am saying is the current reverence and awe for China and its seeming infallibility in the face of Western incompetence and decline reminds me of peak Japan back in the 80s. On the face of it China appears to have pulled off a seemingly perfect emergence.
Beneath the surface there are many cracks (overcapacity, overindebtedness) and with increasing commitments both at home and worldwide, China will be found to be fallible.
Just sayin!
Wednesday, April 15, 2015
Equity Glide Path and Sequence of Return Risks
Being new to retirement issues, I find this area very interesting.
A counterintuitive idea is to increase the equity glide path once retirement hits, ie. increase equity exposure over time. Start at say 20% equity exposure and increase it 1% or 2% per year (by redeeming cash/bonds for withdrawals). One of the benefits of such an approach is not getting caught out on the sequence of risk issue associated with poor equity returns early in retirement. I kinda like that idea. (but only in a high valuation environment)
Definitely food for thought.
A counterintuitive idea is to increase the equity glide path once retirement hits, ie. increase equity exposure over time. Start at say 20% equity exposure and increase it 1% or 2% per year (by redeeming cash/bonds for withdrawals). One of the benefits of such an approach is not getting caught out on the sequence of risk issue associated with poor equity returns early in retirement. I kinda like that idea. (but only in a high valuation environment)
"These results indicate that the optimal equity glide path (as well as the decision about whether to use T-bills or bonds) is in fact quite sensitive to the market valuation at the start of retirement (and indirectly, to expected market returns). While the accelerated rising equity glide path worked best in some scenarios, the fixed 60% equity portfolio did better in most. The rising equity glide path should only be considered in unfavorable valuation environments. Notably, though, the “traditional” steady declining equity glide path is still inferior to some other strategy in all valuation environments. Based on historical data, more aggressive portfolios are rewarded in favorable (undervalued) and neutral environments, and rising equity glide paths performed better in unfavorable market environments, which were the situations that generated the overall historical SafeMax."
Definitely food for thought.
Graham and Dodd tactical allocation rules based on market PE
From Kitces and Pfau in AAII.
Though there are a multitude of ways to define an undervalued or overvalued market, we rely on the switching rules developed long ago by Graham and Dodd (“Security Analysis: The Classic 1940 Second Edition,” McGraw-Hill, 1940). They suggested maintaining the neutral asset allocation when valuations fall within a range between two-thirds and four-thirds of their historical average value. Graham and Dodd increase the stock allocation when valuations are less than two-thirds of their average, and decrease the stock allocation when valuations are more than four-thirds of their average. These numerical bounds correspond to evolving CAPE values of approximately 10 and 21 over time. Given the volatility of the CAPE ratio, these bounds also roughly correspond with the bottom and top quintiles of the historical valuation distribution, which are CAPE values of 11.1 and 21.2 (see Figure 1).
These results suggest that the valuation-based approach is generally superior to the rising equity glide path approach and the fixed equity allocation portfolios, as the valuation-based scenarios produce comparable-to-slightly-better results across the board.
Though there are a multitude of ways to define an undervalued or overvalued market, we rely on the switching rules developed long ago by Graham and Dodd (“Security Analysis: The Classic 1940 Second Edition,” McGraw-Hill, 1940). They suggested maintaining the neutral asset allocation when valuations fall within a range between two-thirds and four-thirds of their historical average value. Graham and Dodd increase the stock allocation when valuations are less than two-thirds of their average, and decrease the stock allocation when valuations are more than four-thirds of their average. These numerical bounds correspond to evolving CAPE values of approximately 10 and 21 over time. Given the volatility of the CAPE ratio, these bounds also roughly correspond with the bottom and top quintiles of the historical valuation distribution, which are CAPE values of 11.1 and 21.2 (see Figure 1).
These results suggest that the valuation-based approach is generally superior to the rising equity glide path approach and the fixed equity allocation portfolios, as the valuation-based scenarios produce comparable-to-slightly-better results across the board.
Friday, April 10, 2015
Average Market Multiple and Its Standard Deviation
Was playing around with Shiller's CAPE database and was curious what the standard deviation of the market multiple was.
Arbitrarily choosing the period 1965 to 2015 the long term average CAPE was 19.7x with a standard deviation of 8.2 (hi = 44.2x, lo = 6.4x).
Using the same period but using a naive PE (ie. non-smoothed), the average market multiple over the period was 18.9x with a standard deviation of 12.6 (hi = 123.7x, lo = 6.8x).
Breaking the period into 5 yr, 7 yr and 10 year rolling periods to simulate various cycles the PE and standard deviations came out to:
Arbitrarily choosing the period 1965 to 2015 the long term average CAPE was 19.7x with a standard deviation of 8.2 (hi = 44.2x, lo = 6.4x).
Using the same period but using a naive PE (ie. non-smoothed), the average market multiple over the period was 18.9x with a standard deviation of 12.6 (hi = 123.7x, lo = 6.8x).
Breaking the period into 5 yr, 7 yr and 10 year rolling periods to simulate various cycles the PE and standard deviations came out to:
| CAPE | Naïve PE | ||||||
| 5 Year | 7 Year | 10 Year | 5 Year | 7 Year | 10 Year | ||
| Average | 19.29 | 19.26 | 19.20 | 19.05 | 18.82 | 18.49 | |
| Standard Deviation | 7.83 | 7.71 | 7.52 | 7.64 | 7.08 | 6.80 | |
| Hi | 36.50 | 33.48 | 31.10 | 33.16 | 30.76 | 31.43 | |
| Lo | 8.59 | 8.87 | 9.39 | 8.10 | 8.81 | 9.37 |
Wednesday, April 8, 2015
Pressure Points In The Market
I just took a look at areas of prospective bubbles in the market the other day and concluded there was nothing significant poking its head out. But I wanted to revisit that question and articulate or expand on a couple more pressure points in the market today:
- The large decline in oil prices has crushed the energy sector which had been one of the drivers of growth in the US. There may be more risk and implications there than what the market is indicating.
- The large decline in commodity prices, predicated on the slowdown in China, which has crushed Australia, Brazil and Canada. Australia, China, Canada and the UK have large residential real estate bubbles.
- ECB QE and the financial repression of NIRP is leading to a recalibrating of currencies and a fight to the bottom.
- Japan QE and rebalancing could push Japan over the edge as the curtain is finally pulled back.
- Geopolitical risks could escape beyond borders and proxies - Ukraine, Syria.
More On The Purpose and Role of Active Management
Most retirement plans offer a menu of index funds and active funds. The active funds typically comprise brand name, "institutional quality" managers. They are in essence a safe bet from a performance, business and career risk perspective. They will likely deliver somewhere between 1% outperformance to -2% underperformance (which incidentally is acceptable). They are the proverbial closet indexers. You may wonder what is their role. If they can't and aren't trying to generate genuine outperformance (alpha), then why use them. I think the reason is as alluded to previously (business, career and performance risk management) but also because they serve several other important purposes.
Namely, they provide the potential for outperformance (an important psychological factor). And they do provide some degree or potential of downside mitigation. Both of which meet the needs of most investors to believe that their fund is being managed by an expert and provides them with a positively skewed opportunity set.
Hard to know whether this is a cynical take on active managements role or simply the reality, which although it is unlikely to deliver alpha, actually does provide investors with a degree of comfort.
If plan providers were to offer "genuinely active" managers then the outcomes could be a real mess. The hit rate on finding and getting a genuinely active manager who then outperforms is pretty low. Not worth the risks and hassles associated with it.
Genuinely active = relatively new fund (less than 3 years old), concentrated bets, small amount of assets under management.
Namely, they provide the potential for outperformance (an important psychological factor). And they do provide some degree or potential of downside mitigation. Both of which meet the needs of most investors to believe that their fund is being managed by an expert and provides them with a positively skewed opportunity set.
Hard to know whether this is a cynical take on active managements role or simply the reality, which although it is unlikely to deliver alpha, actually does provide investors with a degree of comfort.
If plan providers were to offer "genuinely active" managers then the outcomes could be a real mess. The hit rate on finding and getting a genuinely active manager who then outperforms is pretty low. Not worth the risks and hassles associated with it.
Genuinely active = relatively new fund (less than 3 years old), concentrated bets, small amount of assets under management.
Tuesday, April 7, 2015
A Rationale For Active Management
Active managers are throwing in the towel. They haven't demonstrated an ability to beat the market and are now re-evaluating their value and their selling proposition to investors.
http://www.thinkadvisor.com/2015/04/06/the-real-point-of-active-investing
I need to think about this some more. There may be a viable rationale to active management beyond trying to beat the market.
Do I want a plane flown only on auto pilot or do I want a plane piloted by a person who may be able to react in an emergency. The analogy may not work because there may be times when a plane flown by a person takes emergency action for no reason whatsoever.
http://www.thinkadvisor.com/2015/04/06/the-real-point-of-active-investing
I need to think about this some more. There may be a viable rationale to active management beyond trying to beat the market.
Do I want a plane flown only on auto pilot or do I want a plane piloted by a person who may be able to react in an emergency. The analogy may not work because there may be times when a plane flown by a person takes emergency action for no reason whatsoever.
Losing Money Easier Than Making Money
Making money through your investments always seems a lot harder (read that takes longer and does not generate as much) as losing money on your investments.
Just my experience!
Just my experience!
Bubble, bubble toil and trouble
Julian Robertson in an interview today speaks about a bubble being blown by the Fed. Like everyone else, he doesn't know when it is going to pop, but he knows it is going to pop.
A bubble is a serially correlated error on a mass scale perpetrated by a blinded marketplace. Herding if you will.
Which leads me to ask myself the question (which I ask periodically), where do I see bubble characteristics?
What are the characteristics to begin with? Substantial increase in leverage and laxity of constraints wrt to access to cheap capital - leads to misallocation of resources and increase in valuation. Unsustainable and undefensible increase in valuation. Area attracts a large flow of new capital. Industry/sector/country is systematically important due to its size and spreading effects throughout the economy.
In financials? No. Capital has been rebuilt. Lending standards have improved.
In energy? No. The bubble, and there was one in shale, has been popped already. There are dead men walking, but no systematic risk impact on the market.
In technology? No. Not if you look at the balance sheets and valuation of the majors (AAPL, MSFT, SAP, ORCL, QCOM, etc.). I definitely see a bubble in next generation tech (TSLA, NOW, CRM, NFLX, N, etc.) but even many of those have seen their valuations shrink as they grow and market price have come off the boil.
In materials? No. If anything, the bubble has been popped already in that space. Just look at gold, copper, coal, etc.
In industrials? No. Valuation is stretched, but not out of this world.
In consumer discretionary? No.
In healthcare? Don't know. It has had a huge run. Definitely biotech side of sector. But biotech is not a systematically important part of the economy.
In utilties? No.
Dollar. No. That is good for everyone else and the US can handle it. Although if it were to throw the US into recession then that would be bad for everyone.
In bonds? Possibly. Massive move to bonds over last six years. But bonds don't really pose a systematic risk unless the underlying defaults. And most of the new debt is govt.
In China? Possibly. But I've been calling that one for years, so I have zero credibility. Like Julian Robertson I believe there is a bubble (in China), I just don't know when it will burst.
China looks to me as the best potential for a "bubble." The massive run in the Chinese stock market may be a sign of things getting out of control, or it may simply be a sign of a soft landing.
Or, it could be the whole global system which has increased its leverage significantly in the last six years and susceptible to a rise in interest rates.
Perhaps that is it. Interest rate risk is the largest risk out there.
A bubble is a serially correlated error on a mass scale perpetrated by a blinded marketplace. Herding if you will.
Which leads me to ask myself the question (which I ask periodically), where do I see bubble characteristics?
What are the characteristics to begin with? Substantial increase in leverage and laxity of constraints wrt to access to cheap capital - leads to misallocation of resources and increase in valuation. Unsustainable and undefensible increase in valuation. Area attracts a large flow of new capital. Industry/sector/country is systematically important due to its size and spreading effects throughout the economy.
In financials? No. Capital has been rebuilt. Lending standards have improved.
In energy? No. The bubble, and there was one in shale, has been popped already. There are dead men walking, but no systematic risk impact on the market.
In technology? No. Not if you look at the balance sheets and valuation of the majors (AAPL, MSFT, SAP, ORCL, QCOM, etc.). I definitely see a bubble in next generation tech (TSLA, NOW, CRM, NFLX, N, etc.) but even many of those have seen their valuations shrink as they grow and market price have come off the boil.
In materials? No. If anything, the bubble has been popped already in that space. Just look at gold, copper, coal, etc.
In industrials? No. Valuation is stretched, but not out of this world.
In consumer discretionary? No.
In healthcare? Don't know. It has had a huge run. Definitely biotech side of sector. But biotech is not a systematically important part of the economy.
In utilties? No.
Dollar. No. That is good for everyone else and the US can handle it. Although if it were to throw the US into recession then that would be bad for everyone.
In bonds? Possibly. Massive move to bonds over last six years. But bonds don't really pose a systematic risk unless the underlying defaults. And most of the new debt is govt.
In China? Possibly. But I've been calling that one for years, so I have zero credibility. Like Julian Robertson I believe there is a bubble (in China), I just don't know when it will burst.
China looks to me as the best potential for a "bubble." The massive run in the Chinese stock market may be a sign of things getting out of control, or it may simply be a sign of a soft landing.
Or, it could be the whole global system which has increased its leverage significantly in the last six years and susceptible to a rise in interest rates.
Perhaps that is it. Interest rate risk is the largest risk out there.
Monday, April 6, 2015
Is The Market Efficient?
I have asked this question a time or two before. But I have thought about it in a different way and have decided for today that the market is not efficient. At least not efficient in the sense that it adheres to some average valuation level.
The problem is the market is overvalued and undervalued for long periods of time. It is hard for an investor to know when it will revert to the mean, and in all likelihood overshoot on the other side.
Overshoot and undershoot are a structural aesthetic of the market. The duration and magnitude of overshoot or undershoot is not well understood.
I would say the market is virtually never efficient. At least not from a valuation perspective.
It seems to me that there are times when the market is overvalued. The implication is market participants are expecting better things in the future. And there are times when the market is undervalued. The implication being market participants are expecting worse things in the future. But throughout, regime changes and overshoot are a function of changing expectations, money flows, fear/greed levels, and liquidity.
Over and undervaluation point to correlated mistakes. Paul Samuelson said something to the effect, markets are macro inefficient but micro efficient. That is probably right although it doesn't make much sense.
Just as correlations and assumptions of normal distributions are non-stationary and change over time, so to does the market average valuation line. With that being the case, one would presume that more recent data (valuation levels) would be more relevant for ascertaining the "modern" average valuation level as compared to a longer term mean. This may or may not be a good assumption to make. Only time will tell ('tis the answer to everything).
The problem is the market is overvalued and undervalued for long periods of time. It is hard for an investor to know when it will revert to the mean, and in all likelihood overshoot on the other side.
Overshoot and undershoot are a structural aesthetic of the market. The duration and magnitude of overshoot or undershoot is not well understood.
I would say the market is virtually never efficient. At least not from a valuation perspective.
It seems to me that there are times when the market is overvalued. The implication is market participants are expecting better things in the future. And there are times when the market is undervalued. The implication being market participants are expecting worse things in the future. But throughout, regime changes and overshoot are a function of changing expectations, money flows, fear/greed levels, and liquidity.
Over and undervaluation point to correlated mistakes. Paul Samuelson said something to the effect, markets are macro inefficient but micro efficient. That is probably right although it doesn't make much sense.
Just as correlations and assumptions of normal distributions are non-stationary and change over time, so to does the market average valuation line. With that being the case, one would presume that more recent data (valuation levels) would be more relevant for ascertaining the "modern" average valuation level as compared to a longer term mean. This may or may not be a good assumption to make. Only time will tell ('tis the answer to everything).
Drawback of Cap Weighted Indexing
The main drawback with cap weighted investing is that you have bought the market. We know from history and experience the market is not always a good deal. There are times when the market is overvalued. Your entry point (level) into the market is very important for both your short and long term returns. Buying into the market when it is overvalued is likely to result in less than average returns. If you are worried about the valuation level of the market, then perhaps the best approach if you have a lump sum to invest is to set a disciplined schedule to invest those monies over time based upon either a time target being reached, ie. invest 1/4 now, 1/4 in three months, 1/4 in six months, etc., and/or dependent upon the market level path, ie. if the market goes down 10% invest 1/4, if down another 5% then another 1/4, etc.
If you are young and likely to be putting regular savings into the market, then don't worry about trying to finesse your entry. You've got time and the lion's share of your likely accumulated wealth in front of you and there is no time like the present to start investing.
If you are young and likely to be putting regular savings into the market, then don't worry about trying to finesse your entry. You've got time and the lion's share of your likely accumulated wealth in front of you and there is no time like the present to start investing.
Optimal Withdrawal Strategy in Retirement
The general rule of thumb is that retirees should draw down their taxable accounts first, followed by their tax deferred accounts (401k and Individual IRA), before finally accessing their tax exempt accounts (corporate Roth and Individual Roth).
Kirsten Cook, William Meyer and William Reichenstein make the case in, "Tax Efficient Withdrawal Strategies" in the latest Financial Analyst Journal that conventional wisdom may be wrong and in fact using a more flexible approach based on marginal tax rates and pushing drawdowns in tax deferred accounts (and/or converting TDA funds to Roth accounts) could extend portfolio longevity significantly (15% more).
Essentially, using up a combination of all account types in relation to current and likely marginal tax rates, enables an extension of portfolio duration.
One thing they point to is leaving some funds in one's tax deferred account for a lot latter in life to pay for large end of life medical bills which can potentially reduce the effective tax rate to close to zero.
Kirsten Cook, William Meyer and William Reichenstein make the case in, "Tax Efficient Withdrawal Strategies" in the latest Financial Analyst Journal that conventional wisdom may be wrong and in fact using a more flexible approach based on marginal tax rates and pushing drawdowns in tax deferred accounts (and/or converting TDA funds to Roth accounts) could extend portfolio longevity significantly (15% more).
Essentially, using up a combination of all account types in relation to current and likely marginal tax rates, enables an extension of portfolio duration.
One thing they point to is leaving some funds in one's tax deferred account for a lot latter in life to pay for large end of life medical bills which can potentially reduce the effective tax rate to close to zero.
Saturday, April 4, 2015
Everyone is a long term investor, until...
Everyone is a long term investor, until the market tanks.
Friday, April 3, 2015
A Fundamental Misunderstanding
If you believe your financial advisor needs to be fully informed about what is going on in the market so that they can better look after things for you, then you have a fundamental misunderstanding about what the markets are, what somebody can do for you, and what are reasonable expectations.
A long term investment horizon strips away the need to know what is going on in the here and now. 99% of the sturm und drang created by the markets is simply noise.
A long term investment horizon strips away the need to know what is going on in the here and now. 99% of the sturm und drang created by the markets is simply noise.
More on KISS
When simple rules suffice and when in fact simplicity gives you the best odds, why mess with added complexity?
KISS is really a euphemism for a modern rules of finance approach to investing:
Be diversified,
Keep costs low,
Be long term,
Be disciplined,
Be patient.
KISS is not an end. It is a means to an end.
KISS is really a euphemism for a modern rules of finance approach to investing:
Be diversified,
Keep costs low,
Be long term,
Be disciplined,
Be patient.
KISS is not an end. It is a means to an end.
What Period Does Today Look Like
Riffing off a recent post on the performance of a 50/50 portfolio on A Wealth of Commonsense blog.
Today looks like no period specifically and all periods generally. Whether it is wars and famines and unrest and lousy politicians and economics worries or existential concerns. Today looks like virtually ever other period of time.
But that is not the question or the perspective I am looking at it from. I am thinking in terms of general financial market characteristics. And in that regard, today looks very much like the end of the sixties. Interest rates were very low and the stock market was very high. The 70s were not kind to either. Perhaps a portent of things to come.
Today looks like no period specifically and all periods generally. Whether it is wars and famines and unrest and lousy politicians and economics worries or existential concerns. Today looks like virtually ever other period of time.
But that is not the question or the perspective I am looking at it from. I am thinking in terms of general financial market characteristics. And in that regard, today looks very much like the end of the sixties. Interest rates were very low and the stock market was very high. The 70s were not kind to either. Perhaps a portent of things to come.
Growth Is Confusing
In the world of investing the word 'Growth' can mean different things and sometimes it is hard to know what meaning is meant.
Growth can be a reference to an investment philosophy, ie. they are a growth manager.
Growth can also be a reference to the characteristics of an asset class, ie. equities and real estate are growth assets.
Growth can be a reference to an investment philosophy, ie. they are a growth manager.
Growth can also be a reference to the characteristics of an asset class, ie. equities and real estate are growth assets.
Thursday, April 2, 2015
Main Reasons To Keep It Simple
The main reasons to ‘keep it simple’ in
the realm of investing are: (1) Added complexity does not necessarily add
value. (2) A simple approach focuses on the most important factors. (3) Keeping
it simple reduces the clutter and strips out the noise. (4) Something simple is
easier to understand and manage. (5) Keeping it simple promotes transparency which facilitates trust. (6)
Complexity/sophistication is associated with additional cost(s). (7)
Complexity/sophistication speaks more to the ego than the head. (8) A simple
approach helps take emotions out of the investing equation. (9) Simplicity reduces the temptation to make
changes. (10) A simple plan allows you to more easily determine whether the
advertised benefit is actually being delivered.
Wednesday, April 1, 2015
Keep It Simple
With more than 5,000 stocks, 7,700 mutual funds, 1,700 ETFs, 600 closed-end funds, 11,000 hedge funds and 3,000 private equity firms to choose from, investors could be excused for feeling a little overwhelmed. Throw in the industry jargon, the myriad investment approaches and the plurality of slick salesmen and investors are understandably intimidated by the financial markets and the financial services industry.
With that being the case, it is all the more important to cut through the clutter and reduce the investment equation to a manageable exercise. And so it doesn't hurt the case that the primary reason to ‘keep it simple’ is due to the fact that added complexity does not necessarily translate into added returns in the investment realm.
With that being the case, it is all the more important to cut through the clutter and reduce the investment equation to a manageable exercise. And so it doesn't hurt the case that the primary reason to ‘keep it simple’ is due to the fact that added complexity does not necessarily translate into added returns in the investment realm.
At a base level, the most simple form
of investing is the passive index fund. You buy all the companies in the index
in proportion to their weight. There is no attempt to beat the index. There is
no attempt to pick stocks. It does not require selecting an active manager. It
is simply “getting the market.” Beyond index funds everything else increases in
complexity and sophistication (and cost).
What 50 years of theory, research and
empirical evidence point to is the inability of active management on average to
beat the market. In fact, given the market is a zero sum game (one investor’s
gain in another investor’s loss) it is a mathematical tautology that the average
active manager will under perform the index by their fees over time.
The industry is expert at adding layers to obfuscate and increase charges.
With
these facts known, the question then becomes why do most investors continue to
pursue active management. The answer lies not in the evidence presented, but in
the nature of man and the desire to ‘beat the market.’ The industry knows this
and preys upon it. In fact, the industry expertise has always resided in sales and marketing. Investment
management and the promise of returns is simply the cart by which the industry fastens
itself to investors in order to generate high returns for itself and its shareholders.
The promise of
returns and beating the market is much more alluring that honestly conveying
the odds of that endeavor and the reality of helping investors wait patiently. But
there are other reasons why keeping it simple is a great principle to subscribe
to. In a world of increasing complexity, a more simple approach is
not only more reasonable and provides better odds of success, but is much easier
to understand and manage (not to mention measure performance against). Complexity and
added sophistication goes hand in hand with lower transparency and higher
costs. And a vast body of research demonstrates, that all else being equal,
higher costs equal lower long term returns.
In summary, a simple approach increases the odds of success, is easier to manage, creates
understanding and engenders greater trust. It isolates the factors that count
and strips away the ancillary noise as it gets to the heart of the matter.
Inherent Conflict of Interest In Financial Services (and virtually any for profit endeavor)
Keep in mind that when you are dealing with a
financial services firm you are dealing with a for profit entity. The goal of
every for profit entity is to maximize its return to shareholders. Financial
services firm’s balance their ability to take advantage of human nature (which they are very good at and have a lot of knowledge of) with seeking to maximize their
own profits. There is an inherent, built-in conflict of interest.
That is not to say that some financial services companies and financial
services providers aren’t helpful or don’t really try to do the best for their
clients, it is only to say that there is a temptation – usually embedded in the
incentive structures – to lead with your own self interest vs the self interest
of the client.
The Paradox of Skill
With all the amazing changes and “advancements” in finance
over the last thirty years, you would think they had figured out how to beat the
market. In fact, it is getting harder and harder to beat the market. We call
this the “paradox of skill.”
As more and more technology and more and more
expertise is applied to beating the market, this increase in skill
paradoxically makes it more and more difficult to beat the market.
Just as
athletes today are bigger and stronger compared to athletes of yesteryear, so
to investment managers of today are smarter and quicker than ever before.
However, unlike improvements in athletic performance, there are no discernible
improvements in alpha (beating the market) by market participants. And not only
that, but it requires an incredibly long performance history to gather
sufficient data to make any statistical inferences as to whether outperformance
was a result of skill vs luck.
Good luck with that.
The Trap That Is The Financial Markets
-->
Whenever you deal with the future, you are dealing with the
unknown and uncertainty. Multiply that by millions of moving parts and you have
the financial markets.
The financial markets are something that offers hope and excitement, all the while
enticing you to make any number of cognitive mistakes - much like a casino.
A Rough Estimate
At a pinch, I would guess that the financial services industry has
spent more than $2 trillion dollars on information systems, computing power,
and investment expertise over the last thirty years. The end result has been a net decline in alpha.
Every penny spent has actually resulted in a net decrease in ability to produce
above market results. Notch that up to the "paradox of skill."
What would be interesting also, is to gauge how much the industry has spent on sales and marketing.
One day I am going to take a much closer look at these areas and get a better idea of the money spent (compared to the amount of value added for investors).
Should Investing Be Fun?
Should investing be fun? Yes, in the sense that seeing your
money grow is fun. But no, investing should not be pitched as a fun thing
because it cannot deliver on that promise. Nobody has control over the markets
and as a result, if your fun is conditional upon positive outcomes, then you
are setting up for disappointment.
The industry is prone to overpromising and underdelivering.
It cannot deliver on any promise of performance (just look at the disclaimer on
every investment product sold). And yet, investors are sold on outperformance
and the hope they have the right manager. This is an easy sale. Much easier
than educating investors what are realistic expectations and how things
actually work.
Some Notes On The Financial Services Industry and the Investor Experience
Most investors do not want a professional to help them. They
are afraid they will be sold to and are happy avoiding that awkward situation.
They are comfortable managing their accounts online and are just as happy to
avoid a salesman when managing their investment affairs. There is an inherent
skepticism toward the industry, its institutions and the representatives of the
industry.
Parts of the investment advising function are getting
commoditized by technology, including risk assessment, asset allocation,
account aggregation, rebalancing, tax optimization and reporting. Parts of the
investment management function are also getting commoditized by technology
including, security selection, portfolio construction, evaluation, performance
measurement, and portfolio attribution.
The key to success in investment advisory is creating a
great customer experience. This requires not only problem solving skills and
the development of financial solutions, but education skills, communication
skills, and listening and empathy skills.
***inspired by an article in CFA Institute Magazine
Tuesday, March 31, 2015
An Idea Whose Time Has Come
Laurence Siegel et al of his ilk have really thrown a gauntlet to the financial services industry.
But first: I don't like Laurence's close ties and basic advocacy of insurance products and insurance companies - because I don't trust them (they are run by actuaries with ROI hurdle rates on products). Because insurance companies can't control market returns they control their shareholder returns by embedding high costs into their products to cover their business and market risk.
Having said that, Laurence has outlined a simple, robust way for the industry to meet and support the post retirement needs of retirees. To this end he advocates the creation of new low cost annuity companies insulated from corporate default risk structured as follows:
These ideas are something the industry should, and can easily do, but won't because it can't make money from it. Someone will no doubt have a go at it but are likely to struggle. It will be a number of years before the industry mutates toward this model.
But first: I don't like Laurence's close ties and basic advocacy of insurance products and insurance companies - because I don't trust them (they are run by actuaries with ROI hurdle rates on products). Because insurance companies can't control market returns they control their shareholder returns by embedding high costs into their products to cover their business and market risk.
Having said that, Laurence has outlined a simple, robust way for the industry to meet and support the post retirement needs of retirees. To this end he advocates the creation of new low cost annuity companies insulated from corporate default risk structured as follows:
- Separate corporate structure insulated from financial exposure to affiliated companies.
- All reserves held in default-free Treasury bonds and TIPS and properly hedged to the liability as closely as possible at all times.
- “Participating” policies, so that any longevity surprises are
used to reduce annuity benefits proportionally instead of forcing the
insurer to default entirely on some of the benefits (after going
bankrupt)
Advocate for setting up a 20 year TIPS ladder based on expected withdrawal rate complemented by a deferred income life annuity to protect against longevity risk.
- Very broad participation so there is little adverse selection.
Withdrawal rate or spending rate based upon an annually recalculated variable annuity (ARVA).
These ideas are something the industry should, and can easily do, but won't because it can't make money from it. Someone will no doubt have a go at it but are likely to struggle. It will be a number of years before the industry mutates toward this model.
Monday, March 30, 2015
Too Binary, Too Static...Not Out Ahead Of It
It is not that I don't know the main factors related to financial markets and investment decision making or the nuances with respect to said factors, but I find myself too binary in my thinking. All too often I read an article which highlights an important principle or issue which I was aware of and/or agree with, and wonder to myself why didn't I write that.
I find myself too binary. Too static. Even though I know all the issues and am aware of the balls in play, I struggle to get ahead of the herd.
I find myself too binary. Too static. Even though I know all the issues and am aware of the balls in play, I struggle to get ahead of the herd.
Tuesday, March 24, 2015
M&A Activity - Blistering (In More Ways Than One)
3G Capital (Warren Buffett) in talks to buy Kraft foods. Seems to me we are seeing no let up in acquisitions or mergers. This leads me to believe we are still some way from the bull market capitulation. Usually 6-9 months after the last major deals.
We have seen 297 deals in the $1b+ range over the last year, 211 in the $500m-$1b range, and 326 in the $250m-$500m range. Collectively, more than $1.86 trillion in deals over the last year.
Lots of deals. Lots in the healthcare space. A lot of misallocated capital coming down the pike.
We have seen 297 deals in the $1b+ range over the last year, 211 in the $500m-$1b range, and 326 in the $250m-$500m range. Collectively, more than $1.86 trillion in deals over the last year.
Lots of deals. Lots in the healthcare space. A lot of misallocated capital coming down the pike.
Wednesday, March 18, 2015
6 Year Bull Market Covers Over Essence
A rising market blinds. Everyone who has held a long position in the market is a genius.
It blinds you to who is skillful and who is just riding the trend. Hint: 95% are riding the trend (but attributing their good fortune to their own skill).
The next major market correction will provide another flush. That is how markets work. Not because they have some innate mental calculation embedded in them, but because markets and their extremes are a reflection of human nature and human psychology.
Many amateur wannabes will be caught in the downdraft because they misunderstood that their returns were due to serendipitous good fortune and not of their own making.
Buffett was right"only when the tide goes out do you discover who has been swimming naked."
It blinds you to who is skillful and who is just riding the trend. Hint: 95% are riding the trend (but attributing their good fortune to their own skill).
The next major market correction will provide another flush. That is how markets work. Not because they have some innate mental calculation embedded in them, but because markets and their extremes are a reflection of human nature and human psychology.
Many amateur wannabes will be caught in the downdraft because they misunderstood that their returns were due to serendipitous good fortune and not of their own making.
Buffett was right"only when the tide goes out do you discover who has been swimming naked."
Friday, March 13, 2015
The Blinders of Thinking You Did It Yourself
We attribute good results to our own intelligence and good decisions, and we attribute bad results to poor luck or circumstance. This is the nature of man.
Cassandra Does Tokyo captures some of the fallacy of this narcissism in a recent post:
Giving is easy - taking is hard
http://nihoncassandra.blogspot.com/2015/03/giving-is-easy-taking-is-hard.html
...How quickly investors forget. If you'd asked large asset owners in late 2008, or early 2009: "Would you give up a tranche of the future capital gains in asset prices in exchange for a floor under prevailing prices, and the near-assuredness of significantly higher asset prices in the future?", I am quite sure of the answer, given the widespread systemic fears and paucity of alternatives at the time. Investors, after all, pay 2&20 to HFs and PE for essentially the same (pre-tax) premise. Was not QE effectively the same proposition multiplied across the entire economy? The liquidationist alternative was clearly unpalatable to asset owners, and sub-optimal for nearly everyone else. IF, as the result of a policy directive, you bestow large windfall gains, it would be only fair to harvest a an additional share of those for the Public's Interest, since the goal of QE policy was NOT to further stoke inequality, nor accelerate the growth of fortunes for existing asset owners, but rather to prevent unnecessary liquidation, and deflation so private-sector balance sheet deleveraging could work its course, and to foster stability, so reviving private investment decisions in the real economy. But, as it happens, giving is far easier than taking away - irrespective if you're a welfare deadbeat (not my language) or a leveraged rentier...
...Asset owners peculiarly act as if such windfalls somehow resulted from their own brilliance. Many, through every over-leveraged fault of their own, were a pubic-hair's breadth away from financial obliteration, saved by US - and I don't mean the United States, but rather you, and I, as representations of the taxpayer, or bag-holder as the ultimate underwriter of newly issued debt. Others - particularly in the tech world and on the left coast - are blind to the benefits wrought by munificence of The People, and the abundant liquidity finding its way into every inane crevice, and spilling over to provide VC's and PE investors exits at multiples unimagined even three years ago. And the "thanks" that all those west-coast libertarians afflicted with self-attribution bias, is to piss on the under-class who serve them, and wish for a Randian offshore tax-haven to insure they share as little as possible with the undeserving multitudes. These gripes are academic, but asset-owners would do well to reflect upon their self-attribution bias...
Cassandra Does Tokyo captures some of the fallacy of this narcissism in a recent post:
Giving is easy - taking is hard
http://nihoncassandra.blogspot.com/2015/03/giving-is-easy-taking-is-hard.html
...How quickly investors forget. If you'd asked large asset owners in late 2008, or early 2009: "Would you give up a tranche of the future capital gains in asset prices in exchange for a floor under prevailing prices, and the near-assuredness of significantly higher asset prices in the future?", I am quite sure of the answer, given the widespread systemic fears and paucity of alternatives at the time. Investors, after all, pay 2&20 to HFs and PE for essentially the same (pre-tax) premise. Was not QE effectively the same proposition multiplied across the entire economy? The liquidationist alternative was clearly unpalatable to asset owners, and sub-optimal for nearly everyone else. IF, as the result of a policy directive, you bestow large windfall gains, it would be only fair to harvest a an additional share of those for the Public's Interest, since the goal of QE policy was NOT to further stoke inequality, nor accelerate the growth of fortunes for existing asset owners, but rather to prevent unnecessary liquidation, and deflation so private-sector balance sheet deleveraging could work its course, and to foster stability, so reviving private investment decisions in the real economy. But, as it happens, giving is far easier than taking away - irrespective if you're a welfare deadbeat (not my language) or a leveraged rentier...
...Asset owners peculiarly act as if such windfalls somehow resulted from their own brilliance. Many, through every over-leveraged fault of their own, were a pubic-hair's breadth away from financial obliteration, saved by US - and I don't mean the United States, but rather you, and I, as representations of the taxpayer, or bag-holder as the ultimate underwriter of newly issued debt. Others - particularly in the tech world and on the left coast - are blind to the benefits wrought by munificence of The People, and the abundant liquidity finding its way into every inane crevice, and spilling over to provide VC's and PE investors exits at multiples unimagined even three years ago. And the "thanks" that all those west-coast libertarians afflicted with self-attribution bias, is to piss on the under-class who serve them, and wish for a Randian offshore tax-haven to insure they share as little as possible with the undeserving multitudes. These gripes are academic, but asset-owners would do well to reflect upon their self-attribution bias...
Thursday, March 12, 2015
Red herring - Yield that counts
Red herring - distracting attention from an issue by introducing an irrelevant issue or one that is only superficially related to the one being discussed.
I am not sure that is the right fallacy to be using here, but I am sure a fallacy is carried out when investors focus on dividend yields or buyback yield and neglect the true yield (Earnings or FCF Yield).
The equivalent canard in done in the return area when investors focus on dividend yield or buyback yield when they should be looking at total return (capital appreciation + income).
The yield (equity) investors should be concerned with is the earnings yield (not the dividend yield and/or the buyback yield).
With investors searching for, and in many cases chasing yield, they are often focused on the wrong thing.
Earnings yield translates into ROE.
Keep that in mind the next time someone wants to talk about dividends and yields. Yield chasers are making an error of false alternatives by neglecting to focus on total yield (aka Earnings Yield).
I am not sure that is the right fallacy to be using here, but I am sure a fallacy is carried out when investors focus on dividend yields or buyback yield and neglect the true yield (Earnings or FCF Yield).
The equivalent canard in done in the return area when investors focus on dividend yield or buyback yield when they should be looking at total return (capital appreciation + income).
The yield (equity) investors should be concerned with is the earnings yield (not the dividend yield and/or the buyback yield).
With investors searching for, and in many cases chasing yield, they are often focused on the wrong thing.
Earnings yield translates into ROE.
Keep that in mind the next time someone wants to talk about dividends and yields. Yield chasers are making an error of false alternatives by neglecting to focus on total yield (aka Earnings Yield).
Tuesday, March 10, 2015
Reaching For Yield
For the past forty years, investors were accustomed to bond yields sufficient to generate enough income to cover the traditional 4% withdrawal rate. With the 30 yr bond trading below 3% and the 10 yr bond trading below 2.5%, this approach has become much harder to achieve in current markets.
Bonds are still a portfolio diversifier, but with in the current low yield environment they offer lower returns and less portfolio protection than they have in the past. As a result, many investors are seeking higher yields elsewhere and in the process are incurring higher risks than what they may have bargained for. Here are the main trade-offs:
Action Effect
Overweight high-yield bonds Increases credit risk/increased volatility
Overweight longer term bonds (extend duration) Increases interest rate risk
Overweight dividend paying stocks Skews exposure to certain sectors
Shift from bonds to dividend paying stocks Increases portfolio's overall volatility and risk
Investors need to keep in mind that concentrating assets in higher yielding investments can lead to increased risk and volatility. These strategies can be damaging to your portfolio's overall health.
An alternative to reaching for yield by moving out on the risk-return spectrum is to take a total return approach (viewing your portfolio from both a capital appreciation and a yield perspective), harvesting capital gains (which incidentally is often more tax efficient than receiving interest income) to make up withdrawal needs.
Bonds are still a portfolio diversifier, but with in the current low yield environment they offer lower returns and less portfolio protection than they have in the past. As a result, many investors are seeking higher yields elsewhere and in the process are incurring higher risks than what they may have bargained for. Here are the main trade-offs:
Action Effect
Overweight high-yield bonds Increases credit risk/increased volatility
Overweight longer term bonds (extend duration) Increases interest rate risk
Overweight dividend paying stocks Skews exposure to certain sectors
Shift from bonds to dividend paying stocks Increases portfolio's overall volatility and risk
Investors need to keep in mind that concentrating assets in higher yielding investments can lead to increased risk and volatility. These strategies can be damaging to your portfolio's overall health.
An alternative to reaching for yield by moving out on the risk-return spectrum is to take a total return approach (viewing your portfolio from both a capital appreciation and a yield perspective), harvesting capital gains (which incidentally is often more tax efficient than receiving interest income) to make up withdrawal needs.
Monday, March 9, 2015
Solving the failure to deliver problem!
The financial advisory industry has a problem. For years it promoted active management and beating benchmarks. To wit, it is slowly but surely realizing it cannot deliver on those implicit contracts. And to make matters worse, the industry is promoting performance based outcomes when it has no control over the performance or the outcomes. The marketing gurus are going to have to put their thinking caps on and come up with a solution. And this is what they are doing! The solution from what I hear is to redefine success from beating a benchmark to being on track to meet a long term goal and to focus on process. I think the focus on process is a positive (along with tax & estate planning). But the redefinition of success seems to be a fudge or smokescreen for underperformance. Something along the lines of "the greatest trick the Devil ever pulled was convincing the world he didn't exist" translated to "the greatest trick the financial advisory industry ever pulled was convincing investors that underperformance was overperformance" or when in doubt redefine the benchmark.
Ultimately I think the industry will paint itself in a corner again. The irony is that Charlie Ellis has been pointing in the right direction for years (putting asset management outcomes in the context of educated investment counsel). The problem is the industry cannot adopt his suggestions because it means losing a lot of money. This is how deeply entrenched systems work. Vested interests cling to the old ways even as the foundations are eroding all around. Eventually a catastrophic collapse takes place and the foundations are rebuilt anew from the rubble.
Ultimately I think the industry will paint itself in a corner again. The irony is that Charlie Ellis has been pointing in the right direction for years (putting asset management outcomes in the context of educated investment counsel). The problem is the industry cannot adopt his suggestions because it means losing a lot of money. This is how deeply entrenched systems work. Vested interests cling to the old ways even as the foundations are eroding all around. Eventually a catastrophic collapse takes place and the foundations are rebuilt anew from the rubble.
Friday, March 6, 2015
Zero Hedge - The Flipside of the Sellside
I read Zero Hedge everyday. I find the writing witty, pithy and insightful. They are my news source of choice when I want comment and insight to either breaking news or other issues that warrant understanding.
It boggles my mind that they have been so unrelentingly wrong (at least from a helping people make money perspective). It just proves the adage that perma-bear arguments always sound more insightful and compelling than the conflict ridden cheerleading of Wall St.
Zero Hedge is going to be right one of these days. That is just how it works. As they say, even a broken clock is right twice a day. They will likely do numerous victory laps and tout their superiority from the rooftops. When they do, they will exhibit the same lack of integrity as the Wall St shrills they take shots at everyday.
Caveat emptor!
It boggles my mind that they have been so unrelentingly wrong (at least from a helping people make money perspective). It just proves the adage that perma-bear arguments always sound more insightful and compelling than the conflict ridden cheerleading of Wall St.
Zero Hedge is going to be right one of these days. That is just how it works. As they say, even a broken clock is right twice a day. They will likely do numerous victory laps and tout their superiority from the rooftops. When they do, they will exhibit the same lack of integrity as the Wall St shrills they take shots at everyday.
Caveat emptor!
Wednesday, March 4, 2015
What Is Market Efficiency?
No one knows what intrinsic value really is. That is what makes a
market. Myriad investors with different amounts of money, different levels of
sophistication and different motives place their bets and the current market price
is where that supply and demand meet.
I believe there is such a thing as intrinsic value. However, intrinsic value is in the eye of the beholder (different investors use different discount rates, different growth and profitability assumptions, different multiples) and is better looked at as something within a band or range of values (as compared to a singular point estimate). At a micro level that band is narrower for individual companies than it is for the market as a whole. As you add companies to the investment universe, the number of factors, level of uncertainty and multitude of different individual value ranges expands the general market's intrinsic value range.
So, for example, a company's intrinsic value may range between $18-$22 given all currently available information. This might translate to a multiple of 14x-16x based on an historic average multiple of 15x. This does not mean a company's stock will be priced within its intrinsic value range. Conversely, the general market's intrinsic value may range between $16-$24 based on cumulative individual valuations with a multiple ranging from 12x-18x based on a historic average multiple of 15x.
When the market price (and a company's price) is within its intrinsic value range you should go with the trend (momentum). When the market price goes outside its intrinsic value range that is when you should adopt a contrarian or mean reversion position.
80% of the time, the market trades within its intrinsic value range. But there are times when "animal spirits" (whether fear or greed) commandeer the zeitgeist and lead to exploitable inefficiencies (playing defense when things are overcooked and offense when things are falling apart).
I believe there is such a thing as intrinsic value. However, intrinsic value is in the eye of the beholder (different investors use different discount rates, different growth and profitability assumptions, different multiples) and is better looked at as something within a band or range of values (as compared to a singular point estimate). At a micro level that band is narrower for individual companies than it is for the market as a whole. As you add companies to the investment universe, the number of factors, level of uncertainty and multitude of different individual value ranges expands the general market's intrinsic value range.
So, for example, a company's intrinsic value may range between $18-$22 given all currently available information. This might translate to a multiple of 14x-16x based on an historic average multiple of 15x. This does not mean a company's stock will be priced within its intrinsic value range. Conversely, the general market's intrinsic value may range between $16-$24 based on cumulative individual valuations with a multiple ranging from 12x-18x based on a historic average multiple of 15x.
When the market price (and a company's price) is within its intrinsic value range you should go with the trend (momentum). When the market price goes outside its intrinsic value range that is when you should adopt a contrarian or mean reversion position.
80% of the time, the market trades within its intrinsic value range. But there are times when "animal spirits" (whether fear or greed) commandeer the zeitgeist and lead to exploitable inefficiencies (playing defense when things are overcooked and offense when things are falling apart).
Tuesday, March 3, 2015
Helter Skelter
It amazes me the extent to which I am harassed and harried when going into queues or getting into lines with lots of people around.
Basically I'm neurotic and have little appreciation for how good I actually have it in the modern world.
Just saying.
Basically I'm neurotic and have little appreciation for how good I actually have it in the modern world.
Just saying.
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