Category: Uncategorized
Hedge Fund Performance Poor for 2018 – Limited Alpha Generation
Hedge fund styles as measured by the HFR indices, on average showed negative performance for June. EM strategies were the hardest hit sector. The only bright spots were merger arbitrage, defensive strategies like global macro and relative value. The general decline in equity markets globally and more mixed performance in the US held back returns.
Strong Trends Across Most Asset Class Sectors Point to a Strong Opportunity Month
A review of trends in each of the major asset class sectors shows that there should be a strong return opportunities in July. Global stock indices are declining on trade war rhetoric and action. This growing sense of risk has spilled-over to bond markets through classic risk-on/risk-off behavior. Bonds have gained even with the threat of higher inflation. The dollar looks to continue its up trend as money flows back to the US and away from EM. Precious metal prices have fallen on the dollar strength. In spite of the Saudi’s willing to increase oil production in response to falling inventory, oil prices have continued to trend higher. Grain prices have fallen on fears of a trade war in agricultural exports to China. The general direction in commodity prices has been lower.
Risk Should Not Be Determined by Feelings of a Past Experience – Block the Perceptions and Focus on Some Numbers
Risk perception is often about pain and not probabilities. It is about the experience of risk not the mathematical chance or size of loss. I would like to say that everything about risk management is measurable and can be reviewed dispassionately, but that is not the case. There is often a difference between fear and facts and this is the perception gap which often leads to bad judgment. You may be a dispassionate risk assessor, but the market’s perception of risk may be driven by its weighted perception of the risk.
The Power Law, 80/20 Rule, and Concentration of Returns – What It Means for Money Managers
The power law has been become a strong fascination to me. We have been trained to generally think about the normal distribution. The law of large numbers has been pounded into our psyche since our first class in statistics but as you look more closely, the more relevant the power law becomes. Now, a normal distribution will produce extreme values. However, in a power law the extremes follow certain characteristics such that the “top few” are unbundled or more likely to have an extreme, (as opposed to a normal distribution where the “top few” are exponential and bounded).
Ride the Trend, but Remember What Is Possible
“I am not an optimist. I am a very serious possibilist.” – late statistician Hans Rosling.
“I am a trend-follower for both price and fundamentals. I am also a very serious scenario realist.”
How do investors reconcile potential storm clouds with optimistic trends in markets. There is ongoing information of long-term economic problems from a wide variety of sources today, yet many markets have continued to move higher and followed trends. There often seems to be disconnects between long-term peril or risks and shorter-term optimism. Some says this is the essence of a bubble market, a disconnect between price and fundamentals, yet avoiding trends based on yet to be realized threats can easily cause investors to avoid profitable opportunities.
Active Management Should Work Because Active Managers Work Hard – You Are Committing a Fallacy
Which is more likely? A manager who has successful returns, or a manager who has successful returns and gets up early, works hard all day, and spends half the night reading current research. Which one will you choose to run your money?
Tobin’s Separation Theorem – It Can Be Applied Anywhere
One of the greater principles of investment finance is Tobin’s separation theorem which is a powerful simple tool that can be used for any investment portfolio, but is especially useful when thinking about managed futures and alternative risk premiums. (Robin Powell reminded me of Tobin’s contribution in his essay, Can you really stomach the risk you’re taking?) There is a tremendous amount of useful investment advice through just applying the simplest of concepts.
The “Hedgehog and the Fox” Revisited – Have Managers with Big Ideas, But Diversify
The Greek poet Archilochus wrote, “The fox knows many things, but the hedgehog knows one big thing.”
Go Back to Basics with the Efficient Market Hypothesis – Think of it as a Base or Prior
The Efficient Market Hypothesis… has two components that I like to refer to with the terms No Free Lunch and The Price Is Right. The No Free Lunch component says that it is impossible to predict future stock prices and earn excess returns except by bearing more risk. The Price Is Right component says that asset prices are equal to their “intrinsic value,” somehow defined.
– Richard Thaler, “From Cashews to Nudges:The Evolution of Behavioral Economics”, American Economic Review 2018
Risk Preferences are not Stable – The Major Take-Aways
An important problem in finance is trying to properly incorporate risk preferences when forming portfolios. This is especially true if risk preferences are not stable. Yet, we have increasing evidence that risk preferences do change over time. (See article “Are risk preferences stable?” by Hannah Schildberg-Horisch in the Journal of Economic Perspectives Spring 2018 and illustration below.)
What Affects My Sleep This Week – DB, Brazil, and CMBS
Historian Deirdre McCloskey says, “For reasons I have never understood, people like to hear that the world is going to hell.”
John Stuart Mill wrote in the 1840s: “I have observed that not the man who hopes when others despair, but the man who despairs when others hope, is admired by a large class of persons as a sage.” from Morgan Housel “The Psychology of Money”
Trends Dominated by Bond Reversal, But Not Clear the Shock Rally Will Continue
I have always thought that the simple physics analogy that a market at rest will stay at rest and a market in motion will stay in motion is apt for trend-following. Trends will change when there is a shock or catalyst that will change the underlying fundamentals. Trend-following does not require knowing all of the reasons for why a trend is happening or why it may stop. Trend-following only requires that a signal is extracted and followed until price dynamics tell you otherwise. The success with trend-following is driven by the fact that trends last longer than expected. They last longer because most new information is trend reinforcing. Fundamentals do not generally change quickly. Nevertheless, loses will occur when new information causes an expectations reversal. Expectations may change more frequently than fundamentals.
Painful May Performance for International Equity and Bond Investing Requires More Caution with Diversification
May saw a set of return reversals with bonds posting gains on flight to quality while international markets saw strong return declines. Selected country equity declines were very strong based on increased political risks. It was a good month for those cautious and focused on US smaller cap names.