Category: Uncategorized
Financial Conditions – No Signal of Tightening. Trend Says Stay the Course with Risky Assets
The Fed has become more focused on financial market conditions since the Financial Crisis. There is less interest in the classic goal of managing full employment since by many measures we may beyond the natural rate of full employment, and there is admitted confusion on how to control inflation.
Equity Asset Class Value Rotation – Look Outside the US for Upside and Protection
The talk has focused on the overvaluation and “bubble” with US stocks, but there are other relative opportunities in risky equity assets. A comparison of CAPE across the world shows that the UK, euro area, and Japan valuations are closely tied together, significantly below highs from 2008, and all relatively cheap versus US.
“Risk of a Rapid Repricing in Global Markets” – (ECB) With this Narrative, Investors Need Strategies that Generate Portfolio Gamma
“Risk of a rapid repricing in global markets”; this ECB quote was a key talking point in the press release from the ECB Financial Stability Report issued last week. Note that “rapid repricing” is a polite way of saying asset price declines.
Hedge Fund Performance Mixed, but some Bright Spots with Fundamental Growth and Systematic Macro
Hedge funds returns were mixed for November, but the fundamental growth and systematic macro strategies generated strong returns of over 1 percent. The fundamental growth strategy is the HFR leader for the year with a return profile at over 17%. The macro systematic strategy again generated a strong positive return. The HFR macro systematic index return was significantly higher than other systematic indices for November which suggest a high dispersion across managers in this category. The macro/ CTA which includes discretionary managers was actually down for the month. The absolute return, special situations, and emerging markets strategies were the biggest down strategies for the month, but all showed declines of less than one percent.
Sector Return Performance for Equities Strong across the Board – Hold Overweight in Equities
Equity style sectors were strong across the board with only emerging markets posting a negative November return; however, emerging markets have been the best performing sector year to date. The value index showed a strong gain although it still lags the growth index year-to-date. Trend indicators are all positive except for emerging markets and the short-term trend in the small cap index. Price indicators suggest that there is no reason to cut equity exposures.
Trends Signals Still Mixed in Many Asset Classes – Long US Equity Indices Still Strongest Signal
Trend behavior last month was mixed for many CTA managers. The allocation weights had a significant impact on November performance. We believe there may again be significant dispersion in performance because trend dispersion is high. For example, US stock indices show strong up trend signals while non-US stock indices are showing clear short signals. The opposite is the case for bonds where US bond signals are for short positions while non-US bonds signals point to long positions.
Stocks Continue Their Strong Performance – Hard to Fight Equity Trends; The Opportunity Cost of not Following Trends is High
A combination of good economic growth news and a fiscal policy tailwind again drove US equity markets. The discounting of a US fiscal accelerant shows up in the positive US-global return differential for the November.
Expected Yields and Returns for Bonds are Still Low – Go Get More Alternatives
The asset allocation decision concerning the addition of alternative investments, especially for diversification strategies, is actually quite straightforward. One, find strategies that have low and stable correlations with stocks and bonds. Two, find strategies that have a minimum acceptable return that will beat a traditional diversifier.
Normalcy for Stock Bond Correlation Says You Need Other Forms of Diversification
The bond diversification story is based on the strong negative correlation between stocks and bonds that has existed for over a decade, yet it is not a given that stocks and bond returns will move in opposite directions. A quick look at a very long history from a Wellington Management chart tells us that the negative correlation is the exception not the rule.
Strategic Asset Allocation – Adding Value in a Low Returns Worlds
Strategic asset allocation as the name implies requires long-term return assumptions. There are often wide variations in the future forecasts. Many forecasts we have surveyed show positive expected returns, but the numbers are significantly lower than what investors have seen historically since the Financial Crisis. In general, Research Affiliates provides a good tool for analyzing the past and expected returns that we find helpful.
Holding Period Diversification – Investing with Hedge Fund Managers that have Different Trading Time-Frames Adds Value
Diversification can come in many forms. One that is not often discussed is holding period diversification or the time- frame used for making a trading decision. Some strategies are successful based on the expected holding period of the investment and not just the trading process employed. For example, there could be two price-based systematic managers who use similar models, yet they will get very different returns based the calibration of the holding period, short-term versus long-term. In the case of trend-followers, there are some trends that last only a short-time and can only be captured through trading a short time-frame versus other trends that can last for weeks, months, or quarters. These are captured differently based on the look-back or speed of the models.
Changing the Risk Profile from Credit to Macro – Take Away Liquidity Risk and Switch Alternative Risk Premiums
Investors should have a growing concern with the reach for yield in the current market. The reach for yield has pushed investors into illiquid issues where the risk profile has changed from credit/carry to credit/carry/illiqudity. Investors will generally receive a higher premium if an asset is illiquid. Unfortunately, illiquidity premiums are hard to measure; consequently, the traditional credit betas will not be properly measured and there could be the mistaken view that there is greater alpha from managers who hold these types of assets.
Ivy League Performance – Competing With Top Tier Endowments Can Be Done
The latest performance numbers for Ivy League endowments have been nicely displayed in the chart below along with the 60/40 stock/bond portfolio. Since the development of the “endowment” model associated with Yale and the attention on Harvard, the largest endowment, there has been an unusual focus on these funds. There is a fair amount of dispersion between the best and worst managers in the group.