The Evolution of Portfolio Theory

A couple of thought pieces that contribute toward evolution of process. First Nassim Taleb was on CNBC yesterday and his two segments covered a lot of topics including his idea that I have referred to as putting 80% into various currencies (t-bills from various countries) and then going berserk (my word not his) with risk with the other 20%. While that will not be practical for too many folks it is an interesting glimpse into how he thinks about the role that risk should play. With his interview yesterday he appears to have tweaked this slightly. Instead of various currencies he said something that protects against inflation. From the context I took him to mean TIPS not commodities but of course you may draw a different conclusion from his comments. If he did mean TIPS then his idea looks a lot like what Zvi Bodie has been writing about for a long time. The other item was an article run at IndexUniverse by Katrina Sherrerd who is the COO of Research Affiliates. The first point of the article was about the need to keep learning or as she might put it the need to overcome ignorance. The context was investment advisors but it obviously pertains to do-it-yourselfers too. This was particularly interesting; The investment management industry tends to emphasize product—and its invariably linked goal of beating the benchmark—over education and counseling. And I am sure the people who bought the Apple linked debt who now stand to get put the stock a couple of hundred points above the current market would agree with too much emphasis on product. The...

The Evolution of Portfolio Theory

A couple of thought pieces that contribute toward evolution of process. First Nassim Taleb was on CNBC yesterday and his two segments covered a lot of topics including his idea that I have referred to as putting 80% into various currencies (t-bills from various countries) and then going berserk (my word not his) with risk with the other 20%. While that will not be practical for too many folks it is an interesting glimpse into how he thinks about the role that risk should play. With his interview yesterday he appears to have tweaked this slightly. Instead of various currencies he said something that protects against inflation. From the context I took him to mean TIPS not commodities but of course you may draw a different conclusion from his comments. If he did mean TIPS then his idea looks a lot like what Zvi Bodie has been writing about for a long time. The other item was an article run at IndexUniverse by Katrina Sherrerd who is the COO of Research Affiliates. The first point of the article was about the need to keep learning or as she might put it the need to overcome ignorance. The context was investment advisors but it obviously pertains to do-it-yourselfers too. This was particularly interesting; The investment management industry tends to emphasize product—and its invariably linked goal of beating the benchmark—over education and counseling. And I am sure the people who bought the Apple linked debt who now stand to get put the stock a couple of hundred points above the current market would agree with too much emphasis on product. The...

NOT How to Create Your Own Hedge Fund

The WSJ had a peculiar article about how to use ETFs to “create your own hedge fund.” The article isolated several hedge strategies, some recent performance data of these strategies at a broader index level and offered ETF combos to serve as proxies that would have delivered the same results for much less in the way of fees. The suggested hedge fund replicating ETF combos came from research done by William Bernstein who concluded that hedge funds can be mimicked with “varying amounts of just two ETFs, plus cash.” The two ETFs that Bernstein used for this were the iShares Russell 3000 Growth Fund (IWZ) and the Vanguard Russell 3000 ETF (VTHR)–so a total market fund of sorts and the growth slice of the total market. So to capture equity, relative value, event driven or macro hedge fund performance (the four categories cited in the article) all that needs to be done is combine the two funds and cash in different percentages. The article was not clear on the amount of time that was analyzed to draw these conclusions but there was a reference to how one of the combos did over the last two years. The last time I looked at the article there was only one comment and it called the portfolios ridiculous. Since the March 2009 low, hedge funds have broadly lagged the S&P 500 which the article attributes to hedge fund managers being too bearish (or skeptical?) for the last three and a half years. So, stated another way the various hedge strategies have lagged for being too bearish. One flaw in the article is...

NOT How to Create Your Own Hedge Fund

The WSJ had a peculiar article about how to use ETFs to “create your own hedge fund.” The article isolated several hedge strategies, some recent performance data of these strategies at a broader index level and offered ETF combos to serve as proxies that would have delivered the same results for much less in the way of fees. The suggested hedge fund replicating ETF combos came from research done by William Bernstein who concluded that hedge funds can be mimicked with “varying amounts of just two ETFs, plus cash.” The two ETFs that Bernstein used for this were the iShares Russell 3000 Growth Fund (IWZ) and the Vanguard Russell 3000 ETF (VTHR)–so a total market fund of sorts and the growth slice of the total market. So to capture equity, relative value, event driven or macro hedge fund performance (the four categories cited in the article) all that needs to be done is combine the two funds and cash in different percentages. The article was not clear on the amount of time that was analyzed to draw these conclusions but there was a reference to how one of the combos did over the last two years. The last time I looked at the article there was only one comment and it called the portfolios ridiculous. Since the March 2009 low, hedge funds have broadly lagged the S&P 500 which the article attributes to hedge fund managers being too bearish (or skeptical?) for the last three and a half years. So, stated another way the various hedge strategies have lagged for being too bearish. One flaw in the article is...

Defensive Action Started

True to our pre-planned strategy we started taking defensive action yesterday late in the trading day. Our initial step was for “large” accounts where having 30-35 holdings makes economic sense. We have not yet implemented defense for mid sized accounts (these use mostly sector ETFs) or small accounts (mostly broad based asset class funds). The idea here is that because mid and small accounts have few holdings there are fewer potential defensive trades to make so we move a little slower but will be taking action this week if the SPX is still below its 200 DMA. For anyone new we take defensive action when the S&P 500 goes below its 200 DMA. Specifically if it looks like the SPX will close below for a second day, we trade late in that second day. We start small because true bear markets give plenty of time to get out; look at how 2000 and 2008 both started slowly with more of a rolling over.  In our large accounts, the majority of our clientele, we sold ABB (ABB). From the top down we wanted to remove volatility and reduce sector exposure to a sector that would be especially hard hit if we are headed into a recession or bear market or both. The industrial sector is a good place to take this type of action for an account built at the sector level.  We covered this before but in the face of downturn this sector tends to get crushed. You can look at a long term chart of Caterpillar (CAT) to see this in action, CAT epitomizes the point. From the...

Defensive Action Started

True to our pre-planned strategy we started taking defensive action yesterday late in the trading day. Our initial step was for “large” accounts where having 30-35 holdings makes economic sense. We have not yet implemented defense for mid sized accounts (these use mostly sector ETFs) or small accounts (mostly broad based asset class funds). The idea here is that because mid and small accounts have few holdings there are fewer potential defensive trades to make so we move a little slower but will be taking action this week if the SPX is still below its 200 DMA. For anyone new we take defensive action when the S&P 500 goes below its 200 DMA. Specifically if it looks like the SPX will close below for a second day, we trade late in that second day. We start small because true bear markets give plenty of time to get out; look at how 2000 and 2008 both started slowly with more of a rolling over.  In our large accounts, the majority of our clientele, we sold ABB (ABB). From the top down we wanted to remove volatility and reduce sector exposure to a sector that would be especially hard hit if we are headed into a recession or bear market or both. The industrial sector is a good place to take this type of action for an account built at the sector level.  We covered this before but in the face of downturn this sector tends to get crushed. You can look at a long term chart of Caterpillar (CAT) to see this in action, CAT epitomizes the point. From the...