Bond ETF Idea: High Credit Quality Bonds (Tucker)

Monday, March 12th, 2012

First, the bad (and obvious) news: When it comes to investing, you can’t control returns.  Now, the good news: You can manage the amount of risk in your portfolio, and managing risk is one way of influencing returns.

Take, for example, the investment grade corporate bond space, which consists of bonds rated AAA all the way down to BBB-.  Until recently, most pooled investment vehicles such as ETFs and mutual funds offered investment grade access based on this typical definition.  With last month’s launch of the iShares Aaa-A Rated Corporate Bond Fund (NYSE Arca: QLTA), investors now have a tool for targeting a specific amount of credit risk within their fixed income investments and, more specifically, can eliminate exposure to BBB-rated bonds.

Why would an investor want to slice and dice the corporate bond space using credit quality?  I frequently speak with clients that have mandates that stipulate a minimum credit quality of A or higher for their bond portfolios. Just as many insurance companies and public unions have this requirement either by law or as a part of their investment policy statements, so do many individual investors feel generally uncomfortable with lower credit quality.  For both groups, QLTA provides the ability to stay at the upper tier of the quality spectrum, while also offering diversified exposure across sectors and maturities.

Because of the reduced exposure to lower rated bonds, there is a tradeoff in yield vs. broader indices (see graph below).  But the benefit of QLTA is that it allows investors to quantify what that tradeoff is worth.

We typically see clients using this in one of two ways.  First, as a complement to their broad corporate bond exposure (for example, the iShares iBoxx $ Investment Grade Corporate Bond Fund; NYSE Arca: LQD).  AAA to A bonds comprise about 71% of LQD, which means that 29% is BBB-rated bonds.  Adding an allocation to QLTA can tilt overall exposure toward the higher quality end of the spectrum.  And second, investors who are allocating their equity exposure to high quality companies can now take similar positioning in their fixed income portfolio.

* Index data for High Yield, Investment Grade Corporate and Corporate AAA-A. These are iBoxx $ Liquid High Yield Index, iBoxx $ Liquid Investment Grade Index and the Barclays Capital US Corporate Aaa – A Capped Index. Index constituents are subject to change.

Index returns are for illustrative purposes only and do not represent actual iShares Fund performance. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results. For actual iShares Fund performance, please visit www.iShares.com

Bonds and bond funds will decrease in value as interest rates rise. In addition to the normal risks associated with investing, narrowly focused investments typically exhibit higher volatility. The Funds are subject to credit risk, which refers to the possibility that the debt issuers may not be able to make principal and interest payments or may have their debt downgraded by ratings agencies. High yield securities may be more volatile, be subject to greater levels of credit or default risk, and may be less liquid and more difficult to sell at an advantageous time or price to value than higher-rated securities of similar maturity. Diversification may not protect against market risk.

Tags: Bbb, Bond Fund, Bond Portfolios, Corporate Bond, Credit Quality, Credit Risk, Diversified Exposure, ETF, ETFs, Fixed Income Investments, Individual Investors, Investment Policy, Investment Vehicles, Ishares, Launch, Lqd, Managing Risk, Maturities, Nyse Arca, Policy Statements, Public Unions, Typical Definition
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Take Guidance from Market Axioms

Wednesday, January 4th, 2012

As we approach the first trading day of 2012, it will be time well spent to review Arthur Huprich’s list of investment rules. Art is Senior Vice President and Senior Market Technician of Raymond James Equity Research. The list comes courtesy of Barry Ritholtz, writer of The Big Picture blog.

- Commandment #1: “Thou Shall Not Trade Against the Trend.”

- Portfolios heavy with underperforming stocks rarely outperform the stock market!

- There is nothing new on Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again, mostly due to human nature.

- Sell when you can, not when you have to.

- Bulls make money, bears make money, and “pigs” get slaughtered.

- We can’t control the stock market. The very best we can do is to try to understand what the stock market is trying to tell us.

- Understanding mass psychology is just as important as understanding fundamentals and economics.

- Learn to take losses quickly, don’t expect to be right all the time, and learn from your mistakes.

- Don’t think you can consistently buy at the bottom or sell at the top. This can rarely be consistently done.

- When trading, remain objective. Don’t have a preconceived idea or prejudice. Said another way, “the great names in Trading all have the same trait: An ability to shift on a dime when the shifting time comes.”

- Any dead fish can go with the flow. Yet, it takes a strong fish to swim against the flow. In other words, what seems “hard” at the time is usually, over time, right.

- Even the best looking chart can fall apart for no apparent reason. Thus, never fall in love with a position but instead remain vigilant in managing risk and expectations. Use volume as a confirming guidepost.

- When trading, if a stock doesn’t perform as expected within a short time period, either close it out or tighten your stop-loss point.

- As long as a stock is acting right and the market is “in-gear,” don’t be in a hurry to take a profit on the whole positions. Scale out instead.

- Never let a profitable trade turn into a loss, and never let an initial trading position turn into a long-term one because it is at a loss.

- Don’t buy a stock simply because it has had a big decline from its high and is now a “better value;” wait for the market to recognize “value” first.

- Don’t average trading losses, meaning don’t put “good” money after “bad.” Adding to a losing position will lead to ruin. Ask the Nobel Laureates of Long-Term Capital Management.

- Human emotion is a big enemy of the average investor and trader. Be patient and unemotional. There are periods where traders don’t need to trade.

- Wishful thinking can be detrimental to your financial wealth.

- Don’t make investment or trading decisions based on tips. Tips are something you leave for good service.

- Where there is smoke, there is fire, or there is never just one cockroach: In other words, bad news is usually not a one-time event, more usually follows.

- Realize that a loss in the stock market is part of the investment process. The key is not letting it turn into a big one as this could devastate a portfolio.

- Said another way, “It’s not the ones that you sell that keep going up that matter. It’s the one that you don’t sell that keeps going down that does.”

The table below depicts the percentage gain necessary to get back even, after a certain percentage loss.

- Your odds of success improve when you buy stocks when the technical pattern confirms the fundamental opinion.

- As many participants have come to realize from 1999 to 2010, during which the S&P 500 has made no upside progress, you can lose money even in the “best companies” if your timing is wrong. Yet, if the technical pattern dictates, you can make money on a short-term basis even in stocks that have a “mixed” fundamental opinion.

- To the best of your ability, try to keep your priorities in line. Don’t let the “greed factor” that Wall Street can generate outweigh other just as important areas of your life. Balance the physical, mental, spiritual, relational, and financial needs of life.

- Technical analysis is a windsock, not a crystal ball. It is a skill that improves with experience and study. Always be a student, there is always someone smarter than you!

Source: Barry Ritholtz, The Big Picture, January 1, 2010.

Tags: Apparent Reason, Axioms, Barry Ritholtz, Big Picture, Dead Fish, Equity Research, Guidepost, Human Nature, Investment Rules, Managing Risk, Market Technician, Mass Psychology, Pigs, Preconceived Idea, Raymond James, Senior Vice President, Short Time, Stock Market, Stop Loss, Underperforming Stocks
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Soros Backed IPO Adecoagro (AGRO) Provides Hard to Find Access to Farmland

Wednesday, January 26th, 2011

by Trader Mark, Fund My Mutual Fund

No matter what you think of George Soros’ politics, he has his nose in all the right places in the investment world.  I’ve long bemoaned the lack of avenues to invest in farmland for the regular investors – indeed aside from Argentina based Cresud (CRESY), I don’t think there is another option – but this week’s slate of IPOs brings us Adecoagro (AGRO).  This sort of thing won’t be hot money, but if you give me a 40 year horizon, I say arable land (or water) will be the best investments on earth.   And I’m not the only one:

• [Jun 5, 2008: NYTimes: Food is Gold, So Billions Invested in Farming]
• [Jun 14, 2008: Bloomberg: Farmland Reaps Bonanza for TIAA]
• [Jun 2, 2009: The Economist - Outsourcing's 3rd Wave - Buying Farmland Abroad]
• [Dec 31, 2009: Bloomberg - Ethopian Farmers Lure Investor Funds as Workers Live in Poverty]

Meanwhile I am sure all the attention in the short term will go to the hype machine that is the IPO of Digital Media.

—————————–

The English website can be found here

Adecoagro is currently one of the leading companies in the production of food and renewable energy in South America. Present in Argentina, Brazil and Uruguay, our main activities include the production of grains, rice, oilseed, dairy products, sugar, ethanol, coffee, cotton and cattle meat.

Since its creation in 2002, the company´s growth was based on the implementation of a sustainable efficient production model, working on its own land and managing risk through diversification.

Unfortunately, there is a lot of exposure to the politically unstable country of Argentina, but that has not stopped investors from giving Cresud a rich valuation.

Bloomberg gives us a closer look at the company

• Adecoagro SA, a farmland venture in South America that’s backed by billionaire George Soros, plans to raise as much as $429 million in an initial public offering in the U.S. as food prices surge. As much as 21.4 million new and 7.14 million existing shares will be offered for $13 to $15 each, the Luxembourg-based company said today in a U.S. Securities and Exchange Commission filing.
• The company’s main shareholders include Pampas Humedas LLC, an affiliate of Soros’s Soros Fund Management LLC, which owns about 34 percent and will reduce its stake to about 21 percent after the offering.
• As part of the offering, a subsidiary of Qatar’s Doha-based sovereign fund, which already owns 6.5 percent of Adecoagro, may buy as much as $100 million of the stock. The IPO is scheduled to price on Jan. 27, according to data compiled by Bloomberg.
• The company said in the filing it plans to use $230 million of the proceeds to build a sugar-cane processing plant in Brazil and may spend about $145 million on “the acquisition of farmland and capital expenditures required in the expansion of our farming business.”
• The new sugar mill in Ivinhema city, Brazil, will process 6.3 million tons of cane by 2017, more than doubling Adecoagro’s capacity to 11.5 million tons a year. The company said it may also use cash and more debt to fund the construction of the Ivinhema mill.
• Adecoagro grows rice, coffee, soybeans, wheat and corn in about 288,000 hectares (712,000 acres) of farmland, an area that’s bigger than Jacksonville, Florida. It owns 38 farms in Brazil, Argentina, and Uruguay that’s valued at a combined $784 million, the filing said.
• Adecoagro said it owns 21 farms in Argentina, 15 in Brazil and two in Uruguay. It operates rice processing facilities, has a dairy operation with 4,500 cows, owns two coffee processing plants, seven grain and rice conditioning and store plants and two sugar and ethanol mills.

IPOFinancial per TheStreet.com has more data:

• The company has seen its sales explode, with a CAGR of 48% from 2007 to 2009 and +38% improvement in the first three quarters of the year. Among the key factors for growth has been sales in corn and soybean, which are up +112% and +77%, respectively, in the first nine months of 2010 from the comparable period in 2009. That being said, the largest segments by total revenue remain rice and ethanol, the latter of which will expand production following the allocation of IPO proceeds.
• At first glance, it may be puzzling as to why a company growing so fast, with a reasonable debt structure, is still not recording an accounting profit. In reality, AGRO has had to incur non-cash expenses that have skewed its earnings. Even though higher food and cattle prices have increased sales, the accounting benefit is somewhat offset because the markup in total inventory value has made depreciation expenses much higher.
• In the first nine months of 2010, it incurred more than $100 million in charges as a result of faster depreciation and amortization. It also ran into a problem in its sugar market last year, as sugar prices fell by 50% from their early 2010 high of $30 before making a late-year recovery to a 30-year high.

No position

Copyright (c) Trader Mark, Fund My Mutual Fund

Tags: Arable Land, Argentina Brazil, Billionaire, Bloomberg, Brazil, Cresud Cresy, Dairy Products, Emerging Markets, energy, Ethanol, Farmland, George Soros, Gold, Hot Money, Hype Machine, Initial Public Offering, Investment World, Investor Funds, Leading Companies, Managing Risk, Oilseed, Production Model, Tiaa, Unstable Country
Posted in Brazil, Energy & Natural Resources, Gold, Markets, Oil and Gas | Comments Off

Niels Jensen’s Investment Outlook: The Dirty Dozen of Risks in 2011

Tuesday, January 25th, 2011

The Absolute Return Letter December 2010

“The Dirty Dozen”

“Risk concerns the deviation of one or more results of one or more future events from their expected value. Technically, the value of those results may be positive or negative.”

Wikipedia

The definition of risk

No, I am not going bonkers. Some egghead came up with this formula as a way to define risk, but we can do better than that. In the world of finance, risk is essentially the probability of an investment’s actual return being different from the expected return. As most of us are not overly concerned about actual returns being higher than expected, it is fair to say that in practical terms, risk is a measure of the probability of losing some or all of your investment.

Now, risk cannot always be quantified, and there is indeed a term for immeasurable risk. It is called uncertainty¹. Good investment management is founded on robust risk management or, as we ought to label it, the ability to manage uncertainty well. Many moons ago, a good friend with more grey hair than myself gave me the advice to focus on the management of uncertainty. His philosophy was that if you manage that well, over time, performance will take care of itself.

Now, I must confess that over time I have made my fair share of mistakes. Managing risk/uncertainty is a heck of a lot more difficult in practice than the mathematicians want us to believe. I am only human. I get carried away from time to time like most other investors. Unless you were born with the DNA of Warren Buffett, keeping emotions at bay when making investment decisions is far from easy.

Herding like sheep

However, getting carried away seems to be the norm rather than the

exception these days. Maybe it is just me getting older and more cynical, but all around me I see investors chasing the same ideas with little (apparent) consideration given to the elements of risk involved. Find me an investor who is not in love with emerging markets or, for that matter, commodities. I see this sheep-like mentality wherever I turn.

That observation gave me the inspiration to this letter. Please note that I do not provide an enormous amount of detail in this letter (who wants to read a 50 page newsletter?). Rest assured, though, that most if not all of the risk factors mentioned below will be discussed in the months to come.

Before going any further, though, I need to get one more thing off my chest. I get a lot of positive feedback on these letters but also a fair amount of criticism for being too negative. I will admit that the Absolute Return Letter has a ‘negative’ edge to it, but I do not view myself as a perma bear. In fact, right now, we are looking for opportunities to increase the equity exposure in our private client portfolios. So why the somewhat downbeat tone to the letter? Because, as I have already stated, investment management is about managing risk well; hence most of my time is spent on identifying what can go wrong.

Now, let’s get started. In the following I list a number of risk factors which I believe investors should give serious consideration, but I do not for one second pretend for that list to be exhaustive. Neither should you read anything into the order of which those risk factors are listed. If you want my assessment of how to rank the various factors, you need to take a look at the risk scatter chart at the end of the letter.

We begin our journey in the high yield space, which is another asset class currently prone to herding; however, I need not look any further than my own parents to understand the urge to invest in high yield bonds. Now in their mid 70s, they are desperate for a bit of income, and corporate high yield provides that better than most other asset classes. Multiply their situation with over 100 million retired – or nearly retired – people in Europe and North America, and you will understand why high yield spreads keep going down.

# 1:High yield spreads

We have done some research on high yield spreads in recent weeks, as we
were becoming increasingly uncomfortable with the tightening spreads. We began to wonder (risk factor # 1) if high yield spreads are priced for perfection? Are spreads getting so tight that one could even talk of a bubble, and could that bubble burst, should the US (and/or European) economy fall back into recession? There is no question that corporate high yield bonds are now priced for fair weather but, we believe, not yet for perfection (see chart 1). Keep a finger near the trigger but not yet on it.

Source: Kingdom Capital Management

# 2: Double dipping

Obviously, the fate of corporate bonds is closely linked to the well-being of the corporate sector. As we see things, the risk of double dipping (# 2) is currently more prevalent in the US than it is in Europe, so let’s focus on the US for now. The other day I came across some interesting stats on the US economy (all representing year-on-year changes), which may surprise one or two people:

• GDP growth rate +56%

• Personal Income +4.35%
• Savings Rate +23.91%
• Fixed Investment +5.37%
• Steel Output +10.32%
• Business Sales +8.86%
• Durable Goods Sales +12.2%
• Factory Shipments +7.21%
• Retail Store Sales +7.31%
• Factory Orders +17.18%
• Exports +12.58%

Source: Contrarian Musings

I find these numbers revealing, considering how much bad press the US economy actually gets at the moment. Yes, I know that recent comparisons have been easy vis-à-vis a very weak 2009 and, yes, I am aware that this is to a large degree rear mirror analysis. But the reality is that the US economy continues to confound. The weak spot continues to be the housing sector and, unfortunately for the economy as a whole, that is a very important sector.

Tags: Absolute Return, Commodities, Currency, Dirty Dozen, Egghead, Emerging Markets, Fair Share, Future Events, Good Friend, Grey Hair, India, Investment Decisions, Investment Management, Investment Outlook, Jensen, Managing Risk, Many Moons, Mathematicians, Neils, Niels Jensen, Probability, Risk Management, Time Performance, Uncertainty, Warren Buffett, Wikipedia
Posted in Commodities, Credit Markets, India, Markets, Outlook | Comments Off

Take Guidance from Market Axioms

Tuesday, January 4th, 2011

As we approach the first trading day of 2011, it will be time well spent to review Arthur Huprich’s list of investment rules. Art is Senior Vice President and Senior Market Technician of Raymond James Equity Research. The list comes courtesy of Barry Ritholtz, writer of The Big Picture blog.

- Commandment #1: “Thou Shall Not Trade Against the Trend.”

- Portfolios heavy with underperforming stocks rarely outperform the stock market!

- There is nothing new on Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again, mostly due to human nature.

- Sell when you can, not when you have to.

- Bulls make money, bears make money, and “pigs” get slaughtered.

- We can’t control the stock market. The very best we can do is to try to understand what the stock market is trying to tell us.

- Understanding mass psychology is just as important as understanding fundamentals and economics.

- Learn to take losses quickly, don’t expect to be right all the time, and learn from your mistakes.

- Don’t think you can consistently buy at the bottom or sell at the top. This can rarely be consistently done.

- When trading, remain objective. Don’t have a preconceived idea or prejudice. Said another way, “the great names in Trading all have the same trait: An ability to shift on a dime when the shifting time comes.”

- Any dead fish can go with the flow. Yet, it takes a strong fish to swim against the flow. In other words, what seems “hard” at the time is usually, over time, right.

- Even the best looking chart can fall apart for no apparent reason. Thus, never fall in love with a position but instead remain vigilant in managing risk and expectations. Use volume as a confirming guidepost.

- When trading, if a stock doesn’t perform as expected within a short time period, either close it out or tighten your stop-loss point.

- As long as a stock is acting right and the market is “in-gear,” don’t be in a hurry to take a profit on the whole positions. Scale out instead.

- Never let a profitable trade turn into a loss, and never let an initial trading position turn into a long-term one because it is at a loss.

- Don’t buy a stock simply because it has had a big decline from its high and is now a “better value;” wait for the market to recognize “value” first.

- Don’t average trading losses, meaning don’t put “good” money after “bad.” Adding to a losing position will lead to ruin. Ask the Nobel Laureates of Long-Term Capital Management.

- Human emotion is a big enemy of the average investor and trader. Be patient and unemotional. There are periods where traders don’t need to trade.

- Wishful thinking can be detrimental to your financial wealth.

- Don’t make investment or trading decisions based on tips. Tips are something you leave for good service.

- Where there is smoke, there is fire, or there is never just one cockroach: In other words, bad news is usually not a one-time event, more usually follows.

- Realize that a loss in the stock market is part of the investment process. The key is not letting it turn into a big one as this could devastate a portfolio.

- Said another way, “It’s not the ones that you sell that keep going up that matter. It’s the one that you don’t sell that keeps going down that does.”

The table below depicts the percentage gain necessary to get back even, after a certain percentage loss.

- Your odds of success improve when you buy stocks when the technical pattern confirms the fundamental opinion.

- As many participants have come to realize from 1999 to 2010, during which the S&P 500 has made no upside progress, you can lose money even in the “best companies” if your timing is wrong. Yet, if the technical pattern dictates, you can make money on a short-term basis even in stocks that have a “mixed” fundamental opinion.

- To the best of your ability, try to keep your priorities in line. Don’t let the “greed factor” that Wall Street can generate outweigh other just as important areas of your life. Balance the physical, mental, spiritual, relational, and financial needs of life.

- Technical analysis is a windsock, not a crystal ball. It is a skill that improves with experience and study. Always be a student, there is always someone smarter than you!

Source: Barry Ritholtz, The Big Picture, January 1, 2010.

Tags: Apparent Reason, Axioms, Barry Ritholtz, Big Picture, Dead Fish, Equity Research, Guidepost, Human Nature, Investment Rules, Managing Risk, Market Technician, Mass Psychology, Pigs, Preconceived Idea, Raymond James, Senior Vice President, Short Time, Stock Market, Stop Loss, Underperforming Stocks
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Jeffrey Saut: “Don’t Bet the Farm”

Wednesday, July 21st, 2010

by Jeffrey Saut, Chief Investment Strategist, Raymond James

“In 1965 Steve McQueen starred in The Cincinnati Kid, the classic poker movie of all time. This movie has so far saved me from becoming ultra-broke or ultra-rich. The climactic scene in the movie involves a showdown hand of five-card stud between Steve McQueen (“the Kid”) and Edward G. Robinson (“The Man”). This scene made an indelible impression on me during my school years. With three cards dealt, Robinson bets heavily on a possible flush, a stupid bet if there ever were one, particularly since McQueen has a pair showing. The pot gets bigger and bigger. McQueen ends up with a full house – aces over tens, which loses to Robinson’s straight flush. When Robinson turns his hole card, the jack of diamonds, McQueen looks as though he is going to throw up. He has been wiped out. The movie’s soundtrack is throbbing. Sweat is dripping down McQueen’s face, as he stares at Robinson’s hand in disbelief.”

… Frederick E. Rowe Jr., Forbes

I am familiar with cards, dice, and betting in general. While in college I supplemented the monthly stipend from my parents with the winnings from playing cards. The bluffing, the betting, the showdown was all great drama to me. Back then I learned the “one chip” rule. To wit, each time I won two chips I would put one of them into my pocket, not to be used again that night. When I entered this business in 1971 I found that same kind of strategy useful in managing risk. In the stock market’s case, while the human natures of fear, hope, and greed still play a large roll, I tended to substitute card players with the personalities of stocks, the market makers, the Fed, Washington, and the politicians. Using such strategies I found that if you do your homework, and manage the risk, the odds of success in the markets are much better than a card game. When you lose in the markets at least you get back most of your money (if you manage the risk) and the government shares in a portion of your losses via the capital gains/capital losses tax system. In a card game it tends to be basically all or nothing with each hand.

Subsequently, I practiced and honed my market skills in the early 1970s on a trading desk, chalking up my early “lumps” to learning the game and paying my dues. Later on I started winning fairly consistently by sticking with well-defined rules to guide my decisions and by managing the downside risk. Indeed, managing the risk is crucial, for like Mr. Rowe I too remember “The Cincinnati Kid” and while Steve McQueen made the “intelligent” bet (consistent with the odds), “The Kid” made one big error… you do not bet the farm no matter how good the hand looks. Or as one savvy seer suggests, “If you’re going to bet the farm, you had better have two farms!” Manifestly, in life, in cards, in the markets, anything can happen and you never take that “bet the farm” kind of chance because occasionally “The Man” hits the long-shot and you’re busted.

I reflected on mathematics, probabilities, and odds last week after again reading the book “Fortune’s Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street” by William Poundstone. The book centers on Claude Shannon, who in the late 1940s had the idea computers should compute using the now familiar binary digits 0s and 1s such that 1 means “on” and 0 means “off.” Shannon’s information theory is what lies behind computers, the Internet, and all digital media. As the book notes – when asked to characterize Shannon’s achievement, USC’s Solomon Golomb said, “It’s like saying how much influence the inventor of the alphabet has had on literature.” In 1956 Claude Shannon and John L. Kelly turned their skills on how to mathematically “win” at the casinos and eventually on how to “win” in the stock market. Those mathematical insights were subsequently employed by the phenomenally successful hedge fund Princeton-Newport Partners. While there were many formulas for their success (edge/odds; Gmax = R; etc), the manner in which Shannon rebalanced portfolios was elegantly simple. To reprise some lines from the book:

“Consider a stock whose price jitters up and down randomly, with no overall upward or downward trend. Put half of your capital into the stock and half into a ‘cash’ account. Each day, the price of the stock changes. At noon each day, you “rebalance” the portfolio… To make this clear: Imagine you start with $1000, $500 in stock and $500 in cash. Suppose the stocks halves in price the first day. This gives you a $750 portfolio with $250 in stock and $500 in cash. That is now lopsided in favor of cash. You rebalance by withdrawing $125 from the cash account to buy stock. This leaves you with a newly balanced mix of $375 in stock and $375 in cash. The next day, let’s say the stock doubles in price. The $375 in stock jumps to $750. With the $375 in the cash account, you have $1,125. This time you sell some stock, ending up with $562.50 in stock and cash. Look at what Shannon’s scheme has achieved so far. After a dramatic plunge, the stock’s price is back to where it began. A buy-and-hold investor would have no profit at all. Shannon’s investor has made $125.”

Tags: Card Stud, Chief Investment Strategist, Cincinnati Kid, Climactic Scene, Edward G Robinson, Full House, Hole Card, Human Natures, Indelible Impression, Jack Of Diamonds, jeffrey saut, Jr Forbes, Managing Risk, Playing Cards, Raymond James, Steve Mcqueen, Stipend, Straight Flush, Stupid Bet, Two Chips
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Common Sense from Marc Faber

Saturday, July 10th, 2010

This article is a guest contribution from Frank Holmes, U.S. Global Investors.

Dr. Marc Faber, the economist, investor and long-time member of the prestigious Barron’s Roundtable, offers up some good perspective on investing in his latest Monthly Market Commentary newsletter.

The title of the commentary is “One of the First Duties of the Investment Advisor is Educating the Masses not to Speculate,” and it’s worth grabbing out a few of his key points.

I feel that most investors take far too many risks – often with borrowed money – and fail to diversify sufficiently. They also have little patience, very short-term time horizons and no tolerance for losses. Finally, their expectations about investment returns are completely unrealistic… Most investors buy a stock or make an investment with the view that within a month the return should be between 10% and 20%.
A real return of around 4% per annum is about what an investor (exclusive of costs, and without making the mistake to buy “high” and sell “low”) could expect to achieve over longer periods of time… If you can achieve an annual average real return of just 3% on all your assets (inflation adjusted), you will leave a huge fortune to your children.
For the average investor like myself, I prefer diversification and no leverage. I have seen time and again investors (including myself) be right about an asset class’ future performance but fail to convert those views into any capital gains… All I wish to say to my readers who are not managing risk on a daily basis is that the prime consideration should always be capital preservation and avoiding large losses.

Behavioral finance research has identified many emotion-driven tendencies of investors that lead to suboptimal returns – overconfidence, chasing the herd, holding onto investments too long or holding onto them not long enough, and many more.

Marc’s points above are common-sense basics that investors should be reminded of every so often to help them make better long-term decisions.

Tags: Barron, Behavioral Finance, Capital Gains, Capital Preservation, Daily Basis, Diversification, Dr Marc Faber, Finance Research, Frank Holmes, Investment Advisor, Investment Returns, Managing Risk, Market Commentary, Prime Consideration, Roundtable, Sense Basics, Term Time, Time Horizons, Time Member, U S Global Investors
Posted in Markets | 1 Comment »

Myron Scholes takes on Nassim Taleb

Tuesday, May 19th, 2009

Myron Scholes, the Nobel prize winning theorist, and co-developer of the Black-Scholes theory for pricing risk, was interviewed by the New York Times last week, to discuss, among other things, Black Swan author Nassim Taleb’s recent thoughts on his risk pricing model. Here is an excerpt:

Q: In retrospect, is it fair to say that the idea that banks could manage risk was a total illusion?

A: What you’re saying is negative. Life is positive too. Every side of a coin has another side.

Q: The writer Nassim Nicholas Taleb contends that instead of giving advice on managing risk, you “should be in a retirement home doing sudoku.”

A: If someone says to you, “Go to an old-folks’ home,” that’s kind of ridiculous, because a lot of old people are doing terrific things for society. I never tried sudoku. Maybe he spends his time doing sudoku.

Q: Some economists believe that mathematical models like yours lulled banks into a false sense of security, and I am wondering if you have revised your ideas as a consequence.

A: I haven’t changed my ideas. A bank needs models to measure risk. The problem, however, is that any one bank can measure its risk, but it also has to know what the risk taken by other banks in the system happens to be at any particular moment.

Q: What good is a theory of risk management if it applies to one tree instead of the forest?

A: Most of the time, your risk management works. With a systemic event such as the recent shocks following the collapse of Lehman Brothers, obviously the risk-management system of any one bank appears, after the fact, to be incomplete. We ended up where banks couldn’t liquidate their risk, and the system tended to freeze up.

Also, as a addendum to this, Michael Lewis, bestselling author of Liar’s Poker, wrote an in-depth piece about the flaws in Black-Scholes theory in Portfolio Magazine. Here is an excerpt:

…Black-Scholes didn’t work; trillions of dollars’ worth of securities may have been priced without regard to the possibility of crashes and panics. But until very recently, no one has bitched and moaned about this problem too loudly. Lay folk might harbor private misgivings about the clergy, but as lay folk, they are reluctant to express them. Now, however, as the subprime market unravels, the beginnings of a revolt against the church seem to be taking shape.

…One of the revolt’s leaders is Nassim Nicholas Taleb, the bestselling author of The Black Swan and Fooled by Randomness and a former trader of currency options for a big French bank. Taleb can precisely date the origin of his own personal gripe with Black-Scholes: September 22, 1985. On that day, central bankers from Japan, France, Germany, Britain, and the United States announced their intention to torpedo the U.S. dollar—to reduce its value in relation to the other countries’ currencies. Every day, Taleb received a list of his trading positions from his firm and a matrix describing his risks. The matrix told him how much money he stood to make or lose, given various currency fluctuations. That September 22, when the central bankers announced their plan to lower the dollar’s value, he made money but didn’t know it. “I didn’t know what my position was,” he says, “because the movement was outside the matrix they’d given me.” The French bank’s risk-analysis program assumed that a currency crash of this magnitude would occur once in several million years and therefore wasn’t worth considering.

At some point a new theoretician will emerge as the risk-pricing deity, and most likely be the recipient of a Nobel Prize, but for now, it leaves me feeling that this subject falls into the sphere of unknown unknowns.

We thought we knew, but now we know we don’t know.

Sources: NYTimes.com | Portfolio.com

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