Monthly Archives: May 2011

Investment Decisions and Behavioral Finance

Our ability to find real patterns is a mark of our intelligence, but our intelligence often backfires, as when we identify illusory patterns as real. Imagine that we are facing machines with two levers marked S and B. The machines dispense nothing if we pull the worng lever but they dispense $10 if we pull the right one. We’ll get to pull levers many times. A pattern is programmed into the machine but we do not know what it is… How would we go about the task if we want to get the most money out of the machines? Continue reading

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A Redefined Landscape Requires An Updated Map

Imagine creating a map 250 million years ago during the supercontinent phase of Pangaea. You are probably long overdue for an update. Similarly, there is a paradigm shift that is taking place among the investment management community. It is evolving slowly and growing out of necessity. Let’s refer to these strategies as “traditional” and “new normal.” I only suggest “new normal” because it is an already popularized phrase used to describe a time period with a new landscape. The difference between portfolio strategy from the traditional perspective and the new normal perspective is constraint; time constraint, weight constraint and, most importantly, mental constraint.

With time constraint, I’m referring to holding periods with long-term philosophies. With weight constraint, I’m referring to maximum mandated percentages of particular holdings or asset classes. What establishes the prior two obstacles is an emphasis on history; an emphasis that constrains the possibility of what a portfolio structure should resemble in the future. If this is a new normal economic period, it stands to reason that portfolio strategy should be redefined as well. Continue reading

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Past Performance Does Predict Future Performance

Market predictions can be made for several reasons: industry fundamentals, technical analysis, etc. However, the most influential factor in market predictions is past performance. The psychological mindset of the investor dominates the assessment of the future. This is obviously an unintended and unwanted circumstance. Successful long-term investing requires the elimination, or significant reduction, of this behavioral risk. Predictions are not inherently bad. But it is less about the prediction itself and more about the hypothesis that created it. Continue reading

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When the tipping point arrives, how will the market react?

With QE2 ending in June, I can’t help but wonder if we are at a tipping point in anticipation of that date. On the one hand, you have Bill Gross, who runs the world’s largest fund—PIMCO Total Return. On the other, you have Jeff Gundlach, whose Doubleline bond fund outperformed all other bond funds in 2010; gathering $4.5 Billion assets in the process. PIMCO has eliminated Treasuries from its holdings in search for better opportunity—and less risk—elsewhere. The question he poses is this: Who will buy Treasuries? If there is no demand, price will decline. Unless of course, supply also declines and there is demand. Gundlach approaches the situation from this angle, “In any kind of deficit cutting exercise, like we are now heading into, stocks are the losers and bonds are the winners.” Continue reading

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