Tag Archives: risk

The Pricing of Risk: Yield Implications

Stop viewing Treasury yields from the perspective of opportunity. For a moment, consider what they imply about the pricing of risk. The concept, “I’m taking on more risk, therefore I need to earn more return” is often misapplied. Perhaps it should be restated as such, “If you take on more risk, in order to justify that additional risk, your return needs be higher to the less risky investment just to be equivalent.” Continue reading

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Developing Your Portfolio Framework: Priorities

I’ve been laying out the content generation strategy for this blog. Why? Because the Internet is a vast wasteland of disorganized information and analysis. What you don’t need is more of that. This blog is not about providing stock picks. This blog is not about company analysis. And only occasionally, will I discuss thematic investing. It is my opinion that this is not fruitful for you. However, I can be of value elsewhere on your journey. I am going to provide you with something original.

What we need to develop—together—is a framework. This framework needs to build upon the new rules. The rules are different today because the players are different. High frequency trading, algorithmic formulas, and the ubiquity of information has sensationalized limitless possibilities within the investment arena. In this arena we are out of our league; the game favors our opponent. But we will discuss this more in depth at a later time. Continue reading

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The Risk of the Unknown: A New Perspective on Equities

The objective of these viewpoints is to question commonly accepted pillars of financial advice. So I took notice when Consuelo Mack interviewed Lubos Pastor, Professor of Finance at the University of Chicago. Pastor recently completed research stating that stocks become more risky over longer investment horizons. His research takes the investor point of view (i.e. forward looking and accounting for uncertainty) rather than a historical (i.e. backward looking) point of view. Furthermore, he suggests that the 7% annualized real return stocks experienced during the last century–based on Jeremy Siegel’s analysis–is uncommonly high with several lucky events bolstering that figure. Pastor’s final pearl of wisdom suggests that human capital should play a significant role in portfolio construction. Continue reading

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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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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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Playing by the Rules and Winning the Game

You can distinguish one money manager from another by how well they play the game. In order to determine the winners and losers, you must know the objectives. Here they are: consistent returns, positive returns, and–for the bonus round–outperformance of equity benchmarks at all times. There is no rulebook for this game. Nor was this game shrink-wrapped neatly on the shelf of a Toys-R-Us [sic]. These are the rules imposed by clients. While these requirements do change, the past ten years and the current “new normal” economy have formed these parameters. Continue reading

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On A Long Enough Timeline…

The problem with hedging longevity risk is that it requires a significant time period to play out. Things change during the course of that time. Life expectancies change. Population dynamics change. Knowledge and science changes. To “hedge” for the next 78 years—the current life expectancy in the United States—is not hedging, its speculation. Continue reading

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The Positive Effects of Consistent Returns

What I am about to suggest could very well revolutionize portfolio management. In the current market environment—an environment in which one needs to prepare for both the journey and the destination—portfolio strategy and structuring needs to be addressed from a different perspective. The essence of portfolio strategy, for the time being, is this: allow yourself room for error while outperforming absolute and relative benchmarks. Continue reading

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Tax Receipt Increases May Be Too Late

Harrisburg, Pa., will skip a $3.29 million payment on its general obligation refunding bonds, series D and F of 1997, according to a letter obtained by Dow Jones Newswires.

Clients and advisors have found themselves reaching for yield in this low return environment. After calculating the tax-equivalent yield, municipal bonds were some of the highest yielding investments. It is unfortunate that the trend of reaching for yield has ignored the risk associated with these investments. Municipalities do default. Governments do default.

Based upon this default, the risk premium for holding municipal debt obligations just went up. As with a previous post, it is imperative to be able to dynamically adapt your portfolio structure.

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Preparing for the New Investment Paradigm

While both fundamental and technical analysis have their place at 85 Broad St, equity markets have structurally changed. No longer is the environment fit for the retail investor. Retail investors, and most asset allocators, are at distinct disadvantages.

Behavioral risk dominates most investment decisions. The investments that generate the largest returns over the next decade are likely to have some of the most volatile price swings. Do you have the tolerance for this volatility? I think not. Therefore, long term investments are not appropriate for you. But it is questionable if you have to capacity to make objective and accurate decisions on a shorter time frame. Whatever your goals are for your investments (e.g. college, retirement, etc), you must invest for both the journey and the destination.

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