Asymmetric Investment Returns - Insights into portfolio management beliefs, strategies, and tactics that aim to create a positive imbalance between risk and reward

Discovery consists of seeing what everybody has seen and thinking what nobody has thought.

          Albert Szent-Gyorgyi (Hungarian Biochemist, 1937 Nobel Prize for Medicine)

I am not a "Buffett hater" but I notice something that is interesting. Have you ever noticed, or wondered why, Warren Buffett's Shareholder Letters for Berkshire Hathaway report its "corporate performance" as Annual Percentage Change Year in Per-Share Book Value of Berkshire vs. the S&P 500 stock (price) index? 

That is, they compare their estimate of Book Value to the price change of the S&P 500 stock index. Have you ever wondered why? I wonder why they don't compare the Book Value of Berkshire to the S&P 500 Book Value and then compare the price return of Berkshire to the price return of the S&P 500 stock index? 

Does it make a difference?

Well, it seems 2008 was a year that made a difference for a lot of people. That is, they learned if their risk tolerance and/or risk capacity matched their investments. If we look at just that one year, the Letter to Shareholders shows a loss of just -9.6% for 2008 as they measure its Per-Share Book Value. But, if you look at the actual price performance, including dividends, it declined about -50% during 2008 and closed that year down around -30%. That's a bit more than -9.6%. 

Source: stockcharts.com

In a world seemingly filled with greed and bad deeds, it can sometimes be a challenge for any of us to see past those things. I believe we have to deal with the realities that are present, but to do that we have to believe, and sometimes have faith, there is a purpose for it. I mean a bigger purpose - one larger than our self. Only a small fraction of Americans have had he honor to serve their country. Those who have know what it means to serve something larger than oneself. They do these things for you and for me. If you are unsure of that, then ask yourself why are aren't doing it, or didn't. 

I believe we get to choose how we view the world. My belief is best expressed by a quote from A Course in Miracles:

Projection makes perception. The world you see is what you gave it, nothing more than that. But though it is no more than that, it is not less. Therefore, to you it is important. It is the witness to your state of mind, the outside picture of an inward condition. As a man thinketh, so does he perceive. Therefore, seek not to change the world, but choose to change your mind about the world. Perception is a result and not a cause.

We saw Act of Valor at the theater last night. It inspired me because, though it shows some of the harsh realities of our world, it also serves as a reminder of the good things we can find in enough people to make it all worthwhile. The problems of our world aren't going to be solved by ignoring them. Indeed, that's how they become problems today and will become much larger problems for our heirs. I hope all of you have a chance to see Act of Valor.

World English Dictionary

valour or valor (ˈvælə)

— n

courage or bravery, esp in battle

Be brave, America.

Semper Fi

http://actofvalor.com/

To do something, consider this: http://www.woundedwarriorproject.org/

The table below shows how long some of the worst cyclical bear markets since 1950 have lasted and how long it took to recover from them. Recall that losses are asymmetric: the larger the loss, the more gain it takes to recover from it. "Aggressive" investors therefore tend to feel really excited on the upside, then less so when they loose what they spend years accumulating. 

A bear market is defined as a peak-to-trough decline in the S&P 500 Index of 20% or more. The bull run data reflect the market expansion from the bear market low to the subsequent market peak. All returns in the table are S&P 500 Index returns and do not include dividends. The table assumes the current bull run from 3/9/09 through 12/31/11. It could be argued that the index had a bear market in the decline of 2011.

The good news is that cyclical bear markets haven't historically been permanent losses for this stock market index. The losses were eventually recovered in about 2.2 years. This time, however, the bear market has lasted 4 years and 4 months. It could be argued that the this index barely reached its 2000 peak in 2007, so it has actually traded in a range below the current level for more than a decade. To see what I mean, read: S&P 500 Index Inflection Points of the Current Secular Bear Market. Clearly, buy and hold may be a risky investment strategy for individual investors who don't have unlimited time horizons. You can probably understand why a tactical strategy that aims to avoid some of the loss and capture some of the gains has become very popular in recent years. As wealth managers often point out: the trouble is that few investment managers have any skill or experience actually doing it. And, many of them who have actually been doing it long enough to speak of haven't done it very well. 

Source: Standard & Poor’s, FactSet, J.P. Morgan

I came across Credit Suisse Global Investment Returns Yearbook 2012  on Abnormal Returns.

CSFB examines the dynamics and impact of inflation and currency risk and how stocks and bonds have performed in different conditions. Inflation erodes the value of most financial assets, though some assets like gold or homes may actually rise in price. After all, inflation is generally “rising prices” of things (like homes). Stocks may be negatively impacted by rising inflation, but to a lesser extent than bonds or cash. Investment salespeople often promote stocks as an inflation hedge, but stocks may actually only offer limited hedge against rising inflation and that’s due to their higher ‘expected’ return, not because they rise with inflation.

The currency section speaks of how changes in exchange rates can boost or lower the return of foreign investments, such as global or International ETFs.

The various impacts of inflation, currency, etc. is a topic that John Murphy covered very well years ago in Intermarket Analysis. It’s useful to have an understanding of how different assets typically respond to changing conditions. It’s also useful to have historical data so you actually know the probability and can develop an expectation. Therein lies the potential for trouble: when you develop an expectation of something you may create a hope for things to turn out a certain way. If your expectations are strong, you may worry about it and then be upset when it doesn't turn out the way you expected. Or, if your expecation is very strong you may bet heavy on that outcome and the more confident you are, the less adaptive you'll likely be to change when the condition changes. What we learn from past data is that, while things probably play out a certain way, it is rarely all the time. After all, that's why it's 'probablistic'. If you are positioned for a certain outcome, you may be on the wrong side of reality if you aren’t adaptive.

After reading over Credit Suisse Global Investment Returns Yearbook 2012, I find some of the data may be useful knowledge. But at the end of you day- it makes me grateful that I have a system for buying and selling that adapts to changing price trends. I don’t need to know in advance if inflation will be high or if instead the condition will be deflation. I don’t need to know if a change in currency will impact my foreign stock exposure. I don’t need an indicator to tell me if others are “risk on” or “risk off”. None of these things are known for sure in advance. Even if you know how an asset typically reacts to a certain condition, you still don’t know it will this time. No one knows in advance which condition will play out. The best anyone can do is adapt. All of these things are reflected in the direction of the price. If they aren't, then they don’t matter.  If the condition does impact the price of our positions, my system will respond to it. That, I’m sure of. It’s what it does. If we are going with what is rising in price, we may end up with those things that are responding to underlying conditions. If we do that profitability over a long time, then we increase our odds that we outpace the erosion of our buying power due to inflation. 

These are the best possible activities we can do.

People like to predict things. If they guess right, they may smile to others and nod as if they really did know. People also like to believe they or others have special predictive powers. Many people really do believe that some do know the future, or an outcome in advance. 

If a future date isn't yet here, now, in the present, in this moment, then it doesn't yet exist. 

So, if you really believe you or anyone could know, then you necessarily believe they have the ability to pass into the future while everyone else stays here, in this moment. If you or someone you know can really do that, then you probably know the outcome of the Super Bowl. 

Or, maybe you are one of the lucky few who gets tomorrow's newspaper? If you can get it in advance, then you will know the outcome today. If you can jump forward in time, get the paper, then come back here, now, then you'll know the winner. That's all we need to do.

And, we only need to know once. 

If we can be sure we know the outcome, the winner of the Super Bowl, or the price move of a stock or commodity, we only need to be sure one time. If someone is certain, then they could guarantee it. They could make billions if they do it just once. They could leverage it by borrowing all the money they can. I've heard people say they believe large investment banks like Goldman Sachs either know the future or controls it. If they did, they could guarantee it and take a cut. It would only take once. If they know for sure just one time, that's all it would take. Put trillions of dollars behind that one time and be done. The truth is, we can know the probability and probabilities by definition aren't a sure thing. Probabilities play out over many different flips of the coin. We can't bet too much on any one because we aren't sure. We don't need to be. But guessing the winner of Super Bowl XLVI - you get only one guess. If you really know, if you're certain, that's all you need.

Still, someone reading this still believes someone knows the outcome of the Super Bowl in advance. Maybe it's rigged. Someone once told me the Steelers would win because the Mob controls it and they own the Steelers. He really believed that. They lost. 

There are analysts who really spend a lot of time and effort trying to predict who will win. Just as they try to predict what stock will be the winner. They know a lot about all the players and how they match up against the other team. They know about the coaches and their playbooks. You can know a lot going in to the game. Then, the chaos begins. The star gets hurt of the coach pulls out a totally different playbook you were unaware he had. You were unable to predict all the things that may go differently that you expected and that path that would take things. In fact, the winning team will probably be the one that adapts to the conditions the best. The same is true in portfolio management. 

Someone may still be reading this, hoping I'm going to admit that I do have tomorrow's newspaper and tell the winner. They want to know a Savant. 

The truth is, I don't know. Even if I did, it would take away all the fun of not knowing. Watching the game play out is far more fun when you don't know. If you have expectations, you'll be disappointed if it doesn't all play out that way. Will it be Tom Brady and the Patriots or Eli Manning and the Giants? 

We'll see...

Source: Rivals.com

College football National Signing Day is the first day that a high school senior can sign a binding National Letter of Intent for college football with a school that is a member of the NCAA, the main governing body for college sports in the United States.

National Signing Day has become a phenomenon. The athletes get their 15 minutes of fame. Football coaches lobby hard for top ranked recruits to sign with their program. Some will do anything to get a recruit. 

At the end of the day, the media will focus on what program 'won' the contest: who recruited the top ranked class. The rank of the athlete, a one star to a five star, is conducted by outside services like Rivals.com. Rivals then ranks the overall signing class, based on the sum of all the individual ranks. 

At the end of the day, a program will be ranked based on what some outside source thinks of the recruiting class, irregardless of how those individual recruits fit within the program. And, that is what will get the attention. 

That may sound familiar.

As with portfolio management, people are often focusing on the wrong things. I find that most people don't even know how the ranking services quantify the ranking. Is it qualitative? Is it quantitative? Or, is is some combination? I believe the best coaches and football programs operate their own proprietary ranking system based on the factors they believe are most important. 

Chart of the day included a chart of the cost of single family homes priced in ounces of gold instead of dollars.

They said:

Severely depressed real estate prices continue to be a concern for investors. For some perspective on the magnitude of the decline in home prices, today's chart presents the median single-family home price divided by the price of one ounce of gold. This results in the home / gold ratio or the cost of the median single-family home in ounces of gold. For example, it currently takes a relatively low 105 ounces of gold to buy the median single-family home. This is dramatically less than the 601 ounces it took back in 2001. When priced in gold, the median single-family home is down over 80% from its 2001 peak, remains well within the confines of a six-year accelerated downtrend and remains very near its 1980 trough.

I believe, based on empirical quantitative evidence, that marny market prices tend to trend asymmetrically: they decline faster than they rise. It's probably because investors respond to negative news and losses differently than they do good news and gains. As we see in the chart, home prices fell asymmetrically, they increased for 20 years and only took 10 years to erase those gains.

During the secular bear market of the 1960's and 70's, home prices decline along with stock prices. Gold increased in price. You may recall that gold was a popular investment in the early 1990's. Of course, that was 'after' gold had already gone up. You may notice the cost of a single family home priced in gold is near the low in 1980. Some people may look at the chart and conclude that it's at the 'low', but that assumption would be based only on one data point. Statistical significance requires many more to draw inference about the future. Though, this is such a long term trend unfolding that, for all we know, it very well could be one indication that the secular bear market may be closer to its end. Since you don't know, nor does anyone else, you can probably see why it's important that our investment management programs that pursue an asymmetric risk/reward profile be adaptive to changing directional trends.