The ETF conference I am attending creates a dichotomy that is worth pondering.The night before our flight I picked up a copy of Fooled By Randomness by Nassim Nicholas Taleb (apparently in its second edition). I am not very far in at all but the gist early on seems to be that chance plays a greater role in outcomes than people realize and financial market participants are far from immune.
At the same time the ETF conference presumably explores ways for advisers to do a better job, whatever that means to each person, managing client assets. Using ETFs can keep costs down, avoid tracking error and whatever else the merits might be which can ultimately deliver a better result for the end user, the client, when compared to traditional, actively managed mutual funds.
I'm going to skip over a couple of things for now that are either reactionary first impressions from the conference or will be the my conclusions of this conference and move to my belief in seeking out the middle ground between chance driving everything (or close to it) and trying to add value with decisions made. In exploring the difference here perhaps you can get a handle on where you fit in.
A few days ago a reader left a comment that no one hires an active manager unless they think that manager can beat the market. The comment completely misses the idea of risk adjusted return which probably comes close to describing what I try to do and so would be what comes through in the blog posts.
The short explanation would be in an up market I hope to go a long for the ride and in a down market miss a chunk of the decline. More specifically taking defensive action when probability of a large decline is greater. The probability of a large decline is greater, in my opinion with a little bit of data to support the idea, when the S&P 500 crosses below its 200 DMA and or when the market rolls over slowly without much pain or worry over several months (2% rule).
If this sort of market action leads to a bear market then value probably gets added as I heed those warnings. If this sort of market action does not lead to a bear market then value probably does not get added. The same can apply at the sector level (the reason I am at this conference) as well. The risk of owning financial stock increases when the yield curve inverts. The risk of owning discretionary stocks increases as the economic cycle gets long in the tooth. The risk of owning utilities and telecom (the Ma Bell kind) increases when interest rates start to go up. There are other examples.
When the risk to being in one area increases it makes sense to take some of that increased risk out of the portfolio. One underlying truth is that while there is logic behind these concepts and they have worked often they cannot be right 100% of the time. It is in this example where randomness and "adding value" can come together giving the chance to put the odds in your favor sometimes. At least this is how I view things even if Taleb would think I'm a fool.
A what took them so long-congratulations to Jim Rice for getting elected to the Baseball Hall of Fame.
The picture is from Palm Beach.
9 comments:
Good post. I am the reader who left the comment about hiring an active manager.
I guess I should have been a little more clear. First I understand the concept of risk adjusted return. I know what a Sharpe ratio is and how asset classes are correlated and so on. It has been sufficiently demonstrated to me that the overall return of one's portfolio is a largely result of the allocation to stocks and fixed income. It is for that reason, the fixed income side should either avoid corporate issues or at least keep them very short. Same is true for convertibles, preferred, junk etc. Fixed income should provide the ballast to the portfolio, just as we have seen from treasuries. The main question becomes whether or not the fixed income should be taxable or tax-exempt.
Secondly, fees from management, trading, and taxes are next most important factors in determining the overall outcome of an investment portfolio. If the manager cannot overcome (earn back) his fees and losses to taxes, then a passive portfolio obviously would have a better outcome.
The only two factors a serious investor can control is; allocation and cost of exposure to asset classes. Hiring a manager is a random event in itself. Please don't take this as an insult.
Remember, I speak of investing, not speculating. Furthermore, more than 95% of my investible assets are in taxable accounts at a high marginal rate. Short term gains after tax are very very difficult to sustain on a long term basis and therefore avoided. Maybe that helps explain where I am coming from.
I will say, however, going at it alone will not work for most people and advisors certainly have their place; as long as it is at a reasonable cost.
Hope you learn a lot at the conference and have more to share with your readers.
Same guy from the previous post.
I would like to further say that I feel valuations do matter. It is for that reason I seem to visit this blog seeking out serious commentary. I feel that in overvalued equity markets (low yields, high P/Es, high P/Bs) a slight lowering of equities is acceptable provided that the proceeds are placed in an asset class that is traditionally uncorrelated with stocks. The reverse is true when stocks are undervalued (as we see now). A slight overweighting is permissable. The all in or all out is nonsense because of the completely random nature of markets, cost of taxes, and costs of trading.
Income generated in the portfolio by interest and dividends should be directed to the asset class that is currently underweighted by the specified allocation. This helps one to buy low and sell high.
Don't know why I bother to write all this, but I did.
I use to laugh at the advisers who used astrology to make investment decisions. Then I learned there random (IMO) picks had equal performance to most but not all managers.
I do think there are occasions to be all in or all out of the market but they are rather rare events. Unfortunately the debt bubble we are in from housing is one of those rare events.
Being from Boston and blessed with enough luck (Taleb) to hear Jim Rice speak live to a select few many times. He came off as a jerk. Maybe that doesnt have a place in the Hall, but I would guess that is why he made it on his "last chance" - sort of a reluctant "yeah as a baseball player he's in, as a person we don't him." I've also read a lot of Taleb and his non financial paers inaddition to his books. Much like Jim Rice, he comes off as a jerk - a bit self important and putting down the working class (you'll know it when you read it in Fooled By Randomness)...I'm not sure if that makes him less of a good finance guy though - much like Jim Rice.
Would you please tell us once again what the 2% rule is? You had mentioned this in the past also. Do you mean, a drop in s&p500 index value of 2% a month for few months?
Thanks for taking the time to respond.
stranger
I have been following this blog for a while and enjoy what Roger has to say. This is my first post.
The fact that many buyandholders visited this site is an indication that they are not satisfied with their current strategy. They are either looking for re-confirmation about buyandhold by challenging what Roger has to say or they are looking for refinement.
The refinement could be keyed on P/E, P/B or 200DMA and the change could be 2%, 50% or 100%. How much adjustment one chooses depends on one's own believe, risk tolerance, tax situation, time horizon and investment style.
Comparing 38% drop of total account value (cost + gain) with 40% tax on gain only, it makes sense for a lot of people to pay the tax, pay the fee and be all out this go around.
To encourage meaningful discussion, let's refrain from using loaded words and painting people into a corner. You might get the information you are seeking but I found it much more enjoyable doing the other way.
Again, I want to thank Roger for sharing his thoughts.
ks
"The fact that many buyandholders visited this site is an indication that they are not satisfied with their current strategy."
That is an exceedingly misinformed statement. Buy and hold investors don't look for knowledge? Better ways to wring more performance out of a portfolio?
Talk about painting people into a corner.
the 2% rule as I know it came from Ken Fisher. When the market averages a 2% decline 3 months in a row it means the bear has started. The point as I take it is not exactly 2% but a small decline 3 months in a row. It does not happen very often, the psychology is that the decline is small and so trouble is denied by most people. it contributed my my Send In The Bears post from Dec 13, 2007.
First of all I want to make it clear this post and the previous one today was not to any person specifically. I was thinking about writing something a few days ago when there were several buyandhold discussions but I was busy and did not write. I have some time today and here I am.
Maybe I did not make myself clear the first time. I have only 2 points:
The first one is buyandhold is fundamentally different from the active management discussed in this blog.
Roger advocates to watch out for market warnings, do not hold and make changes to avoid big losses. This is fundamentally different from buyandhold. You either believe in buyandhold strategy or you don't. There is no middle ground like 5% pregnant. It is not my business how people label themselves, but it is interesting to see people who consider themselves SATISFIED buyandholder and checking into blog like this one. I do not believe in astrology and you will never catch me visiting any astrology blogs to check out what color to wear next week to improve my luck let alone telling the blog host he makes no sense and no one in their right mind should use his service (which is indeed my position). re: Improving performance for a buyandhold portfolio? maybe Fama/French's Blog at dimensional a better fit?
The second and my main point is "Be respectful in other people's house".
If you do not believe in active management, if you look down on active management or if you do not like his ideas then don't come over; If you think he has something to offer and want to ask a question, ask nicely. if you have a different view and want to debate, be cool and be open minded. Do not come over and then trash active management, saying it does not make sense...and no one should use an active manager... etc . If you have a blog, I guess that is what you wanted, right?
Vote with your feet and money.
ks
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