RGE Monitor has done some in depth coverage on Latvia comparing it to Thailand in 1997 with the implication that as Thailand's baht crisis became the world's problem so too might Latvia become the world's problem. I got this via email and tried to find it on the site but had no luck (apologies).I first wrote about Latvia possibly being in trouble a couple of years ago and have written about it several times lately at GreenFaucet. I never made the Thailand comparison but there is obviously at least a little something there. Several more developed European countries have exposure in Latvia specifically and the region more generally most notably Sweden in Latvia an Austria everywhere.
As the world has learned most of these countries, both the lenders and borrowers, are fairly small and the banks became enormous relative to their respective countries which never mattered until the music stopped. It is tough to say what the real impact of a Latvian blow up would mean and how it would compare to Thailand or for that matter Iceland. Clearly Iceland caused trouble for the UK and for now we may not know the full consequence of that. We have a sense of some countries are threatened by Latvia but do we know them all?
One difference between Thailand and Latvia is that Thailand was an easily accessible investment destination in the US long before 1997 via closed end funds. There are no Latvian funds or stocks available in the US. Not that US investability is the be all end all I believe it is correct to say that Thailand had a much bigger role in the world economic order in 1997 than Latvia does today.
Some bigger picture context that I have touched on before with this stuff is trying to follow certain countries in case they end up mattering for some reason. Clearly Latvia matter more than it used to even if the reasons are negative and I guess for some reason Latvia resonated with me so I wrote about it, maybe it was having seen Artūrs Irbe in the Olympics a few months earlier?
As the Permanent/Lazy Portfolio debate raged on in yesterday's comments long time reader Stephen Drone left a link to a discussion at Bogleheads about a portfolio concept attributed to Larry Swedroe that caught my attention. So I don't get in trouble let me say I did not find where Swedroe put the following forth but I saw a question about it directed at Swedroe that Swedroe answered without saying "no I never talked about that allocation mix" but he also was not specific an talking about it either so with that in mind....
70% TIPS
5% Collateralized Commodities Futures (hat tip annonymous commenter)
25% Small Cap Value
This is mostly going to be a low impact portfolio. It will go up less than the broad market in a raging bull phase but the drawdown in a decline should also be much less. Commodities, however they are accessed should zig the US equity market's zag but this will not be true 100% of the time second half 2008 as an example). Small cap value tends to be the best performing style box over long periods of time so the allocation there gives a bang for the buck over large cap effect. The TIPS weighting would seem to communicate an obvious concern about price inflation.
It seems to me that this is potentially a very sophisticated concept. I believe it tries to capture some very nuanced effects which is not easy using broad based products. It is not clear to me if Swedroe would include foreign stocks in with small cap value. As a side note there are ETFs that cover foreign-developed small cap and at least one that covers emerging market small cap (note these are not necessarily small cap value), there may be OEFs to over this space but am not sure what those would be.
While I am not a fan of lazy portfolios and the like I am a big fan of seeking out subtle effects on a portfolio. By subtle effect I mean managing things like average market cap, style, yield, volatility and so on. It is much easier to do this using narrower products like individual stocks, sector ETFs and theme or sub-sector ETFs.
The pictures; A FaceBook friend became a fan of the Ford Country Squire and I fell over laughing when I saw it. The picture above has it all; the desert, an Airstream and a red stationwagon the size of Delaware! When I was a kid we had the Chevy version of this. It was so big that my dad could hit fly balls for me to shag in the back of it. My childhood friend Doug Stocklan's parents had a Country Squire that I think was blue.The second picture is Ricky Gervais on the left and ESPN announcer Dave O'Brien on the right. Am I the only one who thinks they look alike?
27 comments:
I went home early last night and missed some of the fun from yesterday's comments. Some truly great stuff. I saw two things, one that you mentioned, Roger, that there are foreign covered call CEFs. I wasn't aware, but CEFs aren't my favorite things in the world and preferred ETFs. I will check out the CEFs though, thank you. Second, what exactly is a collateralized commodity fund? I think it's the 5 syllable word that's scurrin' me. I'm a graduate of a government skools, ya know.
Roger,
For clarification purposes, the infamous "Larry Swedroe" portfolio that is discussed frequently by Larry and others at the bogleheads site is not the one referenced by Stephen Drone.
The following is Larry's strategy that aims at eliminating the "left fat tail."
70% bond allocation (prefers all TIPS if one has the tax advantaged space). If no tax advantaged space than use high quality intermediate municipals (approximately 5 year duration). Also, note Larry does not advocate a TIP fund rather one is better off in purchasing individual TIPS.
30% equity allocation (target 50% US and 50% International mix, however this ratio should be adjusted based on each individual circumstances, in Larry's case due to his other US holdings he has a mix closer to 40% US and 60% International in order to keep his total assets closer to a 50/50 mix).
Equity investments consist of 50% US Small Cap Value, 35% International small Cap Value and 15% Emerging Market Value.
Roger- for a detailed comparison of Swedroe's portfolio versus PP since 1970, refer to the following link. The post is by Trev H dated Wed Jun 10, 2009 @ 6:46 am
http://www.bogleheads.org/forum/viewtopic.php?t=15434&mrr=1244674671&start=851
I for one would like to see someone identify the flaws of this portfolio OR Harry Browne'spermanent portfolio and provide an argument as to why someone should seek out a more active approach to investing (Roger or another). Roger??
I think we discussed the Perm portfolio in great depth a couple of days ago in the comments. It boiled down to that it's a steady portfolio that underperforms long term with a lot less standard deviation. If you need less risk in your life and slight underperf doesn't bother you, the perm should be an item that interests you.
So I guess the flaw in the slaw is underperformance.
To dovetail with what Anon 6:25 said about providing an argument for an active approach, it seems Roger that you are making a case for a diversified passive approach to international investing. I mean really, who can possibly keep track of each country open to public investment?
Also, Anon 6:25's comments regarding Swedroe's portfolio matches my understanding too. The links you were provided represent at best 1% of his writings on bogleheads. He discusses his portfolio in other threads.
On of the points he continually stresses is that after tax returns are important. He personally has most of his fixed income in high quality intermediate munis.
Another point he stresses is that most people probably cannot handle a portfolio such as his because it is subject to much tracking error. That is, his portfolio's return may not be anywhere close to what S&P is doing. It really takes a lot of self-control and discipline. It is all about exposure to the highest expected return asset class in the cheapest possible manner (index funds). He says the expected return is the same as a 60/40 portfolio, but with much less downside.
Bill B- the one glaring ommission that you are neglecting to mention is after tax returns. For a taxable investor the permanent portfolio is extremely tax efficient and low cost, so how much does it truly underperform on an after tax basis to TSM?
I don't understand, how could you not simply buy and hold something like VTI and be tax efficient? Either way, I think we're talking about portfolio theory at this point. Whether or not it can happen in the real world is worth considering for sure. Tracking error, transaction costs, taxes, management fees, etc are all items to toss around after the theory itself sticks.
It was pretty clear in Browne's writing that he understood investors could become impatient with the Permanent Portfolio and, by way of also making it clear that the oft-cited difference between trading and investing was a red herring -- it was the distinction between trying to earn what a particular market offered and trying to beat that market that really needed to be appreciated -- he recommended a separate, "speculative" portfolio to accompany the mix.
This is where I first encountered the notion that the conceptual distinction between strategy and tactics might and indeed could have a real-world distinction in portfolio structure. I now run three distinct portfolios: A fairly large strategic portfolio modeled after (but not precisely emulating) the Permanent Portfolio, a smaller and more active tactical portfolio mostly in tax-advantaged accounts, and a 'legacy' portfolio of assets acquired earlier that it would frankly be inconvenient or costly to liquidate; e.g., very large unrealized gains. I only combine these portfolios into a single view once a year to make sure things aren't becoming too skewed in terms of sectors and geography and this could affect strategic allocation modestly the following year but otherwise the portfolios live separate lives on my screen and in my head; helps to simplify what could otherwise become too complex.
RW- would you mind posting your emulation of the permanent portfolio along with specific investments and weightings?
thanks
BillB I take collateralized to mean zero leverage in owning futures which applies to most funds. you'd know whether they are leveraged.
Anon 6:40, i don't see where I am making an argument for passive intl investing. You ask who can follow many countries, well plenty of people do have the time. If you don't ok but other do. Everyone has different amounts of time they can devote to this stuff. The more time the more that can be followed. Perhaps you do not have time to follow Latvia but other do.
Roger, this might be the Latvia article you were referring to.
thanks SD, that is the article
Just for clarification this is what Larry Swedroe approximately has:
10% US SV
11% Intl SV
4% EM Value
3% Collateralized Commodity Futures (CCF)
6% TIPS (tax advantaged space is limited)
66% intermediate muni bonds of natural AAA/AA. No insured.
Ideally Larry has mentioned he would want more TIPS and might own REITs if there was some room.
The value funds are all DFA.
"stratton" on bogleheads.org
@RW
"RW- would you mind posting your emulation of the permanent portfolio along with specific investments and weightings?
I'll second that request if you don't mind sharing.
by way of also making it clear that the oft-cited difference between trading and investing was a red herring -- it was the distinction between trying to earn what a particular market offered and trying to beat that market that really needed to be appreciated -- he recommended a separate, "speculative" portfolio to accompany the mix.
This is where I first encountered the notion that the conceptual distinction between strategy and tactics might and indeed could have a real-world distinction in portfolio structure. I now run three distinct portfolios:
Very interesting way to conceptualize the differences here in various portfolio structures and objectives.
I do something similar myself, but I don't use the terminology of "strategic" and "tactical" portfolio. I've got my "long-term investment portfolio" which I guess is more strategic in nature and my "aggressive trading portfolio" which I suppose is more tactical.
I use the long-term investment portfolio model for client accounts as frankly I'm not sure someone else could stomach the volatility of the trading portfolio nor would it be suitable or appropriate for someone's IRA.
I'm not sure "beating the market" has to be mutually exclusive though with that strategic portfolio.
For example, in my long-term investment portfolio, I presently have a certain percentage committed to U.S. stocks (still about a 30%ish cash position). The overwhelming majority of that U.S. stock exposure is divvied up amongst Fairholme Fund (FAIRX), Berkshire Hathaway, and Hussman Strategic Growth. I figure I've got 3 of the smartest guys (Hussman, Berkowitz, Buffett) all working to beat the overall stock market for me. I would be shocked if over the next 5 years those 3 positions in aggregate don't beat the S&P 500 by at least 2%ish.
Another example maybe on implementation. For numerous reasons, I believe gold is in a long-term secular bull market, and the next major upleg is probably getting ready to commence. Furthermore, I think it might very well be the next bubble move in a sequence of bubbles (NASDAQ, housing, China) so I don't think 3000ish is totally crazy.
What to do with that opinion? In my long-term investment portfolio, I think Roger's generalized advice about not making "big bets" applies, and I'll probably reestablish a 5% GLD allocation. As much as I believe gold will outperform the S&P 500 or even Hussman and Berkshire the next 3 years, I'm not going to go 50% GLD.
Aggressive trading portfolio is a different story. This is my "maybe get rich" portfolio so I am contemplating putting 25-50% of the account into GLD LEAP options. I've done this sort of thing before, and I've gained 500% in this account in short time frames and had 70% drawdowns. I figure I just need to get my batting average and slugging percentage higher here for it to be where I want it in 20 years.
Feel free to comment.
Roger, commodities (excluding energy) did sort of zig when stocked zagged, just not in dollars.
Specifically, note cotton's meander up to its highs just when sterling did. Then they both bottomed about the same time this spring. Other softs and ags were less obviously correlated with the pound but still smoothed out the peak and trough.
Probably not worth a moment of your time to analyse the correlation with regards to a portfolio, but interesting nonetheless.
I'm not sure if this means sterling acted like a commodity (my first guess), vica versa, just a coincidence born of lots of technical stuff or something completely different?
Off topic; I find it amusing people jump onto one idea an economist has and then debunks their whole career.
What have the Romans ever done for *us*?
For those who haven't read the book or worked through the wrinkles the specifics would look like just another asset allocation scheme -- there's a fair amount of philosophy and portfolio theory implicit in Browne's work -- and I am only willing to say I had to modify the approach for largely pragmatic reasons. For example, in significant respects, the Permanent Portfolio model was an early rendition of a balanced-beta play in that it required each of the four main portfolio segments be quite volatile in order to pull the other segments up in the respective macroeconomic environment(s). Browne was a sophisticated investor with experience in a wide array of tools and access to international markets so stock warrants, foreign currencies, futures, physical gold (in a Swiss bank account), long strips, and so forth were not problematic for him.
He tried to make things practical in his book but IMO implementation of the full model would be rather tricky even now and for sure it was beyond my reach back in the 80's -- I could not balance the volatility of the segments even using leverage -- but the concepts involved struck me as so useful I wanted to stick with it if I could so I changed the fixed 25% allocation to broader % bands with lower and upper boundaries respecting the relative volatility of the assets therein and started tweaking, initially using relative strength, and of course always on the lookout for assets that would better reflect their world(s). A couple decades later it works for me but I continue to tweak and it would almost certainly appear idiosyncratic to others regardless so any explanation would necessarily devolve into a methodological defense; not interested, sorry.
Not sure I'd feel differently even if I was trying to sell something.
Great discussion going here Roger! One thing that RW and others have alluded to is how the Permanent Portfolio was constructed is quite unique. It was not a backward looking "stocks for the long run" type observation.
In the '70s Browne and his partner decided to put together a portfolio that would float through the 4 economic climates that are possible: times of prosperity, high inflation, recession, and deflation. Evidence that they succeeded at this objective is the back testing Browne did as well as the in-sample performance that continues through today. So economic theory begets proposed implementation begets backtest results. Browne did teach the PP through 2005 so it is not "old fashioned" per se.
Here is my rendition of the PP if anyone is interested in a concrete example. I use this for my core.
25% Stocks: equal amounts IWN and PXH
25% 'Gold': CEF and physical Ag and Au
25% Bonds: TLT
25% 'Cash': SHY
IWN and PXH are small value and fundamental emerging stock funds. I personally am not worried that value investing is going to stop working, as Buffet says "I can only tell you that the secret has been out for 50 years... yet I have seen no trend toward value investing in the 35 years that I've practiced it. There seems to be some perverse human characteristic that likes to make easy things difficult."
The question about weaknesses in Swedroe and Browne's portfolios is a good one. IMHO Swedroe is not prepared for stiff inflation or deflation. Browne is pretty solid but not exciting by design. There are times when a lot of money can be made abroad, in oil, in softs, shorting a bubble, etc. These would need to be done in "variable portfolio" to use Browne's nomenclature.
I lost over half my million+ portfolio and you idiots are excited about the stock market's future.
i'm sorry you're down so much but it is unlikely we are the idiots.
Collateralized commodity futures, are an interesting investment. DBC is a good way to gain exposure in my opinion. The idea is that the fund holds some of its money in futures contracts and the rest in T-bills. This reduces the leverage compared to 100% invested in futures as Roger mentioned.
The important differences between commodity funds lies in the types of commodities that are purchased, the allocation amongst commodities, the leverage, and the strategy for rolling from one contract to the next.
You sometimes hear people say 'the theoretical return on commodities is zero'. This statement refers to the spot return of a hypothetical commodity that doesn't experience an macro changes in supply and demand. CCFs on the other hand due have a positive expected return.
CCFs earn a return from spot return "oil's up year over year". They also earn a roll return that can be positive or negative because the next contract can be more or less expensive than the current contract for each commodity. DBC uses a strategy to (ideally) improve the roll yield of the fund compared to a naive strategy. The fund also earns interest on the T-bills it owns.
Additionally it is possible to earn a return due to rebalancing the allocation of the fund between commodities. In mean-reverting market stretches, rebalancing gives a valuable return.
It makes sense to me that commodities would become more valuable over time because of business. Consider that businesses use commodities as one input, if GDP grows that means there is more business adding more value to the economy. The existence of prosperous growing businesses imbues value on inputs such labor and commodities. That's what I can tell from the armchair anyhow.
Sort of looks like one of those Wile E. Coyote moments….. the bulls thought they were breaking out above 950 and the 200 day EMA and then no follow through…and no bids into the close…
I think they settled the S&P500 pretty much spot on with the 200 day EMA and now it looks like a mild shooting star daily candlestick….though we’ve seen a lot of action like this the last several weeks. The bears need to hammer this market tomorrow to start making some headway. Bulls should be concerned about any action below 915 ish…it looks like the steep uptrend line from 3/20/09 crosses there…if that trendline breaks it will look pretty damn bad.
Bigger picture though, the market needs to break down below 878-888 before bulls should become gravely concerned…
Swedroe's portfolio seems a country mile from an endowment portfolio.
Matthew - the usual quote I read isn't "theoretical return" but "long term return" on commodities is zero.
Long term research featured several years ago in the Journal of Financial Advisors (by Ibbotson, maybe?) showed that long term return was essentially zero, but that the value of a the investment wasn't in the return. It smoothed out the portfolio returns somewhat by reducing volatility.
As a farmer who uses the futures markets to manage price risk, I urge caution to all those who think they want to invest in commodities. And for the record, some farmers trade for themselves, but most use agents through marketing cooperatives, merchants, etc. and are able to get trades executed on the floor when others can't. You must understand this.
Just think about who is on the other side of your trade. Futures trading for speculators involves a high degree of leverage. Read those fund prospectuses (sp?) carefully and invest with your eyes wide open. You'll probably lose. In the futures markets, speculators provide liquidity and bring nothing else. I urge everyone who needs to preserve their capital to avoid commodities.
There's been a great deal written here about preserving the value of one's portfolio. Even in the context of a risk adjusted portfolio where commodities might zig while everything else zags...they are still dangerous for speculators.
DANGER - AVOID SPECULATING IN COMMODITIES!
Does anyone know how CCFs are taxed? Do the funds generate a lot of short-term cap gain? Do CCFs make sense in a taxable account assuming >28% tax bracket?
5:31 that is a good point about endowment portfolios. My understanding of endowments is they construct their portfolios by first thinking about the markets in which they can create the most alpha and overweight those areas. Additionally they may tactically allocate the portfolio based on economic forecasts for the markets they use.
The Browne and Swedroe portfolios start with basically the opposite assumption; that it is better to avoid major errors by misjudging the economic outlook.
Hi Roger,
You may want to add Richard Kang and EGShares to your weekly read...
http://www.egshares.com/newsletter.cfm?CFID=8521477&CFTOKEN=39387317
A million Zimbabwe dollars isn't what it used to be.
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