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  #21  
Old 07-30-2007, 02:44 PM
DcifrThs DcifrThs is offline
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Default Re: Daily Reading suggestions/ideas/criticism

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so, to sum, you use:

-Stocks
-Bonds
-Cash
-Real estate stocks (as in REITs or companies that RE cenetered??)

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REITs


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thats good since you gain dividend access that you wouldn't get via those companies. REITS have two sources of returns: price changes and dividend payments. they perform differently than stocks and provide a degree of diversification

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this is why i asked. in the discussion about the real return of commodities, i noted that institutional investors move slowly.

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Are you talking about a thread here? What do you think the real return of commodities will be on average for the next 20-50 years?

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> 0%. that is all that matters since their diversification (after deleverageing, which is apparantly easily available in CCFs) can then be used to boost risk adjusted returns.

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the above portfolio, no matter how you structure it (i.e. one that has access to real estate, stocks, bonds, and cash) is not optimal for long term investing.

it is mostly geared towards economic environments that favor stocks. especially when you consider that (and i'm guessing here), the financial advisor's clients are far more likely to have a majority of their CAPITAL in stocks. consider that a 50% capital allocation to stocks w/ a 50% allocation to bonds actually means your portfolio is about 75-90% stocks in risk space.

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I don't really know what you mean by "risk space." Yes, the stock portion has a lot more risk than the fixed income portion. I go by the principle that the only purpose of fixed income is to reduce the risk of the entire portfolio.

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this is one of the issues at hand. bonds shoudl be diversifying rather than just "risk reducing." you can lever short term bonds to match the duration of long term bonds (and higher) to get the same risk profile as equities. thus you gain diversification while not sacrificing expected returns. this will improve returns & performance more than it will increase risk, thus improving risk adjsuted returns.

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By using short and intermediate term only (no long bonds), and only high quality (no junk bonds), I am able to take more stock risk, using Int'l small stocks, EM small stocks, and so on, and have good risk-adjusted returns.

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right, but your portfolio is still massively stock based. and you could have BETTER risk adjusted returns.

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additionally, small commodity allocations and leverage (for TIPS and other S-T nominal bond allocations to bring them to the same risk level as equities) is simply not used.

these additions would significantly improve your (and your client's) risk adjusted returns.

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I basically build my portfolios based on the academic research done by the folks affiliated with DFA: Fama, French, and so on. I think their thoughts are that there is no reason why commodities should have a positive return. Stocks have +EV because the companies are profitable and growing. Bonds have +EV because the issuer is paying interest for borrowing our money.

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and commodities are paying returns since production hedgers likely out number purchasing hedgers and net short positions exist and are thus transfering returns to holders of net long positions.

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Commodities trade based on supply and demand. There is no profit, and no income. They probably will go up over time near the rate of inflation, but there are better investments to deal with that (like a 1-year bond fund).

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see directly above. further, they provide FAR more diversification than a 1 year bond and in a deleveraged vehicle (CCF) provide income via bonds while still deliver diversificaiton and returns.

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It is true that commodities do have a low correlation with stocks and bonds, and that in the past, using them may improve the portfolio a little. We currently use 10% of the equity portion into REITs. If we swapped out commodities for a portion of that, we may get a little improvement, but I don't think it would be that significant.

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it would be more significant if you took that allocation out of your largest equity position. while being a little less deleveraged to maintain relatively high returns (not comparable to equities but the diversification would more than compensate for loss of return in risk adjusted returns)

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As for leveraging short-term bonds or TIPS, do you have a history of returns to show that it is good to add to a portfolio?

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abso-freaking-lutely. this is what we researched at my old employer. it improves portfolio efficiency greatly. and it isn't short term bond OR TIPS, it's leveraging short term bonds AND tips! you lever everything (or delever as the case may be) to hit a target risk level.

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Is there a low-cost investment available to the average investor (meaning, not a hedge fund)?

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you can do it yourself for minimal cost via leveraged TIPS funds (i think available via IB). or, if you have massive assets behind you, engage in continually rolling repos yourself.

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one additional question (are you developed & emerging mkt international ) stock allocations hedged for currency risk?

if not, that is another area where your (and your client's) risk adjusted returns are being hampered by being exposed to risk while not being compensated for it, thus lowering your risk adjsuted returns. i think it is also very funny that the int'l bond allocations you mentioned ARE hedged, though the risk coming from hedging that allocation is far smaller than from your int'l stock allocations both a) because the stock allocations are likely far larger, and b) because the stock allocations are definitely way more risky.

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The Intl and EM stocks are not currency hedged. You can certainly try to show me research to the contrary, but I think the long-term EV of hedged or non-hedged international stocks should be about the same.

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of course they are, but not even close on a risk adjusted basis.

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However, by keeping them unhedged, there is much less correlation, so the overall portfolio has lower risk.

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right, but for the wrong reason. the "less correlation" comes from the ADDED ON exposure to currencies (currencies have about a 0 correlation. it is "added on" in the sense that a 100% unhedged int'l equity allocation has an addition exposure to currencies that you didn't purposely allocate to). you haven't allocated to this risk, you are exposed to it, and it delivers 0 expected return. it hurts your risk adjusted returns by delivering significant volatility without any compensation for it.

you can break an unhedged in'tl stock exposure into 2 pieces:

1) the int'l return from equities
2) the added on exposure to currencies.

if currencies were truly good to have, then why hedge the int'l bond exposure?

in fact, they are detrimental to risk adjusted returns in all applications since they deliver volatility without any compensation.

i've researched this personally for training and studied the research of some of the sharpest minds out there and can tell you for certain: it is a fact.

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so while financial advisors tout their "diversification," (even though their clients may be better off than they woudl be without them), it is clear that a similar portfolio can be constructed via vanguard with a small amount of effort (and without the fees).

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Vanguard is good, and I recommend Vanguard for people on here that do not want to use an advisor. However, DFA's funds are generally better, because the small funds have greater exposure to small stocks, and value stocks have greater exposure to deep value. Plus, intl small, intl small value, EM value, and EM small are not readily available at Vanguard.

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i don't know product offerings well enough to comment here. all i do know is even for 401k investments, my old company gave us a very good allocation plan that mimicked (sp?) a very well managed passive product the hedge fund managed fairly closely relatively speaking. so i do know it is definitely possible despite the possible shortcomings you mentieond.

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these stock based portfolios though likely have risk adjusted returns around .30 vs. the acheivable # of around .4 (with more diversification and hedging) and .5-.7 with intelligent use of leverage and full diversification.

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Not really sure what you are using here with .3, .5... Expected return / SD? Sharpe ratio?

-Tom

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i mean exactly what i said: risk adjusted return. that is not expected return, nor is it standard deviation. sharpe ratio would be the most apt description since we are dealing with passive allocations. since terminology is varying, i use risk adjusted returns or sharpe ratio when talking about passive allocation and risk adjusted returns or "information ratio" when dealing with active allocations.

either way, it is the expected or historic excess return divided by the expected or historic volatility (however you measure it) depending on your perspective.

normal portfolios that you mention, based on research and analysis of their (like institutional investor) return streams result in about a .3-.35 expected risk adjusted return.

a higher risk adjusted return is available (acheived at the hedge fund i worked for) of .69 (historic) or ~.7 (expected) through the use and application of all methodologies i've mentioend. (fees for this passive product were about 50bps/year so net performance was still extremely high: around .65 IIRC though don't gquote me on the net figure)

given that not all are legitimaately available to the normal investor, an actual risk adjusted return of about .5-.6 can still be achieved ideally or even .4-.55 without as much work/research/etc.

that is still higher than the typical portfolio you speak of which delivers about .3-.35 in expectation based on research i've done and seen.

Barron
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  #22  
Old 07-30-2007, 06:23 PM
Evan Evan is offline
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Default Re: Daily Reading suggestions/ideas/criticism

Barron and jively,

Step 1) Read the title of this thread
Step 2) Read the posts in it
Step 3) Smack forehead repeatedly with open palm while saying, "idiot, idiot, idiot."
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  #23  
Old 07-30-2007, 06:57 PM
DcifrThs DcifrThs is offline
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Join Date: Aug 2003
Location: Spewin them chips
Posts: 10,115
Default Re: Daily Reading suggestions/ideas/criticism

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Barron and jively,

Step 1) Read the title of this thread
Step 2) Read the posts in it
Step 3) Smack forehead repeatedly with open palm while saying, "idiot, idiot, idiot."

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but daddy...i hurted myself with the smacking [img]/images/graemlins/frown.gif[/img]

(seriously, sorry about that. Tom, to continue in another thread i think would be the best way to move the discussion along if you want)

Barron
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