Weekend Links

QUOTE OF THE DAY

"...the world is not a predictable casino game…All we can do is make intelligent estimations, work to get the rough order of magnitude right, understand the consequences if we’re wrong, and always be sure to never fool ourselves after the fact."  Shane Parrish farnamstreetblog.com

"You should fret less about getting any particular decision precisely right, and instead worry about whether you’re tackling the right range of issues." jonathanclements.com

CHART OF THE DAY

3D visualization of mean-variance-diversification for ~4500 out of >4.6M combinations of 5 asset classes (large cap US, aggregate bond, international developed, gold, and real estate) over 34 months in 2014 to 2016.  A diversification function with respect to the relative concentration of the allocations is used for the z axis.  I had the main post here. Had to give myself COTD, right?

RETIREMENT FINANCE AND PLANNING

The Five Types of Retirement, MoneyBoss.com.  You see, while the idea of retirement might be relatively young, it’s achieved a level of complexity that I find fascinating. Retirement is no longer one thing. It’s many things. Or many possibilities. I thought it might be fun to visualize what I consider the five most common kinds of retirement in our current economy. 

How to Understand the ‘Probability of Success’ Metric forRetirement, David Blanchett in the WSJ.  The simplicity of “success” in this metric belies the complexity of “probability.” Because no one can predict the future, this approach requires a bunch of random projections that can be used to estimate a probability.  A better name for the metric would probably be “educated guess,” but that doesn’t sound as mathy.  

Why a ‘Bond Tent’ Can Protect a Portfolio in Retirement, M. Kitces in the WSJ.  The downside, however, is that while an extended period of owning low-return bonds may eliminate the near-term risk, in exchange for the near-certainty of a long-term retirement disaster, as even modest inflation over the span of multiple decades can cut the purchasing power of bond income in half. So what’s the solution? To own more in bonds–but only for a limited period of time.

Which Retirement Spending Strategy Is Right For You? Pfau.  

Simple Deterministic View of the PV of Spending Rates vsLongevity, by me.  No one seems to think much about longevity uncertainty these days except the academic researchers. 

Retirees’ Tax Puzzle: Pay Now or Later? Boston College.  That’s why we’re still seeing people who are “surprised” when they turn 70½ and the required minimum distributions (RMDs) begin, and their tax bill gets a whole lot higher. They say, “Why didn’t we plan for this?” We say, “We’ve been recommending you plan for this for years!”

Visualizing A Missing Piece of Monte CarloSimulation in 3D, by me.  "while I can probably manage a 34% fail rate with enough advance warning, I sure don't want to (or plan to) be the guy in the upper left corner of the cube." 

MARKETS AND INVESTING  

The Risk Reduction Characteristic of Dividends, Kendall Anderson.  As you can see, cash dividends are a direct deduction from shareholder equity. This is the equity we own as investors and as such, a dividend payment reduces our capital investment dollar for dollar against our original investment. … When accounting for a dividend paying security, we reduce our capital investment by the amount of dividends received.

price.

Long-Term Bonds Behave More Like Stocks Than You Might Think, Fortune Financial.  

Real Estate Back in the Saddle,  calculatedriskblog.  The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index, covering all nine U.S. census divisions, surpassed the peak set in July 2006 as the housing boom topped out. 

A Behavioral Bias Cure? Jason Voss, CFA Institute.  With his fellow researchers, Kirk has tested people’s ability to master behavioral biases and has found something remarkable: Meditation is a way to conquer biases. 

Playing Around with a 3D Mean-Variance-DiversificationModel, by me.  

Why Rising Rates Are Good for High-Yield Credit, abglobal.  In our view, a short-duration high-yield strategy can offer a particularly good opportunity to take advantage of rising rates; the quicker the bonds mature, the faster investors can put the proceeds to work in higher-yielding securities.  

Predicting Forward 60/40 Returns, econompicdata.blogspot.  The result are likely forward real returns for a 60/40 portfolio in the 0-2% range pre-tax with more downside in my view than upside (post-tax - you can take off another 1-2%). 

ALTERNATIVE RISK

Winton Capital’s David Harding on making millions throughmaths, FT.com.  In 1994 the Philosophical Transactions of the Royal Society, a leading scientific journal, published an unusual paper. Entitled “Making money from mathematical models”, it was authored by a young financial trader in London. His name was David Harding, he was a Cambridge physics graduate and he used the paper to lay out what he saw as the “intellectual front line” of investment research. Harding’s idea was that finance could use science to identify and exploit inefficiencies in the markets.  He was right. 

A Very Different Kind of Trend Model, followingthetrend.com  "…what if I told that we could make a kind of trend following model which does not use the price direction as an input at all? It also has no stops and no targets."   

A Market Leverage as an Explanation of Low VolatilityAnomaly, quantpedia 

Is The Low Volatility Anomaly Driven By Lottery Demand? AlphaArchitect.  This paper highlights the fact that investor’s demand for lottery-type stocks can explain the low beta anomaly (using the MAX measure — simply the largest single-day return over the past year).  

Managing the Risk of the 'Betting-Against-Beta' Anomaly:Does It Pay to Bet Against Beta?  Barroso & Maio.  SSRN.  We study the risk dynamics of the betting-against-beta anomaly. The strategy shows strong and predictable time variation in risk and no risk-return trade-off. A risk-managed strategy exploiting this achieves an annualized Sharpe ratio of 1.28 with a very high information ratio of 0.94 with respect to the original strategy. Similar strategies for the market, size, value, profitability, and investment factors achieve a much smaller information ratio of 0.15 on average. The large economic benefits of risk-scaling are similar to those of momentum and set these two anomalies apart from other equity factors. Decomposing risk into a market and a specific component we find the specific component drives our results.  

Commodities for the Long Run, Levine et al AQR.  Abstract: This paper analyzes a novel data set of commodity futures prices over a long sample period starting in 1877, which allows us to shed new light on several important and controversial questions. We document that commodity futures returns (1) have been positive on average; (2) vary significantly across business cycles, inflation episodes, and periods of backwardation versus contango, (3) are driven mostly by variation of spot returns and therefore closely linked to the underlying commodity spot market; (4) perform well during inflation cycles and provide more return in backwardated states; and (5) display low correlation with stocks and bonds. These long-run stylized facts imply that commodity futures can add value to a diversified portfolio from an asset allocation perspective. 

Are Alternative Investments Worth It? RCM Attain.  How much do stocks need to outperform alternatives in order for the long term benefit of alternatives to be made insignificant? In short, when is the excess return worth the increased risk?  …  In the meantime, we’ll always have periods of underperformance and over performance and everything in between as assets cycle into and out of beneficial market environments, leading to broad proclamations that hedge funds are dead, stock markets are broken, and so forth and so on. But those with a longer view see something different. They see non-correlation in action – with different return drivers producing different looking return streams over short periods of time. They see better risk adjust performance over the long term even when employing a strategy that is underperforming in the short term. 

Book Mention: Quantitative Momentum by Gray and Vogel, by me.  

Common Mistakes of Momentum Investors,  dualmomentum.net.  Like most investors, those using momentum are often guilty of chasing performance. In fact, momentum requires that we do this. But it should be done in a disciplined and systematic way. Performance chasing should not be due to myopia, irrational loss aversion, or other psychological biases.  

SOCIETY AND CAPITAL

America’sFirst All-Renewable-Energy City, Politico.com Much of the rest of what Burlington’s 42,000 citizens need to keep the lights on comes from a combination of hydroelectric power drawn from a plant it built a half mile up the Winooski River, four wind turbines on nearby Georgia Mountain and a massive array of solar panels at the airport. Together these sources helped secure Burlington the distinction of being the country’s first city that draws 100 percent of its power from renewable sources.  

The Probability Distribution of the Future, Shane Parrish, Farnam Street.  the world is not a predictable casino game…All we can do is make intelligent estimations, work to get the rough order of magnitude right, understand the consequences if we’re wrong, and always be sure to never fool ourselves after the fact.  

How much is enough.  NYT  [good question]