Aug 25, 2017

Weekend Links - 8/25/17

QUOTE OF THE DAY

[strategy decay] doesn’t happen in a field like physics. Gravity doesn’t get arbitraged away due to popularity. Morgan Housel 


GRAPHIC OF THE DAY



RETIREMENT FINANCE AND PLANNING

All together, by slashing fund expense ratios from 1.0% to .10% and the advisory fee from 1% to .40%, the retiree could receive $32,000 additional annual retirement income — or roughly $2,600 more each month between the ages of 70 and 95. Clearly, the impact of portfolio costs is huge.  

Risk really matters when you no longer have human capital and are planning to live off your investment earnings for the remainder of your days…Sequence of return risk can be painful if you’re on the wrong end of it but it becomes a double whammy if you end up being a forced seller of stocks when they’re down. This can be avoided through portfolio design, diversification and intelligent deployment of cash flows.  

If you over-estimate your future spending liabilities, you run the risk of underspending today.  If you under-estimate your future spending liabilities, you run the risk of overspending today.  Clearly, the more “conservative” strategy is to over-estimate your future spending liabilities and spend less today.  On the other hand, if you are too conservative, you may be denying yourself the lifestyle you really want to enjoy today and may be unintentionally increasing the amount you ultimately leave to your heirs.  This is perhaps one of the most difficult trade-offs that you (possibly with the help of your financial advisor) will have to face in your financial planning. [He estimates a 22% reduction at 65. I estimate a ~17% reduction at 68.  In addition I get even more aggressive after 85-86 where I assume I am statistically dead and then factor in a very-minimal "income"/expense for a longer superannuation regime between 85 and ?] 




MARKETS AND INVESTING

On the surface, the fact that a portfolio steeply declines in value may be the primary concern, and for retirement and other spending events, this is indeed a very important consideration. But large drawdowns create strong emotional responses even for investors who can, at least on paper, weather them. These emotional times are when well-intentioned plans are often abandoned, locking in losses and putting the portfolio on a rough road going forward. 

Abusing ETFs, alphaarchitect
The authors find that there is no distinct investor group that significantly benefits from ETF use or that experiences significant increase in diversification. Differently, they also find that no group will lose by investing in the right market ETF. 

the ability to see your daily price fluctuations in bond funds significantly increases the behaviorally induced risk of short-termism in bonds. This is important. 

Behavioral bond bucketing, abnormalreturns
risk cannot be erased it can only be transferred (or hidden from plain sight)… A bond fund is just a collection of bonds. If that collection of bonds does not fit with your particular risk profile don’t buy it. What I think is way more interesting about this debate is the behavioral aspect of owning individual bonds vs. owning a bond fund.  

We briefly introduce the Kelly criterion and then present its multivariate version based only on the first and the second moments of the asset excess returns. Additionally, we provide a simple numerical algorithm to manage virtually arbitrarily large portfolios according to so-called fractional Kelly strategies. [ I made it to about page 4 before I hit the wall but still interesting]  

once the allocations are put in place, how do you know you are getting the exposures you were looking for? And how do you avoid assuming unintended risks?  

Even though we do think we have useful tactical signals for making predictions about future returns, we believe that no tactical signal is powerful enough to warrant wholesale changes to a well-balanced strategic asset allocation…. The decisions we do make, particularly on asset allocation, affect only excess returns, about which the low yield environment says little. Our conclusion then is that the odd environment that prevailed in 2016 and persists in 2017 does not contradict the strategic case to maintain a diversified asset allocation. Rather, it highlights the continued need for investors to diversify across more traditional and alternative return sources and size those return sources so they matter in their portfolio. 

  

ALTERNATIVE RISK

So what can be a good alternative to corporate bonds? We think it needs three things: a stand alone return of Treasury yields plus the corporate spreads, an uncorrelated return to corporate spread widening, a risk that is symmetric and not skewed to higher spread duration. …Managed futures or global macro could be a good alternative. …Switching to managed futures from corporate bods achieves three goals: 1. a reduction in credit risk; 2. a switch into a strategy that may have more upside potential; and 3. an increase in the diversification within the overall portfolio. 

This process benefits everyone: the borrower, who gets a lower rate and better service; individuals, who have access to attractive investments; and our economy, which now has less systemic risk concentrated in a few major financial institutions. [ sure, but...]  

Fear of drawdown, sr-sv.com
Experimental research suggests that probability of outright loss rather than volatility is the key driver of investor risk perceptions. Moreover, fear of drawdown causes significant differences of prices for assets with roughly equal expected returns and standard deviations. Investors forfeit significant expected returns for the sake of not showing an outright loss at the end of the investment period. This suggests that trading strategies with a high probability of outright losses produce superior volatility-adjusted returns. Rational acceptance of regular periodic drawdowns or “bad years” should raise long-term Sharpe ratios.  

A factor-based approach to analyze CTA performance may put some more color on the recent trend as it helps decompose it in the main driving risk factors. Four factors, representing the global fixed-income and U.S. stock markets, currency (EUR-USD), and crude oil collectively appears to explain about 60 percent of its weekly performance over the last year.³ During the last week of June and the first week of July, the simultaneous declines in US equity prices, global bond returns, and a weakening of the USD proved especially painful to CTAs. 



SOCIETY AND CAPITAL

Purpose can provide organizational framework and strategic direction at a time of industry-wide structural change. Purpose can provide an avenue of employee motivation, engagement, and retention. Purpose — when clearly articulated and followed through with action — can also build organizational goodwill. 

Is there a really inescapable economic reason why immigrants are so essential to the country’s economic future? There might be. That reason is agglomeration -- the tendency of economic activity to cluster in highly productive cities…businesses need to be near their customers, while customers -- who are also workers -- need to live near their employers. …a second reason cities are so crucial to a nation’s productivity. When knowledge workers -- engineers, designers, managers and other creative folks -- live near each other, ideas tend to flow freely between them, increasing innovation and progress. Companies that rely on these workers can also take advantage of having a lot of them in a small area -- an effect known as a thick market. The innovative potential of cities is especially key to the modern knowledge economy…This is why immigrants are so vital. With a growing population, agglomeration effects work their magic. 

Life expectancy gains have stalled. The grim silver lining? Lower pension costs 

Economics and Race - 18 studies, nationalaffairs.com

Blockchain is a technology that offers reliable by decentralized record-keeping. The best-known applications of "blockchain" technology are still the alternative currencies, of which Bitcoin remains most prominent. But it looks more and more as if the main near-term expansions of blockchain technology are not going to be about currencies, but instead relate to other kinds of ownership, transactions, and record-keeping.  A couple of recent studies emphasizing this theme are "How blockchain technology could change our lives," written by Philip Boucher, Susana Nascimento, and Mihalis Kritikos for the European Parliamentary Research Service (February 2017), and "Blockchain and Economic Development: Hype vs. Reality," written by Michael Pisa and Matt Juden for the Center for Global Development (CGD Policy Paper #107, July 2017).  


it won’t be easy to win broad acceptance that some agricultural landscapes might be better off returned to the wild – or to agree what “wild” really means. And even when land is seen as useless for farming, it’s not enough to just switch off the tractors and walk away. Land that’s no longer irrigated is prone to fires and drought; and what initially finds root in worn-out soil may be less than ideal in an ecological sense. 

It’s a tenuous predicament, growing low-cost food, feed, and fuel (corn-based ethanol) on ever-more-expensive land, and it raises a host of questions. Is this a sustainable situation? What happens to small farmers? And are we looking at a bubble that will burst? …there’s an additional factor: well-heeled investors are snapping up farmland, driving prices up. Here’s how the Economist explained it:  “Institutional investors such as pension funds see farmland as fertile ground to plough, either doing their own deals or farming them out to specialist funds. Some act as landlords by buying land and leasing it out. Others buy plots of low-value land, such as pastures, and upgrade them to higher-yielding orchards.” 
  
"One winter in 1995, to have a little fun I constructed a computer model of diverse problem solvers confronting a difficult problem. Put aside for now what counts for fun at CalTech; "fun" at CalTech rarely makes sense to the outside world. In my model, I represented diversity as differences in the ways problem solvers encoded the problem and searched for solutions. I referred to these ways of solving problems as tools. In working through the implications of my model, I stumbled upon a counter-intuitive finding: diverse groups of problem solvers -- groups of people with diverse tools -- consistently outperformed groups of the best and the brightest."  

The [negative] superlatives come fast and furious in the spate of reports coming out on the dwindling participation in the labor force by Americans still in their prime working years.  … “We have won the race to the bottom…” 

…whatever party wants to take this on would need to keep its own extremists in check. 

Put another way, the risk premium on property is high because property returns are low when the marginal value of wealth to the marginal investor is high (ie, when times are bad for the average homeowner) and high precisely when the marginal value of wealth to the marginal investor is low (ie, when times are good for the average homeowner). This is as it should be given the relatively progressive vertical distribution of housing wealth. [right out of the gate this comes across as politically tendentious but interesting nonetheless] 

The public-sector pension industry is claiming a comeback from losses suered during the Great Recession. But this recovery is greatly exaggerated: even years past the end of the recession, most pension sponsors are unable to their full annual contributions, and pensions are taking as much investment risk as ever. The first step to eective pension reforms is an honest, accurate view of the costs and risks that public plans impose on government budgets and taxpayers. [he wrote an under-informed editorial in today's wsj on retirement finance so I'm not sure how much cred he has anymore...]

A lack of pension knowledge undermines adequate savings decisions. To understand what motivates individuals to inform themselves about their pension situation, we conducted a field experiment with 245,712 pension fund participants. We find that a small financial incentive is cost-effective and increases the rate by which individuals visit their personal pension website by 70%. Our experiment directly compares the effect of financial incentives to different social norms, which turn out to be ineffective in the pension domain. Financial incentives are effective regardless of gender, age and income, while nudges are ineffective for each subgroup.  


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