Oct 19, 2017

Weekend Links - 10/19/17


…for psychologists seeking to understand the apparent nexus of success and abuse, Weinstein’s apparent downfall is just the tip of an analytic iceberg.  -- Persaud & Bruggen   



Households with limited savings, on the other hand, may well find that their non-discretionary spending gradually overwhelms their portfolio spending. Even though the portfolio would be doomed by continued spending, they will still need to pay for groceries and housing and may have little recourse other than to keep spending and pray for a tremendous bull market. They may find themselves in a “spending trap” in which they must sustain their level of spending simply to meet non-discretionary spending demand with the knowledge that doing so will most likely soon bankrupt them…Sometimes a retiree may keep returning to that ATM for as long as possible because she has no better alternative. That's rational.  

The paper suggests ways that advances in the theory of finance combined with innovations in financial contracting technology might be used to improve social welfare by designing and producing a new generation of user-friendly life-cycle products for consumers. It contrasts the old Markowitz single-period paradigm of efficient diversification with a new Mertonian paradigm that takes account of multi-period hedging, labor supply flexibility, and habit formation.  

A Flexible Plan For Health Insurance In Early Retirement, Chris Mamula
Using the “Rule of 300”, and plugging in the ranges from the example above means that projected savings needs for health insurance premiums would range from $24,900 ($83×300) to $232,500 ($775×300). Each of our individual numbers will vary based on factors such as age and area of residence. However, the case of this individual is representative of, and possibly even underestimates, the challenges faced by those planning to retire early.  

When I decided I was going to retire early, I needed to select the country I was going to live in. I decided to move to a country that would allow me to take advantage of geographic arbitrage, which is defined as the practice of taking advantage of different prices and tax rates in different markets.  

Oftentimes, a lower cost of living is the most prominent reason for living abroad , said Olivia S. Mitchell, director of the Pension Research Council at the University of Pennsylvania's Wharton School, to the Associated Press.  In addition to lower rents, many boomers find cheaper healthcare.  

Ultimately, because our clients are most concerned with the potential downside, and because Monte Carlo incorporates not only downside risk, but sequence of returns risk as well, we use it as the best-available tool in our Financial Plans to answer the question, “do I have enough?” But these inconsistencies at the extremes are important to acknowledge. As with any model, understanding it’s sensitivities and limitations is essential so that we don’t use it to answer a question it isn’t fit to reliably answer. 

The best-laid retirement plans take into account investment-return assumptions and withdrawal rates. They should also include planning for unexpectedly early departures from the workforce.  


Losing With a Winning Hand, ofdollarsanddata
even when we know we are behaving optimally, we may not always get the best results. This is especially true with investing where a diversified portfolio of broad asset classes with low fees can have periods of underperformance. Some of your individual asset classes are likely to lose money in every year, but you should expect this. If everything you own is moving up all of the time, maybe your assets are too correlated and the next crash will be particularly ugly.  

Most people intuitively understand that time is a critical component of investing.  Whether it’s the time it takes to work and save a portion of every paycheck or the miracle of compound interest that gets better and better as you go, the importance of time is a central part of any detailed investing discussion.  But the human brain is sometimes ill-equipped to comprehend things that are far away, and that can lead to some mental over-simplifications that obscure the reality of future uncertainty.  For example, let’s talk a bit about a question I see come up pretty often: Do stocks get less risky the longer you invest?   …Averages are not the same thing as portfolio account values, and investors who mentally justify a risky portfolio under the belief that time will reduce risk could be in for a rude awakening!
Investing and time will forever be linked together. What is investing but the sacrifice of current consumption in expectation of increased future consumption? Investors who want to get rich quickly tend to forget this truism and the importance of being patient. I understand this, but even I am surprised by the time horizons over which some of the greatest investors tend to think. 

The event (as first argued by N. N. Taleb) was not an outlier…These events can happen at any time if there is sufficient panic…All leveraged investors and traders reached uncle point on that day.   [COMMENT: I was in grad school in '87.  I remember hanging out in a hallway with 10 people staring at a screen. All 11 were standing there slackjawed]


Read this paper if you claim to be an evidence-based investor. Many of the products and investments you currently hold may be reliant on funky studies. These strategies often use metrics that don’t replicate. 

The asset allocation set by PRINCO is heavy on equities, with 95% of the portfolio dedicated to them. However, only 10% of the portfolio is allocated to US equities. Large portions of the portfolio are also allocated to high-return categories, such as international, hedged, and private investments. 

I will review the historical evidence on the correlation of time-series momentum in U.S. stocks and how it performs when equity returns are negative. In the process, I’ll examine the question of whether the correlation turns negative when diversification benefits are most needed.  

One of the significant problems for the first formal asset pricing model developed by financial economists, the capital asset pricing model (CAPM), was that it predicts a positive relationship between risk and return. However, empirical studies have found the actual relationship to be flat, or even negative. 

There are a number of ways to beat the simple 60/40 blend in the long-run. One, add diversifying assets from the list used in the graph above. .... Two, add hedge fund strategies that have diversification of assets along with diversification of style. This, for example, could be a portfolio of managed futures programs which already are globally diversified across a broad set of markets including equities, bonds, rates, currencies and commodities. Along with the asset class diversification, investors get strategy diversification that will often weight long and short positions by trends. The advantage of managed futures is that there is the opportunity for adding convexity or portfolio gamma. 

Momentum risk premium is one of the most important alternative risk premia. Since it is considered a market anomaly, it is not always well understood. Many publications on this topic are therefore based on backtesting and empirical results. However, some academic studies have developed a theoretical framework that allows us to understand the behavior of such strategies. In this paper, we extend the model of Bruder and Gaussel (2011) to the multivariate case. We can find the main properties found in academic literature, and obtain new theoretical findings on the momentum risk premium. In particular, we revisit the payoff of trend-following strategies, and analyze the impact of the asset universe on the risk/return profile. We also compare empirical stylized facts with the theoretical results obtained from our model. Finally, we study the hedging properties of trend-following strategies.  …  the traditional diversification approach based on correlations must be supplemented by a payoff approach. However, most risk premia have a concave payoff. The momentum risk premium thus plays a central role as it exhibits a convex payoff, and we know that mixing concave and convex strategies is key for managing skewness risk in bad times.  …  Contrary to traditional assets, the returns of a momentum strategy cannot be approximated by a Gaussian distribution. This is why the momentum risk premium has a positive skewness contrary to traditional risk premia. This result makes the momentum very singular in the universe of risk premia, because it is certainly the only strategy that presents this property of positive skewness. However, this does not mean that it is not a risky strategy.  … In the end, long fixed-income exposures contributed more to the momentum risk premium in 2008 than short equity exposures.   

On paper, momentum is one of the most compelling factors: simulated portfolios based on momentum add remarkable value, in most time periods and in most asset classes, all over the world. So, our title may seem unduly provocative. However, live results for mutual funds that take on a momentum factor loading are surprisingly weak. No US-benchmarked mutual fund with “momentum” in its name has cumulatively outperformed its benchmark since inception, net of fees and expenses. Worse, because the standard momentum factor gave up so much ground in the last momentum crash of 2008–2009, it remains underwater in the United States, not only compared to its 2007 peak, but even relative to its 1999 performance peak. This means 18 years with no alpha, before subtracting trading costs and fees!  

A recent paper called "Time-series and cross-sectional momentum strategies under alternative implementation strategies" suggests that times series is actually superior because it does not place constraints on the winner and loser portfolio. This research is focused on a portfolio of stock indices, but the intuition can be used to help describe different managed futures approaches.  … However, the research does show that regardless of approach momentum is still a factor worth pursuing.  [related: Time-series and cross-sectional momentum strategies under alternative implementation strategies]


In other words, there are roughly 11 million millionaires in America. This count is at a record high thanks to a bull market in stocks, bonds, and real estate. Although 11 million sounds like a lot, it still only accounts for roughly 3.5% of the US population. I suspect the actual number is higher due to stealth wealth and plenty of unreported or underreported assets. 

Why Simple Beats Complex, Ben Carlson from July 2017
I wrote a whole book on this topic that even says “Why Simplicity Trumps Complexity in Any Investment Plan” in the title. While I can’t prove this as 100% fact, here are the reasons why I believe simple beats complex in the investment world: 

The Price of Progress, Michael Batnick
The economic machine that we’ve built in the United States has done extraordinary things and I can’t wait to see what we come up with in the future. But what do we do when progress leaves so many behind? 

How Americans Differ by Age, visualcapitalist
From the day of birth, most Americans are told by society that their life should follow a certain trajectory: go to school, get a higher education, get married, start a career, and retire as soon as they are gray and old.  For many people, their life story plays out exactly like this – but people actually do it at very different speeds, or people end up hitting these milestones in different orders. Meanwhile, some Americans deviate from the typical path altogether, forging their own unique stories.  Interestingly, all of these landmark life events can be viewed through the lens of demographics, and today’s charts from Overflow Data help to tell this tale. In the below charts, we’ll look at education, employment, and marital status all visualized based on a spectrum of age. 

Gender lens investing — using capital to alleviate the economic plight of women and girls — is gaining steam. From being a blip on the screen a mere two decades ago, this field is being embraced by more than 100 private and public funds. And their investment products are getting more targeted: Investors can put money in funds that aim to improve women’s access to health care, for example.  

The Psychology of Superstar Sex Predators, -- Raj Persaud ,  Peter Bruggen
One intriguing finding from this research, published in 2016 in the journal Personality and Individual Differences, is that personality traits associated with a proclivity for harassment may be “specialized psychological adaptations” that allow individuals to exploit “niches” in society. In other words, some sexual predators may seek careers in particular industries that allow them to exploit others…This last trait – also known as narcissism – is a key component of the dark triad. Narcissists tend to be convinced of their own magnificence, and believe that other people should be flattered to be in their company – even if that involves unwanted sexual advances.  …for psychologists seeking to understand the apparent nexus of success and abuse, Weinstein’s apparent downfall is just the tip of an analytic iceberg.

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