Dec 7, 2017

Weekend Links - 12/7/2017


Reminder: Pearl Harbor Day

QUOTE OF THE DAY

Even the most pessimistic forecasts of household undersaving fall short of the most optimistic estimates of government retirement plan underfunding. Andrew Biggs 



RETIREMENT FINANCE AND PLANNING

I understand the skepticism you may have listening to a 27 year old financial blogger tell you that retirement isn’t only about the money. However, the fact remains that once you have some base level of financial security, your day to day happiness in retirement will be more heavily impacted by your relationships, your hobbies, and your sense of purpose than your financial assets. I completely relate to this as my day to day happiness is effected far more by my dating life and blogging life than what is happening with the S&P 500. 

SeLFIES Can Improve the Nation’s Retirement Security, Merton & Muralidhar
SeLFIES address many of these issues. Governments could issue a new, low-cost, liquid and safe ultra-long bond instrument. SeLFIES start paying investors upon retirement and pay real coupons only—say, $5—indexed to aggregate per capita consumption—for a period equal to the average life expectancy at retirement, e.g., another 20 years. Instead of current bonds that index solely to inflation, SeLFIES cover both the risk of inflation and standard-of-living improvements.  

For those who don’t actually need to use their retirement accounts – yet, or at all – the mandatory withdrawals of the RMD obligation presents a substantial tax challenge, as the forced distributions not only trigger taxes on the RMD amount itself, but also risks driving the retiree up into a higher tax bracket when stacked on top of all of his/her other retirement income as well. Fortunately, though, the reality is that there are numerous strategies that can be leveraged to manage and minimize required minimum distributions – both for those who have already reached the RMD phase, and also those still accumulating towards it, who want to plan ahead to minimize the bite of RMDs in the future. 

There are many things that blow up the best laid plans.  Some we can control and some we can’t.  Below is a list of big risks and some ideas about hedging them based on my own experiences and what we’ve observed from our retirement planning users.  

Although I prefer the second strategy to the first, both are missing critical elements of the decision by proposing that we claim Social Security benefits as an isolated exercise. In reality, the correct claiming decision is largely influenced by the composition of the remainder of our retirement plan…The key point is that a retirement plan is a portfolio of income-generating assets that interact with one another in much the same way as do stocks and bonds in an investment portfolio. Choosing a Social Security benefits-claiming strategy in isolation from the other decisions of the retirement portfolio excludes critical considerations and is likely to provide sub-optimal choices. It's like trying to pick a stock investment without considering what's already in your portfolio. 

  
MARKETS AND INVESTING

The purpose of this short piece is to highlight five ideas, influenced by behavioural science, which could lead to better long-term investment decisions: 

Ways To Manage Risk, Blue Sky Asset Mgmt
It is critical to construct portfolios that investors can live with through both good and bad times. In order to do so, we believe the approach needs to be systematic to attempt to remove the behavioral biases that can hurt investor returns. We also believe the approach needs to be responsive to market changes where we can make adjustments that can help avoid prolonged bear market losses while attempting to capture bull market gains. Of course, this is can be a very difficult balance to meet – there are no silver bullets. Investors in risk managed strategies like we’ve described, will most likely see relative under-performance during bull markets due to the risk management strategies that are employed to protect their capital, and out-performance when the risk management pays off as markets decline. 

With the 2/10, we gain a rare example of a forward indicator with a decent track record but it comes at the expense of timing. To put it in clearer words, the world doesn’t automatically explode once the 2/10 gets inverted. 

This is a guest post from an endowment fund investment manager and a blogger who blogs at Our Family Fortune. We have no financial relationship. Today he walks us through the various decades of our lives and where we should be focusing. 

MPT can be fixed by explicitly incorporating a term for investor leverage aversion, as well as volatility aversion, allowing each investor to determine the right amount of leverage given that investor’s preferred trade-offs between expected return, volatility risk and leverage risk. Incorporating leverage aversion into the portfolio optimization process produces portfolios that better reflect investor preferences. 9

The authors find that as we move toward 10 fund managers (aka portfolios, aka strategies), it becomes exceedingly difficult to a create a blend with active risk greater than 2%, suggesting that even if pension funds are determined to maintain high levels of active risk, it becomes practically impossible to do so. Similarly active share and stock specific risk decline.  

If individuals want to assess the probability of the event actually happening in order to make portfolio decisions, then they have to focus on the real-world probabilities.  Ultimately, an investor’s cost function associated with market events depends more on life circumstances. While a bad state of the world for an investor can coincide with a bad state of the world for the market (e.g. losing a job when the market tanks), risk in an individual’s portfolio should be managed for the individual, not the “typical household”. 
  
ALTERNATIVE RISK

Momentum is one of the strongest, if not the strongest, of the major market “anomalies” documented in the literature. But most academic studies ignore real world costs and other forms of slippage when examining factors, which is likely a larger issue for momentum due to its higher turnover. The concern is that momentum is so costly to trade that its return premium is diminished in the real world…We don’t address this in the paper, but I would argue that this finding — that momentum is implementable at low cost — holds even more strongly when it’s part of a multi-factor portfolio, where factors that complement momentum, like value, will dampen turnover. All considered, we find that momentum is quite implementable in real life.  

we show that a bottom-up approach to multi-factor portfolio construction can produce superior results than a combination of individual single factor portfolios, at least for well-known factors such as Value, Quality, Low Volatility, and Momentum. Because the bottom-up approach assigns weights to securities on multiple factor dimensions simultaneously, it accounts for cross-sectional interaction effects in a way that combining single factor portfolios does not.  

This chapter delves deeply into an area of rules based portfolio construction which has largely been overlooked. … we demonstrate a closed form solution to the maximum effective multiplier under a certain set of conditions. Importantly, we highlight that screening and weighting decisions interact, and should therefore not be made independently. Ultimately, the performance and characteristics of a portfolio is linked to the combined effect of screening and weighting decisions through the maximum effective multiplier.  

Essentially, bitcoin's cash market is like a river. Its flow is dependent on constants and so it generally flows in one direction. The bitcoin futures market, on the other hand, is like an ocean with thermohaline circulation: its flow is dependent on several variables.  Marine life in the futures market is not as friendly. The waters are infested with killer whales. Apex predators that feed on other whales. They even feed on themselves. 

Wes Gray on Momentum at The Capital Spectator  

All the major equity factor strategies are posting solid gains for the one-year trend through yesterday’s close (Dec. 6), which makes momentum’s run all the more impressive. Indeed, the strategy’s return edge over the rest of the field has continued to accelerate since our update a month ago. 


SOCIETY AND CAPITAL

The Effect of Education on Health and Mortality: A Review of Experimental and Quasi-Experimental Evidence. RAND, Princeton, Erasmus U
There is no convincing evidence of an effect of education on obesity, and the effects on smoking are only apparent when schooling reforms affect individuals’ track or their peer group, but not when they simply increase the duration of schooling. An effect of education on mortality exists in some contexts but not in others, and seems to depend on (i) gender; (ii) the labor market returns to education; (iii) the quality of education; and (iv) whether education affects the quality of individuals’ peers. 

Making tons of money at an early age is probably a combination of the best and worst thing that can happen to you. It gives you tons of possibilities but also opens you up to potential problem situations if you’re not equipped to handle it…One of the biggest problems with becoming wealthy, especially when it happens really fast, is that people become overconfident and assume wealth equals better decision-making ability. If anything, more money often causes people to make worse decisions. Success early on in life can also give you a false sense of intelligence or skill.  

…filial support laws “could be a sleeping giant.” Why? Because they could make adult children legally responsible for long-term-care expenses — such as nursing home bills — should a parent be unable to pay. While these statutes are not new, their enforcement is. 

Risk and Returns in Shariah Compliant Cross-Section Stocks: Evidence From an Emerging Market, Hanif & Shah
This study is intends to understand and document the impact of market-based — market returns and momentum — as well as firm-specific — size, book to market ratio (B/M), price to earnings ratio (PER) and cash flow (CF) — factors on pricing of Shari’a compliant securities as explanation of variations in stock returns in an emerging market  

It’s no secret house prices differ across the U.S. There are also large differences in how these prices change over time. In the short-term, the data include a lot of noise and temporary regional peculiarities. Over the longer haul, though, clear trends can emerge… 

It covers over 70% of the Earth’s surface, is home to millions of species of life, and it makes up 97% of all water on the planet. But, with this massive size and ubiquity also comes a significant challenge for humans interested in trade: it must be constantly traversed in order for us to move goods around. 

A series of studies shows that the interstate migration rate has fallen substantially since the 1980s. Americans now move less often than Canadians, and no more than Finns or Danes. ... [M]obility rates are lower among disadvantaged groups and that mobility has not increased despite becoming “more important” to individual economic advancement. 

Dalio then described how the dynamic works, similar to his economic cycles explanation in his 2003 paper “How the Economic Machine Works.” As SALT rates and debts rise due to shortfalls, high-income taxpayers will move from high SALT locations to low SALT locations  to temporarily escape these issues. As this increasingly happens, the value of the higher SALT locations depreciates because there is now less spending in those locations, while the opposite occurs in the low SALT areas thanks to their new inhabitants. This eventually bottoms out when the SALT ratios switch. Unfortunately, the process creates more polarity between the “haves” and the “have nots” as neighborhoods change to accommodate the “haves” while the “have nots” are essentially pushed out due to the realization that they can no longer afford to live in their neighborhoods. Dalio points to the recent gentrification of downtown Manhattan and Brooklyn as an example. 

“I think it’s a harbinger of things to come, I think this is a Trojan Horse,” said Charles Skorina in an interview with CIO. Skorina is the founder of San Francisco-based Charles Skorina & Co., which recruits CIOs and asset managers for endowments, foundations, and institutional investment firms. “Congress has wanted to tax non-profit entities, and I think this is the foot in the door. Some in Congress have regularly railed against tax-exempt organizations.” 

There has been a strong upward trend in collateralization since the great financial crisis. Suitable collateral, such as government bonds, is essential for financial transactions, particularly repurchase agreements and derivative contracts. Increased collateralization poses new risks. Collateral prices and haircuts are pro-cyclical, which means that collateralized transactions flourish when assets values rise and slump when asset values decline. This creates links between leverage, asset prices, hedging costs and liquidity across many markets. Trends are mutually reinforcing and can escalate into fire sales and market paralysis. Central clearing cannot eliminate this escalation risk. The collateral policies of central banks have become more important. 


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