QUOTE OF THE DAY
...beware of incoherence that passes itself off as complexity. Dani Rodrik
RETIREMENT FINANCE AND PLANNING
Are SUVs Ruining Retirement Savings? Ben Carlson
if you’re one of the many people who are woefully unprepared
for retirement or any of your other saving goals, a good place to start would
be cutting back on any unnecessary spending on transportation. http://awealthofcommonsense.com/2018/07/are-suvs-ruining-retirement-savings/
Target-Date Funds Aren’t the Retirement Bull’s-Eye, Nir
Kaissar
target-date funds are no cure-all. One obvious defect is
fees. I counted 227 retirement share class target-date funds with $100 million
or more in net assets. Their average expense ratio is 0.67 percent a year, and
their asset-weighted average expense ratio — which accounts for the size of the
funds — is 0.58 percent…It’s also not clear why retirement savers should own
more bonds over time. People are living longer and a bond-heavy portfolio
raises the risk of running out of money. And that isn’t the only risk…The
combination of those factors — high fees and the potential for unlucky timing
and misuse — could easily add up to 1 percent to 2 percent a year in lower
returns, costing retirement savers hundreds of thousands of dollars over the
course of a career. https://www.bloomberg.com/view/articles/2018-07-18/target-date-funds-aren-t-the-retirement-bull-s-eye
The Unique Retirement Issues Facing Women, Swedroe
Women face at least 12 unique challenges from financial and
life circumstances related to long-term retirement planning. … Specifically,
women: 1. Earn less. 2. Live
longer. 3. Have fewer years of earned
income. 4. Start investing later… https://www.advisorperspectives.com/articles/2018/07/30/the-unique-retirement-issues-facing-women
Why is Retirement Harder than Saving for Retirement? (SWR
Series Part 27), ERN
ust because saving for retirement is relatively simple it
doesn’t mean we can just extrapolate that simplicity to the withdrawals during
retirement. And that’s what today’s post is about: I like to go through some of
the fundamental factors that make withdrawing money more complicated than
saving for retirement. Think of this as an introduction to the SWR Series that
I would have written back then if I had known what I know now! https://earlyretirementnow.com/2018/07/25/why-is-retirement-harder-than-saving-for-retirement-swr-series-part-27/
MARKETS AND INVESTING
The Myth of Volatility Drag (Part 2), Will Morrison
What? Calling it “drag” creates an association since “drag”
is generally understood as a force. But there is no “force” here, merely a
mathematical relationship.
[I find this kind of thing useful. If Mr Morrison does a
part 3 of this series I hope that he goes beyond the useful focus on semantic
issues and the effects of time over multiple periods. I hope he includes a
discussion of both (a) consumption (often ignored) which can introduce a very
real buy-high-sell-low effect into the volatility equation and (b) horizon
(while the tendency at infinity is towards return expectations adjusted by -V/2
it’s a slightly different game between now and infinity, a game retirees play
every day)]
Machine Learning, Subset Resampling, and Portfolio
Optimization, Justin Sibears
building a robust portfolio optimization engine requires a
diligent focus on estimation risk…We summarize the results from two recent
papers we’ve reviewed on the topic of managing estimation risk. The first paper
relies on techniques from machine learning while the second paper uses a form
of simulation called subset resampling….We perform our own tests by building
minimum variance portfolios using the 49 Fama/French industry portfolios. We find that while both outperform
equal-weighting on a risk-adjusted basis, the results are not statistically
significant at the 5% level. https://blog.thinknewfound.com/2018/07/machine-learning-subset-resampling-and-portfolio-optimization/
ALTERNATIVE RISK
Winton’s David Harding on Turning Away From Trend Following,
winton.com
Momentum is not a fixed law of markets, he says; it was a
good trade and it got crowded. “If any trade gets very crowded then it can
backfire,” he says. “It’s a standard market thing. If everyone tries to do the
same thing at the same time it goes wrong.” … Equally he rejects the suggestion
that because trend-following returns have waned, the opportunity for firms like
Winton has shrunk. Such thinking comes from the flawed assumption that markets
fit the efficient market model, he says. … his view of market returns as “in
general the product of a complex, multidimensional chaotic process” impossible
to characterise by any simple mathematical model. … The quant culture in
finance, conversely, he sees as often dogmatic. “Many mathematicians and
programmers don’t read a lot of history, philosophy, religion,” Harding says.
“That’s what you need to be a successful investor. You need to have an eclectic
outlook on the world.” https://www.winton.com/news/2018/risk-net-wintons-david-harding-on-turning-away-from-trend-following
The dangerous disregard for fat tails in quantitative
finance, sr-sv
With fat tail distributions, extreme events away from the
centre of the distribution play a very large role. Black swans are not more
frequent, they are more consequential. The fattest tail distribution has just
one very large extreme deviation, rather than many departures form the norm. http://www.sr-sv.com/the-dangerous-disregard-of-fat-tails-in-quantitative-finance/
Academics Avoid Equity Curves, priceactionlab
Equity curves show the increase in equity of an investment
strategy as a function of time. This is the most valuable data visualization
for people with skin-in-the-game. http://www.priceactionlab.com/Blog/2018/07/equity-curve/
Momentum Solutions for Retirement, dualmomentum.net
But the vast majority of SWR studies are based on various
allocations of buy-and-hold portfolios of stocks and bonds. Researchers have only recently begun to
consider how the SWR calculus could be affected by factor-based investment
styles like value or momentum (Kitces 2016[5] ; Gray 2017[6]). … At least one investor in the momentum camp,
Toma Hentea (2015)[8], compared SWRs of buy-and-hold portfolios to those of
momentum-based portfolios and noted that SWRs could be substantially higher for
momentum-based portfolios. … Many
investors could benefit from incorporating some element of momentum strategies
into managing their retirement accounts, whether to accomplish a higher
withdrawal rate or simply to reap the well-established benefits of momentum and
trend following for other purposes. http://www.dualmomentum.net/2018/07/momentum-solutions-for-retirement.html
Reducing the Risk of Black Swans: Using the Science of
Investing to Capture Returns with Less Volatility (a review), Swedroe and
Grogan
This new edition revamps the previous one by elucidating two
key developments: (1) “the ‘retailization’ of investment strategies that were
once solely the domain of hedge funds and institutional investors such as the
Yale Endowment Fund” and (2) the fintech revolution, which has disintermediated
traditional lenders and, in the process, created new channels of access for a
broader swath of investors. These developments, according to the authors, have
made possible investment vehicles that embody uncorrelated return factors
beyond the Fama–French set. As a result, financial advisers and sophisticated
retail investors can avail themselves of the full menu of style and risk
factors previously accessible only to endowments and other large institutional
investors via private equity, hedge funds, and more-esoteric vehicles. https://www.cfapubs.org/doi/full/10.2469/br.v13.n1.4%40faj.2018.74.issue-2
Everybody’s Doing It: Short Volatility Strategies and Shadow
Financial Insurers, FAJ The extraordinary growth of short volatility strategies
creates risks that may trigger a serious market crash. A low-yield,
low-volatility environment has drawn various market participants into
essentially similar short volatility-contingent strategies with a common
nonlinear risk factor. We discuss these strategies, their commonalities, and
the generally unrecognized risks that they would pose if everyone were to
unwind simultaneously. Volatility-selling investors essentially provide “shadow
financial insurance.” Investors and regulators would benefit from preparing for
large, self-reinforcing technical unwinds that may occur when/if central banks
change policy or macro or political events affect investor confidence. We also discuss
potential mechanisms that might provide stabilization against largely adverse
financial outcomes. https://www.cfapubs.org/doi/pdf/10.2469/faj.v74.n2.6
Measuring Process Diversification in Trend Following, Corey
Hoffstein
In this commentary, we attempt to measure how much
diversification opportunity is available by employing multiple models with
multiple parameterizations in a simple long/flat trend-following process. … As
it specifically pertains to trend-following, we see that diversification
appears to be maximized by allocating across a number of lookback horizons,
with an optimizer putting a particular emphasis on barbelling shorter and
longer lookback periods. https://blog.thinknewfound.com/2018/07/measuring-process-diversification-in-trend-following/
Infographic – Top 100 Managed Futures Programs, RCMAlternatives.com
Quant Hedge Funds Trail Old-School Ones, But Reap All the
New Money, CIO [pwd wall]
The allure of computer-based investing is powerful, despite
inferior returns. https://www.ai-cio.com/in-focus/market-drilldown/quant-hedge-funds-trail-old-school-ones-reap-new-money/
The importance of volatility of volatility, sr-sv.com
Options-implied volatility of U.S. equity prices is measured
by the volatility index, VIX. Options-implied volatility of volatility is measured
by the volatility-of-volatility index, VVIX. Importantly, these two are
conceptually and empirically different sources of risk. Hence, there should
also be two types of risk premia: one for the uncertainty of volatility and for
the uncertainty of variation in volatility. The latter is often neglected and
may reflect deep uncertainty about the structural robustness of markets to
economic change. A new paper shows the importance of both risk factors for
investment strategies, both theoretically and empirically. For example, implied
volatility and “vol of vol” typically exceed the respective realized
variations, indicating that a risk premium is being paid. Also, high measured
risk premia for volatility and “vol-of-vol” lead to high returns in investment strategies
that are “long” these factors. http://www.sr-sv.com/the-importance-of-volatility-of-volatility/
SOCIETY AND CAPITAL
On Preferring A to B, While Also Preferring B to A, Tim
Taylor
"In the last quarter-century, one of the most
intriguing findings in behavioral science goes under the unlovely name of
`preference reversals between joint and separate evaluations of options.' The
basic idea is that when people evaluate options A and B separately, they prefer
A to B, but when they
evaluate the two jointly, they prefer B to A." Thus,
Cass R. Sunstein begins his interesting and readable paper "On preferring
A to B, while also preferring B to A" (Rationality and Society 2018, first published July 11, 2018, subscription
required). http://conversableeconomist.blogspot.com/2018/07/on-preferring-to-b-while-also.html
Longevity bond pricing in equilibrium, Jevtic et al.
there exists a risk that liabilities related to previous
financial commitments grow higher than expected due to the unreliability of
forecasts of mortality trends. This risk is called longevity risk ;
essentially, it is the risk that lives in a reference population might, on
average, live longer than anticipated. It is clear that providers of pension
plans, annuity, and social insurance share a strong interest in proper
assessment and management of this risk. Whereas assessing longevity risk is
intimately connected with the development of better mortality models with
stronger forecasting capabilities, its management, in order to facilitate
transfer of longevity risk to capital markets, is at least in part dependent on
the development of mortality linked financial instruments, such as mortality
bonds, swaps, and mortality options type derivatives…We consider a model with
stochastic mortality intensity that affects the income of agents in the market
and introduce a longevity bond market that can be used to hedge longevity risk.
By using the Clark-Haussmann formula, we prove that our longevity bond
completes the market. In addition, we provide numerical results for the
survivorship longevity bond. https://ssrn.com/abstract=3206195
How Does Consumption Habit Affect the Household's Demand for
Life-Contingent Claims? Tan et al.
This paper examines the impact of habit formation on demand
for life-contingent claims in a life-cycle model. We solve the optimal
consumption, portfolio choice, and life insurance/annuity problem analytically,
and illustrate the mechanism how consumption habit can alter the bequest motive
and therefore drive the demand for life-contingent products. We show that habit
formation alone can partially address the mismatch in the life insurance market
between the life insurance holdings of most households and their underlying
financial vulnerabilities, or the mismatch in the annuity market between the
lack of any annuitization and the risk of outliving their financial wealth, but
not both. However, habit formation together with social security may shed some
light on the puzzling thinness of both life insurance and voluntary annuity
market. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3211009
Unambiguous Uncertainty, Sam Savage
So, what’s the difference between these two experiments? In
the second one, the subject’s amygdala (the emotional center of the limbic
system, which triggers the fight or flight response) lights up like a Christmas
tree when viewed with functional MRI! The explanation for this strong reaction
is that the ambiguity of the second deck induces anxiety[1]… The relevance to
probability management is that in our discipline, uncertainty is communicated
in SIPs (Stochastic Information Packets), which are randomly shuffled potential
outcomes similar to the first deck of cards. With SIPs, the uncertainty is
unambiguous. https://www.probabilitymanagement.org/blog/2018/7/24/unambiguous-uncertainty
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