Hedge Funds And S&P 500 Nearly Identical - Business Insider

Hedge Funds And S&P 500 Nearly Identical - Business Insider:

This one surprised me.  I was expecting the normal "Hedge funds don't outperform" article but this is much better.  It shows that hedge funds while not outperforming indexes, have (on average) had lower risks.

A look in:

" ...the path of achieving the 8.6% return would have been dramatically different between these two. The monthly return volatility for the S&P500 is nearly double that of the hedge fund index. And while the correlation between the two indices is almost 0.6, the beta of the hedge fund index has consistently been low - about 0.33 over the 20 year period."

I definitely recommend clicking through and seeing the charts.  They do tell a story that is often forgotten when only returns are considered.
Read more: http://www.businessinsider.com/hedge-funds-and-sp-500-nearly-identical-2013-8#ixzz2bltKrLgq

Are Stocks Still Good for the Long Run? - TIME

Wow. The other day I reTweeted a tweet from Zvi Bodie. I did not have time to blog it then, but saved it. And just finished reading it and two follow-ups to it all I can say it that they are definite must reads! (and will be so for all of my fall classes!)

Are Stocks Still Good for the Long Run? - TIME by Justin Fox:

While now it is commony held that stocks have a higher expected return than bonds because of fact that stocks are more volatile (more risk, more return demanded), the article begins off by recounting that this was not always believed. After this interesting history, Fox brings the reader to the recent finding by Arnott that over the past 40 years stocks underperformed (albeit slightly and at a time when stocks had just fallen precipitously) bonds. (here is a post on that from last month.)

"...[after the 1929 crash the] idea that stocks could be good investments became a joke and remained that--in the popular view, at least--for decades. Yet whenever anyone in later years re-examined the data on stocks' long-run performance--major scholarly studies on the topic were published in 1938, '53, '64 and '76--they reached the same conclusion Smith did. Even with the dire experience of the early 1930s factored in, stocks had proved an excellent long-run investment, with returns that far outpaced those of bonds."

Much of the article is grounded on solid academic research including work done by Jeremy Siegel and others. This research suggests strongly that sometimes financial assets are mispriced and thus there may be significant relative performance differences for long periods of time where bonds outperform stocks (as in the 40 years that Arnott found).

So given what we know about mispricing and the historical performance of index funds vis-a-vis actively managed funds (unstated in article), one solution is to use a hybrid of indexing and picking. This suggests a strategy where rather than buying individual assets that have appreciated greatly (and are thus more likely to be overpriced) it is wiser to invest in assets that are out of favor (so called value stocks).

"He [Siegel] says the one significant change in his advice over the past decade has been an increased emphasis on "value" stocks with prices that are low relative to earnings, book value and other fundamental measures. Both Arnott and Siegel are boosters of a new investment approach called fundamental indexing, in which one assembles a portfolio weighted by earnings, dividends or the like in order to avoid the tendency inherent in conventional capitalization-weighted index funds to load up on the most expensive stocks.

An alternative solution, which Bodie has proposed many many times but has not yet caught on to a great degree, is to use TIPs and long term options. The logic behind this is that stocks are volatile (indeed more volatile in the long term than the short term) and largely because stocks do tend to be so risky, you can never be assured how they will perform over your investment horizon. Therefore, you should invest in TIPs to get the what you NEED for future and if you want to invest the rest in riskier scurities (long term options is Bodie's well reasoned choice) the extra for things you may WANT.

From the Time article and a follow-up piece from Time's Curious Capitalist blog.

"To Boston University finance professor Zvi Bodie, another frequent debating partner of Siegel's, this entire discussion is beside the point for most Americans. "He could be right," he says of Siegel's argument that stocks are a good deal right now. "I'm just more risk-averse than he is." Bodie, co-author of the perennially best-selling business-school textbook Investments, wrote a 2003 book titled Worry-Free Investing and has been trying ever since to steer personal-finance advice in a radically new direction. For most Americans, Bodie says, stocks are entirely inappropriate vehicles for saving for retirement. The reason they outperform bonds over time is the very reason they should be avoided: they're riskier. And if you're putting away money that you're going to need to live off in retirement, you shouldn't be taking any risk at all...."If your goal is to maintain your standard of living, then here's how much you should be saving and putting into TIPS," he says. "If you want to save more than that and speculate in the stock market, by all means, do it. But you need to recognize that you can't count on it when you do that."

In an email to Justin Fox as reported on Time's the Curious Capitalist blog, Bodie writes:

"If you doubt the rationality of the stock market, then isn't investing in stocks a crap shoot? How can you be sure that there is a positive risk premium? The historical evidence is far from conclusive. It depends on what time periods and what countries you look at. Even the experts disagree."

Bodie concludes:

Under such circumstances, shouldn't a rational investor follow the TIPS + calls approach that I advocate?"

The problem is, as Fox points out, that this will likely (albeit not necessarily) yield a lower return so

"To follow Bodie's advice, then, you're probably going to need to save a lot more money for retirement than you've been doing"

So what is the takeaway? With high long term volatility and the academic evidence pointing more and more to markets being less than perfectly efficient, it seems that Fox nails it when he end with

"Stocks are still the best investment for the long run. But maybe not for your long run."

Which again suggests that the investment world (at least individual investors worried about their retirement or other largely fixed future obligations) should give much consideration to Bodie's advice and use TIPs for the part that you "need" and then LEAPs and other risky securites for what you "want".

And lest you doubt that this is a new idea or that Bodie is just saying this after a bad period in stocks, here is from a 2004 FinanceProfessorBlog post.:

"So what is one to do? My favorite idea comes from Zvi Bodie who applies modern hedging theories to retirement planning. As he wrote in in 2001 Retirement Planning: a New Approach paper the first part of the plan is to assure some minimum standard of living (this is the minimum amount that you will need) by investing in "inflation-protected bonds and annuities as the way to guarantee a minimum standard of living in retirement.""

FTR His Worry-Free Retirement book is available here.

So if it is such a good idea why hasn't it caught on? I have thought about that a great deal. The best answer I have is transaction costs.

Bonds outperforming stocks over the last 40 years? WOW!

"You are never as good as you think in a winning streak nor as bad as you think in a losing streak."

The other night I was listening to a Mets-Giants game on the radio and the announcer reminded us of the above quote and attributed it to Bobby Valentine (former Mets' manager). I have no doubt that Bobby V did say it, but I am also willing to bet it has been said millions of times over the years by coaches in all sports and said to teams from Little League also-rans to world champions.

But somehow, the word did not get to those who now claim that Bonds outperform Stocks in the long run.

I won't argue with the math. I will argue with the timing. The measurement comes at a time following a bear market (losing streak) in equities and a bull market (winning streak) in bonds.

Now that said, 90% of all sports articles seem to be written like this and it makes them no less interesting, so long as you keep in mind Valentine's sage warning, I strongly urge you to read the article as it is very thought-provoking.

Stocks Losing the Long Run to Bonds - WSJ.com:

"Two brutal bear-markets for stocks within a decade and a stunning bull run for government bonds is challenging the gospel that stocks will always beat bonds if investors just hold on long enough.

Now, Rob Arnott, a veteran financial analyst and market pundit, has lobbed the academic version of a Molotov cocktail at one of the most sacred tenets of investing....

'For the long-term investor, stocks are supposed to add 5% a year over bonds. They don't,' Arnott, founder of investment consultants Research Affiliates and former editor of the Financial Analysts Journal, wrote in a paper published in the latest Journal of Indexes.

'Indeed,' Arnott contended, 'for 10 years, 20 years, even 40 years, ordinary long-term Treasury bonds have outpaced the broad stock market.'

and later:

"Through the end of April, the 10-year annualized return on the S&P 500 was negative 2.5%, according to Standard & Poor's.

Meanwhile, an index fund tracking long-term U.S. Treasury bonds, Vanguard Long-Term Treasury Fund, gained 7.2% annualized over the same period.

"People fret about our 'lost decade' for stocks, with good reason, but they underestimate the carnage," Arnott wrote.

Arnott's research shows that starting at any point from 1979 through the end of 2008, an investor in 20-year Treasurys who continually rolled over into the nearest bond and reinvested the income would have come out ahead of the S&P 500."

So while it is always good to question what we "know" and to think about it from the perspective of what if we are wrong, these findings likely are driven by timing. If I were making a long-term bet I still believe that stocks will outperform, but maybe will remember that such an expectation does not mean it will always be that way.

Indeed, sometimes the Pirates have a better record than the Mets, but I am still willing to bet that over a longer haul, the Mets (and equities) will come out ahead.

Looking back at Pearl Harbor

In a week that we spent quite a bit of class time talking about impact of "non linear" events (Black Swans etc) and almost 67 years to the day, I wanted to take a look at some Pearl Harbor sites and then got thinking maybe showing what happened to the US stock market would be interesting. So:

Disasters and Their Impact On the Stock Market:

"...for Pearl Harbor, on the first day after the attack the market dropped 2.93%. On the second day, it dropped another 2.84%. And on the third day it dropped an additional .27%"

Over the time of the war as it because apparent the Allies would win, the US stock market climbed dramatically. See this chart.

How Stocks Have Returned 10% Per Year

After Henry Blodget from Clusterstock was on NPR saying that stocks were back to "fair value" (i.e. their long run average), he had a listener email him about how the 10% annual return in stocks is found. His answer is below:

How Stocks Have Returned 10% Per Year:

"...the 10% number includes dividends, which is the way people normally look at stock market returns. On a pure price basis, returns have been far lower.

In fact, here's an approximate breakdown of the 10% average return for the last 80 years:

4 points: Dividends
2 points: Real EPS growth
3 points: Inflation (reflected in EPS growth)
1 point: Multiple expansion

Now that stocks have finally dropped back to fair value again, I thinkt the long-term return from here is likely to be in the average range again. The multiple expansion might not continue, and dividends are currently about 3%, not 4%, so it could be lower. But the dividend payout ratio could rise again, and it may be that structural changes (more cash-efficient services companies vs. low-return-on-capital industrial companies) will lead to continued PE expansion"

Stocks For The Long Run, v. 3

Ouch!
Clusterstock mentions that real returns following a market peak have been very different than after a bottom.
Stocks For The Long Run, v. 3:

"If you invested at the 1929 peak, it took 29 years for the value of your shares to recover in real terms; if you invested at the 1968 peak, it took 24 years.

The takeaways are: 1) dividends have provided the lion's share of long-term stock market returns; real capital gains have been comparatively modest; and 2) if you invest at a peak, you probably won't see a real capital gain for a quarter-century."