Yes, Your Favorite Hedge Fund Manager Is Probably Just Lucky

ClusterStocks' Henry Blodget pointed this out yesterday: The actual link is from Ken French, so you know it is good!

Yes, Your Favorite Hedge Fund Manager Is Probably Just Lucky: "Your favorite hedge fund manager has walloped the market by 5% per year for the past 10 years, so he's obviously a genius, right?

Actually, no. He had a one-in-five chance of doing that just by throwing darts."

From the April 29th Q&A with Ken French:

"If we pretend his returns are normally distributed, the probability that his average abnormal return exceeds 5% per year for a ten year period is more than 20%. In other words, in a group of hedge fund managers with standard deviations of 20%, we expect one in five to have a ten-year average annual abnormal return of at least 5%—even if none actually have any skill. We expect one in twenty of the unskilled managers to produce a ten-year average annual abnormal return of at least 10%."

When you consider large number of funds and that many underperforming funds "drop out" of samples (sure not for academic papers anymore, but in reports and marketing it is still a major issue), it is easy to see why many believe they (or their fund managers) have the ability to outperform.

Fama/French Forum

Fama/French Forum: Search Results:

"Observations, opinion, research and links from financial economists
Eugene Fama and Kenneth French."

How had I never seen this? For real? Amazingly good. Maybe even better than that! LOL...

Two Very Sad Posts from the UnknownProfessor (Financial Rounds)

The academic finance blog community is pretty small and the blogger/professor I have followed longer than any other is the UnknownProfessor and his FinancialRounds. (The unknownprofessor and I have much in common. Not only both financeprofessors, but also both like cycle and oversee student invested portfolios.)

So it is with great sadness I share his post from today and one from Friday. Entirely without permission and breaking custom and all copyright rules I will run them both in their entirety and verbatim.

It is Done

" At 1:55 this morning, the Unknown Son (his name is Jonathan, by the way) eased away and stopped breathing. Our son has finally let loose the bonds of earth and gone home. No more suffering, no more limitations, and no more cancer. He now rests in the lap of the Father with his cousins Jacob and Jennifer. And that's NOT a figure of speech - it's a description.

It's been a tough time - 2,439 days since his diagnosis on 10/1/2002. After gallons of chemotherapy, multiple surgeries, and visits to six hospitals, our son is finally free. After years of pain and limitations, he can now run without tiring, jump without limits, and stay up as long as he wants.

We miss him, and will every day for the rest of our earthly lives. But believe it or not, it's not all grief (but there is that). We're glad that his pain and struggles are over. But now he doesn't just have the absence of pain. He has JOY. For him, this isn't the end - merely the end of the beginning. We know that we'll be together again.

If you know us in our "real" lives and would like to read our son;s story (or just want directions to the memorial service Saturday), send me an email.

Tough Times Ahead

This tough to write. The recent post on the Unknown Son's treatment was somewhat encouraging. In the blink of an eye, this one turns our lives around 180 degrees.

This morning, Unknown Son tried to go for a walk around the hospital unit (the walking helps expand the lungs, and would speed his recovery). We noticed after a few steps that his left leg was dragging. We put him back in bed, and he was unable to squeeze my hand with his left hand. A quick CT scan followed, and revealed that the cancer had spread to his brain – in three separate spots. We hadn't known this previously since all our scans had been focused on his chest region. One was pretty large, and since it was on the right side, it was the likely cause of the problems with his left leg, arm, and hand.

This changes everything – he now likely has a matter of days rather than weeks. We gave him some radiation to see if we could slow the swelling, but at best that only buys a bit of time. So, we took him home tonight in an ambulance so that he can be in familiar settings and be as comfortable and safe as possible in the short time he has left with us.

In the meanwhile, The Unknown Wife's mother and father and one of her sisters are here. Her other sister and her family (and my mother, brothers and sister) are coming down tomorrow to lend support and see the boy.

Please keep us in your prayers as we ease his transition. For him, this is not the beginning of the end of his life – only the end of the beginning. But even though we know that he's going to a place with no more pain or limitations, and only joy, it’s going to be a rough week or so for us – likely the toughest we’ll ever have to go through.

So keep us in your prayers.

posted by The Unknown Professor at 7:40 PM Comments (9) | Trackback (0)

If you get a chance, send the father a quick email or comment on his post. I guarantee he will read and cherish the thoughts in this hard time. Or better, make a donation in Jonathan's name. I have no idea if they have picked out a charity or not, but two that jump immediately to mind are Livestrong and the JimmyV Foundation. Do it now. Not only will the family appreciate it, but maybe if enough of us do it, we can prevent this from happening to others in the future.


UPDATE (6/15) from the UnknownProfessor)
UPDATE:

Since many of you have have asked, our charity of choice is: The Tomorrow Fund, 593 Eddy St., Providence, RI 02903. Put "Jonathan" in the note of the check. They're affiliated with Hasbro Children's Hospital where Jonathan had a significant part of his treatment done, and they're a very worthy recipient of any donations - they both support research in cancer and provide a lot of support (financial, emotional, etc...) to families of children undergoing treatment. They'll allow us to choose the manner in which the funds will be spent (probably something relating to computers, books, or videos), so that we can come up with something that really captures something of who Jonathan is.

Maybe the talk of run away inflation is just that, talk.

Martin Wolf responds to the fears that we are doomed by future inflation due to the large government expenditures and deficits.

His arguments are essentially that bond price drops are a reduction of the fear of DEFLATION and not necessarily a signal of high inflation. Additionally, to the degree that we see we are seeing is risk aversion levels drop (which is a another good thing!) and the safety premium that comes with Treasuries is reducing.

Evidence of this reduced premium can be seen looking at the VIX and in this this chart showing Treasuries vs corporates. Notice how the relative value of treasuries peaked during the worse of the uncertainty.


This flight to quality in bad times is normal and seeing it now ebb might well be a signal that the economy is returning to some semblance of normalcy and not a signal of higher inflation.

FT.com / Columnists / Martin Wolf - Rising government bond rates prove policy works:

"Is the US (and a number of other high-income countries) on the road to fiscal Armageddon? Are recent jumps in government bond rates proof that investors are worried about fiscal prospects? My answers to these questions are: No and No. This does not mean there is no reason for worry. It is rather that there are powerful arguments against fiscal retrenchment right now and strong reasons for welcoming recent moves in the bond markets."

And later

"What has happened is a sudden return to normality: after some turmoil, the yield on conventional US government bonds closed at 3.5 per cent last week, while the yield on Tips fell to 1.9 per cent. So expected inflation went to a level in keeping with Federal Reserve objectives, at close to 1.6 per cent"

and still later:

...the fear of inflation....is essentially the question of how to exit from current extreme policies. People need to believe that the extraordinarily aggressive monetary and fiscal policies of today will be reversed. If they do not believe this, there could well be a big upsurge in inflationary expectations long before the world economy has recovered....The exceptional policies used to deal with extreme circumstances are working....policymakers are walking a tightrope: on one side are premature withdrawal and a return to deep recession; on the other side are soaring inflationary expectations and stagflation. It is irresponsible to insist either on immediate tightening or on persistently loose policies"

Well said.

Thanks to RortyBomb at SeekingAlpha for pointing this article out

BTW does anyone know how to embed a Yahoo Finance graph, I can link to it, but not embed it. Any advice would be appreciated. :) thanks..

Peter Bernstein, Consultant, ‘Capital Ideas’ Author, Dies at 90 - Bloomberg.com

We have lost a great great mind in finance. :( If you have not read his books, I highly suggest you do! Great writer.

Peter Bernstein, Consultant, ‘Capital Ideas’ Author, Dies at 90 - Bloomberg.com:

"June 8 (Bloomberg) -- Peter L. Bernstein, an economic consultant and historian whose prolific writing built a bridge between academic theory and practice in the financial world, has died. He was 90.

He died after contracting pneumonia, according to the New York Times, citing his family.

Bernstein had run his New York-based consulting firm and produced Economics & Portfolio Strategy, a twice-monthly newsletter, since 1973. The publication’s readers own or manage more than $5 trillion, according to the firm’s Web site.

He wrote 10 books on economics and finance, including “Capital Ideas: The Improbable Origins of Modern Wall Street” (1991), which is considered a landmark work on modern investment theories and practices."

The Still Over-Leveraged Consumer | The Big Picture

The Still Over-Leveraged Consumer | The Big Picture:

"Despite spending less time at the mall, throttling back consumption, and increasing their savings rate, the US consumer still finds themselves with too much debt and too little savings. Even worse (at least for the economy), they lack the income or the equity to fund their previous lifestyles."

A couple of things deserve mention:

1. The graphs are fascinating. They show that as a percentage of net worth the amount of debt had actually gone up since equity and real estate prices have fallen.
2. Adjustments since as reducing debt and/or increasing savings take time. This story is not over. It will continue to play out over the next few years as firms and households shed debt. Of course the implications of this on the economy are not particularly rosy.

The Best Online Tools for Personal Finance - WSJ.com

The Best Online Tools for Personal Finance - WSJ.com:

"There are a host of Web sites that help you lay out a budget and track your spending and investments. Some let you set up a plan for a long-term goal, like college or retirement, and others offer advice about where to put your money. And many of these services are free of charge.

To help you wade through all the choices, we scoured the Web to find some of the best online tools and got recommendations from personal-finance pros. Here’s a look at some of the best sites we turned up, in a range of categories."

NY Times on Market Efficiency

Nice recap of current standing on EMH (Efficient Market Hypothesis) from the NY Times

"[It] grew out of the University of Chicago’s finance department, and long held sway in academic circles, that the stock market can’t be beaten on any consistent basis because all available information is already built into stock prices. The stock market, in other words, is rational.

In the last decade, the efficient market hypothesis, which had been near dogma since the early 1970s, has taken some serious body blows. First came the rise of the behavioral economists, like Richard H. Thaler at the University of Chicago and Robert J. Shiller at Yale, who convincingly showed that mass psychology, herd behavior and the like can have an enormous effect on stock prices — meaning that perhaps the market isn’t quite so efficient after all. Then came a bit more tangible proof: the dot-com bubble, quickly followed by the housing bubble. Quod erat demonstrandum."

The story is mainly centers on Jeremy Grantham of GMO "an institutional asset management company".

"As Mr. Grantham sees it, if professional investors had been willing to acknowledge these aberrations — and trade on the fact that the market was out of whack — they should have been able to beat the market. But thanks to the efficient market hypothesis, no one was willing to call a bubble a bubble — because, after all, stock prices were rational. “It helped mold the ‘this time it’s different’ mentality,” "

That said, the market is still very difficult to consistently beat (maybe because we are all biased) and thus as Grantham also states that passive index investing is still often the best way to invest due to lower costs and to protect ourselves from ourselves.

A possible upside of a monopoly: increased innovation

Probably more of an economics article, but we deal with anti-trust issues in finance classes all the time too and it is such a good thought-provoking article I will include it:

Columbia Ideas At Work : Feature : The+Price+of+Competition: "Antitrust laws aim to protect consumers and spur innovation by fostering competition, but in some industries ingenuity thrives under monopolists.....

"Working with Ronald Goettler of the University of Chicago, Gordon studied the dynamics between the two firms and developed a mathematical model that allowed the researchers to predict Intel’s behavior if it were the sole microprocessor developer in the industry. The researchers were particularly interested, Gordon says, in determining the rate of technological innovation and whether consumers would be better or worse off if Intel had no competitors...."

Their conclusion?

"...Intel would innovate more rapidly if it weren’t competing with AMD.”

Great read. Not sure if I agree or not, but definitely one that will make me think for a long time! At least after one read I don't think I agree. The arguments seemingly hinges on whether the incentive to make a new sale (and hence have a new product/upgrade to sell) is sufficient to overwhelm the incentive to overpay executives and pay out dividends to shareholders.

BTW an interesting factoid that can be used in class easily:

"Between 2000 and 2003, for example, the U.S. Department of Justice and the FTC challenged 109 mergers; in 41 of these cases, they cited slower projected innovation rates as the reason for challenging the mergers"

Thanks @Columbia_Biz for the heads up on this one.

US to Propose Wider Oversight of Pay

An update on last week's WSJ piece:

US to Propose Wider Oversight of Compensation the from the NY Times:

" The Obama administration plans to require banks and corporations that have received two rounds of federal bailouts to submit any major executive pay changes for approval by a new federal official who will monitor compensation, according to two government officials.

Some of the rules... apply only to companies that received taxpayer money.

Others, which are being described as broad principles, would set standards that the government would like the entire financial industry to observe as banks and other companies compensate their highest-paid executives, though it is not clear how stringent regulators will make them."

Wow. I will admit it, last week I said I was scared scared but it is a new week and the news is not getting any better. Does it stop at TARP firms? Or Wall Street firms? Or all finance firms? Or all firms? Ignoring the fact of misaligned incentives, how would it be done? I mean do you place a US official on every firm's executive compensation committee? Please not.

Maybe this is just a trial balloon? Maybe it will get shot down? But long term if this is any more a trial balloon it has the potential to be devastating to the US economy as in time the best and brightest will leave and start businesses elsewhere.

Henry Blodget writing for ClusterStock's Business Insider lays out why this is such a horrible idea better than I do.

Obama Geithner Wall Street Pay Caps:

"We clearly need tighter financial regulation, but capping pay shouldn't be part of it. Executive compensation should be decided by the shareholders and management of each individual company. The last thing we need is a government bureaucrat deciding how much is too much, especially on a case-by-case basis.

To be clear: The fact that the TARP banks took huge handouts and then turned around and paid deca-million-dollar bonuses to executives was outrageous, as was the pathetic defense that they had to do this or the execs would leave....

That said... the idea that the folks on Capitol Hill should routinely decide how much is fair to pay a commodities trader, investment banker, or stockbroker is a horrifying lurch toward socialism"

Read the Blodget article.

ForumSPB.com - St. Petersburg International Economic Forum :: Search

ForumSPB.com - St. Petersburg International Economic Forum: "Plenary S

ession
Post-crisis financial acrchitecture Global imbalances and the reform of financial regulation. Reforming international financial instruments (FSB establishment, IMF reform) and building new relations between ministries of finance and regulators worldwide to mitigate global systemic risks (coordination, supervisory boards)."

There are MANY MANY other videos here as well. Good stuff!

The Jim Rogers video that everyone seems to be talking about

Have had a couple of people ask me about the video and more directly the US Dollar and potential inflation.

Here is the Jim Roger's interview

How Ben Bernanke Saved Us From a Second Great Depression -- New York Magazine

How Ben Bernanke Saved Us From a Second Great Depression -- New York Magazine:

"I’ll just come right out and say it: Ben Bernanke will go down as the greatest Federal Reserve chairman in history. The soft-spoken academic who has toiled in the shadows of his legendarily self-promoting predecessor, Alan Greenspan, will be known as the man who averted the Great Depression Two, a sequel that could have eliminated the United States as a world financial superpower and reduced us to this century’s Britain. Make no mistake about the parentage of this success story. President Obama pushed through a stimulus plan that will ultimately help the economy later this year, and Treasury Secretary Tim Geithner chose to adopt Bernanke’s strategy of allowing banks to raise money themselves rather than bowing to calls from politicians and pundits to have taxpayers bail them out even more than they already had. But it was the 55-year-old former Princeton professor who spent his teaching career studying how the Great Depression could have been prevented who deserves the bulk of the credit."

Thoughts?

Yale's Levin on the Age of Diminishing Endowments - WSJ.com

Yale's Levin on the Age of Diminishing Endowments - WSJ.com:

"University endowments once invested primarily in stocks and bonds. Yale's longtime chief investment officer, David Swensen, pioneered a new strategy that found better returns in less traditional vehicles like hedge funds, private equity partnerships and real estate. The Swensen approach produced a 16% average annual return the past decade through last June. But the steep and sudden drop has left schools heavily invested in assets that can't be quickly sold for cash.

An academic economist who sounds as if he knows his school's finances as well as anyone here, Mr. Levin defends the so-called Yale Model against emboldened critics. 'We made huge excess returns on the way up. When it's all over and things stabilize I think we'll find the overall long-run performance [of the endowment] is better than if we didn't.'"