Sunday, October 8, 2017

The Crossley ID Guide: Waterfowl

Back in 2011 I reviewed The Crossley ID Guide: Eastern Birds. In that post I suggested some ways in which identifying a bird is similar to identifying a good trading opportunity. It’s not as much of a stretch as you might think.

Richard Crossley has now published his fourth flexibound guide, this one to waterfowl. Like his previous books, it features gorgeous, lifelike compositions that are “painted in pixels.” It shows North American ducks, geese, and swans in their natural seasonal settings (winter/spring and summer/fall) as well as in flight. The illustrations also include juveniles at various stages of development. There are some mystery birds to identify, with answers provided. The second half of the book is text written by Paul Baicich and Jessie Barry, giving a detailed account of each species. All in all, about 500 pages of absolutely wonderful material

If you are a birder or a hunter, this book definitely belongs on your bookshelf. It is available at Crossley’s site.

Wednesday, October 4, 2017

Burchard, High Performance Habits

Most self-help books fail because they offer easy paths to success. Brendon Burchard’s High Performance Habits: How Extraordinary People Became That Way (Hay House, 2017) describes what it takes to become a person who creates ever-increasing levels of both well-being and external success over the long term. And it takes a lot.

Many factors can affect your long-term success—luck and timing, for instance. But Burchard sets out six things that “are under your control and improve your performance more than anything else we’ve measured.” First, seek clarity on who you want to be, how you want to interact with others, what you want, and what will bring you the greatest meaning. Second, generate energy so that you can maintain focus, effort, and well-being. Third, raise the necessity for exceptional performance, tapping into the reasons you absolutely must perform well. Fourth, increase productivity in your primary field of interest, focusing on prolific quality output. Fifth, develop influence with those around you. And sixth, demonstrate courage.

Burchard’s HP6 go beyond the usual nostrums: work hard, be passionate, focus on your strengths, practice a lot, stick to it, and be grateful. You can be a grateful hard worker and still be on the bottom of the pile. Or you can be passionate and practice a lot—and burn out.

Some of Burchard’s suggestions seem hokey, but for the most part they ring true. I, of course, haven’t tried the vast majority of them. I just finished reading the book, after all. But what’s the worst that can happen? That you do nothing, just keep going the way you always have. Unless, of course, you’re already a consistently high performer.

Sunday, October 1, 2017

Carver, Smart Portfolios

Robert Carver, author of Systematic Trading, has turned his attention to the thorny problem of portfolio construction. In Smart Portfolios: A Practical Guide to Building and Maintaining Intelligent Investment Portfolios (Harriman House, 2017) he deals with such topics as how to blend assets with different levels of risk, the reasons that forecasting returns is so difficult, and how to calculate the true costs of your investments.

One problem that investors face is that not only is the future uncertain, the past is as well. This is a point that Carver drives home multiple times. He shows, for instance, that “the uncertainty of the past is largest for risk-adjusted returns. We can be 95% confident that the estimated relative Sharpe Ratio (SR) of the two assets was within a range of around 0.5 SR units. For US stocks and bonds this uncertainty range is -0.16 to 0.36. This is a huge degree of estimation error: our estimates of Sharpe Ratio are effectively worthless.” By contrast, “the uncertainty of standard deviation estimates is much lower than for the Sharpe Ratio,” and “in typical financial data estimates of bond and equity correlations are 95% likely to be within a range of around one-third (actual range -0.12 to 0.21).”

To manage the problem of past parameter uncertainty in portfolio construction, he assumes that risk-adjusted returns are identical for all assets, he uses risk weighting to account for differences in asset volatility, and he employs a technique he calls handcrafting to handle correlations sensibly.

In over 500 pages Carver takes the reader through both theoretical considerations and practical applications. He shows how to build a smart portfolio top-down, contingent on portfolio size, from an institutional investor to a person with $40,000. He introduces two forecasting models (momentum and yield) to aid in the construction of a portfolio. And he addresses the need for maintenance, such as smart rebalancing and portfolio repair.

Smart Portfolios is a sophisticated but not overly technical treatment of a topic that every investor has to come to grips with. As such, it is a recommended read.

Wednesday, September 27, 2017

Reynolds, From Here to Security

Robert L. Reynolds, president and CEO of Great-West Financial and Putnam Investments, was a pioneer in the 401(k) business for Fidelity Investments in the 1980s and 1990s. In From Here to Security: How Workplace Savings Can Keep America’s Promise (McGraw-Hill, 2018) he advocates improving and extending workplace savings plans.

First, however, it is imperative to make Social Security—“the country’s largest, most successful, and most popular government program”—solvent over the long term. “As multiple bipartisan commissions have shown in recent years, the compromises needed to restore Social Society to fiscal health are blindingly obvious, namely a balanced combination of revenue increases and benefit cuts.” The problem is that Social Security has long been viewed as the “third rail” of American politics—“Touch it and you die!” Moreover, compromise is not exactly the hallmark of Congress these days.

To supplement Social Security, working Americans traditionally relied on defined benefit pensions. But today pensions are flat-lining. Defined contribution plans are taking their place, extending coverage to more workers and workplaces. Roughly half of American workers have access to 401(k)-type plans. The problem is that, although they serve middle- and upper-income workers well, they don’t reach low-income, part-time, or contingent workers—or those in small firms that have no payroll savings plans at all. This is especially troubling in a gig economy.

Moreover, it is not enough to extend 401(k)-type plans to more workers. Reynolds suggests that the holy grail of the next generation of workplace savings is “to convert accumulated assets into guaranteed lifetime income” so that people won’t run out of money before they run out of time. Annuities are one obvious solution to this problem, although annuities often get a bad rap.

Reynold’s book, which describes where we’ve been and where, in his opinion, we should be going to achieve retirement security for the largest number of American workers, raises policy issues that should definitely get more attention in Washington.

Sunday, September 24, 2017

Kula et al. Beyond Smart Beta

More than 4,400 ETFs are currently available globally, and more than one million indices are calculated daily—“a dizzying range of asset classes, strategies and exposures.” In Beyond Smart Beta: Index Investment Strategies for Active Portfolio Management (Wiley, 2017) authors Gökhan Kula, Martin Raab, and Sebastian Stahn explore exchange-traded products and the evolution of indexing to “unchain innovation—the future of active investing in passive products.”

After a lengthy account of the characteristics of exchange-traded products, the authors turn to the evolution of indexing. The first generation of indexing ties classic benchmark indices to “the market”—the Dow Jones Industrial Average, to cite the most classic. The authors provide 24 mostly full-page tables highlighting the main features of major benchmarks—equity, sector, fixed-income, and commodities.

Smart beta indices represent the second generation. They are “designed to provide exposure to specific factors, market segments or systematic strategies.” Typical factors are value, size, momentum, low volatility, quality, and dividend yield. The authors analyze each of these factors, pointing out their advantages and disadvantages.

In the third generation of indexing, optimized indexing is combined with risk-based dynamic asset allocation. This generation of indexing aims “to control for and to mitigate costly behavioral biases.” One example is target volatility indexing. “Investors in equity-based ETFs are always better off in the long run investing in the corresponding target volatility ETF instead of the pure equity ETF.” Another example is the best-of-assets strategy, which switches allocation levels between equities and fixed-income depending on specific market signals.

One trend that has legs is customized indexing, where investors can construct a bespoke index solution that may exhibit a better risk-return profile for their specific needs. MSCI is currently calculating more than 7,000 customized indexes globally for over 700 clients, around 70% of which can be launched within 48 hours.

Academics keep churning out papers, firms keep churning out new ETFs. There’s no end in sight.

Wednesday, September 20, 2017

Zeisberger et al., Mastering Private Equity

Claudia Zeisberger, a professor at INSEAD, and two INSEAD alumni, Michael Prahl and Bowen Whtie, joined forces to write Mastering Private Equity: Transformation via Venture Capital, Minority Investments & Buyouts and its companion case study volume Private Equity in Action—Case Studies from Developed and Emerging Markets (Wiley, 2017). Industry professionals added their thoughts to each chapter of Mastering Private Equity.

The core book, written for both graduate students and professionals, is structured like a textbook (including lots of color). It is divided into five sections: private equity overview, doing deals in PE, managing PE investments, fund management and the GP-LP relationship, and the evolution of PE.

Mastering Private Equity is a model of clarity. For instance, in a table the authors summarize the advantages and disadvantages of various exit options. The advantages of a sale to a strategic buyer are: full exit, often pay a premium (synergies), pay in cash. The disadvantages are: less sophisticated buyers prolonging process, strategics require a majority stake. The advantages of a sale to a PE fund are: ample dry powder in market, can ‘warehouse’ company until eventual IPO. The disadvantages are: sophisticated and demanding buyers, minority stake may reduce pool of potential investors. As for an IPO, the advantages are: potential for high returns, access to future liquidity, often preferred by management, high profile exit. The disadvantages are: lock-up, risks of going to market, uncertainty of returns, strain on management time. The last alternative is a dividend recapitalization. Here the advantages are: returns cash to limited partners, no new shareholders, does not dilute equity stake. The disadvantages are: partial exit, value of investment unknown, not a high profile exit.

All of the cases covered in Private Equity in Action are taught in INSEAD’s various business programs. They span the globe, from an Indian vineyard and rice farming in Tanzania to creating a private equity fund in Georgia.

Anyone who wants to better understand private equity, especially PE with a global reach, would do well to read these books.

Sunday, September 17, 2017

Henriques, A First-Class Catastrophe

Black Monday (October 19, 1987), when the Dow Jones Industrial Average fell over 22%, was not a black swan event. Although it occurred in the context of heightened geopolitical risk, with Iran hitting two American-owned ships with Silkworm missiles and the United States retaliating by shelling an Iranian oil platform in the Persian Gulf, the potential for a huge market sell-off had been telegraphed day after day in 1987.

Diana B. Henriques, an award-winning financial journalist writing for The New York Times, is the author of The Wizard of Lies (the best-selling book about Bernie Madoff, subsequently made into an HBO movie), Fidelity’s World, The Machinery of Greed, and The White Sharks of Wall Street. In A First-Class Catastrophe: The Road to Black Monday, the Worst Day in Wall Street History (Henry Holt, 2017) she once again lives up to her reputation for careful, exhaustive research and engaging prose.

People (I among them) have often claimed that the financial market is a complex adaptive system. Henriques convincingly shows that, in the run-up to Black Monday, it was complex but not reliably adaptive and certainly not a system. Moreover, she claims, “we are still living in the world revealed to us on Black Monday.” In fact, the factors that led to the 1987 crisis “have become even more deeply embedded in Wall Street’s genetic code.”

Henriques explores multiple areas in which the financial market (and here I include equities, bonds, and derivatives) exhibited the potential for cracks in the 1970s and 1980s, starting with the fractured regulatory agencies. Also contributing to the crisis was the introduction of indexing, initially for pension funds, would give rise to herding; these huge funds were “all likely to shift their assets in the same direction at the same time.” Portfolio insurance, often incorrectly cited as the cause of Black Monday, relied on index arbitrageurs (and there had to be enough of them) to zig when it zagged. Computerization sped up trading and the back office processing of orders but brought with it the inevitable glitches.

Populating these potentially problematic areas were people who were protective of their turf, powerful, and creative—regulators and heads of exchanges, agents for financial behemoths, and innovators. As a result of the extensive interviews the author did with the primary players, we get a sense of how they understood their roles in this calamity.

A First-Class Catastrophe is a first-class book. Perhaps through it we will learn some lessons that were ignored in the wake of Black Monday.