Wise Money Decisions

Seekingalpha has a fascinating and short interview with Roger Ibbotson (”fascinating” and “short” seem to be highly correlated for me).

If you want to learn more about Ibbotson, read the intro to the article.

In case you don’t have time to read the whole interview, here are the highlights and money quotes:

• Because many hedge funds had (have?) a similar strategy, many hedge funds had to unlever at the same time in summer 2007, contributing to the meltdown “as they rushed to the same exits.” 
• “In both cases, the quant funds that were able to stick with their strategies were able to quickly recover. But those who targeted volatility got whiplashed. Those who kept their leverage intact did reasonably well. Unfortunately, many investors lumped quant funds into one big category, and have become wary of the whole group.”
• “Investors often select funds with the highest returns, without tracing where the returns came from. Most hedge fund returns are actually associated with beta, rather than alpha….. they do not really provide alpha and can be replicated for less than typical hedge fund fees.”
• “The drop exposed the fact that many hedge funds are really not absolute return vehicles, but actually contain a lot of beta.”
• And the most interesting quote in the interview:  “[H]edge fund alphas are still positive, although not as high or significant as before….  [T]he majority of the returns can be classified as beta, then fees, then net alpha, in that order. Despite the fact that alpha makes up the minority of the return, it is still noteworthy that the net alphas are positive. This is in contrast to the mutual fund industry where there is little evidence of aggregate positive alpha, even on a gross level. On a net level, aggregate mutual fund alpha is usually negative.”

The last quote is interesting for a few reasons.  First, it shows that hedge funds are not about “hedging,” as most of their returns is beta.   

Second, it contradicts another study I’ve seen that concluded the hedge fund industry has net negative alpha.  Unfortunately I didn’t save a link to the study.  If I come across it I’ll post it.

Third and most intersting, it’s more ammo that mutual funds in general are bad investments. There’s too much to say about this topic.  I’ll save it for a future post, or series of posts.

If you are interested in asset allocation, or investing in general, you should check out Wall Street Journal’s graphs showing the correlation of various asset classes with the S&P500.

There are two graphs. 

The first shows a timeline from 1994-2009 showing the correlations over time.  The striking feature of the graph is the rise in correlation of just about every asset class with the S&P500.  For equities, it’s been increasing for several years.  For bonds, it’s a more recent rise (although notice that bonds were even more highly correlated with the S&P500 in the mid-1990’s).

The second graph shows similar data, except aggregated from 1973 to 2009. It also shows the correlation of each asset class with the S&P500 for 2008.  The point of the graph is the correlations became more extreme in 2008, either more positive (most asset classes) or more negative (short-term treasuries and TIPS).

The conclusion is that most asset classes become more correlated during a crisis, reducing the benefits of diversification.

Unfortunately I can only read the first 3 paragraphs of the attached WSJ article because I don’t have a subscription.  It seems to conclude that asset allocation as a strategy is not effective because the correlations rise during a crisis. 

I suppose there’s some truth to it if you only invest during crises.  But do you know anyone that only invests during crises?

On the other hand if you plan to invest long-term, the relevant data is the long-term correlation (the grey bar on the graph) and not the 2008 correlation (the blue bar).  I’m in the market long-term.  I don’t care if the blue bar rises during a crisis. It’s temporary.

And there’s one more salient point.  A well-thought-out asset allocation strategy, coupled with low fees/expenses and a strategic tax approach, is the only way to beat the market in the long-term that is : 1) Easily accessible to most investors, and 2) Legal. 

If you abandon an asset allocation strategy, you’re left with the problem of figuring out a better strategy. 

A few other points worth noticing on the second graph, going from right to left:

• The “U.S. Stock Market” to the right only shows a 0.64 correlation with the S&P500.  I would have expected something in the 0.90’s given that the S&P500 is often considered “the market.”  Not sure if their data is bad, or if there’s some other reason for the discrepancy.
• Hedge funds have a 0.35 correlation.  This shouldn’t be news to anyone, but hedge funds are not really for “hedging.”  There are half a dozen asset classes on the graph with correlations closer to zero, all of which would be better hedges.
• The emerging market stocks correlation is shockingly high at 0.99.  I would have expected much lower. 
• European stocks correlation is shockingly low at 0.05.  I would have expected much higher, perhaps in the 0.80’s.
• Junk bonds are essentially uncorrelated to the market, making them a good hedge against general market risk.

I just stumbled across this article at Fortune:

“Using your contacts without making them feel used” by Nadira A. Hira

It’s well worth a read, especially if you are “hitting up the network” looking for a job or for some other reason.

I wish my name rhymed.

Today Boone Pickens announced he’s scrapping plans for a massive wind farm in Texas.   

Problem is, he already ordered the 400-foot tall giant wind turbines.   687 of them.  He has nowhere to put them. 

Via the AP:

“When I start receiving those turbines, I’ve got to … like I said, my garage won’t hold them.  They’ve got to go someplace.”