Geoff Considine

Opportunities in a High Correlation World

Eric:

See the following discussion:

www.prweb.com/releases...

The original research paper describing the analysis is here:

www.quantext.com/Econo...

Geoff

Risk Management, Or Risk Manipulation

Sir:

Your perspective is a common one--and Nassim Taleb has been banging this drum for quite some time. There are two questions that need asking:

1) Do the models work if used correctly?
2) Do people have an incentive to misuse the models?

Your answer to both appear to be no--but you provide no evidence that actually refutes (1). Certainly, we know that many firms have used risk management to obsure risks--to their own benefit. But there is a severe logical flaw in then assuming that you have addressed #1.

When we have people like David Swensen and Ray Dalio who have consistently made money over decades relying on good quantitative portfolio management (although both took their lumps in 2008), we would be fairly foolish to ignore these guys and simply jump on the bandwagon that risks are not quantifiable and that portfolio analysis is worthless.

Frankly, I will throw in my lot with Dalio and Swensen over Taleb any day of the week.

Risk Management Lessons From 2008

Chicago Guy:

Not sure what your point is. On balance, QPP has provided a lot of useful insight and help to me and to many readers / users. Pointing out that there are individual stocks that I have mentioned in the the past that have not done well seems sort of silly. There are plenty that have done well, too. My articles are typically about broad themes and not "stock picks" anyway. If you have done much better, then I am happy for you. If you write articles, let me know and perhaps we can all learn from them.

Regards,

Geoff

Watch for Yourself: 60 Minutes Oil Story Was Spot On

This article and the following discussion shows how much misinformation is floating around about what drives commodity prices. Perhaps the saddest thing is how many people weight in on commodities markets without really understanding them--including politicians. As is so often the case, the dialog/comments are even more interesting than the article.

Risk Management Lessons From 2008

Fluvius:

If you are really concerned about the kinds of risk you are talking about--the 6SD (6 standard deviation) risks and up--buy lots of put options. This is the obvious choice. The only problem is that if a 10SD event happens, the results are so severe that there are good odds that your counterparty will have failed, too or that the markets have collapsed.

Also, Taleb has forwarded this idea that we need new models for the fat tails--so why not do it? The answer is that estimating the parameters for said models is very unstable because there are so few data points out there. So, rather than trying to model them, it is better to try to clip them off with options.

The irony to everyone being Taleb fans these days is that you could buy put options very cheaply until early 2008--I wrote several articles on the unsustainably low volatility we had seen--and that meant you could easily buy coverage. This showed that the entire market was discounting basic volatility--forget extra "fat" tail risk.

I wrote an article recently on options and I have some others in process.

To rms000:

Just take the projected return in QPP and subtract three times the projected standard deviation to get the 3SD risk for one year....

Manufacturing Collapse Reminiscent of Great Depression's Beginning

Bring on the gloom and doom! The reason markets move so much is because investors swing from glee to despair. Obviously we are in the "despair" end of things now. Despair, like glee, feeds on itself. It is well known that economists outlooks are correlated to what has been happening recently. To give up on equities is to say that owning a business makes no sense--why bother--you'll just lose because the world is ending. Even if there is an extended severe recession, there are businesses that I will want to own. Investors who flee all equities because they believe a forecast are making just this decision. Investors own businesses. Speculators bet on forecasts.

Analyzing Grantham’s Asset Class Outlooks

Tinman:

Yes, correlation matters--though it did not feel like it for 2008. During extreme market downturns, correlations all go up--and during a panic correlations go to 1 (i.e. perfect correlation). Over the long haul, however, my analysis using QPP and that from a range of really good sources suggests that you can add 2% per year from diversification without increasing risk. When the market is down double digits, it is hard to appreciate 2%, but this is a huge factor for the long-term investor. Also, correlation matters for gettings your hands around relative volatility of different assets---very important for options strategies. I have written about both of these themes here on SA.

Analyzing Grantham’s Asset Class Outlooks

If ICF were to drop in 2009, you are asking what would happen to the outlook for EFA? First, the model will not have "failed" in ICF goes down in 2009. The projected return from QPP is expected return, but there is also a high projected uncertainty. QPP projected an annualized SD for ICF of almost 30%. In other words, ICF is a high return/ high risk investment--as I said in the article. Grantham has uncertainty bars on his projections too. It is thus crucial to distinguish between a point forecast (ICF will return 15% in 2009) and a probabilistic forecast (expected return = 15% with a standard deviation of 30%).

Second, EFA and ICF are correlated. As the market changes, the outlooks for all asset classes tend to change. The outlooks for any one asset class are not independent of another--nor should they be.


On Dec 31 03:36 PM aitvaras wrote:

> Let me rephrase, ICF and EFA have certain percentage projections.
> If instead of going up, if ICF were to drop in 2009, would the EFA
> projection remain intact, or would the Model have to be rerun because
> part of it failed.

Analyzing Grantham’s Asset Class Outlooks

aitvaras:

I am not sure of your point. Are you casting doubt on all quantitative models, or just mine? When different models converge, this is a source of interest to me--hence the article. QPP is not a crystal ball--nor will you find me claiming that it is. What are you asking?


On Dec 31 01:08 PM aitvaras wrote:

> Interesting, just run a program and the Answers are printed out for
> you. Black and white.
>
> The only human element appears to be the Programer and those who
> provided the Input.
>
> Buy and Hold.
>
> Are there any failsafes? Does the failure of one Asset Class mean
> that the entire Model is suspect.
>
> Just curious.
>

Analyzing Grantham’s Asset Class Outlooks

Auto44:

If you just want to know what Grantham says, sign up for his email list--you will get that for free to your mailbox. I get these emails and pay attention to them. The fact that an econometric model (QPP) and a fundamental model (Grantham's approach) agree so closely is the issue that I am addressing. This is very interesting to me. There are so many factor that go into a statistical outlook, the odds of two different approaches agreeing so closely are very low. I am, frankly, still processing what this means. There are, for examples, some things in QPP that Grantham does not discuss. One is correlation. QPP projects asset classes maintaining correlations between them--and this is a major driver of the risk and return for each asset class. Another issue is volatility. I infer that Grantham believes vol will settle to its long-term average, though he does not say so. This is very important. If stocks return 9% with a 20% vol. this is very different than with a 10% vol, for example.

Like I said, I am still trying to figure this out in terms of what it means. I did an analysis a couple of years ago in which I showed that Buffett's equity holdings looked very good as a portfolio in QPP. This adds information--for me at least--and suggests some consistency in terms of thinking and how to build and manage portfolios...


On Dec 31 01:40 AM auto44 wrote:

> NEXT TIME PLEASE LEAVE OUT ALL THE QPP JIBERISH THAT CONFUSES SIMPLE
> SOULS LIKE ME AND JUST TELL ME WHAT JEREMY SAID. THANK YOU

Analyzing Grantham’s Asset Class Outlooks

To SeekingTruth and Dawase:

In QPP's projections, REIT's are a high risk / high return asset class--this does not make them a short term win nor does it mean that I am rushing out to buy REIT's. An investment with high expected return and high risk is tricky due to the problem of gambler's ruin--or to quote Keynes(?): the market can stay irrational a lot longer than you can stay solvent. Gold has historically been a high risk/high return asset class. I have a family member who bought gold during the last bull run in that metal and had to keep it 20 years to see it get back to the price he paid.

Analyzing Grantham’s Asset Class Outlooks

Chris B:

QPP's approach has been tested extensively using robust out-of-sample testing. Here is the most recent article, and it links to earlier articles:

seekingalpha.com/artic...

QPP's approach uses no fundamental variables as input at all--it is purely econometric.


On Dec 30 01:48 PM Chris B wrote:

> Interesting, but have the projections produced by this method been
> backtested? How did they fare?
>
> Did the data take into account record levels of consumer and government
> debt or the results of likely whipsawing in inflation/deflation for
> the next couple of years?

Are Index Funds the Only Rational Choice?

Garance:

Sadly, you are correct. I have cited this very body of research myself in my article called The Humble Arithmetic of Portfolio Management. The majority of investors under-perform the basic indexes--so the first thing to do is to improve a portfolio so it has good odds of at least matching the index. Second, you want to diversify properly to exploit diversification benefits. And yes, in a market panic, correlations seem to go to one. You are making Bogle's argument and the world would be better for most investors if they followed Bogle. This article is looking at a topic to be considered late in the process of portfolio strategy.

There are some issues with "agency" problems with mutual fund managers which I have written about elsewhere. Many are afraid to stray much from the index. See the research on Active Share, for example.

The Death of Profitable Journalism

Hi:

I like your article, but I also find it a bit condescending. I am not a professional journalist--but I write for my own business, on SeekingAlpha and also for other relationships. I believe that my writing is high quality stuff. I also find quite a bit of high quality writing on SeekingAlpha. When I want to learn about drilling and exploration, I would often prefer to get my info from a professional petroleum geologist who writes than from someone with an MA in journalism who has no technical training--which is often what you get among journalists for major newspapers.

To imply that professional journalists are the gold standard for writing is way out of touch. Reuters picks up SeekingAlpha feeds. Barrons picks up SeekingAlpha articles. This marked a major shift in the production of the written word. There are many great professional journalists--and I know of more than one who post here on SeekingAlpha--and there will always be a market for these people, I believe. But the idea that the NY Times and other traditional media outlets have some monopoly on mass distribution of quality writing for public consumptuion is ludicrous.

Should we subsidize these old-line media firms because they are somehow in the public good? I think not. We already have NPR.

The Death of Profitable Journalism

Hi:

I like your article, but I also find it a bit condescending. I am not a professional journalist--but I write for my own business, on SeekingAlpha and also for other relationships. I believe that my writing is high quality stuff. I also find quite a bit of high quality writing on SeekingAlpha. When I want to learn about drilling and exploration, I would often prefer to get my info from a professional petroleum geologist who writes than from someone with an MA in journalism who has no technical training--which is often what you get among journalists for major newspapers.

To imply that professional journalists are the gold standard for writing is way out of touch. Reuters picks up SeekingAlpha feeds. Barrons picks up SeekingAlpha articles. This marked a major shift in the production of the written word. There are many great professional journalists--and I know of more than one who post here on SeekingAlpha--and there will always be a market for these people, I believe. But the idea that the NY Times and other traditional media outlets have some monopoly on mass distribution of quality writing for public consumptuion is ludicrous.

Should we subsidize these old-line media firms because they are somehow in the public good? I think not. We already have NPR.