HoosierGuy

The Problems with Constant Compound Interest

Totally agree, David. For most institutional plan sponsors and consultants, asset allocation is the kingpin of everything that is done. But when those assumptions are off just slightly, it wreaks havoc on the entire plan. A couple things come to mind:

1. Since it is so incredibly difficult to make predictions and properly discount future assumptions, it seems to me one key is flexibility. People talk about the inherent advantage of the institutional investor, be it a pension fund, mutual fund, insurance general account, etc., because they have access to types of vehicles or securities that Average Joe investors do not. However, what is rarely discussed is the complete lack of flexibility that institutional investors face. The cost to transition hundreds of millions of dollars between asset classes is not insignificant in most cases, so flexibility becomes something that may be ideal but is absolutely not feasible.

2. Because institutional investors are lumbering (see #1 above) and generally have medium-to-long term time horizons, agency theory comes into play here as well. Investment management shops obviously want to cater to the huge institutional dollars, and what types of strategies tend to play the biggest role in any asset allocation? Large Cap US Equities. How can a manager make the most money for himself? By managing Large Cap US equities and employing a low turnover approach, thereby incurring fewer transaction costs and thereby having higher capacity to manage even greater and greater sums of money. But in order to manage that type of strategy, you inevitably end up making fairly explicit forecasts about what the future holds and then discounting back to present. While that strategy has worked reasonably well for a few asset managers, it tends to be more of an on-again, off-again type of approach that has little predictability and repeatability in terms of performance. BUT it makes the asset managers more wealthy than if they employed a more flexible approach that had more limited capacity…and therein lies the agency rub.

I’ll stop my rambling now.

Oil ETFs and ETNs: More Complicated Than You Think

Gary,

Interesting article. Can you explain then why OIL and presumably also USO tracked the price of crude so closely during 2008? When crude went up ~50% from Jan 1 through the peak, OIL was within just a couple percentage points. The same goes for the fall from the peak to the trough. I understand the mechanics of what you are saying, but until the last few weeks, the divergence doesn't seem to be significant. What is the explanation for that? Thanks.