A unique view on Goldman Sachs
July 24, 2009
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Archive
Archive for July, 2009
Financial Guru…Lenny Dykstra
July 17, 2009
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This is both hilarious & tragic all at the same time…
| The Daily Show With Jon Stewart | Mon – Thurs 11p / 10c | |||
| Lenny Dykstra’s Financial Career | ||||
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and the link in case it doesn’t work is here
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How many bank failures?
July 17, 2009
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Just back from holidays with a week off…anyway…another couple of bank failures in the US…First Piedmont Bank, Winder, Georgia and BankFirst, Sioux Falls, South Dakota …these
are the 54th and 55th banks to collapse in the US since the start of this “Great Recession”.
Other interesting US economic points of note…
- The state of Michigan (home of the US Car Industry) has the highest unemployment in the US at 15.2%; Rhode Island has the second highest unemployment level at 12.4%
- FOMC (a component of the Federal Reserve) staff revised up its projection for the increase in real GDP in 2010, to a pace above the growth rate of potential GDP. As a consequence, the staff projected that the unemployment rate would rise further in 2009 but would edge down in 2010. Meanwhile, the staff forecast for inflation was marked up.
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Mutual Fund Theorem – Ignored by most financial advisers
July 8, 2009
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According to John Campbell, Professor of Finance at Harvard, “academic finance has had a remarkable impact on many financial services. Yet, financial planners offering portfolio advice to long-term investors have received curiously little guidance from academic financial economists”.
A case in point is the Mutual Fund Theorem, which was developed by Nobel Laureate, James Tobin in 1958. The mutual fund theorem is a very simple approach to investing based around Harry Markowitz’s efficient frontier framework suggesting that all investors should hold only one portfolio of risky assets. This one portfolio can then be adjusted for the conservative investor by adding risk free assets (or cash), or can be geared for the aggressive investor.
The figure above shows the efficient frontier and the Capital Market Line (CML) which is drawn from the expected return of Cash through the tangent of the efficient frontier (represented by the Optimal Portfolio). Whilst it is not a perfect representation of reality, it demonstrates the possibilities that:
- By adding cash (or a risk free asset) to the optimal portfolio (which contains bonds, equities, etc) it is possible to achieve a high return for less risk than a portfolio of bonds…this is the benefit of diversification
- Gearing the optimal portfolio has the ability to achieve a high risk-adjust return than a portfolio of 100% equities. Most of the high growth portfolios include only equities (which clearly may be less efficient than a geared diversified (or optimal) portfolio)
Whilst most if not all financial planners and advisers are aware of the Markowitz efficient frontier and the derivation of the optimal portfolio (i.e. the portfolio with the highest expected return per unit risk), the use of this very simple part of modern portfolio theory has seldom been put into practice. Financial planners throughout the world typically look to personalise portfolios for individual clients based on their risk profile, income and growth needs and most likely looking to build portfolios that are on the efficient frontier. As Figure 1 shows, in theory this may not be the most efficient approach and is potentially creating unnecessary work that adds little to no value in terms of what matters to investors the most, investment returns.
From a practical financial planning perspective, adding cash or gearing an “optimal portfolio” certainly makes things a lot simpler.
Now whilst every investment professional in the world attempts to design an optimal portfolio within their constrained investment universe, we all know that it is impossible, but of course, it doesn’t stop us from trying. For the retail investor the optimal portfolio is often regarded as the “balanced” portfolio, which has a diversified allocation across all available asset classes whether equities, bonds, real assets, etc.
So to really keep portfolio construction simple, recommend the “balanced” fund for the balanced investor and add cash for the more conservative investors and gear into the balanced fund for the growth and high growth investor.
Some of the challenges with implementation include, choosing the optimal portfolio; the limitations of implementation in various investment vehicles such as superannuation where gearing may be difficult; or simply getting cost effective gearing.
Overall, this theorem should provide some food for thought next time a portfolio is constructed and some questions to ask before building the next “tailored” portfolio could be…can a geared diversified portfolio be more efficient than 100% equities or should the client really be out of equities just because they are conservative? At the very least, the Mutual Fund Theorem demonstrates the best method to manage risk is diversification and diversification across all asset classes should be considered irrespective of the investor’s risk profile.
Categories: General Investment, Investment Strategy
Hedge Funds vs Banks
July 5, 2009
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Whlst hedge funds have their problems, thanks to lack of transparency, high fees, etc; lets never forget that hedge funds did not cause this global financial crisis…banks did
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Is there value in inflation linked bonds?
July 1, 2009
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The RBA provides daily reporting on three Treasury Capital Indexed bonds. They each mature in the month of August in 2010, 2015, and 2020 and are currently yielding 2.40%, 3.11%, and 3.02% respectively as at 30th June 2009. If we compare these Capital Indexed yields to the Treasure Fixed Rate yields for similar maturing securities we achieve the market’s estimation of inflation over the term to maturity.
The yield of the Treasury Fixed Rate Coupon Bond maturing August 2010 is 3.45% indicating the expected inflation through to August 2010 is 1.05% (i.e. 3.45% – 2.40%) which is clearly very low.
Applying the same logic using April 2015 and April 2020 Fixed Rate Bond yields of 5.32% and 5.62% respectively we achieve an inflation outlook of 2.21% and 2.60% over each respective term.
The inflation outlook is:
- 1.05% to August 2010
- ~2.21% over the next 6 years to 2015, and
- ~2.60% over the next 11 years to 2020
Whilst I agree that inflation is likely to be relatively low over the coming years, for the fixed rate investor, inflation will always be a significant risk. If you invest in a government bond yielding 5.62%pa over the next 11 years high inflation could easily wipe out any value in this type of investment. As a result, despite, these subdued inflation outlooks, there appears to be significant long term value in inflation linked bonds whilst yields appear to be at historically low levels and also whilst the outlook for inflation appears low.
The risk for the inflation linked bond investor is that inflation turns out to be even lower than the above-mentioned forecast…if you think inflation will be lower than stick to the fixed rate bond, otherwise inflaiton linked bonds are definnitely worth serious consideration.
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US House Prices
July 1, 2009
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Source: www.calculatedrisk.com
I last published this chart two months ago and the trend has not abated. US House prices continue to decline and are currently around February 2003 levels. Include inflation and the housing prices are even lower.
I guess some of the lessons in this include:
- never take increasing house prices for granted like many of us do in Australia
- household wealth in the US continues to decline whilst their biggest asset continues to decline in value
- the economic crisis is not over yet
With continued declines this will probably mean more people defaulting on their loans and more problems for the US banks. Whilst a handful of banks have paid back some of their TARP money there are still a few that haven’t yet. This housing problem is part of a vicious cycle that needs to stop so hopefully the fiscal stimulus in the US will kick in soon.
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