The 10 Biggest Myth in Asset Management - Morningstar,...
Transcript of The 10 Biggest Myth in Asset Management - Morningstar,...
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The 10 Biggest Myth in Asset Management
Morningstar Conference, Vienna, March 2012
Dr. Bernd Scherer
Professor of Finance, EDHEC Business School
Chief Investment Officer, FTC CAPITAL, Vienna
Revisit Diversification
Diversification eliminates unsystematic risk and all that investors areleft with is systematic risk. Diversification does not reduce risks. Risksare reduced with cash, i.e. deleverage. (SHARPE, 1972)
Investors have should not complain that they got exactly what theyasked for which is systematic risks.
However, investors fooled themselves by investing into products thathad mainly the equity factor running through them (equity, privateequity, high yield, corporate bonds, etc.)
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Myth 2:
Young People Should Invest Into Stocks –
Only Some
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The Role of Shadow Assets
Time does not diversify risks (SAMUELSON, 1968)! Withoutpredictability there are no horizon effects (CAMPBELL/VICEIRA,2002)!
Individual investors have both financial assets and shadow assets(human capital)
–The characteristic of human capital determines horizon effects
–Civil Servants and Investment Bankers
Shadow Assets are Everywhere; It is Shadow Assets That Make Investors Differ
Given that YOUR shadow assets are all equity like you should ALL rethink your portfolio
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Risk Parity is About Return Expectations Only
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S&P + 2Y Futures
S&P + 5Y Futures
S&P + 10Y Futures
S&P + 30Y Futures
Excess Return 1.77% 3.48% 5.26% 6.20%
Volatility 1.74% 4.14% 6.77% 9.42%
Sharpe 1.02 0.84 0.78 0.66
t-value 4.57 4.02 4.18 3.56
Turnover 24.74% 87.07% 138.83% 193.74%
Cum. Loss 3.94% 8.03% 15.63% 22.02%
Cum. Loss / Volatility 0.65 0.56 0.67 0.67
Average equity weight 1.7% 8.3% 16.5% 29.9%
Exhibit 1: Performance summary for risk parity portfolios. All strategy characteristics are calculated from monthly data and annualized where applicable. The data set is described in Appendix A. Returns are measured as log returns. Turnover is measured as the average of absolute monthly portfolio differences
multiplied by twelve. The t-value for SHARPE ratios is calculated from ( )212
1 /SR T+ , where SR
denotes the SHARPE ratio measured at monthly frequency over T months.
Risk Parity is About Return Expectations Only
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Risk parity investing is a heuristic portfolio construction rule that is only
accidentally compatible with portfolio theory.
It neither attempts to arrive at explicit return forecasts nor does it require the
specification of an objective function.
Risk parity relies on the historical performance of low risk bond futures and
that the back-casted performance of risk parity portfolios depends entirely on
the choice of assets rather than on the concept itself.
While leverage aversion might provide theoretical support to risk parity
investing, the concept of risk parity is at odds with consumption based asset
pricing. In any case risk parity seem like an implicit bet on the continuation of
a bull market in bonds (e.g. via quantitative easing). Investors believing in
this can find better ways to take advantage of central bankers with a god
complex.
Myth 4:
Fully Funded Pension Systems Invested into Equities
Can Mitigate a Pension Crisis –
Definitely Not
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We Could All Be Rich Fallacy
„ An investor that would have invested 200 years
ago one Euro into Equities would (assuming a 10%
return per annum) sit on 189 million Euros today
With 5% return (bonds) tbis would accumulate to
17.000 Euro instead. This shows the advantage of
equities and the advantage of a investing pensions
into equities. The whole society should do this.
Why is this statement wrong?
Survivor bias
Economic leverage changes and so change the
returns on equity
The real side and the financial side of the economy
are tightly linked.
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Factories
Human
Capital, etc.
Bond
Market
Stock
Market
Financial
Assets
Real
Assets
Low Risk Anomaly and Leverage Aversion
• In a recent paper FRAZZINI/PEDERSEN (2010) present strong cross sectional evidence for the beta anomaly across 20 equity markets.
• Leverage constraints are driving this anomaly (those who can leverage can exploit it)
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Where are the Yachts?
Very much as the efficient market hypothesis suggests few madeprofits from the credit crisis. Hedge fund performance has been bad inparticular.
Market events reminded us that past anomalies have either beenstatistical flukes or rewards for taking on (tail) risks
– January effect
– Carry strategies
– Short Volatility
– Value Effect
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A Vicious Research Cycle
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Utility Optimization
NEUMANN/MORGENSTERN,
1944
Mean Variance Optimizationas an approximation to
Utility Optimization(MARKOWITZ, 1955)
Lower partial Moments
(FISHBURN/SORTINO 1990)
VaR and CvaRoptimization
(ROCKEFELLER/URYASEV,
2000)
Spectral Risk Measures
ACERBI, 2004
From Managing Client Risk to Revenue Risks
Asset based fees (for benchmark long only managers) contain in-build market risks
These risks are incidental to the managers production process and need to be hedged
Asset managers need to start managing their own risks
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0
0.5
1
1.5
2
2.5
3
3.5
2001 2002 2003 2004 2005 2006 2007 2008
Beta(rela
veto
localind
ex)
Year
Schroders
Invesco
BAER
NorthTrust
State
Price
Myth 9:
Corporate Pension Funds Should Invest Into Equities
– This is In (Almost) All Cases Wrong
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Portfolio Theory versus Theory of the Firm
How do firms create value?– Invest into projects with positive net present value (positive EVA)
What is the net present value of capital market investments?– NPV equals 0 (capital markets are likely to be many times more efficient than investments
into real capital)
Shareholder value: (FISHER/HIRSHLEIFER)– Investments into max NPV projects maximize shareholder value(separation theorem)
All arguments that are in favor of corporate hedging also point to
pension liability hedging!
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The Definition of an Asset Class
Are returns (from unconditional buy and hold futures positions) positive and
statistically significant?
Index level returns often represent back-testing bias (if you don’t like back-tests you
don’t like commodity indices…) with respect to their weighting schemes (e.g. GSCI).
Are returns spanned by existing asset classes?
A statistically significant positive risk premium is not enough! The correct question to
pose is: is the risk premium already explained by existing asset classes?
Is this excess return enough to compensate for non-normality in return
exposure?
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