For a friend we recently evaluated their private equity statement. To not be specific but avoid being vague, hint hint it was a major PE shop in Washington DC. Anyways, this statement had our jaws dropped!!!!!
Client commitment: 3.5 million EUR
Contributions to date: 1.0 million EUR
Fees / expenses to date: 270,000 EUR
You forgot the punchline: this is after only year 2 of the investment and oh yeah, the “investments” are down 30% …. way to earn your management fee guys!!!!
First lets review the formula.
A correlation between two variables is the covariance between each divided by the product of each variables standard deviation (or the square root of each variables variance).
Since the correlation is a normalized number it is important to remember that it is a user friendly but not that usable variable. It describes the co-movement but says little more than that. There are much more powerful analytical co-dependence functions than correlation. Product advertisement: we are thinking about developing a powerful yet fun to use platform that will facilitate statistical modelling of financial markets.
Anyways, look at the recent rolling correlation of the S&P 500 and the US dollar. This is a rolling 1 year correlation using weekly percent return figures on SPX and DXY.
S&P 500 and DXY Correlation: (Weekly, 1 year)
It is important to mention that though the trade weighted Dollar is up 8% since early December, it is up almost 11% versus the EUR. This implies that versus other currencies the USD has not gained much.
Thanks for reading,
The Covert Analytics Team
We agree with the Wall Street Journal article, implying that serious investors need to rethink asset allocation. It goes without saying that an asset allocation strategy “works” over the long run, but that doesnt help navigate through ferocious bear markets.
“In their research, managers came across Denmark’s ATP fund. In 2008, that $112 billion pension fund moved from allocating investments based on asset type to what drives risk, a spokesman confirms. For example, it put private and public equities into one category called corporate earnings, which usually perform badly during economic downturns.”
That is exactly how Covert Analytics suggests portfolio managers manage portfolios! Allocating investments based on what drives risk? That is the exact definition of what our platform is trying to achieve!!!
Suggestion: CALPERS can fire all their employees (except 2), hedge funds, advisors. Maintain one employee to manage their Covert Analytics subscription and other employee to execute trades! Problem solved.
We wanted to let people know how and why we are called Covert Analytics. The idea initially was that an investment advisor would use our platform as the secret tool to help them navigate markets. The secret tool, you may ask? Yes … secret because most investment advisors would claim that their approach to the market was revolutionary, proprietary, etc. Hey at our old investment advisory firm, we did the same…
So if their asset allocation approach was from an “off the shelf” or in this case “off the web” software, it would diminish the sophistication level they projected. We wanted to partner with our clients (money managers) in offering the “best in the world” product to their end clients. Granted our platform is our perspective, and our expertise and experience in the trenches, in an attempt to better navigate the markets.
Covert + Analytics: a powerful tool used by money managers to arrive at optimal allocation decisions.
The simple picture is that Covert Analytics is a dynamic asset allocation software that we built because we felt we needed smarter software! It is your secret weapon to manage your client assets and build a dynamic and proprietary model using our platform.
Thanks for listening,
The Covert Analytics Team
Ed Thorp, not only a leading thinker on markets and investing, but also one of the most successful hedge fund managers out there was quoted a few years back regarding trade idea generation and how money managers need to evolve. It is a great quote and should lead anyone in the business to refocus on the essentials:
“Where do the ideas come from? Mine come from sitting and thinking, academic journals, general and financial reading, networking and discussions with other people.
In each of our three examples (blackjack, convertible bonds, statistical arbitrage), the market was inefficient and the inefficiency or mispricing tended to diminish somewhat, but gradually over many years. Competition tends to drive down returns, so continuous research and development is advisable. In the words of Leroy Satchel Paige, “Dont look back. Something might be gaining on you.”
We wanted to write a brief note on an “enlightening” topic that Bloomberg carried recently. Rarely do we get annoyed with Bloomberg, which usually reports the news, not shoves their view down a viewer’s throat (think CNBC or Fox). It burns us that the hometown of Covert Analytics would be given such a stigma on Bloomberg. However we would like to make several comments.
Background: Bloomberg sends Deirdre Bolton (we assume) to get an insider’s perspective on the local economy in Miami.
What happens: they interview the CEO of Bacardi (yes!!!!), an “expert” on the local real estate market, and … a legal expert on white collar crime to cover the occurrence of scam artists and corporate fraud in South Florida. The video can be found here
Some immediate things to note on Bloomberg’s coverage:
Over the long term, it is clear that stocks outperform bonds and cash. Since 1926, the compounded annual return on stocks (large cap) was 9.8%, compared with government bonds return of 5.4%. This is including three periods of horrible equity market performance:
- the 1930s (Great Depression)
- the 1970s (Great Inflation)
- the 2000s (Great Recession)
The last 40 years show a different picture however, with stocks returning 9.5% and bonds returning 9.3%. Is this amazing risk adjusted outperformance in bonds to continue? It is unlikely. Here is the important differentiating factor to remember going forward:
Since the early 1970s bonds had high and falling yields, but now have low and possibly rising yields. It is important to remember that back then, US yields peaked above 15% when inflation was high. Currently 10 year US Treasuries are yielding 3.7%, and Eurozone 10 year is yielding 3.1%. The likely path of least resistance is for yields to increase (which would depress prices) or stay relatively low thus earning a yield like return. Either way, the glory days of the bond market are behind us.
Global Equity Snapshot
Here is where the S&P stands now, both on its EPS (Earnings per share) and the P/E multiple (Price divided by Earnings). This gives us the current value of about 1,135 on the S&P.
Now, where to from here? Assuming bottom up company forecasts of about $78 of an EPS number for this calendar year (thus an estimate), let’s see how this calculates through for a range on the S&P. Jeremy Siegel recently was quoted as saying that in this range of a low real interest rates environment, a P/E multiple of approximately 18x fits. That would give us a decent amount of upside still in the Equity market.
The first table was taken from a Barron’s article, “Happy Anniversary, Investors” commetning on the 1 year anniversary of the stock market bottom (3/9/2009). Basically the conclusion is that there are still a plethora of good investment options, and though they are not outright giveaways. Here is a summary of some “giveaways” from last year:
Ford (F) at $2, now at $12
General Electric (GE) at $6, now at $16
Goldman Sachs (GS) at $53, now at $171
Anyways, in conclusion: there are solid investments out there, for buyers with patience.
We grew up in the ‘hood. The “hood” of academic circles. Our formative years in money management were spent surrounded by brilliant academics, a few literally with Nobel Prizes, a few more PhDs, and a bunch of graduates from Wharton / Kellogg etc. This should be a great start, you would say? It actually wasn’t.
Quoting Warren …
In retrospect, we all learned a bunch. What I would sarcastically say is that we learned what not to think. In our defense, even Warren Buffett said at his 2009 annual shareholders meeting that if he taught a course on investing, the first thing he would do is unteach the “efficient market hypothesis”!
Cross-Check
The problem was we were building a new type of money management firm, based more on index-investing (since you could not outperform the index) rather than blindly allocating to managers. The problem with that approach was still that you needed an asset allocation approach to “beat the business cycle”. The “Chicago boys” thought this was a waste of time, markets were efficient, you could not outsmart them, etc. This greatly upset the other half of us, who wanted eventually to run our own hedge funds and were insulted at this death knell to our future careers.
Our focus has always been on using quantitative techniques to identify when investment opportunities offer the most probable profit. Thus why we developed Covert Analytics. We were frustrated that some basic tools were not commercially available for portfolio managers, money managers, investment management firms, asset allocators, family offices, whatever label you want to give them.
Fast forward to Covert Analytics
Our platform is not a market timing software. Our software is about identifying when forces are in place to propel asset markets further, or when valuations, monetary conditions, etc are so stretched that a price collapse is likely in the medium term.
What the Research Says
We realize how important the confidence our clients place in us is. Our entire premise is that asset allocation is the most important decision a money manager has to make. More important than security selection, more important than the aggregate effect of tactical trades, etc. Here are some studies we recently evaluated and their conclusion on market timing.
Clearly market timing is a tough task. We believe that with our approach, and a wide variety of assets, outperforming the market in a systematic way is achievable. What this research proves is the following: forecasting bull markets is just as important (actually more important) than forecasting bear markets over the long run.