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Archive for the ‘Dynamic Rebalancing’ Category

Using a quantitative approach

Wednesday, December 23rd, 2009

A quantitative approach does not necessarily imply a black box. We like quantitative approaches because they help us remove the subjectivity of markets. Granted it helps that we like math:

But we do not recommend a blind, mathematical approach to investing. Covert Analytics is a program that allows portfolio managers to combine personal market views on technical signals, economic data, valuation, liquidity measures etc and to combine these measures into one unified approach. This unified approach allows portfolio managers to evaluate multiple markets in a similar fashion, thus removing the noise and hysteria, the bullishness and the bearishness, and to “stick to the plan”.

As a side note, we wanted to point out that following quantitative rules is something you already do. An odometer is a quantitative tool, it removes the subjectivity of speed measurement and tells you how fast your car is going. You dont leave it up to gut feeling do you? When the officer pulls you over would you say “I wasnt looking at my odometer, I thought I was going around 38 mph!”

What about measuring your blood pressure? If your doctor were to tell you “I think your blood pressure is X” you would not think it was a sufficient measurement, would you? The concept here is that interpreting tons of variables as most portfolio managers have to do is a very difficult task. Breaking it down into quantifiable signals that can be easily digested, interpreted and combined into one cohesive measurement is what Covert Analytics is all about. Simply tracking a few measures (say 5) per market for an Equity portfolio allocated to the G7 is 45 variables!

Tags: dynamic asset allocation, quantitative approach
Posted in Dynamic Rebalancing, Our Approach | 1 Comment »

Our Approach: A better way to money management

Monday, December 21st, 2009

Portfolio management is not just about asset allocation and matching your tactical approach to the client’s investment objectives. It is also about a range of other issues: existing relationships your clients have (with private bankers, fund managers, etc), existing “legacy positions” and how to unwind them, allocation to illiquid holdings, security selection, etc. Our approach has always been to advocate that portfolio managers maintain as much control as possible over portfolio holdings, and the top down allocation decision. The more intermediaries there are, the less control the portfolio manager has.

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Intermediaries come in many shapes and colors: alternative managers such as hedge funds and private equity shops, private bankers with typically expensive fee structures and a penchant for selling structured notes (a low risk way to collect a nice fee without doing much work), mutual funds that have great “track records” that mysteriously fizzle out as soon as you invest with them. Our response: why risk it? Your clients entrust you with their money. Your job is to protect capital. The more control you have, the higher your chances at doing just that. Diversification out to intermediaries may seem like an appropriate way to diversify risk. But in the end, it simply complicates your life because now in addition to having to worry about markets and how to position portfolios, you have just added a slew of other variables you must now track: managers tracking error, operational risk, private equity sub company holdings, etc etc.

We love global, liquid, capital markets. Why entrust your money to a Private Equity manager that makes a killing off your client’s hard earned capital for them to sit back in a comfortable Manhattan office and allow an army of employees to make a living doing the groundwork. We suggest you cut the fat. Why worry about your mutual fund manager’s stock picking ability when in a declining equity market, 200 bps of outperformance still could mean a decline of -25%! You see why our emphasis is on global (because opportunities in investing are NOT limited to the US), and liquid (because why risk illiquidity when more often than not the vehicles to get access to illiquid assets are way too costly) capital markets.

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Posted in Asset Allocation, Dynamic Rebalancing, Illiquid Assets | No Comments »

Asset Allocation Paralysis

Monday, December 14th, 2009

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The problem with not having a dynamic approach is that what often results is something I call “asset allocation paralysis” where a portfolio manager in essence stays stuck with a clients asset allocation. Though minor portfolio changes are made, the overall asset allocation stays rather “stuck” within very tight ranges and rebalancing is rarely implemented.

We do not think that portfolio managers should try to time markets. That is for sure a fools game. What we do strongly believe, on the flipside, is that structural trends and forces take shape which are either bullish or bearish for asset prices. A systematic approach to measure what is the environment for each asset class will help to (1) remove emotion from evaluating these markets and (2) aggregate multiple indicators into one consolidated measure for a specific market.

Asset allocation is one of the most important and difficult tasks a portfolio manager must choose for clients. Over the long run, it is the most largest determinant of how much wealth a portfolio manager creates for clients. By responding tactically and aggressively to market movements, portfolio managers can really add alpha. Asset allocation paralysis is a cross between “buy and hope” and trend following, because whether you like it or not, your portfolios will trend with the markets.

Covert Analytics is a platform designed to help you avoid asset allocation paralysis! We initially conceptualized this platform to help investment advisors and portfolio managers have a systematic approach to fall back on when deciding on how to react to market movements. Our clients use it blindly, because their asset allocation models are designed by them, built around their gut feelings, and produce clear and specific recommendations subject to their clients constraints.

Posted in Asset Allocation, Dynamic Rebalancing | No Comments »

What our software does

Tuesday, December 8th, 2009

Taking a peek at the cover the FT today I almost had a panic attack ** again ** thinking about continued clashes in Iran, and what effect this would have on the market, continued Middle East tensions, etc. Then I realized that press rewind or fast forward a few months, and the same headline will likely be there. I calmed down instantly when I realized that insofar as positioning a portfolio goes, a very high percentage (I would say over 90%) of what is discussed over and over again on a daily basis is what I call “noise”. Very little should be included into your approach to portfolio construction. It is very difficult to do this, as humans we get caught up in the whirlwind of media speculation, financial market commentators, existing portfolio positions, hesitation over future purchases, that it is difficult to discern what is noise or what is signalling a new trend. Coming from an engineering background this reminded me of the signal-to-noise ratio and how engineers attempt to maximize this ratio to “get a good signal”. How should a portfolio manager eliminate noise?

Noise is everywhere! Is the Fed doing too much? Not enough? Is Chimerica doomed to destroy America’s economic and financial market dominance? Is the US$ set to crash, or is this fully priced in by markets and therefore should I position for a dollar rally? Are we entering a multi year bull market after 10 lost years of Equity returns? If I had a $100,000,000 portfolio sitting in Cash, how would I allocate it today!?!

This is where Covert Analytics comes in. By having a systematic approach such as our tactical asset allocation model builder, you are encouraged to take in all the noise you want, our system filters out what isnt relevant and spits out what is. Our quantitative approach is a “noise filter” for your portfolios. Rest easy, and take in all the noise you want. Our system takes the data, uses your methodology to analyze what the data is saying, and recommends an asset allocation.

Tags: signal versus noise
Posted in Dynamic Rebalancing | No Comments »

The best defense is offense

Thursday, December 3rd, 2009

We all know how difficult the investment climate has been for the past decade. What’s worse: the outlook going forward is increasingly tricky, and human nature causes us to extrapolate recent trends out into the future and expect for a similar outcome. After disastrous portfolio performance resulting from the 2000-02 TMT bear market or the 2008-09 Great Recession it seems investors would be happy to achieve steady returns north of 5%, an unimaginably boring bogey in the prior two decades.

In addition to being boring, this target return would be seen as “un-ambitious” before, but now seems difficult to achieve, especially in a world of near-zero interest rates and in a world with enormous financial and economic uncertainties. Evaluating global stock markets is tricky if we are on the verge of a “double dip” in the developed economies. There is talk of too-hot speculative activity in the BRICs. Investing in government bonds feels like skating on thine ice due to an ever increasing supply from the money printing central banks. Gold is breaking new all time highs. Like Mr. Pellegrini (formerly of Paulson & Co) said recently: “It is a time of risk management rather than real decisive positioning”.

We propose that the best defense for this environment is offense. Having a plan, a systematic strategy for how to rebalance assets and look for opportunities across the spectrum of financial assets and across the globe strikes us as the real best defense. Focusing on risk management without an approach like ours at Covert Analytics, is a bit like driving with the parking brake on. As former portfolio managers we know what can occur without a systematic strategy, something we like to call “Asset Allocation Paralysis”. We coined this term to describe what happens when a portfolio manager is unconvinced whether a market is overbought or a good opportunity, whether to sell a legacy position or maintain it, whether to increase Equities or not. The uncertainty of making aggressive portfolio bets ends up causing inactivity, and the end result is a portfolio sailing through treacherous waters like a ship without a sail.

Posted in Asset Allocation, Bonds, Dynamic Rebalancing, Stocks | No Comments »

Portfolio management now versus in the 80s and 90s

Monday, November 30th, 2009

Being a portfolio manager in the 80s and 90s was easy. The chart below shows how well investors in stock and bond markets fared in the 80s and 90s. Everyone knows what a disaster being a stock investor was in the late 60s and 70s. That was the first secular bear market since the Great Depression. In 1966 the Dow Jones was hovering around 1,000. In 1982, it was still there, hovering around 1,000. After adjusting for inflation, the results were even more disastrous. The early 80s saw Time magazine quoting “The Death of Equities” and other similar headlines (great contrarian indicator in retrospect). This of course coincided with the start of one of the greatest bull markets of the 20th century, as equity markets bottomed in 1982 and staged one of the greatest rallies on record.

From 1982 until 1999, US equity markets suffered only 1 negative year! And that is factoring in Black Monday – the one day market correction of over 20%! The average annual return for US stock markets during this period (total return) was 18.6%. Even being conservatively positioned in bonds, investors saw great returns. The Lehman Aggregate returned 9.5% average annual returns during the same period. Like I said, being a portfolio manager in these years was easy.

The Good Times: Stocks (black) versus Bonds (amber) in the 80s and 90s

The current decade was another story. Since January of 2000 (through November 2009), Equity investors are still underwater even factoring in dividends. The annualized return during this period is -1.5%, or a total loss of -14.3%. How have bonds fared? Far worse than the previous two decades, but still a respectable 6.5%. This has been one of the most trying times in recent memory for any investor. When looked at from a longer term perspective it is clear we entered another secular bear market some time in early 2000, and as history has shown, these can go on for many more years than investors are ready for. And just when you are ready to throw in the towel, a new bull market is born.

The Bad Times: Stocks (black) versus Bonds (amber) since 2000

For the time being however, it is clear that Buy and Hold is a disastrous investment strategy in a secular bear market. Investors will be rewarded for being dynamic, not static. Keeping a global perspective on investment opportunities and not having a dogmatic approach both to asset allocation (the mix to stocks, bonds, commodities) will aid portfolio managers who need to generate alpha over the coming years. Now is a time when portfolio managers will earn their salaries!