Derivative markets are zero-sum games, with each long position offset by a corresponding short. As such, the aggregate return to all participants in the futures market is the risk-free rate, less any management fees. In order for managed accounts to earn a positive risk-adjusted return after fees implies other market participants who systematically earn less than the risk-free rate. This is possible because many participants in the futures markets are hedgers, who may be willing to accept the lower return as an insurance premium protecting them from outlying events.
Managed futures managers can also exploit mispricing opportunities that arise when certain contracts are not trading at the proper relationship to other contracts.
Even with limited return opportunities, managed futures may play a role in the portfolio due to a low correlation of returns with those of traditional investments such as stocks and bonds. The diversification benefits have been shown to accrue even for portfolios that include other alternative assets such as hedge funds.
The Sharpe ratios of portfolios that include managed futures dominate those that do not. However, the benefits may be specific to the investment vehicle, time period and strategy under consideration. Managers have been shown to demonstrate short-term persistence in returns and a manager’s beta relative to his benchmark is often a good indicator of future returns.
Since futures involve leverage and derivatives, particular consideration should be paid to risk management strategies.
Posted on 28th September 2008
Under: Active Management, Alternative Assets, Asset Allocation, Futures, Investing in Commodities, Investment Returns, Personal Finance | No Comments »
For individuals drawing on retirement funds, a 4% withdrawal rate is generally recommended to result in only a small chance of the portfolio running out of money. In the October 2007 Journal of Financial Planning Spitzer, Strieter and Singh simulate thousands of 30-year periods to assess the overall probability of running out of funds.
They find that a standard 50/50 split between stocks and bonds can allow for a 4.4% withdrawal rate with just a 10% chance of depleting funds. Withdrawal rates of up to 6% can be supported with stock allocations of 75% or more.
Posted on 10th July 2008
Under: Asset Allocation, FInancial Planning, Investing in Stocks, Investing in bonds, Investment Returns, Personal Finance, Portfolio Management, Research, Risk Management | No Comments »
Longevity annuities exchange an up-front payment for a stream of payments that will begin some years after retirement. For example, the annuity may be purchased when the investor is 65, but only begin to pay benefits when the investor turns 80. Benefits will continue for the remainder of the investor’s life.
Investment annuity payouts per dollar invested are much higher than immediate annuity payments for several reasons:
- The lack of payouts in early years allows for greater compounding benefits on investment returns
- The shorter remaining expected life span after payouts begin allows for each payment to be larger
- Potential annuitants who die before reaching the target age subsidize returns for those who live longer
In the January/February 2008 Financial Analysts Journal, Scott argues that many investors will benefit from an allocation to longevity annuities, and that the optimal bundle depends upon the percentage of total assets the annuitant is willing to allocate to annuities. The greater the proportion annuitized, the earlier payments should start.
Posted on 4th May 2008
Under: Alternative Assets, Asset Allocation, Investment Returns, Personal Finance, Risk Management | No Comments »
Retirement plans generally come in one of two varieties: defined benefit (DB) or defined contribution (DC). In a defined benefit plan, the plan sponsor promises a specific future benefit, with no specific present obligation. In a defined contribution plan, the sponsor’s present contribution is specified but the future benefit is not. The distinction raises some important differences between the plans from both the empoyee’s and the employer’s perspective:
- For the plan sponsor, DC plan obligations are fully met when the initial contribution is made. Sponsors bear a future liability in a DB plan.
- Investment risk is borne by the sponsor of a DB plan, but by the participants in a DC plan.
- Participants in a DB plan bear the risk of an early plan termination. There is no such risk to participants in a DC plan, because the participants own their own accounts.
- DC plans offer portability to participants changing jobs.
Posted on 13th November 2007
Under: Active Management, FInancial Planning, Personal Finance, Portfolio Management | 1 Comment »
In the November 2006 Journal of Financial Economics Cooper, McConnell and Ovtchinnikov examine whether investment returns in January have predictive power over returns for the subsequent 11 months. Between 1940 and 2003, when the market-weighted portfolio is positive in January returns for the remainder of the year have averaged 14.8% and when January returns were negative the remaining 11 months returned an average of just 2.92%.
The authors find no explanatory value from business cycle variables, presidential party affiliation, or consumer sentiment. Further, the results occur independently of other recognized factors such as portfolio weighting, market capitalization or valuation.
Posted on 21st July 2007
Under: FInancial Planning, Investing in Stocks, Investment Returns, Personal Finance, Portfolio Management, Research | No Comments »
Behavioral Finance suggests that overconfidence will cause investors to attribute market-related returns to their own skill level and trade more frequently when markets are rising than when they are falling. In the Winter 2006 Review of Financial Studies Statman, Thorley and Vorkink examine the relationship between past returns and stock turnover in portfolios. This is related to the disposition effect, in which investors will realize gains but delay realizing losses.
The authors find a statistically and economically significant positive relationship between market turnover and lagged market returns, consistent with the overconfidence hypothesis. They also find that individual security turnover is related to both market and security specific returns, supportive of both overconfidence and the disposition effect. Finally, they find that the effect was smaller after 1982 and in large cap stocks, which may be explained by larger institutional (rather than individual) participation in those subsets.
Posted on 20th July 2007
Under: Behavioral Finance, Investing in Stocks, Investment Returns, Personal Finance, Research | No Comments »
Much of financial planning fails to account for the investor’s human capital, and how that interacts with financial capital. Ibbotson et. al. address the issue in depth in a recent CFA Institute Monograph, Lifetime Financial Advice: Human Capital, Asset Allocation, and Insurance.
Human capital, in the context of the monograph, is simply the present value of a person’s future earnings. When the investor is young, human capital likely far exceeds financial capital. As retirement approaches, financial capital needs to be able to replace the income as human capital dwindles.
The monograph contains a variety of models and case studies, but some of the important considerations include:
- Security selection should include assets with low correlation to the investor’s income. Too many people, for example, invest too much of their human and financial capital in their employer.
- Insurance products to protect against premature death (life insurance) and unexpected longevity (annuities) must be a part of the overall plan.
- The types of plan in which the investor participates must be considered to develop the optimal mix of lifetime income and bequeath.
Posted on 16th July 2007
Under: Book Reviews, FInancial Planning, Personal Finance, Portfolio Management | No Comments »