Wednesday, February 25, 2009

What You Need For A Job In Investment Management

When this commercial came out, I thought it was great. The fact that it starred the king of the B-Movies, Bruce Campbell (a.k.a. "The Chin") was just icing on the cake. But it's the sort of conundrum that's faced by almost every undergrad trying to get a job in the Investment Banking or Investment Management field:
"If you have it, you don't need it; If you need it, you don't have it. If you have it, you need more of it. If you have more of it, you don;t need less of it....

... The point is, if you've never had any of it -- ever, people just seem to know.

So, if you don't have it, don't try to fake it, because you will get embarrassed. So the trick is to get things on your resume that demonstrate that even if you don't have "real" experience, you at least have the personal characteristics (and some reasonably related background that make you likely to get it.

Of course, the only reason I really did this post is that I wanted to put a video of Campbell up on the blog.

If Dogbert Was a Bailed Out CEO

Some of the political theater surrounding the auto bailouts was pretty ridiculous. In particular, the kerfuffle about them taking corporate jets vs. driving vs. flying coach was a bit much.

So I thought this Dilbert cartoon was pretty good:

Tuesday, February 24, 2009

Diversification Across Risk Premiums

Things have been crazy lately - we have two speakers this week at Unknown University's College of Business, and I'm involved in both visits. In addition, I'm getting ready for my CFA prep class and trying to get a paper out for a conference. So, blogging has been light this week (and will probably continue to be spotty for the rest of the week).

But in the meantime, here's an interesting paper to chew on. We were recently talking about different risk premia (size, market/book, momentum, etc...) in class. This paper, "Portfolio of Risk Premia: A New Approach to Diversification" by Remy Brian, Frank Nielsen, and Dan Stefek paper that takes the idea of risk premia combines it with a equally-weighted portfolio weighting scheme across assets with exposures to the various premiums.
Traditional approaches of structuring policy portfolios for strategic asset allocation have not provided the full potential of diversification. Portfolios based upon a 60/40 allocation between equities and bonds remain volatile and dominated by equity risk. In this paper, we introduce a different approach to portfolio diversification. This approach looks at structuring portfolios using available risk premia within the traditional asset classes or from systematic trading strategies rather than focusing on classic betas such as equities and bonds. We start by reviewing the various ways of dissecting asset classes into their underlying systematic drivers or risk premia and analyze the historical risk and return patterns for a number of risk premia across asset classes. In a second stage, we illustrate empirically that correlations between risk premia have been low, offering significant diversification potential. We then confirm the benefits of diversification with a simple asset allocation case study by comparing a typical 60/40 equity/fixed income allocation with an equal weighted allocation across eleven style and strategy risk premia. From 1995 to 2008, this simple combination had returns similar to the traditional allocation but with 65% less volatility.
You can read the whole thing on SSRN here

Sunday, February 22, 2009

UCONN Basketball Coach Explains Basic Economics to Reporter

It's not that often that I get to see two of my favorite topics (UCONN basketball and executive compensation) collide (and on Youtube, yet).

After a recent game, during the press conference, UCONN coach Jim Calhouh was asked a question by "freelance journalist and political activist) Ken Kreyeske, who apparently working for some outfit called “The Hartford News" . He asked Calhoun
"Considering that you're the highest paid state employee and that there's a two billion dollar budget deficit, do you think tat"
Calhoun doesn't even let him finish, and responds, "Not a dime back." He then goes on to explain that he actually makes quite a bit more than that, and that the UCONN program actually results in a significant surplus ($12 million a year) that flows back to the university.

But I love the smackdown he puts on the reporter. At one pint, he asks him, "You're really not that stupid, are you?", followed by "My best advice to you? Shut up. Get some facts and then you can talk"

For that alone, if I ever see the man (and I almost rode in his Cancer Bikeathon last summer), I'd like to shake his hand.

Here's the video. Caution: do not watch while drinking any liquids, or be prepared to clean off your monitor and keyboard):

In addition to pure entertainment value, it also raises some interesting questions or points:
  • Who is in a better condition to determine whether a $1.6Million-plus annual salary for Calhoun adds value to UCONN?
  • Since it's a university, and not a company, a winning basketball team also has externalities over and above the financial impact of the team
  • Most executive salaries are benchmarked to the salaries of industry peers' compensation. How does Calhoun's stack up to his peers (perennial top-25 schools who regularly go to the Final Four)
  • What are the likely effects of capping executive compensation (either for Basketball coaches or for executives at troubled banks)?
Can anyone come up with a better response to a stupid reporter's question?

HT: The Ace of Spades

Friday, February 20, 2009

A Quantitative Approach to Tactical Asset Allocation

I'm not a big fan of market timing and/or technical trading rules. From what I've seen, the empirical evidence casts a lot of doubt on their effectiveness.

But I just read a very interesting paper titled "A Quantitative Approach to Tactical Asset Allocation", by Mebane Faber. Here's the abstract:
The purpose of this paper is to present a simple quantitative method that improves the risk-adjusted returns across various asset classes. A simple moving average timing model is tested since 1900 on the United States equity market before testing since 1973 on other diverse and publicly traded asset class indices, including the Morgan Stanley Capital International EAFE Index (MSCI EAFE), Goldman Sachs Commodity Index (GSCI), National Association of Real Estate Investment Trusts Index (NAREIT), and United States government 10-year Treasury bonds. The approach is then examined in a tactical asset allocation framework where the empirical results are equity-like returns with bond-like volatility and drawdown, together with over thirty-five consecutive years of positive performance.

The paper is definitely worth discussing in class. In most investment classes, there's at least some mention of the relations between arithmetic average returns, geometric average returns, holding period returns, and volatility. The reported returns to the strategy in the paper result in arithmetic average returns that are about the same (if not slightly less) than a buy/hold strategy. However, because of the lower volatility of this timing strategy,, it yields a significantly higher geometric average (and holding period) returns
It's also a good paper for a discussion on the return patterns to a market timing strategy vs. to a buy and hold one.

So, regardless of your views on market timing, it's worth a read: a short paper, interesting results, and written from a practitioner's viewpoint, so it's an easy read - even for an undergraduate.

You can download it from SSRN here.

Ah well, enough bloggery - back to work.

The Slings and Arrows of Research

Sometimes research is not for the faint of heart.

Yesterday, I got a rejection letter on a piece I'd done with a former student. I sat on her doctoral committee (not her chair- just a member) , and this was one of her essays. It had already been rejected at a two top-tier journal, and a second-tier one. Now we send it to a lower-tier one. After all, better to have it published somewhere than nowhere.

Then I got a phone call from a second coauthor (another student who's committee I'd been on, but at another school). I'd spent the last couple of weeks putting a data set together for a project we'd discussed. Unfortunately, the initial analysis turned up a dry well - there wasn't anything remotely interesting.

So, since the approach seemed promising (although it didn't work out on this data set, we'll use it to examine another topic. We might as well use the approach that we developed, even if it didn't pan out for this data. If it turns up nothing the second time, we'll drop it.

Meanwhile, I continue onward with another study with very good results where we've done pretty much all the empirical work. At this point, we're writing up the results (and the rest of the paper) to send to a conference with a deadline is in a couple of weeks.

That's the nature of research. After a while, if you have a number of projects going on simultaneously (and papers under review), you'll have some that turn out well and some that go up in smoke. The secret is to enjoy the successes and not get too upset about the rejections and dry wells and keep rolling.

The law of large numbers works pretty well in research - have a large enough number of things going on, and something will hit. And no one will care about your failures- only the ones that pan out.

Wednesday, February 18, 2009

Our New Travel Plan

Unknown University is going through some budget cuts. Since I'm planning on going to the upcoming Eastern Finance Association meeting in April, I checked out our university's current travel plan. It didn't look too good:

Ah well - everything old is new again. In college I hitchhiked 17 miles to campus each way for several years. I don't recall any alleged killers, but I did meet a lot of people who offered me weed (or more often, asked me if I had any). This includes memorable one time I got picked up by a 250 pound, muscle-short wearing, fu-manch wearing, bald-headed biker driving a Crown Vic late 70 model) with a Harley strapped to the back. I was hitching from Northeast Connecticut to the Rutgers campus to chase teh latest object of my misguided affection. By the time I got there (he was driving right by the campus by happy coincidence), I was woozy and had the munchies from the second-hand smoke (I no longer partook by that point - I'd gotten my crazy on earlier than most and got it out of my system)

On another occasion I also hitched 200 miles to see my best friend's wedding. I missed the wedding, but made the reception. I made quite an impression when I asked the mother of the bride (my friend' bride was a preacher's daughter, and my friend a preacher's son) if I could use her shower because "I'd been hitchhiking through rural Vermont for 6 hours, and I probably smell bad". After my friend explained that I wasn't crazy (well, at least not too much, even if I did smell bad), they agreed and I changed into the spare clothes I'd brought for the reception. And it was worth the trip.

Those were the days when we really brought teh crazy. Had a lot of fun, too. I still do, but in a much more laid back way.

Monday, February 16, 2009

Finance Profesors' Salaries?

One of the most common questions people email me is "how much do finance professors make?

The Annual AACSB salary survey is the definitive source for business school faculty salaries. Here's the most important table from the report - it shows the mean salaries for new doctorates for the major business disciplines

The figures above are for 9-month salaries. At research schools, summer research support can add another 10-20% to that, and there are also opportunities to pick up additional $$ teaching over the summer. However, at teaching oriented schools, there typically isn't summer support, and summer teaching money is also much lower.

For years, Finance professors got the highest salaries across all business disciplines. That's changed in the last few years, with accounting salaries pulling ahead. The increase in accounting new-hire salaries is likely due to smaller numbers of accounting PhD's being graduated and a lot of retirements in their field. But still, $120K isn't bad.

Click here for the free executive summary (you can also get the full report, but it'll cost you).

Sunday, February 15, 2009

The Graduate Assisitant

In my darker moments, I'd like to put one of these on MY grad assistant.

But then, I had a similar idea back in graduate school. Back then, we still worked on an IBM mainframe, and I thought these would be good fit for the computer operators who often took a couple of hours to load the blasted tapes for jobs we were running on stock market data.

I particularly like the "product liability announcement"
...side effects may include learned helplessness, PTSD, incontinence, emotional outbursts, inexplicable crying, counter-control, twitching, diarrhea, impotence, sterility, and transient global amnesia"
Our new "revolutionary innovation" is to introduce clickers in the classroom. I wonder if we could make them a package deal with these?

Saturday, February 14, 2009

A Collection Of Study Tips For The CFA Level 2 Exam

We're now well into the countdown for the CFA Level 2 exam in June. In fact, I'm about to teach a few sections of the CFA prep class I teach in a nearby city. So, the exam (and the preparations for it) have been on my mind, and I thought I'd start putting down some tips on how to approach the beast.
  • First off, don't take it lightly. Although a good number of people pass Level 1 with only a month or two of studying, realize that the Level 2 exam is much more difficult. While pass rates are similar for Levels 1 and 2, the pass rates for Level two are based on a much more select pool- all people sitting for the Level 2 exam are in the group who've already taken and passed the Level 1 exam. So, treat it with a lot more respect than Level 1. The best description of the difference is that the L1 exam is "a mile and a foot deep" while the L2 exam is "a mile wide and a mile deep". A smart undergrad from a good program will probably recognize most of the material on the Level 1 exam. In contrast, the Level 2 exam had a fair bit of material that I'd never seen before (and not just on the Financial Reporting and Analysis section).
  • Second, the Level 2 exam is based on "item sets" - a short (1-2 page vignette followed by 6 multiple choice questions). So, there's much more information provided in the vignette than needed for any individual question. This has several implications: first, that one item set represents 5% of the total exam, so if you miss one vignette, it's a lot of points, and second, that you have to learn how to efficiently pull out the necessary information from the vignette.
  • Most people find that they're less time-constrained on the L2 exam than on the L1 exam. But it's still important that you learn how to process information in the vignettes efficiently. One strategy that works is to quickly read the questions before you read the vignette. Then read the vignette while focusing on the first question. This will help you stay aware of the material for the other questions. Underline relevant points in the vignette and make notes in the margin. And most of all, answer a LOT of end of chapter questions.

Having said that, here are a handful of suggestions I've heard over the years:
  1. What ever amount of time you spent on the L1 exam, plan on spending 20-50% more for Level 2. It's even more more important to start earlier, since "stuff happens" - given the amount of material is too large to cram for. So set up a schedule, and stick to it as much as possible.
  2. As you go through the material, strive for consistency in your studies. Even if you started just now, you could make the recommended 250 hours of study on about 2 1/2 hours a day on average. Don't plan on missing days and making up for it later. Instead, study every day. Set a goal of a MINIMUM of 30 minutes to an hour EVERY DAY. Once you put in the minimum, in most cases you'll do more. But make it a goal to avoid "zeros". And track your study time.
  3. Try to steal little bits of time to study throughout the day - a half-hour here and there can really add up.
  4. In Level 1, you can afford to "triage" material (focus more on some sections, and spent relatively less time on the smaller ones - not gonna happen for Level 2. Because of the item set format, missing a topic can result in you missing 6 questions (5% of the exam). So, plan on covering everything with time to spare. CFA institute has a tradition of making one vignette on something that seems like it's not that big a thing in the curriculum - in 2008 it was Balance of payments (I kid you not), and in 2007 it was the Treynor-Black model. So try to be at least minimally familiar with everything.
  5. Get a good study package (a set of study notes with test software). While the study notes alone might be sufficient to get you through L1, they should be used as supplements for L2. So, read them for a summary, then test yourself, and use the CFA curriculum material to patch up your weak spots, then test yourself again.
  6. Use the test bank to take a quiz every week, and go back to prior material every couple of weeks. If you don't periodically review, you'll forget most of your earlier material.
  7. Ideally, plan on finishing your first pass through the material with 2 months to spare. Then do a review with tests, and spend the final month patching up your weak areas. That's ideal. But at a bare minimum, schedule your studies so that you finish all the readings with a month left over for review and testing.
  8. Use the final month for mock exams and for polishing up. If you have a study pack from Schweser or Stalla, they have some mock exams included. BSAS (the Boston CFA society) also has a mock exam that's pretty good. Then take at least one CFA mock exam (and two if you can stomach them). They're not cheap ($50 each), but they'll give you a good idea as to the type and level of questions to expect on the real exam.
  9. If you're weak in the accounting/Financial Reporting and Analysis area, consider taking John Harris' 2-day review course. He's one of the best instructors I've ever seen, and paying the $500 for his seminar might well make the difference between passing and failing (after Equity Investments, FRA is the second most heavily weighted section on the exam, and could comprise up to 25% of the total points). I've talked with a couple dozen people who've taken his class, and ALL of them raved about it. I actually took it myself, since accounting is not my strong suit, and after 16 hours of accounting, the room actually gave him a standing ovation.
  10. In the final month, buy Schweser's Secret Sauce. It's a great summary of the material on the exam, it's small enough to carry around with you, and it does a great job of hitting the high points.
In summary, start early, plow through everything as early as you can, and test, test, test. And if you can afford it, buy a study package from Schweser or Stalla.

If you have other tips, put them in the comments, and I'll add them in.

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Friday, February 13, 2009

Getting Students To Prepare For Class

This semester, my advanced corporate finance class is going better than it ever done before. The class is about 80% case-based (the rest is lectures used to support the cases), so having the students come to class prepared is the main determinant as to whether the class goes well or not: If they've read and thoroughly analyzed the case before coming to class, leading the discussion is easy. If they haven't, it can be deadly dull and frustrating.

So, what's the difference this time around?

At the beginning of every class, I flip a coin (usually a quarter). A student calls it. At the beginning of the semester, I told them "If you call it right, you win - you get to demonstrate your knowledge; If you don't I win because I don't have to grade anything". If they "win", they get a brief one or two question quiz. The questions are generally very straightforward and test their general knowledge of the case, like "what was the market reaction (within 3%) to the announcement of the firm's restructuring, or "name one concern of the manager of XYZ division". They're straightforward and fairly easy so that, if they've read the case, they have a very high probability of getting it right. If not, they have almost no chance.

The kicker is that it's easy to make the coin come up whatever way you want. When you catch it, while it's in your palm, run your thumb over the surface. With many coins, you can tell what side it's on (try it with a quarter, and you'll see). If you then put the coin in your hand so that it is partway between between your first and middle fingers, you can roll it so that it comes up whatever way you want. If you have difficulty telling which side is which, take a very small piece of scotch tape and put it on one site of the coin- it's essentially invisible except under very close inspection, but makes the coin feel different on that side.

So, they get expect a quiz every day, and come to class prepared. And, you can control when they get a quiz. They're easy to grade, and they get about 10% of their grade based on the total % of the quiz questions they get right.

Since a critical mass of my students now come to class having read the material beforehand, I have a much easier time in class - it's the third week of class, and I haven't had one case where three straight students in a row haven't read the material. So, the discussions are much more lively, and the analysis is much better. And best of all, you don't have the usual dead weight slowing the class down as much.

Thursday, February 12, 2009

Soda Made From Cow Urine?

You can't make this stuff up, and it's too bizarre to pass up without comment:
Does your Pepsi lack pep? Is your Coke not the real thing? India's Hindu nationalist movement apparently has the answer: a new soft drink made from cow urine.
Read the whole thing here.

Whenever I See things like this, it reminds me of something that Malcolm Muggeridge (the British theologian and satirist) once said: "Being a satirist is tough sometimes. You work very hard to make up a humorous fictional situation in which to place a person. And then they go ahead and do something far more stupid and comical than anything you could conjure up. "

Wednesday, February 11, 2009

Wikinvest - Wikis Meet Investing

Here's an interesting cross-breeding of Internet technology and financial information: A wiki-style resource for investors called Wikinvest. In case the term is unfamiliar to you (other than Wikipedia, that is) a wiki is an Internet community where participants can load pages up on various topics and edit pages put up by others. Ideally, it serves as a self-editing source of information, where experts correct mistakes posted by those less informed. Wikinvest has the following areas:
  • Information on companies (0ver 2200 posted to date)
  • A Concepts section, covering topics ranging from industry-specific areas like Technology and the Internet and Energy to "Green Issues)
  • ACommodities section (i.e. metals, energy, grains, etc.)
  • An area coveringFunds and Indices (a handful of ETFs and 37 different indices, from the S&P to Baltic Dry Goods)
  • And, of course, Global Markets, ranging from interest rates to investing in Brazil.
It's not a source of data, but rather a collection of entries by various parties. An initial perusal of the site found some pretty good stuff, some absolute dreck, and everything in between (kind of like on Wikipedia).

HT: Christine Hurt at The Conglomerate

Tuesday, February 10, 2009

One More Thing Off My Desk

I just spent the last 2-3 weeks putting together a data set for a paper with a former student. Ten minutes ago, I sent it off to him. Now it's his problem for a while.

That's the nice thing about working with coauthors - you get to hand work off.

Of course, all this means is that I get to work on another project while I wait for this one to come back. I have several that coauthors have handed off to me. So, it all works out, I guess.

Enough bloggery - back to work.

This Reminds Me Of My Past Life

Before becoming an academic, I worked a succession of jobs that didn't suit me, including selling financial services (insurance, mutual funds, etc...), being a headhunter (the executive placement type, not the shrunken head type), and working as an orderly in a locked inpatient adolescent psychiatric ward (which was probably the best possible preparation for working in academia).

But my least favorite job was being a tax collector for the state. I spent my days calling people up and threatening them with dire things if they didn't pay the sales tax they'd collected. So this Dilbert cartoon really hit home:

I think I'll keep this one above my desk to set me straight whenever I start griping about how hard my day is.

Stylin at the Cancer Clinic

Unfortunately, one of the side effects of the Unknown Son's Chemotherapy is that his hair has fallen completely out. Everyone says it increases our resemblance. But, as he often reminds me, "Daddy, at least MINE will grow back".

So, I looked around on the web, and found this company JKaye Designs (actually, a one-lady shop) that makes colorful surgeons caps. Yesterday, he showed up at the clinic wearing a cap in this pattern:

I wore one with multiple Snoopy characters on it, but unfortunately it's out of stock, so I don;t have a picture. And the Unknown Daughter has this one on order:

Unfortunately, we can't convince the Unknown Wife to wear one.

In any event, if you know anyone undergoing chemo who wants to dress up their noggin, give JKaye Designs some business. A small one fits a kid pretty well.

Monday, February 09, 2009

Could Blogging Have Stopped Madoff?

Here's a very interesting piece from the New York Stock Exchange's blog:
...Certainly, any failure to convince others was not due to lack of effort. Perhaps Mr. Markopolos lacked only an effective medium to communicate his warning. Here's a thought experiment: What would have happened if Mr. Markopolos had blogged his analysis? That is, what if he had posted the entire piece on a blog, under his name or a pseudonym?
RTWT here

I think the blogger has a point. True, blogging wasn't available back in the late 1990's. But if it were, my guess is that a blog post like the one he muses about would have been picked up and passed around from trading desk to trading desk, and eventually gotten aired by a major news outlet. When a story like this "goes viral", it's hard to stop. And as a card-carrying financial economist, I typically fall on the side of "More Information is Good".

Finally, who knew the NYSE had a blog. Verrrrryyyyy Interesting.

Chemo Weeks Bring Teh Crazy

It's a chemo week for the Unknown Son, so things are a bit on the crazy side. While I don't usually get into the details too often, I thought it might be instructive to walk you through a typical chemo week.

U.S. gets the chemo every day for five days (the clinic where he goes is only open on weekdays), so we make the 45 minute drive every day. We leave the house at 7:30, armed with a backpack full of whatever his latest video obsession is - for the moment, it's classic Pink Panther (the cartoons, not the movies).
  • Monday's are the long days - he first has to get his fluids up to snuff, so they take about 2 hours to put in lots and lots of saline. Then they start the chemo (two separate drugs, proceeded and followed by various other meds to protect him from side effects) usually around noon or so. I get the morning shift, and the Unknown Wife relieves me around noon (after her Ladies Bible Study) and takes the afternoon slot, which allows me to go into my office for a few hours to prep for the weeks' classes. When all's said and done, Unknown Wife gets home around 4 or so.
  • The rest of the week, we're out of the house by 7:30 and home by 2 - they don't need to pump as many fluids in as on Mondays, so the chemo starts (and ends) much sooner.
  • Tuesdays and Thursdays I teach until about 2 and then rush home to meet the Unknown Daughter at the Bus Stop (Unknown Wife gets chemo duty),
  • Wednesdays and Fridays, I get chemo duty. If all works well, I get to go in the office for a couple of hours afterwards.
Unknown Son typically handles the first day (or two) of chemo fairly well, with only a bit of nausea, By the end of the week, however, he pretty much is sick until about 6 every night (and sometimes into the evening, and we're pretty tired out.

Somehow in the midst of this, we manage to get everything else done (with the help of the Unknown Wife's friends, who bring us a LOT of meals). We also typically have a family member (usually the Unknown Mother in Law) stay over for a couple of days to help out and lend moral support.

Luckily for Unknown Son and I, the clinic has all the essentials: a DVD player and Game Cube for him, and Broadband for me (hence, this post). So, he gets to watch hours of Pink Panther DVDs and I can catch up on my emails, blogging, and work -- between working on two existing projects (one of which I'm just about done with and ready to hand off to my coauthor for his part) and prepping for the new cases I've added to my Corporate Finance class, it never ends.

But at least it keeps me off the streets begging for data.

Saturday, February 07, 2009

And Now a Word From Our Sponsors

I just thought I'd throw this out - UConn (one of my alma maters) is now ranked #1 in the country for both their men's and women's basketball teams (and the men just spanked #7 Louiville - by 17 points).

Go Huskies!

Friday, February 06, 2009

"Bonuses" and "Maluses"

One of the problems with bonuses is that they create asymmetric payoffs - there's typically an upside for some actions, but no downside (yes, I know, there's the settling up in the labor market, etc., but that's a story for another piece). To deal with this, at least one firm (UBS) has started using "maluses" along with bonuses
"Just as bonuses (Latin for “good”) are paid out for good performance, maluses (“bad”) will be meted out if the bank subsequently makes losses or if the employee misses performance targets, UBS said. The maluses could wipe out all previously agreed share bonuses and two thirds of all cash bonuses under stringent new rules designed to align the interests of executives and traders with those of shareholders."
This concept is aslo called a "clawback", and embedding it in compensation packages so that a person has a downside component is a great idea. Looks like something we'll end up discussing in class.

HT: Proxyland, ("corporate governance and other oxymorons"), a blog worth reading.

Thursday, February 05, 2009

200,000 Hits, Baby

Sometime Tuesday night, Financial Rounds had it's 200,000th visitor. I'm amazed that this many people have so little to occupy themselves.

Just kidding - I appreciate all the traffic, and I'm humbled by people actually reading what I post up here. When I started this four years ago, I never thought I'd be seeing almost 10,000 hits a month (the average the last few years).

Wednesday, February 04, 2009

Beware The Bid-Ask Spread in ETFs

When the average Joe (or Jane) looks at transactions costs from trading, they typically focus on the commission charged by the broker. But in the case of some thinly-traded ETFs (exchange-traded funds), the bid-ask spread can add significantly to that cost. Here's a good piece on the topic from Morningstar:
No one has a very precise definition of liquidity, but it roughly boils down to how easy it is to buy or sell a particular security and how much agreement there is in the marketplace upon the security's fair value. The most liquid funds or stocks have miniscule bid-ask spreads, where the prices differ by only a penny. On the other side, a brand new ETF tracking a selection of more thinly traded mortgage-backed securities has a bid-ask spread near 0.80% as I write this. That means that buying and selling the fund at market prices, even without any commissions charges or price changes, would result in a 0.80% loss. Not exactly a terrifying loss, especially compared with what we all saw in 2008, but still an unwelcome drag on portfolio returns if it can be avoided.

Read the whole thing here

Monday, February 02, 2009

The Financial Crisis Set to Song

A reader sent this in - The Financial Crisis Set To Song. Enjoy.

Econbrowser on Hedge Fund Risk

James Hamilton at Econbrowser gives a good example of "tail risk" from a Financial Analyst's Journal article by MIT's Andrew Lo:
1992-1999 was a good time to be in stocks-- a strategy of buying and holding the S&P 500 would have earned you a 16% annual return, with $100 million invested in 1992 growing to $367 million by 1999. As nice as this was, it pales in comparison to CDP's strategy, which would have turned $100 million into $2.7 billion, a 41% annual compounded return, with a positive return in every single year.

Want to learn more? CDP stands for "Capital Decimation Partners", a hypothetical fund created by Professor Lo in order to illustrate the potential difficulty in evaluating a fund's risk if all you had to go on was a decade of stellar returns. The strategy whereby CDP would have amassed a hypothetical fortune was amazingly simple-- it simply sold put options on the S&P 500 stock index (SPX).

Read the whole post here

And if you want to see another study on the returns of put-writing strategies, here's an older post. It documents what Lo (and Hamilton) discuss - consistently good returns in the overwhelming majority of periods along with rare massive losses.

Sunday, February 01, 2009

PETA, Sea Kittens, and Steak

Some of you might not have heard about PETA's latest half-baked attempt (pun intended) to dissuade people from eating fish. Their "logic":
  1. People eat less of creatures that they think are cute
  2. Fish aren't cute
  3. Kittens are cute
So, the solution? Just rename fish "sea kittens", and people will think they're cuter, and eat less fish. Riiiiiiight.

Luckily, someone had already registered the site When you go to the site, the PETA site shows in the lower frame. What's in the upper frame? An ad for Omaha Steaks.

Making money off a far-left whacky group? Priceless.

If I ever have a PETA sticker on my car, it will be People for the Eating of Tasty Animals, and it will have the phrase "All God's Creatures Have Their Place - Right Next To the Mashed Potatos"

HT: Wall Street Journal's Best Of The Web