Friday, August 27, 2010


Are a CFA designation, an MBA degree and experience critical success factors for fund managers? In their July 2010 paper entitled “Are You Smarter than a CFA’er? Manager Qualifications and Portfolio Performance”, Oguzhan Dincer, Russell Gregory-Allen and Hany Shawky examine the impact of having an MBA, a CFA and/or investment experience on investment manager performance. They control for market conditions and investing style and seek robustness of results by using five portfolio performance and two risk measures. Using fund performance data and manager characteristics for a sample of 890 managed equity and fixed income portfolios free of survivorship bias over the relatively calm period of 2005-2007, they find that:
  • 40% of key portfolio managers hold a CFA designation, 28% have an MBA degree and 18% have both. 46% (35%) of funds have at least one CFA (MBA) on the management team. The average job tenure for key portfolio managers is about 12 years.
  • On average over the sample period, managed funds beat the S&P 500 Index by 0.06% per month, with a monthly four-factor (market, size, book-to-market, momentum) alpha of -0.08%.
  • The 890 funds in the sample employ 32 different benchmarks, with about 8% of funds changing their benchmarks during the sample period. The most commonly used benchmarks are the S&P 500 Index (21.6%), Russell 1000 Growth Index (14.5%) and the Russell 1000 Value Index (11.4%).
  • Considering the full array of performance measures, along with risk and style adjustments, there are no differences in fund performance reliably attributable to CFA designation, MBA degree or experience level, either separately or in combination.
  • However, there is evidence that portfolios managed by CFAs tend to have lower risk than portfolios managed by MBAs. There is some evidence that experience also relates to lower portfolio risk.
In summary, evidence from an array of tests does not support beliefs that CFA designation, MBA degree and level of experience are critical success factors for investment managers.
See also “What It Takes to Drive the Big (Hedge Fund) Rigs”.

Thursday, August 05, 2010

Kass: Short Bonds

Doug Kass

08/04/10 - 02:00 PM EDT
This blog post originally appeared on RealMoney Silver on Aug. 4 at 7:52 a.m. EDT.
As stocks begin to challenge my upside S&P 500 target of 1,150 (in a range between 1,025 and 1,150), I would now reduce stock positions in the belief that shorting the U.S. bond market, via a ProShares UltraShort 20+ Year Treasury (TBT) long, provides a better downside risk/upside reward ratio than owning the S&P now.-- Doug Kass, "A Risk-On, Risk-Off World"
I would not get caught up in the optimism that has surrounded the sharp ramp up in the indices since early July.
Indeed, in yesterday's opening missive, I argued to further reduce long exposure as we traveled toward the higher end of my expected second-half trading range in the S&P.
continue to believe that the July 1 lows will not be revisited in the months ahead as the hyperbole surrounding a double-dip in the domestic economy has abated, along with steady improvement in certain risk metrics and risk markets (e.g., junk bond yields down, euro up, industrial commodities higher, two-year swaps down).
Nevertheless, the ambiguity of the economic soft patch grows daily and was reinforced by Tuesday's sluggish data (factory orders, pending home sales, personal income and spending were all weak). Moreover, a reduction in inventories and some other influences now point to a revision of second-quarter GDP to under 2% later this month.
Since the generational low, I have argued that we are in a period of inconsistent and uneven economic growth that will be difficult for corporate managers (who do not have pricing power and face tepid top-line growth) and investment managers to navigate. In this anticipated sloppy setting, it will sometimes appear, in the quarters ahead, that we are reentering a recession. At other times, it will appear that we are reentering an expansionary phase.
Lumpy growth and the emergence of nontraditional headwinds (fiscal imbalances at the federal, state and local levels, higher marginal tax rates, a costly and burdensome regulatory backdrop, etc.) will serve to cap the market's upside.
Supporting the market (among other factors) will be low interest rates and reasonable P/E multiples (especially when viewed vs. generational low interest rates and quiescent inflation).
As well, the risk premium (S&P earnings yield less the risk-free rate of return in fixed-income) is at the highest level since 1980, when the bull market started. This means that stocks are cheap relative to bonds and/or bonds are way overpriced and possibly in bubble territory.
As I wrote yesterday, I tip in favor of shorting bonds over being long stocks. I believe that my downside in a bond short is limited and, if stocks rally, the reasons behind that rally (economic clarity) could produce a larger drop in fixed-income than a gain in equities.
How expensive are bonds? Consider, that at a 2.89% yield on the U.S. 10-year note fixed-income is priced at a P/E multiple of 34.5x (the inverse of 2.89%) against the S&P's P/E multiple of only 12.0x.
Regardless of one's views, erring on the side of conservatism seems to be the preferable course of action, especially after the sharp rise in the U.S. stock market.

Yield Wins in the Long Run

WSJ (hat tip Abnormal Returns):
Bonds continue to trounce stocks, sending mixed signals to investors and raising the question: Are stocks too cheap or are bonds too expensive?

After consistently lagging behind bond performance this year, stocks appear historically cheap compared with bonds, offering investors reason to favor stocks, particularly if they are optimistic about the economic outlook.
EconomPic has detailed this quite a bit over the past few months:
Back to the WSJ detailing how things have played out:
So far this year, the stock market's total return is slightly negative, while normally staid investment-grade corporate bond returns are up nearly 8%, according to Bank of America Merrill Lynch indexes. Even risk-free Treasury returns are up 6%.
This equity-like performance of high quality bonds can not continue. At some point the level of yield... wins. With the current yield to worst of the "Barclays Agg" index at less than 2.6%, investors expecting anything more than 2.6% over the next 4-5 years (i.e. the duration of the index) will be disappointed.

As for risk assets... as I detailed in my post Investing in a Low Return Environment my guess is that while high real returns are possible, there is a lot of risk out there.
And THAT'S the problem with investing these days (and not just with bonds). With risk-free rates hovering near zero, an investor must take a much larger amount of risk to achieve any level of absolute return. This concept is even more meaningful for an investment in risk assets, such as equities and commodities, as the downside risks of those asset classes are MUCH higher than even the worst case rising rate scenario on an investment in the BarCap Agg.
Source: Barclays Capital

Pushing on a string

In an equity-centric world it sometimes easy to forget the unforgiving mathematics of bond pricing.  Unlike equities, fixed income securities have limits on their potential for capital appreciation.  Bond prices can only escape the inevitability of par for so long, absent a trip to bankruptcy court.  As the yield curve continues its path downwards the attempt to squeeze excess returns from the bond market becomes more like pushing on a string.
One can see from the chart below the downward moves in both the Treasury and BBB-corporate bond curves.  The moves are especially pronounced at the short end of the curve.

Source:  research puzzle pix
In today’s financial markets it seems that we are beginning to see some of these limits come into play.  For example IBM was recently able to issue 3 year bonds at 1%.  Even an instantaneous drop in the yield by 50 bp yields only a 1.5% rise in the price of the bond.  In short, absent earning the coupon there is little in the way of capital appreciation opportunity here.
The aforementioned is an extreme example due to both its coupon and maturity, but it is indicative of the situation facing the overall bond market. Given the puny yields on so-called safe investments like bank deposits and Treasury securities it should not be surprising that individuals are in a desperate search for yield.  Cash has been flowing out of money market mutual funds in search of higher yields.
Given the recent performance of high yield bonds this is not surprisingly a likely destination for some of this cash.  Investors have been pouring money into high yield bond funds as defaults ebb.  From a Bloomberg article one fund manager called the market behavior “a little big bubblelicious.”  The risk is that individuals don’t know exactly what they are getting themselves into.  As Carl Richards wrote a few months ago:
One of the things that I’m most worried about right now is people taking money that they want to keep safe and trying to find investments that earn a yield that’s a little higher. This is called “stretching for yield,” and it can be be a dangerous game, especially if you don’t understand the rules.
The logical conclusion is to short the bond market, right?  Some analysts like Doug Kass are currently recommending that approach.  Kass argues for getting long the ProShares UltraShort 20+ Year Treasury ETF (TBT).  While this approach is technically easy, one should recognize that this approach comes with some costs.  Those include the feeds of the underlying ETF and the costs of carrying the short bond positions themselves.
The other bigger picture issue to deal with is the case of Japan.  Japan has been mired for nearly the past two decades in a low-growth environment.  This has lead to 10-year JGBs now trading with a yield below 1.0%.  If one is an ardent believer in the deflation case, then current government bond yields may not seem all that high in the future.
In any event we should all get used to the notion that we are investing in a low nominal return environment.   Some interesting charts at EconomPic Data highlight the limits we are now facing in the bond market.  We should view future returns through the lens of current yields:
This equity-like performance of high quality bonds can not continue. At some point the level of yield… wins. With the current yield to worst of the “Barclays Agg” index at less than 2.6%, investors expecting anything more than 2.6% over the next 4-5 years (i.e. the duration of the index) will be disappointed.
There a number of implications from this discussion.  Included in this would be pension funds having to revisit their rate-of-return assumptions.  Playing a reversal in this interest rate trend remains an option, but it is not a risk-free one.  The bottom line is that fixed income investors need to face up to the realities of current bond prices and brace for an extended period of diminished returns.

Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.