Sunday, May 26, 2013

Is Low Vol Overbought?

Robeco's Pim van Vliet on whether low-volatility stocks are expensive:

Basically, he says that looking P/E ratios they are slightly expensive. His low vol fund has a P/E ratio similar to the average, but on a dividend rate, it's actually cheaper.

He argues that low volatility stocks have predictable performance based on valuation, so in today's trendy environment, it pays to have a nuanced approach.

Value and Momentum Everywhere by Asness, Moskowitz, and Pedersen just came out in the Journal of Finance, 4 years after appearing on the SSRN. It's a great paper highlighting two important factors for any equity investor. Indeed, I'd surely have it on the reading required reading list for anyone in the business, alongside classics on value via Fama and French's 1992 paper, and Jegadeesh and Titman's 10 year retrospective on momentum.

An interesting argument is that value and momentum are, well, everywhere: currencies, country bonds, commodities, and of course, equities.  This suggests that, if you are a long-short investor (ie, zero beta to the index), you should really go broad when you are implementing these strategies.

Then there's Pension Portfolio Choice and Peer Envy, also just published, which was Jacqueline Wise's dissertation back in 2006 or so (see pic right). She does a good job of discussing envy in investing, the theme of my book. She references the usual suspects in this space: Duesenberry (1949), Abel (1990), Gali (1994). I'm surprised she didn't mention DeMarzo, Kaniel and Kremer.

Her model generates the following result that I too find, namely that equity allocations are identical when people are envious.  She also finds situations where this equilibrium implies a higher equity allocation than in the base case. I would think, if you took this further, you would find that when trendy risky investments become popular, their expected return is actually negative.

The paper stops short of the bigger implication: there is no risk premium in such a world.  Further, if 'everyone' is buying a specific asset, it's expected return can be significantly negative in equilibrium.  Instead, she suggests that investors preferences can be materially different when looking at pension plans. True, but she could be stronger.

This reminds me of Feynman's explanation for why the mass of the election was constantly revised upward over decades after Robert Millikan's initial estimate:
Millikan measured the charge on an electron by an experiment with falling oil drops, and got an answer which we now know not to be quite right. It's a little bit off because he had the incorrect value for the viscosity of air. It's interesting to look at the history of measurements of the charge of an electron, after Millikan. If you plot them as a function of time, you find that one is a little bit bigger than Millikan's, and the next one's a little bit bigger than that, and the next one's a little bit bigger than that, until finally they settle down to a number which is higher.
Similarly, people find piecemeal application of envy relevant, but currently aren't going 'all-in' because it's too large a change from the consensus.  Instead, it simply explains little things, more and more little things. If you believe it's the truth, the benefit is that you will get to see more agreement over time, which is fun.

Speaking of envy, Steve Wisdom points me to this observation on the Stockholm riots, another piecemeal application.  Immigrants aren't happy, but not because they aren't doing well in absolute terms, just that relatively, things are not so good:
[Swedish immigrant] finds it hard to be as thankful as his parents still are to his adopted homeland. "They compare it to Baghdad or Somalia," he said. "But we younger immigrants only really know Sweden, and we just compare our situation to the one around us."
So remember that. Immigrants today are happy for their change in situation. They children won't be so grateful if they stay in the underclass, and will vote to redistribute accordingly. That's why I'm not a big fan of the always-interesting Bryan Caplan's call for unrestricted immigration.

BTW, if you think you're smart, see if you can tell which way the bars move in this video, a test of which generates a 60% correlation with IQ, higher than that for reaction times (40%).  It seems like a quick and easy way to administer IQ tests without worrying about cultural bias. If you're really smart, you'll understand that it's not a perfect predictor of IQ, or wisdom, so don't tell me about how this test is stupid because you are smart and don't do well on this test, because a smart person wouldn't make that argument.

Speaking of taboo topics, there's a big brouhaha for hedge fund billionaire Paul Tudor Jones after he mentioned, in a untaped supposedly off-the-record seminar, that women are underrepresented from 'macro trading' because children tend to divert their focus. Now, in many professions there are stark gender disparities and a strange thing in our times is that if one publically states this could be somewhat 'natural' all hell breaks loose.  This is the kind of thing that makes us moderns idiots, where any really public person can't say truthful important things if they violate the axiom of equality (ie, all human demographics have exactly equal innate preferences and abilities for any activity conceivable).

In Isaac Newton's day, his big secret was that he believed the Trinity wasn't true, and he had to pretend it was true to save his job.  That's a pretty small concession, practically, compared to the PC taboos of today.

 As a practical example, among the several good changes they've made to wrestling to get it back into the olympics (Please vote to save wrestling here!) was to increase the number of women's weight classes at the expense of men's weight classes.   There are at least 100 boys wrestling for every girl, why give them anything close to equal representation? Because it pleases some outsider's sense of fairness? Presumably, women like to wrestle as much as men, they just don't because of cultural norms  This is absurd.


Anonymous said...

Th envy paper says: " I model anticipated envy when workers make portfolio allocations,"

Finally, in the history of mankind, someone modelled metaphysics. Good Lord...Save us...from equal opportunity...

Anonymous said...

Thanks for the references.

A couple of "mass of the election"

"They children"

Mercury said...

A robust culture is bigger and stronger than mere envy because it has evolved around it and developed mechanisms for dealing with it along with other components of human nature (for better or worse). But when a culture is in flux or clashes with another there is rough sledding ahead. The British soldier recently slain in broad daylight by a member of the “immigrant community” was likely being paid by the state less than what the state had been paying his killer in welfare benefits so envy was probably pretty far down on the list of motives.

I don’t know about this “motion quotient” IQ test as is. They’re probably onto something but in order to isolate IQ I would think you would need to select a test group of people who all scored at the same level on an eye test first. Pro baseball players can resolve fast-motion a lot better than the rest of us. Ted Williams could read the label on a 78rpm record. Some of these guys are probably pretty sharp, others not so much. I bet determining which way the lines are moving on this video would be easy for all of them. Also, if a subject has a 50/50 chance of guessing the right answer you want a lot of questions on the test.

Socrates was tried and sentenced to death for “not believing in the gods of the state”. Little if anything of human nature has changed since then.

Anonymous said...

Glad you are back to blogging. You consistently put up highly intelligent, super interesting stuff. Thanks. Keep it up.