Sunday, May 19, 2013

RAFI's Low Vol, My Winning Lotto Ticket

Research Affiliates (RAFI) suggests that you can dominate simple low volatility portfolios by blending them with some fundamental metrics.  Specifically, value, cash-flow, dividends, and sales, combined into a 'fundamental value' metric, generates a 200 basis point return premium that can carry over into the low beta portfolio, all while generating 25% lower volatility. These are reasonable expectations.

I'm skeptical that dividends and sales add to the Sharpe ratio of this approach, but hey, at least it's four factors, not 40.  One of the bigger opportunities here is that  low volatility, is  correlated with other metrics associated with higher returns like higher cash flow, value, low probability of default, etc. That is, it's like if small cap stocks had low betas, then clearly one should merge the two factors because they both are good selection criteria.

But then, it's easy to reach too far, and much value destruction comes from trading too much, overfitting, and that's what this kind of approach encourages. So, it takes great discipline trying to improve the low volatility approach whilst not overdoing it. The 200 basis point bogey suggests RAFI has realistic expectations.

In this video, Fiefie Li (right) notes two reasons for the low volatility attractiveness.  First, Asness, Frazzini and Pedersen's leverage constrained investors. Second, her paper Agency and Institutional Investment, with Michael Brennan and Cheng on delegated investors maximizing excess (ie relative) returns.  Both papers suggests irrational rules of thumb create incentives for massive misallocations of capital, which implies selling low volatility funds should be a piece of cake.

Interestingly, Li taught at UC Irvine, the same place Harin de Silva of Analytic Investors got his PhD, and also low volatility maven Bob Haugen.  I would think this is a good place to look for personnel to help with low volatility.

I bought a Powerball ticket for the $500MM lottery last Saturday, and was actually interviewed by a local TV crew when I bought my one ticket, and said something to the effect that $2 buys me several minutes of daydreams about buying ridiculous things (that $100k lake submarine in SkyMall magazine).  Later I discovered a better reason for my purchase. In the many-worlds interpretation of quantum mechanics, every quantum event happens. It's basically the only way many can reconcile the EPR paradox or Schrodinger's cat being alive and dead. All possible alternative histories and futures are real, each representing an actual "world" or "universe". Therefore, after buying that ticket, I actually won the $500MM jackpot in many of those universes. Unfortunately, in this particular universe I did not win the lottery, but, I can take comfort that many of 'me' did win, and my utility function somewhere among those universes is insanely high. For some reason, I'm not enjoying that as much as I should based on the math.

A neat paper highlights that married couples have higher divorce rates when the woman earns more than the man. Interestingly  the hypothesis the authors give for this is 'gender identity', the idea that men and women think a man works outside the home, the woman inside, and there's a cost to deviating from this norm.  They never try to motivate why men and women might think that's a good way to frame things. That strikes me as rather hollow, a patently arbitrary tradition that makes  couples seem like stupid ciphers of sociological tides.

I think it's definitely true that men like women who make money, just not more than what they do, similar to what men say about intelligence (in speed dating surveys, men like their women smart, just not smarter).  I also think women feel their man is not as dominant, and thus less masculine, when they earn more than him, related to research showing women have more orgasms with wealthier men.  In either case, this highlights people are social animals, and so they don't maximize 'absolute wealth' but rather, something more contextual, which is often highly correlated with absolute wealth.


It was a good week in wrestling, as the US hosted a match against Russia and Iran in New York City. While the US beat Russia pretty handily, and got killed by Iran, they had different teams for each match so it's kind of hard to compare Iran vs. Russia. I'm really excited by the young US wrestlers that won, especially Dake, Taylor, and Stieber.   Also, the international wrestling body elected a new president from Serbia, and hopefully he will be more effective than the last guy, who reportedly thought that wrestling was old enough to not need lobbying at the Olympics--wrong!  The first thing he did was implement new rules, most importantly, a cumulative score for the whole match, 2 points for a takedown, and two three minute periods.


  1. Anonymous2:04 AM

    Even if you don't buy a ticket in this world, surely you would in some of the parallel worlds? :-)

  2. Mercury10:17 AM

    On the other hand almost all men are perfectly comfortable partnering up with women who simply HAVE much more wealth than they do. Some men are so comfortable with this that they seek out such women serially or more than one at a time. Plus, the male physiology has developed an innate coping mechanism which prevents them from being overly concerned by the whole strong/not so strong female orgasm thing. In this way Mother Nature has short-circuited what would likely be another reason for men to fight each other over potential mates.

    So, we’re very easy-going, accommodative and understanding in these respects which kind of balances out some of our other, nastier attributes. 

  3. Anonymous7:21 PM

    what better use of quantum physics than to justify one's dumb decisions? :)

  4. Great stuff Eric. Interesting topics, presented interestingly. Love these weekly roundups.

  5. Anonymous7:45 PM

    Good shit bro!