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2018 | Buch

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Success in a Low-Return World

Using Risk Management and Behavioral Finance to Achieve Market Outperformance

verfasst von: Michael J. Oyster

Verlag: Springer International Publishing

Enthalten in: Springer Professional "Wirtschaft+Technik" , Springer Professional "Wirtschaft"

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Über dieses Buch

Following the Great Financial Crisis, the S&P 500 advanced more than 17 percent annualized from February 2009 through June 2018. At this pace, a buy-and-hold investor in the stock market would see their money double in 5 years and more than triple in 7 years. This performance has lulled many investors into thinking that such above-average returns will be with us into perpetuity. Unfortunately, this may not be the case. Far more likely, the return an investor may receive from the stock market will be slightly better than half the long-term average, about 5% to 7%.

Most investment portfolios hold a greater allocation to stocks than any other class of investment asset. Massive amounts of wealth were created from the bull market since early 2009 providing institutions and individuals with a rising tide that lifted their portfolios above their goals without much effort. The environment of the future stands to be far less accommodating, so finding suitable investments (other than U.S. stocks) that can achieve the necessary returns (or make up the shortfall) will be a critical component of achieving goals in years to come. This book will explore those solutions.

Inhaltsverzeichnis

Frontmatter

Challenges in Investing

Frontmatter

1. The Future Isn’t What It Used to Be

Abstract

The risk of the US stock market posting below-average returns in the coming years is high, yet not widely appreciated. Oyster describes three data points (dividends, earnings growth, and P/E ratio changes) that combine to form a stock market’s total return and considers how they might contribute to performance in the future. He references a study that shows nearly all commonly viewed equity-market-predicting metrics offer little if any predictive power, save one. Although the Shiller cyclically adjusted price/earnings multiple (CAPE) has provided less than perfect foresight, it has potential as a predictive tool. CAPE readings are suggesting future returns could be lower than historical averages. Oyster points out that the absence of the declining interest rate environment that supported stock market ascension since 1981 may inhibit returns as well.

Michael J. Oyster

2. An Obsolete Fundamental Philosophy

Abstract

Oyster points out that the philosophy employed by most stock-picking active managers was developed many years ago. He mentions that Benjamin Graham, the father of fundamental analysis, knew that buying good companies at an attractive price could add value over time. Oyster describes Graham as a brilliant visionary and one who remains among the most revered investment minds of all time. The problem with his philosophy, Oyster surmises, is that it’s actually too good. It worked until its impact was diluted by overuse.

Michael J. Oyster

3. As a Group, Professional Investors Are the Market

Abstract

Oyster describes today’s investment industry to be as competitive as it’s ever been, with a myriad of different firms following a limited number of stocks. He suggests that such an environment prevents actively managed mutual funds and other stock-selecting professional investors from gaining and maintaining an advantage over their competition. Decades ago when individuals accounted for most of the stock-ownership transactions, the market was less efficient and provided the professional an opportunity to outperform. As professional ownership of stocks has risen, “errors” in pricing have become rarer and smaller, yielding fewer opportunities to gain a competitive advantage. If professional investors are the market, Oyster surmises, it’s easy to see why the average mutual fund (after fees) lags the market over time.

Michael J. Oyster

4. The Specifics of Market Efficiency

Abstract

Oyster suggests that mutual fund managers and other stock-picking professional investors would love to disprove the mountains of academic research that says markets are efficient, but that’s easier said than done. Eugene Fama developed the Efficient Market Hypothesis (EMH), which through its various forms indicates that gaining a consistent advantage over the market is difficult, if not impossible. In 2013, Fama shared the Nobel Prize in Economics for his work on market efficiency. Efficient markets, Oyster surmises, are difficult to outperform by picking stocks and he even provides a surprising quote from Benjamin Graham, the father of fundamental analysis for security selection, who in a comment from 1976 dismissed security selection in favor of the efficient market school of thought.

Michael J. Oyster

5. Fund Manager Fees

Abstract

Accessing an actively managed investment product comes with a cost. Some of the fees that managers charge can be confusing and are to be avoided by some investors. Oyster describes different fee structures and nuances of each. He also points out that not only can unnecessary fees detract from performance, so too can poorly timed fund hiring/firing decisions based upon behavioral errors. Managers are often fired after poor performance only to experience better performance thereafter. Pre-hiring performance of managers is strong but not often repeated. Oyster also highlights some of the more common hedge fund fee structures as well as how in response to poor performance, many hedge funds have either lowered fees, become more creative in how fees are structured, or both.

Michael J. Oyster

6. To Err Is to Be Human. To Make a Behavioral Error Is to Be a Human Investor

Abstract

Unique abilities in how human beings communicate, process information, avoid danger, form groups, and collectively come together in support of a common cause all likely contributed to our species’ survival. As investors, however, we are left with legacies from our ancestors that served them well as tribal hunters and gatherers but can inhibit our ability to make sound investment choices. Oyster shares a classification system for cognitive biases developed by Buster Benson then discusses how some important biases can detract from investment performance. He also shares how the assumptions that support certain economic models appear more appropriate when viewed through the lens of behavioral finance.

Michael J. Oyster

7. How Regulations Impact Investment Managers

Abstract

In this chapter, Oyster recounts how confidence in corporate America was shaken in the first part of the twentieth century due to the onslaught of troubling accounting scandals and glaring conflicts of interest that cropped up during the dot-com bubble. Leaders responded swiftly with tough regulations like Sarbanes-Oxley that is designed to ensure accuracy in the earnings reports produced by publicly traded companies. Regulators also erected a wall between investment research and investment banking within companies that provide both. More recently, Dodd-Frank was designed to provide stability in the US financial system. Although these regulations did not necessarily target the work conducted by stock-picking investment managers, they were impacted. Oyster discusses how and highlights the challenges active managers face as a result.

Michael J. Oyster

8. Performance Doesn’t Tell the Whole Story

Abstract

Given how convenient it is to do so, Oyster indicates that many investors rely too heavily on past performance to determine whether a fund manager is skillful and likely to repeat strong returns, or was just lucky. But past performance provides little insight into that question because most funds experience both great and terrible performance at one point or another. Oyster shows a statistical means of illustrating how an investment manager may outperform simply by randomness. He also points out changes over time that further inhibit researchers’ ability to differentiate skill from luck. Changes such as personnel turnover, sizeable increases or decreases in assets under management, philosophical changes, and others all cloud the picture when attempting to parse skill from luck in investment management.

Michael J. Oyster

Part II

Frontmatter

9. Intuition

Abstract

Here is a bit of history on the ladies behind the tool. Katharine Cook Briggs (1875–1968) began her research into personality in 1917. Upon meeting her future son-in-law, she observed marked differences between his personality and that of other family members. To maintain her relationship with her daughter, Briggs sought to better understand Myers and his differences.

Michael J. Oyster

10. Focus on Asset Allocation

Abstract

Oyster indicates how spreading investment assets among a variety of different, uncorrelated types of risks can lower risk portfolio wide. For diversification to work effectively, allocations should be made to truly differentiated investments, not just different forms of the same risk. Harry Markowitz, with Modern Portfolio Theory, won a Nobel Prize for showing how combining two risky but uncorrelated asset classes can reduce risk and add value to an investor’s bottom line. Oyster also describes a number of different asset-allocation philosophies employed by some of the industry’s most astute investors including the Yale Investment Office, large public pensions in both Norway and Canada, as well as the unique asset-allocation approach employed by the Massachusetts Institute of Technology Investment Management Company.

Michael J. Oyster

11. Indexing

Abstract

Oyster begins by pointing out how most large cap US equity stock-picking funds fail to outperform the S&P 500 Index, making the point that passively investing in a low-cost market-wide index fund can prove effective. Although many statistics show that the average stock-picking mutual fund has underperformed the market over time, even those percentages may be artificially positive if not adjusted for survivorship bias. Oyster provides a Monte Carlo simulation that shows that if the performance of all active stock-picking investment funds in the United States was completely random, more funds would outperform than actually do. He also points out the growth in assets flowing into indexed products including exchanged traded funds and talks about various indexing methodologies.

Michael J. Oyster

12. Active Share and Private Equity

Abstract

Oyster cites academic research indicating that stock-picking investment managers who have a willingness to deviate from their benchmark, those with “high active share,” have been more likely to outperform than their benchmark-hugging “closet indexer” counterparts. Additionally, the high active share managers who exhibit strong conviction by holding their names for long periods of time have been among the best performers. Oyster also highlights private equity as a potential source for market outperformance, though cautioning that the flood of private equity commitments that must be put to work by managers may diminish future returns. More so than nearly every other category, manager selection in private equity, Oyster surmises, is critical.

Michael J. Oyster

13. Momentum

Abstract

Much academic research has been conducted regarding the use of momentum, the tendency for near-term performance to persist for the near term, for security selection but less so in support of sub-asset category allocation decisions. Oyster recounts some of the momentum research conducted by leaders in the field such as Mark Carhart and Cliff Asness and goes on to describe a means by which momentum analysis can be utilized at the broader portfolio level when making active asset-allocation decisions. Oyster’s technique draws upon two forms of momentum, cross-sectional and time series. A momentum score for 25 different asset categories is determined and then the group is ranked. The portfolio formed from those categories exhibiting top quartile performance is shown to outperform the lower ranked 75 percent.

Michael J. Oyster

14. Smart Beta

Abstract

Oyster describes smart beta as an investment concept that can potentially provide outperformance without deviating greatly from the benchmark or making substantial individual stock bets. Pioneers of smart beta strategies such as Rob Arnott, Cliff Asness, and Jeremy Seigel, have shown how building portfolios that tilt toward factors or alternative risk premia can outperform the market and/or produce returns in line with accomplished hedge funds for a fraction of the cost. Oyster also recounts the disagreement between Arnott and Asness regarding whether factors should be “timed” in that certain conditions merit the overweighting of one factor versus another. Oyster discusses how data-mined factors should be avoided, the inevitable cyclicality of factor performance, and the challenges smart beta faces given their rise in popularity.

Michael J. Oyster

15. Risk Management

Abstract

In this chapter, Oyster cites how risk management can be employed to help achieve investment goals. After citing standard deviation as a primary measure of risk in common economic models, Oyster discusses other risk metrics and shares the concept that risk in investing is not necessarily the variability returns. The risk that most investors should care about is the possibility that capital could be permanently impaired. Cognitive errors and behavioral biases can contribute to this risk. Oyster also describes shortfall risk, the potential of failing to achieve goals. Recognizing that equity risk is common and strong, Oyster shows some methods for hedging it out, along with the shortcomings of doing so. He also discusses some limitations of mean-variance optimizations.

Michael J. Oyster

16. Buy-Write

Abstract

Oyster begins by describing the buy-write or covered call strategy. The ownership of a core position in a stock or an index combined with the sale of a call option can provide for stock market outperformance in many kinds of environments, a runaway bull market being one exception. By systematically capping upside returns, the buy-write strategy limits returns when stock market performance is particularly strong. Oyster analyzes the returns of the Cboe S&P 500 BuyWrite Index (BXM) recognizing underperformance versus the S&P 500 was due to tremendous stock market returns, and that in years when the S&P 500 posted below-average performance, the BXM almost always outperformed it. Oyster also describes how different risk/return exposures can be formed by modifying yet remaining within a buy-write construct.

Michael J. Oyster

17. Put Selling

Abstract

Oyster describes the Volatility Risk Premium (VRP) as perhaps the most significant, untapped resource available to investors today. Systematic put selling or writing strategies offer investors a means to monetize that resource at low cost and historical data makes a strong case for relative outperformance compared with US equity benchmarks. Oyster analyzes the past performance of the Cboe S&P 500 PutWrite Index (PUT) recognizing that PUT underperformance versus the S&P 500 Index occurred during especially bullish stock market periods and that PUT outperformed when the S&P 500 posted below-average returns. Oyster also describes put-call parity and offers an explanation of why the PUT has outperformed the Cboe S&P 500 BuyWrite Index (BXM) when the two have identical payoff profiles.

Michael J. Oyster

18. The Options Income Index

Abstract

Oyster describes the Volatility Risk Premium (VRP) as perhaps the most significant, untapped resource available to investors today. One means of monetizing that premium is through a put option spread strategy that forms the basis for an index Oyster developed, known as the Options Income Index (OICX). The OICX is a passive, rules-based strategy for monetizing the VRP that seeks equity-like returns with less risk. Oyster analyzes the historical returns of the OICX noting its design produced greater consistency in performance, lower stock market beta, and smaller maximum drawdowns relative to other volatility indexes. The OICX employs a dynamically adaptive strike placement methodology that helps smooth returns as well as a risk-management contingency function that helps limit drawdowns during periods of stress.

Michael J. Oyster

19. Portable Alpha

Abstract

Oyster recognizes that many investors shy away from derivatives such as futures, options, and swaps. Although derivatives can be risky, Oyster surmises, they don’t have to be. A core position can be structured with a derivative investment with little-to-no capital outlay. The remaining assets in the mandate can be invested in some other opportunity then “ported” back to the core position. If the outside investment earns a profit in excess of costs, the mandate will outperform. Oyster describes how a common factor or alternative risk premia could be used as a potential source of alpha. He also describes four volatility investment strategy categories and shows how an investment in one of them could also be used to achieve outperformance through portable alpha.

Michael J. Oyster

20. Epilogue

Abstract

In this chapter, Oyster highlights a number of challenges investors may face in the future as well as opportunities that can enhance returns. Following a period of exceptionally strong stock market returns, stock prices became elevated strongly suggesting that when combined with the lack of a declining interest rate environment, it could lead to disappointing future stock market returns. Expecting outperformance from traditional stock-picking mutual funds, Oyster surmises, is not likely to make up the shortfall. Low-cost indexing can outperform the average mutual fund, but opportunities to achieve outperformance exist. These include effective asset allocation, smart beta, and private equity. Additionally, Oyster indicates that monetizing the Volatility Risk Premium can help investors achieve performance goals.

Michael J. Oyster

Backmatter

Titel: Success in a Low-Return World
verfasst von: Michael J. Oyster
Verlag: Springer International Publishing
Electronic ISBN: 978-3-319-99855-8
Print ISBN: 978-3-319-99854-1
DOI: https://doi.org/10.1007/978-3-319-99855-8