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Swenson on asset allocation
Sara G
Posted: 10 December 2017 09:33:50(UTC)
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Just watched the recent podcast from the Council of Foreign Relations - about an hour long, but well worth it. There's a link on the Monevator site (along with an interesting article and chart on asset correlation):

http://monevator.com/

Areas Swenson is adding to / positive on:

1. Private Equity ("a superior form of capitalism")
2. Short duration credit for liquidity (not clear whether he means Treasuries or corporate debt)
3. Short sellers (they've not been successful for a long time so may be overlooked)
4. Japan, India, China (for value, with some reservations on China - generally he still prefers the US as an investing environment)

I thought #3 was especially interesting and am looking at Jupiter Absolute Return to gain some exposure. I held it years ago and it performed quite poorly but the current manager is an experienced short seller.

Swenson's exposure to uncorrelated assets (cash, short term bonds* and absolute return) is rising - heading towards 32% which is higher than before 2008.

* Interestingly the Monevator chart suggests that long term bonds are less correlated than short term debt and that it may be worth putting up with the inferior returns for that reason.
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MikeT
Posted: 10 December 2017 12:40:13(UTC)
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I've been wrestling with the non-equity element of my asset allocation.

At its core (for me anyway) is a capital preservation role and that has made me shy away from even intermediate length bonds. I do have a plan to move in to equities on a sliding scale if and when the next downturn arrives.

Leaving a huge chunk of my sipp in a money market fund at 0.3% return isn't a long term strategy either though.
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Mr Helpful
Posted: 10 December 2017 18:53:40(UTC)
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MikeT;54105 wrote:
I've been wrestling with the non-equity element of my asset allocation.
At its core (for me anyway) is a capital preservation role and that has made me shy away from even intermediate length bonds. I do have a plan to move in to equities on a sliding scale if and when the next downturn arrives.


We too are keeping to short term/duration bonds.
Among the 'Passive Protagonists', Frank Armstrong has been a lone voice suggesting durations on the Bond side be kept short, although others in the Passive School now seem to be coming round to the view that defensives should be defensive!

Looking at 10 year treasuries :-
http://www.multpl.com/10-year-treasury-rate
since about 1982 yields have been steadily declining, meaning Bond prices have been continually rising. With that tail-wind it has paid to go for longer duration, hence the Total Bond favoured by the 'Passives'.
It was impossible to go wrong with Bonds as markets moved from 'capital hungry' to 'capital sated' as today.

There is a possiblity Bonds have been tracing out the long Kondatrieff wave, and are about to go into reverse. But why on earth that wave should be relevant to Bonds bemuses this investor. If indeed Bonds do go into reverse, then short term/duration will be the safest place to be.

We may see the 'flight to safety' (Bonds) blip when Stocks are falling, superimposed on the long wave of rising interest rates, a rather complex pattern as pre 1982.
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Sara G on 10/12/2017(UTC)
PaulSh
Posted: 11 December 2017 09:58:12(UTC)
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It's worth remembering that back in 2008 it was liquidity funds that were the first to have a liquidity crisis. For just 0.3% return (and that's before any platform charges), why even bother? You may be able to get almost that just on cash in some SIPPs.
Tug Boat
Posted: 11 December 2017 10:22:35(UTC)
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Bonds, I just go for highest yield RL Extra Yield fund pays about 7%

What else are they for other than the yield?
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MikeT
Posted: 11 December 2017 12:35:52(UTC)
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Tug Boat;54143 wrote:
Bonds, I just go for highest yield RL Extra Yield fund pays about 7%

What else are they for other than the yield?



I see bonds as a vehicle to get me to a risk/volatility position that suits my profile. I'm wary of selecting fixed income with a return at the forefront of my because in a crisis it is likely they will correlate with equities.

That said, after studying historical bear markets my plan is to start transitioning in to equities in chunks from a point they are 25% down. The average drop is 35% so i'm going to divide my non-equity holdings in to quarters and invest at -25%,-30%,-35% and -40%.

Plans and contact with the enemy etc etc.
King Lodos
Posted: 11 December 2017 13:12:04(UTC)
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Tug Boat;54143 wrote:
Bonds, I just go for highest yield RL Extra Yield fund pays about 7%

What else are they for other than the yield?


Basically the worst case scenario for a portfolio is a loss of 'purchasing power' .. Whether that's being able to buy assets when they're down, or pay the heating bill, the more purchasing power you lose, the less use your portfolio is.

A 50% loss requires a 100% return to break even – an 80% loss requires a 400% return .. So there are good reasons to limit that (especially as downturns can last decades) .. And this is what government bonds are for .. Unlike Corporate or High Yield (more likely to default when stocks go down), government bonds are basically risk-free.

So when markets look risky, people want to buy more risk-free assets .. When stocks look like they'll lose you money, a guaranteed return looks more attractive, and bonds get bid up .. This means there's usually something in your portfolio going up – so you limit absolute losses, and by rebalancing, you have purchasing power to pick up stocks when they're cheapest.
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Guest on 11/12/2017(UTC)
Tug Boat
Posted: 11 December 2017 13:37:20(UTC)
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If only it was that easy.
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King Lodos
Posted: 11 December 2017 13:45:42(UTC)
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Considering you didn't know what bonds were for 2 posts ago, you should probably just take my word for it.
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Guest on 11/12/2017(UTC)
Keith Cobby
Posted: 11 December 2017 14:14:55(UTC)
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It isn't easy because market timing is impossible. People (and posters on here) have been talking about corrections for years. Unlike in the past, cash has no return now, and if you go to cash too early, although you may then buy at depressed prices, you have lost the previous upside.
Tug Boat
Posted: 11 December 2017 14:32:55(UTC)
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Think I'll go and buy some government bonds then as they are risk free.
Mr Helpful
Posted: 11 December 2017 15:02:26(UTC)
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Keith Cobby;54153 wrote:
It isn't easy because market timing is impossible. People (and posters on here) have been talking about corrections for years. Unlike in the past, cash has no return now, and if you go to cash too early, although you may then buy at depressed prices, you have lost the previous upside.


Depends what is meant by 'Market Timing'!
Sometimes 'Market Timing' and 'Adaptive Value Investing' get mixed up.

Ben Graham had this to say in The Intelligent Investor.
‘Since common stocks, even of investment grade, are subject to recurrent and wide fluctuations in their prices, the intelligent investor should be interested in the possibilities of profiting from these pendulum swings. There are two possible ways by which he may try to do this : by way of TIMING and the way of PRICING. By timing we mean the endeavour to anticipate the action of the stock …… . By pricing we mean the endeavour to buy stocks when they are below their fair value and to sell them when they rise above such value. … We are convinced that the intelligent investor can derive satisfactory results from pricing …. We are equally sure that if he places his emphasis on timing, in the sense of forecasting, he will end up a speculator and with a speculator’s financial results This distinction may seem rather tenuous to the layman, and it is not commonly accepted in Wall Street.’.

See also 'Constant Ratio' v 'Variable Ratio' in link.
http://thismatter.com/mo...la-investment-plans.htm

Quite difficult to entirely satisfactorily define 'Market Timing', to please all, but some may consider anything other than 'Constant Ratio' to be 'Market Timing'.
Others look to the more active peering into the future using 'Technical Analysis' for signs of 'momentum' or 'inflection points' where time is definitely included in the measure and KL will be able to expand, and Keith might have in mind as an escape mechanism?

Excuse the prolonged rant!!!
But moving gently between Asset Classes dependent on valuations is uppermost in our minds, and has saved us from financial disaster on more than one occasion, then leading on to relative financial security.
And should anyone say "time in the market is more important than timing the market", at any point in this thread, "will scream and scream until I make myself sick, and I can", Violet Elizabeth (Just William).
End of rant!!! :-)
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King Lodos
Posted: 11 December 2017 15:26:39(UTC)
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Keith Cobby;54153 wrote:
It isn't easy because market timing is impossible. People (and posters on here) have been talking about corrections for years. Unlike in the past, cash has no return now, and if you go to cash too early, although you may then buy at depressed prices, you have lost the previous upside.


You're missing the argument completely..

You don't go to cash or bonds .. Rather you maintain an allocation to stocks, and an allocation to bonds – and because they move contrary to each other, by simply *maintaining* the allocations relative to each other, you automatically buy stocks when they're low, and sell bonds when they're high .. and vice versa.

This is how portfolios like Swensen's (Yale) manage risk without market timing .. This is what's known as 'the only free lunch in investing', because you reduce risk much more substantially than you reduce returns (risk and return normally being in a tight alignment)
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Keith Cobby
Posted: 11 December 2017 17:24:49(UTC)
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I don't think you can compare the private investor with Yale because they have completely different time horizons and investment flows. For me the only way to make money from a standing start is through equity investment. Cash, bonds, gold will from time to time appear to be better, but looking at the long term they will not let you benefit from economic growth and progress. They are completely passive. They offer no real return.

My allocation to equities, since beginning to invest in 1982, has been 100%, compounding returns. With interest rates lower than for centuries we are in a completely different environment now. I don't want 1-2% for the next 10 years which is what cash and bonds are offering. The equity yield is much higher than cash or bonds and this is telling us something important.
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Mr Helpful on 11/12/2017(UTC)
King Lodos
Posted: 11 December 2017 17:45:43(UTC)
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Well Yale used to be stocks-heavy before Swensen turned up, but like RIT Capital Partners, diversification is a genuine 'free lunch' that allows you some control of how much you want to risk, and how much you want to make.

https://finlord.cz/wp-content/uploads/2016/05/Rot1.png

1982 happened to be a great time to go long on stocks, but if you'd started 20 years earlier, you'd have been waiting 25 years to make a positive real return at all .. 20-30 year periods of flat returns from stocks aren't unusual.

http://www.crossingwallstreet.com/wp-content/uploads/2013/04/image1327.png

So what diversification gives you is a much higher chance of a good outcome – being that we can't predict the future – and the option to use leverage (whether private equity or gearing) to aim for higher returns than stocks alone .. Swensen's original argument was: why not invest 100% in private equity or small-cap value?: You might wind up with a 20x better result, but risk means that it's even less predictable – so risk and return have to be understood as two sides of the same coin
Alan Selwood
Posted: 11 December 2017 18:38:25(UTC)
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Going back to high-yield bonds, one of the problems faced (and this applied in the 1980s too) is that the higher the yield, the more the current market price tends to lose touch with an important reality called 'maturity value'.

So if you buy a stock priced at £95 (it was possible once!) with a maturity value of £100, you will have a capital gain (which is tax-free in the UK) of £5 at maturity.

If, however, you buy a stock at £120, with a maturity value of £100, you will have a guaranteed capital loss of £20 at maturity.

You will notice when reading quoted prices and yields of gilts that there is an amazing inverse correlation between yield based on present price and final value of capital.

So you will get a higher yield from the high coupon stocks but these will lose the most to maturity. Meanwhile the low-coupon stocks will (in normal times) give you a low yield but a capital gain at maturity.

I remember looking at various gilt funds in the 1980s and noticing that those that were heavily marketed towards those wanting a high yield were invested in gilts that would lose capital to maturity. Not a brilliant proposition when income is taxable and capital losses are not reclaimable! It was like a market stall owner shouting out : "Never mind the quality, feel the width!"
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Mr Helpful
Posted: 11 December 2017 19:14:02(UTC)
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Keith Cobby;54166 wrote:

My allocation to equities, since beginning to invest in 1982, has been 100%, compounding returns. With interest rates lower than for centuries we are in a completely different environment now. I don't want 1-2% for the next 10 years which is what cash and bonds are offering. The equity yield is much higher than cash or bonds and this is telling us something important.


The 100% Stocks philosophy is difficult to gainsay looking for example at semi-log charts like :-
http://www.multpl.com/s-p-500-historical-prices

But as KL has pointed out Stock drawdowns can be significant, and on a next upward leg the 100%er will be starting the next lap of the relay race from behind where he was. Perhaps by as much as worst case 50%, or half a lap? The Adaptive Value Investor not so much.

But maybe that snag pales into insignificance versus the fear of erroneously moving partially out of Stocks, only to miss the next upward surge not 100% committed? As observed many have been predicting Stock drawdowns for some years.

But the last sentence in your post is spot on, but leads to the slightly dangerous conclusion :-
"there is nowhere else left to put the money".
The main markets valuation measures are indeed all over the place,
but we find valuations today for Stock positions in our own portfolio mostly within 10% of their historic valuation ceilings, so there doesn't appear to be that much upside potential, and rather more downside risk. But that doesn't mean going 0% Stocks! Merely trimming back somewhat.

Personally would never have felt comfortable even when in employment with 100% Stocks; and now well into retirement the last thing needed is to be forced to sell Stocks at distressed prices, just to meet some unexpected expense. Maybe 100%er or not debate hinges on other available sources of income?
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King Lodos
Posted: 11 December 2017 19:31:07(UTC)
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Well this is also worth considering – on the topic of common sense being based on recent history:

http://www.marketoracle.co.uk/images/2009/Apr/4-april-10.jpg

Stocks vs bond returns from the 19th century

You see a 68 year period in which bonds beat stocks .. You could argue the outperformance of stocks over the next century had more to do with the world opening up to capitalism – and passive gurus like Jack Bogle, I believe, think stock and bonds returns should mean revert over long enough time periods, and both return the same.

It depends whether the market's compensating you for the extra risk of stocks, and whether it really is extra risk?

The key for an individual is that any asset class can have a disastrous 10 or 20 years, and considering how long a typical investor's horizon is, that could be the difference between retiring poor and retiring wealthy .. Also consider this:
If you ever *knew* stocks would return more than the cost of borrowing, over any period, then you SHOULD borrow to buy stocks .. We do it with houses, after all .. Imagine borrowing 10 or 20x your income to invest 100% in stocks .. We could all retire after 10 years in a low-paid office job .. But of course we never know stocks will return more than the cost of borrowing.
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kWIKSAVE
Posted: 11 December 2017 20:43:54(UTC)
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In the old days, the good old days one often bought a high coupon gilt with maturity a long way


off and sold it 5 years before redemption.

Capital value hardly changed and the net after tax income useful
Alan Selwood
Posted: 11 December 2017 22:05:42(UTC)
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Gilts (bonds) and shares (equities) have swapped places with each other over the years.

Go back to Victorian times, or before, and you had most investors 'being prudent' and buying gilts, which would give a fixed income and a fixed final value. Nice, and also reassuring. ("My dear, marry him! He has an income of £250 per year!").

But that was in the period when prices were fairly stable (The British Empire had cheap resources coming in from abroad, a strong manufacturing and exporting base, and profit levels were high).

Once things had moved on (the costs of world wars, and also loss of empire), the costs of imports went up, debt rose, inflation took a hold, and suddenly a fixed income was no good any more, because its value was eroded over time to a significant degree.

So it became important to invest in things which were tied not to fixed paper values but to real assets - companies, houses, and similar. But these were seen as risky, since there were no guarantees, so people hedged their bets by having lots of gilts and some equities. The equities provided the spice, the potential for gain, and the gilts gave the predictability and erosion of purchasing power.

Come the financial crisis, and gilts and cash deposits no longer provided any significant income - and broadly speaking, inflation was kept at bay by global competition. Meanwhile the thought of using injected amounts of cash to get leverage by using that cash to buy equities seemed to be the only game in town. Equities gave more income than gilts or cash, and also offered growth.

It seems likely that much of that growth was really a different form of inflation. More buying power from helicopter money meant that anything offering an income was both in demand and affordable, so prices were forced up by the supply of cash more than by the growth in the companies' true profitability.
So even though wages have largely stagnated, capital has been available (and borrowing rates on the floor), so equities and property have risen, to the extent that most equities no longer give the sort of annual return that we used to expect, and property (especially in London) has become unaffordable to many if based on a multiple of salary, even if still affordable by those with already-accumulated capital.

If QE is unwound, the supply of capital for investment will diminish, and equities and property will in theory fall back (or at least lose ground compared with cash).

If this comes to pass (which logically it should, though we don't know when and by how much), it would be wise to reduce reliance on equities, hold more in cash, and at some point, when gilts have fallen back in value, buy some of those. Things might even revert to the 'old normal' of 30+ years ago!

But of course, the thing about the future is that it may be like the past, but it may only 'rhyme' with it.

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