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Marketing Volatility – A Tendency to Oversimplify

Posted by Mike McLaughlin on Aug 09, 2011, in Thoughts , tagged with , , ,

Take a look at the following chart:

It’s taken from a recent MainStay Investments piece on volatility. MainStay uses this chart and two others to point out why volatility (standard deviation) matters: despite a significantly higher average annual return (12.6% vs. 7.3%), Investment A underperforms the more-stable Investment B in terms of 5-year total return to the tune of about 9%.

The piece is solid overall. It’s both concise (1 page) and visual (graphics communicate the message). However, I think it also illustrates one of the pitfalls in talking about volatility: oversimplification.

In MainStay’s example, the more volatile product delivers lesser performance. Pointing out the potential pitfalls of looking at average annual returns is ok, but I don’t think a thoughtful investor/advisor is truly challenged by the conclusion here. They can get lower volatility and a better return with the same product. It’s a slam dunk.

But a simple, minor shift in the data creates a much different conversation. For example, what if the Year 3 return for Investment A was -53% (instead of -58%)? In this case, Investment A delivers excess total return of about 4% over the 5-year period, but with twice the volatility. Now we have an interesting discussion. Should people forgo the extra return for a smoother ride?

In these more complicated scenarios is where the illuminating conversations about volatility can be had. As firms continue to incorporate volatility into marketing messages, especially with alternatives, I suspect that the most successful ones will be those that most deeply explore the details of how volatility really matters.

More on volatility later this week…

Best Blogs of the Week

Posted by Anu Heda on Aug 08, 2011, in Best Blogs of the Week , tagged with , , ,

We had to start this week’s best blogs with the best blog covering the S&P downgrade.  That blog belongs to Wells Fargo.  Additionally, there were two strong posts – one sharing many topics, the other clarifying just one.

  • Wells Fargo Advantage Funds – The author posts a bit about why downgrade and then covers consequences succinctly.
  • BlackRock – This post is the first in a monthly series covering the best of (obviously we have a soft spot) research and reading attributed to the iShares team.
  • Russell – What is the magic around quarter-end?  It seems like short-term bias at its worst and this post shares why quarter-end isn’t that important and how to discuss that with clients.

Best Blogs of the Week

Posted by Anu Heda on Aug 01, 2011, in Best Blogs of the Week , tagged with , , ,

This week’s posts do not include debt ceiling discussions, though that is the most important topic of the moment.  They do include easily shared content that advisors may value sending on to clients.

  1. Vanguard – Possibly the strongest language I’ve ever read on this blog; the author clearly thinks buying gold is a bad idea.
  2. BlackRock – This post applies a common, short-term  institutional investment approach – cash equitization – to retail and individual investors.
  3. American Century  – This post is the final of a four-part series dedicated to inflation.  The author presents a straightforward case on how inflationary trends may change in years to come.  (Also, the author used commodity intensity – a great term.)

One Day of Hedge Fund Discussion, Two Takeaways

Posted by Mike McLaughlin on Jul 26, 2011, in Thoughts , tagged with , , ,

Last month I presented at an Ivy Plus hedge fund event. The discussion throughout the day was spirited, and two issues in particular stood out to me. Without further ado:

1. First-Loss Capital is Controversial

We all know it’s a tough market for smaller hedge funds looking to raise capital. With a lot of smart, ambitious investment minds out there trying to jumpstart funds, it makes sense that first-loss capital continues to grow as a tool for increasing AUM.

But is all of this a good idea for the hedge fund and its limited partners? I’d characterize the Ivy Plus attendees as somewhere between “dubious” and “morally outraged”.

I’m tempted to argue this is all one big gray area. After all these are legitimate, if risky, funding deals willingly entered into by the hedge fund. But there is one issue that raises red flags – as Santangel’s Review points out, first-loss deals introduce a potentially severe short-term bias to the hedge fund.

It is this variable that I think (a) invites managers to stray from their strategies, (b) presents a potential blindside risk to limited partners, and (c) ultimately undermines the fund’s stability. I understand why funds consider first-loss capital, but I’m not optimistic that the impact of its current incarnation will be positive for the hedge fund industry.

2. The Pitfalls of High Fixed Costs

One of my favorite investing axioms is “when a company builds a shiny new headquarters, it’s time to short their stock.”

This idea came to mind as Merlin Securities presented takeaways from their latest whitepaper on operating a successful hedge fund. The biggest mistake hedge funds make? Inflating fixed costs by overinvesting in people, office space, and technology.

In other words, hedge funds are no different than many other businesses. You can check out the full Merlin paper for a basic reminder that no business can thrive when its expenses outpace its revenue.

Best Blogs of the Week

Posted by Anu Heda on Jul 25, 2011, in Best Blogs of the Week , tagged with , ,

This week’s list begins with a topic on everyone’s mind: the national debt.  Additionally, we found two interesting blog posts that comment on the S&P (very differently).

  1. Wells Fargo – This post covers the concept of sustainability – who much debt can the US manage?
  2. BlackRock – The author makes a compelling case to consider Mega Caps (larges 100 of the S&P) and why they may be set for higher returns than the broader index.
  3. Virtus – Unlike the prior case, this post uses technical data to show how “directionless” the S&P is this month.