Wealth, Strategy & Risk
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December 20, 2011
Algorithmic Trading of Precious Metals
By Frederick Novomestky, Ph.D.
Algorithmic trading has become both a significant new trend in financial markets and for many seasoned professionals, a pariah. A closely related concept is high frequency trading. A brief check of Wikipedia gives you a concise description. There are two important characteristics of algorithmic trading which is also known as Algo, Black-Box, or Robo trading. The first is the use of electronic platforms for entering trading orders. The second is the use of algorithms or quantitative oriented decision making tools that determine the timing, pricing, or quantity of the order. Often the orders are initiated without human intervention.
Algorithmic trading has been in use for decades even before the advent of electronic financial markets. Buy side institutional investors with in house index funds have performed periodic re-balancing of their portfolios using block trading...........continued
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December 14, 2011
Risk Alchemy with Precious Metals
By Frederick Novomestky, Ph.D.
Alchemy is one of those magical words that bring to mind the workings of a medieval magician or sorcerer. They would transform base metal to gold. Another interpretation of the word is “the process or power of transforming something common into something special.” In the blog Managing Downside Loss with Gold, we used the Upside Reward Downside Loss Frontier chart to both highlight the potential value of gold to both enhance reward but minimize downside loss. We also explored allocations to individual asset classes and portfolios that resulted in minimum downside loss. Let’s see how well we can transform into something special the downside loss and upside reward of portfolios of financial assets by including precious metals or gold by itself.
We maintain the same empirical framework that has been used in the past several blogs. We observe the performance results of four distinct portfolios: all stocks, all bonds, 40% stocks 60% bonds and 60% stocks and 40% bonds..........continued
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November 28, 2011
Blending Financial Assets & Precious Metals
By Frederick Novomestky, Ph.D.
In my previous blog, All That Glitters Is Not Gold, I looked at the benefits and issues of long term investments in other precious metal commodities, namely, silver and platinum. The benefits of diversification were noticeable. The platinum futures market, however, is not sufficiently large to make it accessible to investors in any meaningful manner. We found on the basis of the omega measure that the Dow Jones UBS Precious Metals Index fared somewhat better than our equal weighted portfolio of gold and silver in two time periods and worst in the other two time periods. In this blog we will see what happens when you combine precious metals with financial assets using the equally weighted portfolio.
We maintain consistency with the previous blogs by using the same four, five-year time periods of 1991 to 1995, 1996 to 2000, 2001 to 2005 and 2006 to 2010.........continued
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November 3, 2011
All That Glitters Is Not Gold
By Frederick Novomestky, Ph.D.
The past several blogs have been devoted to a thoughtful analysis of the inclusion of gold along with financial assets. Using partial moments analysis, it is clear that gold exposure over longer periods of time can be reward enhancing and risk reducing. Gold is but one of several precious metals that commodity trading advisors (CTA’s) incorporate in their managed futures accounts. We take a look at two other precious metals in this blog, namely, silver and platinum.
Gold and silver play a major role in the Dow Jones UBS Commodity Index. The exposures to the various commodities in the index are reset annually. For 2011, the exposure to gold is 10.45% and the exposure to silver is 3.29%. ..........continued
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October 14, 2011
Managing Downside Loss with Gold
By Frederick Novomestky, Ph.D.
The current wide swings and volatility in both the financial and commodity markets continue to provide opportunities for and challenges to the investor. Gold prices recently dropped dramatically only to be followed by increases as the equity markets have moved upwards. My previous blogs show how adding gold to financial assets and portfolios of these assets over long time periods can result in significant rewards. Well, it turns out that the inclusion of gold in portfolios can help reduce downside losses as well.
In the blog Partial Moments – the Up and Down of Performance and Risk we showed charts that presented upside reward and downside volatility for each of several asset classes. These charts were compared to the traditional investment opportunity sets. ..........continued
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September 21, 2011
Portfolio Strategy and Gold
By Frederick Novomestky, Ph.D.
The blog on Asset Allocation and Gold set the stage for encouraging investors to consider the inclusion of gold as a strategic investment. I want to make it clear that there maybe a better alternative to just investing in gold and will get back to this point in the future.
We want to expand on the notion of allocation to gold futures by considering the effect of including gold futures in four illustrative portfolios. The component asset classes are U.S. large cap stocks, small cap stocks, long term government bonds, intermediate term government bonds and long term corporate bonds..........continued
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September 9, 2011
Asset Allocation and Gold
By Frederick Novomestky, Ph.D.
In my previous blog, The Prudent Investor and Gold, I looked at the long term behavior of traditional asset class returns and the gold spot returns. We established that the flat-currency price of gold will by flat or decline when real returns on assets are high. Conversely, when real returns have been low or stagnant, then gold has been strong.
We also found a surprise in that these correlations are not really meaningful. In fact, for all intent and purposes, gold spot returns are uncorrelated with the returns of U.S. stocks and bonds. This is still good news for the investor.........continued
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August 9, 2011
The Prudent Investor and Gold
By Frederick Novomestky, Ph.D.
There has been considerable interest, discussion and debate on investing in gold since the recessionary period that started in 2008. Regular television viewers have been barraged with advertisements saying that it has never been a better time to move a portion or all of our assets into gold investments. The current downgrade of U.S. debt by Standard & Poors has fueled aggressive trading in the gold spot and futures markets.
The article by John Dizzard in the May 9, 2011 edition of the Financial Times Monthly Review on the Fund Management Industry has an attention grabbing title, “Reasons not to fondle your gold”...........continued
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August 3, 2011
Purchasing Power and Commodities
By Frederick Novomestky, Ph.D.
It is difficult to think beyond the crisis we have been facing as a deal is made in Congress to increase the debt ceiling. Conflicting economists predict either a recession worse than the one in 2008, or a continuation of sluggish economic growth. The baby boomers are faced with the problem of how to safeguard the assets they have, and somehow protect themselves from running out of money before their time.
This blog takes a look at how asset classes have fared over the forty year period 1971 to 2010 by using partial moments to quantify the likelihood that the purchasing power of these asset classes is protected and to what extent..........continued
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July 6, 2011
Peer Group Analysis with Partial Moments
By Frederick Novomestky, Ph.D.
The evaluation of active portfolio management relative to a benchmark is one of two commonly approaches to portfolio performance analysis. The blog Active Management Evaluation with Partial Moments shows how to merge the well known measures of active return and asymmetric measures of reward and risk to gain additional points of view on manager performance
Many organizations that offer performance evaluation services on traditional investment funds also offer peer group comparison. Carl Bacon, in his book Practical Portfolio Performance Measurement and Attribution, offers his views on the pros and cons of peer groups which he defines as collections of competitor portfolios of similar strategies grouped together to present comparable statistics.........continued
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June 28, 2011
Active Management Evaluation with Partial Moments
By Frederick Novomestky, Ph.D.
In my previous blog, I showed how different the world of investment return and risk when viewed through the prism of partial moments. Your personal target determines the performance of capital markets and the efficient frontier from which you select desirable portfolios.
Services that offer performance evaluation services on traditional investment funds such as mutual funds have traditionally focused on distilling reported performance history into statistical measures such as average return, the volatility or standard deviation of historical returns, systematic risk or market beta, and, in the case of U.S. equity funds, style analysis derived from exposures to multiple common factors such as market, size, book to market and momentum........continued
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May 20, 2011
Partial Moments - the Up and Down of Performance and Risk
By Frederick Novomestky, Ph.D.
The design and analysis of investment portfolios were forever changed with the development of the Capital Asset Pricing Model (CAPM) and Modern Portfolio Theory (MPT). Since the early 1970’s, academics, consultants and investors have used statistics to quantify expected or realized reward and the variability or dispersion of these rewards. Investment performance attribution models built using the statistical technique of linear regression are widely used to measure the potential sources of investment performance for portfolio managers. Services such as Morningstar, Lipper Reuters and eVestments report statistics beautifully packaged to give an investor the impression that there is one size that fits the needs of all investors........continued
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November 23, 2010
What to look for in a mutual fund
By Andy Lawson, Ph.D.
The short answer: Positive risk-adjusted returns, stable risk exposures, long management tenure, diversification and moderate turnover.
• Positive risk-adjusted returns, or alphas. A fund with positive alphas adds value by delivering returns in excess of those expected from the fund given the fund's risk exposures. In contrast, a fund with zero alphas behaves like an index fund by earning returns exactly commensurate with the amount of risk it is taking on. A fund with negative alphas underperforms by earning returns which don't compensate investors for the risk they are exposing themselves to by investing in the fund and therefore a negative-alpha fund should be generally be avoided.......continued
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October 11, 2010
Asset Allocation, Diversification Now Passe'?
By Frederick Novomestky, Ph.D.
A surprising notion is currently gaining traction on Wall Street: asset allocation and diversification are now passé. Just pick the asset classes you like and ride the market. Really? Let’s look at this more closely.
Brinson Partners has generated significant investment value for its clients through a quantitative, disciplin
ed approach to global asset allocation. Early in his career, Gary Brinson, one of the founders of Brinson Partners, published an important paper based on empirical research that he performed with Brian Singer and Gilbert Beebower on the impact of asset allocation and the effect of active management on realized returns.
They found that more than 90 percent of the portfolio returns comes from the asset allocation, with the balance due to active management. Others have repeated his analysis, based on more recent data, and have reached the same conclusion.......continued
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August 3, 2010
Leveraged Bonds – Déjà Vu All Over Again
By Frederick Novomestky, Ph.D.
“Those who do not remember the past are condemned to repeat it.”
-- George Santayana
It has been only a few years since August 2007, the beginning of the global recession and the credit market turbulence. The highly publicized problems facing institutional investors, high-net-worth individuals, investment advisers and the financial institutions that provide services to these market participants suggest a more conservative and risk focused approach to wealth management is necessary. Unfortunately, history appears to be repeating itself.
The bond geeks and derivatives mechanics are at it again, attempting to sell a concept that flies in the face of what investors have learned and practiced over 50 years. The concept is called leveraged bonds and was recently described in very cautionary terms by Rodney N. Sullivan in Pensions and Investments and in the Financial Times as an alternative to equity investing.......continued