testing

As of Oct. 31, an estimated 90% of the nearly $3 trillion of global hedge fund assets was in the hands of firms that manage more than $1 billion, according to HFR, a Chicago firm that tracks the industry. In contrast, firms overseeing less than $100 million accounted for under 5% of total assets. And roughly two-thirds of hedge fund assets are managed by the top 6% of all hedge-fund firms. The hedge fund industry ecosystem is now about scale and not just skill. There may still be skill with hedge funds, but as firms get larger, there is more focus on maintaining the stability in AUM and management fee. There is also more focus on diversifying styles and products under the same firm name. This diversification dilutes manager focus. Hedge fund behavior changes with scale and is one of the reasons for the better performance for smaller managers. Larger managers are more risk averse.  Smaller firms  are willing to take on risks in order to gain recognition and generate incentive fees. They

What is becoming clear from behavior research is that investors are overconfidence in their abilities. Overconfidence comes in two forms - overoptimism and over precision. With overoptimism, we have more confidence in our abilities and our ranking relative to others. We are all above average drivers and investors. This leads to the self-attribution bias. We believe that if we receive high returns it is due to our skill and any mistakes or poor returns are attributed to bad luck. Overprecision states that we have too much confidence in our forecasts. We overestimate our accuracy with any forecast we make. The result of overconfidence is that we trade more than we should because we believe that we are better than our peers and more accurate in assessing valuation. Overconfidence can help explain the active investing puzzle. There is high volume during periods of uncertainty because investor do not believe in the uncertainty they face. They know better. This can lead to overreaction and m

December will set the tone for the direction of the dollar in 2016. The ECB will meet this week and there is a high likelihood that it will increase the scope of their QE program. They are preaching the QE religion like a camp revival although there are some side comments of doubt whether monetary policy alone will be enough to help the economy. The Fed will then have its FOMC meeting which will likely announce an increase in the Fed funds rate. Any uncertainty will be with the language used and the expectations of further increases in 2016.  The differentials between longer rates between the EU and the US are at the highest levels since the introduction of the Euro. Clearly, there is little to stop the dollar from going higher especially with European rates negative for maturities out a few years. There is no reason to hold a Euro fixed income asset. We further expect that the BOJ will have to rethink their policies given Japan is back in a recession. The PBOC has been loosening rates

CTA's will talk about their ability to manage risk; however, there have not been any good tests or measures of what this means. There are different methods for conducting risk management, but a recent paper by Kathryn Kaminski of Campbell & Co has spelled out four well-defined key factors to measure risk management differences across firms: Liquidity Correlation Volatility Capacity All of these risk management factors or betas can be compared with an index or an individual manager. Liquidity measures the effect of allocating more risk to liquid markets, the correlation factor measures the excess returns from investing in markets that are better diversifiers, volatility measures the responsiveness to changes in volatility, and capacity measures  the sensitivity of returns to a constrained portfolio given the size of a program.  The paper measures whether engaging in these activities have been helpful for the CTA. This testing was done against an equal weighted portfolio, the New

One of the key themes in 2015 has been the decline in the foreign reserve stockpile by EM central banks. EM central banks have been selling to help support their currencies from a free fall that will lead to private capital outflows. These banks added to reserves to stop exchange rates from rising in the period from Asian crisis until this year. They are now engaged in what some are calling "quantitative tightening". There have been good arguments that suggest that there is no quantitative tightening effect in the sense of being the opposite of QE, but there will be spill-over with global credit.  With the Fed deciding to raise rates perhaps at the December meeting, monetary liquidity will be the  key issue in 2016. The ECB is likely at their next meeting to flood more money in the system. So we will have EM central bank foreign reserve effects which will spill-over to EM domestic markets and DM QE and rate effects which will also spill-over to global credit and exchange mark

With more talk of the bond market being overvalued and when the Fed should move, it is natural to turn to what is the appropriate rate of interest for the current environment. The market needs to know what is the natural rate of interest as a benchmark for where nominal yields should be in the long-run.   If we know where the natural rate should be we should be able to better understand the path rates would take over time and whether bonds  are rich or cheap. Unfortunately, the concept of the natural rate of interest is not easy to measure. Discussion about the level has declined since spring even though it is the key issue for the central bank. Assume that we could measure the natural rate, it seems as though this should be an important input in the decision process for the Fed. The natural model that is often cited by the Fed was developed at the San Francisco Fed by Thomas Laubach and John Williams and has recently been updated as of mid November and shows a -.09 rate. This is one o

One of the key strategic consulting ideas over the last twenty years has been the concept of an industry as an ecosystem. This business view states that an industry can be thought of three levels, the market, hierarchy, and ecosystem.  Markets facilitate the transaction of goods and services. Hierarchies facilitate the the control of activities that produce the goods, and the ecosystem facilitates the coordination of innovation and co-evolution of firms.  The ecosystem defines how firms interact and grow. Regulation and innovation may not allow co-evolution with the same market players or it may force changes in the hierarchy. The futures industry ecosystem has changed significantly with new technology and regulation causes all firms to adapt. The innovation of easy electronic trading has done everything from unbundling brokerage services to cutting the cost of execution and eliminating the social network of trading. Regulation has changed the cost of playing in futures and has redefin

If you are reading this blog you have a lot to be thankful for and it is not because of my thinking or writing. Enjoy the day but carve-out some time to read Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty by Abhijit Banerjee and Esther Duflo between now and the end of the year. We don't have to be powerless with the problems of poverty. Poverty can be solved or at least reduced through thinking clearly about the economics of incentives and behavior.The solution is not big programs nor some form of free markets. It is about finding ways to have programs that incent behavior that will allow people a way out of poverty traps. It requires new thinking and experimentation because we often do not have the right answers. Through humble thinking and a desire to connect with those less fortunate, we can make a difference.  Poor Economics is about the research of two economist on the forefront of this new thinking. They are two of the most thoughtful in the profess

The futures industry has changed radically since the Financial Crisis. Many of these changes were in process before the Crisis, but the new regulatory environment and the further focus on cost cutting has sped the industry change. Brokerage firms have wanted to further cut overhead and the movement to electronic trading has allowed for massive reductions in personnel. Electronic trading has accentuated and highlighted the unbundling of brokerage services and allowed the cost cutting to occur with volume increases. In the old world of brokerage, there were many of the services bundled in the course of providing execution. There were networking effects and even though it was not often discussed as a bundled service, brokerage was more than just execution. The voice broker served as a social network for and conduit for these other services. Brokerage included: Execution of actual order Market color on what may be driving prices in short-run Execution advice on how to manage block or large

There is economic reality and then there is the rhetoric of talking heads about the economy. Depending on the week, we can hear from Fed officials that the economy is ready for a rate increase or you can hear about how "data dependent" decisions require more information. So what will a simple look at the data tell us as we prepare for the holiday? The leading economic indicator (LEI) index has been available for a long-time but sometimes gets missed in all of the talk about the latest economic announcement. It is still a good base indicator that provides early warning about economic downturns. There is no question that if the index turns negative, there will be a recession or you are in a recession. Generally, if the index falls below 1%, there will be a recession. The US economy shows signs of slowing but we are still above the 1% threshold. There should be a concern about the decline, but the rate is still good.  Looking at the percentage change from a year ago will show th

Most have been brought up on learning to be upbeat and positive. Think about positive thoughts and fantasize about success.  Monty Python has made fun of positive thinking extremes with their song "Always look on the bright side of life". No matter how bad it gets be positive. The latest research suggests that this way of thinking actually harms you. In the book Rethinking Positive Thinking: Inside the New Science of Motivation by Gabriele Oettingen, we are told that the research calls for balance between positive thinking and the potential negatives. Quit with fantasy thinking and engage in reality which looks at both the good and bad for achieving what you want. Balance leads to more success. The author discusses the four step technique of WOOP for balanced motivation. WOOP stands for Wish, Outcome, Obstacle, and Plan, and is a technique for providing motivation and successful thinking without the potential for extreme thinking. Too much positive thinking and you will have

There is a view that managed futures is a long volatility strategy or at least should do well in higher volatility. Some researchers have described managed futures as being long a straddle, but a simple examination of the data suggests that the relationship between managed futures returns and volatility is more complex. I ran a simple test across monthly and daily data over the same time frame between the leading managed futures indices and the VIX volatility index. For the period January 2000 until September 2015, I matched the managed futures performance with the VIX index. I compared the average daily and monthly returns for the top 20% and bottom 20% of the sample against the mean return for the entire sample. This is a very simple test and may only be suggestive of the results, but it did cause me to have think more closely about the link between managed futures and volatility. If you believe that managed futures is a long volatility strategy, the average returns for the top 20% o