Asset Allocation and Bad Habits
Andrew Ang, et al.
September 17, 2014
This article explores the detrimental habits that investors often exhibit in asset allocation. Financial markets display momentum over multi-month periods and a tendency to revert to the mean over multi-year spans. However, many investors behave as if they are momentum traders, even in these longer time frames. While these behaviors are often acknowledged anecdotal evidence, they lack comprehensive statistical documentation, especially in conjunction with one another. The article seeks to answer two key empirical questions: First, how do funds adjust their allocations based on previous returns? The authors present direct evidence utilizing CEM Benchmarking data on pension fund target allocations spanning 22 years. Second, what are the patterns of momentum and reversal in financial market returns? This is supported by over a century of data. The integration of findings from both datasets indicates that investors tend to chase returns across multi-year periods, which can adversely affect their long-term performance. Nonetheless, the statistical significance regarding pro-cyclical multi-year asset allocations and mean reversion in asset-class returns remains marginal.
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Barry Ritholtz poses a crucial question—Why hedge?—especially in light of Calpers’ recent announcement that California Public Employees’ Retirement System (Calpers), a major player in the pension fund landscape, is concluding its decade-long venture with hedge funds. The appeal of hedge funds has largely hinged on the expectation of superior returns compared to traditional investments. Yet, savvy investors like Calpers have also been attracted by the risk-management benefits these hedge funds may offer, such as their low correlations with standard portfolios of stocks and bonds. Following the 2008 financial crisis, the necessity of holding assets that behave differently during periods of market stress while also providing decent long-term expected returns became clear. However, the reality has often fallen short of the high expectations set by marketing materials.
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Recent reports indicate a larger-than-anticipated slowdown in US economic activity for August, as highlighted by the latest update from the Chicago Fed National Activity Index. The three-month average for this economic benchmark (CFNAI-MA3) fell to +0.07 last month, compared to a revised +0.20 for July. Nevertheless, these figures still suggest that the US economy is growing at an “above-trend” pace, as per the Chicago Fed. However, this release raises skepticism regarding the assumption that the US economy is on an accelerating trajectory.
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According to The Capital Spectator’s median econometric nowcast, US economic growth is projected to decelerate in the third quarter. The latest GDP estimate anticipates a rise of 2.2% (real seasonally adjusted rate) for the July-to-September timeframe, a significant drop from the 4.2% growth recorded in the previous quarter, based on the Q2 report issued by the Bureau of Economic Analysis (BEA) in late August.
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● American Power After The Financial Crisis
By Jonathan Kirshner
Summary via publisher (Cornell University Press)
The global financial crisis of 2007–2008 was both an economic disaster and a defining moment in international politics. In “American Power after the Financial Crisis,” Jonathan Kirshner examines how the crisis shifted the global balance of power, influencing the dynamics of international relations. Kirshner posits that the crisis marked the end of what he calls the “second postwar American order,” as it undermined the credibility of the economic principles that supported it—especially those advocating for unregulated financial practices. He also highlights how the crisis accelerated the relative decline of American power and political influence, while enhancing the political clout of other nations, particularly China.
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The three-month average of the Chicago Fed National Activity Index (CFNAI) is projected to rise slightly to +0.29 in the upcoming August update, according to The Capital Spectator’s median econometric forecast. This prediction is modestly higher than July’s reading of +0.25, indicating above-average economic growth relative to historical trends. Values below -0.70 indicate an “increasing likelihood” that a recession has begun, in line with guidelines from the Chicago Fed. Based on the latest estimate for August, the CFNAI’s three-month average is expected to sustain a level that typically indicates moderately above-trend growth.
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While recent economic updates appear inconsistent in some areas, such as the report on housing starts released yesterday, the monthly variations for various indicators seem to be minor disturbances at this juncture in evaluating the business cycle. Overall, a broad examination of macro conditions suggests that growth remains consistent. Although the expectations for accelerated economic activity have diminished, the moderate expansion observed recently is expected to continue, according to the August update of a diversified set of 14 economic and financial indicators.
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I am headed to Manhattan today, where I will join a panel at the 360 Exchange conference hosted by Bloomberg. My discussion will focus on market volatility and macroeconomic trends, alongside my co-panelist Dan Farley, who serves as the chief investment officer for State Street Global Advisors. Regular updates from The Capital Spectator will resume tomorrow.
In tomorrow’s update for August, housing starts are predicted to drop to 1.050 million, based on The Capital Spectator’s median econometric point forecast (seasonally adjusted annual rate). This projection indicates a slight decline from 1.093 million starts in July.
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Volatility is beginning to re-emerge in the markets. While not entirely visible from a high-level overview, certain sectors of the global markets are increasingly unstable. A prime example is US real estate investment trusts (REITs), which have recently seen significant declines, likely due to concerns that this interest-rate-sensitive asset class may suffer if the Federal Reserve is nearing an interest rate hike.
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