Month: July 2011
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Real World Problems versus Homework Problems
Supposedly, one of the reasons so many statistical analysis have been conducted on financial markets is because that’s where the data is. Millions of finance students have learned how to apply financial models using historical data from the real world. However the problems they solved were homework problems, not real world problems. Real world problems…
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There IS a name for that: “Reconstructed” portfolios
In several posts I have struggled to articulate the mathematically convenient concept of a historical representation of an index or portfolio as if its past weights had always been equal to its current weights. I have called the returns to such a time series various terms, including “matrix returns,” “imaginary returns,” and “pro forma returns.”…
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The Inequity of Long-only Performance Fees
The stereotypical hedge fund fee structure is “2 and 20,” meaning a 2% fee on assets plus 20% of the gains. Typically gains are calculated above some threshold, particularly a high water mark. The purpose of the high water mark is to ensure the manager doesn’t get paid an incentive fee twice following periods of…
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If you’re not rebalancing, you’re not diversifying
My brother, not an investment professional, recently asked me whether he ought to rebalance his 401(k) portfolio. The short answer: “Yes!” One of my first projects after business school had to do with assessing the effects of different hypothetical portfolio weighting and rebalancing schemes in an international equity portfolio, using EAFE countries. Tricky to do…
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Strategy implementation: Investing discipline or investing habit?
Over the past 20 years I have spent much time meeting, researching, interviewing, and otherwise picking the brains of traders and investment managers. Most of them could talk your ear off about their discipline and the rationale supporting it. Ultimately, any investing or trading discipline requires that you recognize your edge and execute your strategy…
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Arithmetic Means and Expected Returns: Don’t Fool Yourself
(Author’s note: This year I have volunteered to coordinate the Society of Actuaries (SOA) Investment Section’s sessions at the SOA annual meeting, which will be held this October in Chicago. For more information, visit the SOA annual meeting website). At this year’s Society of Actuaries’ annual meeting, one of the more anticipated discussions is likely…