Here are some things I think I think:
1) The older I get the more I know how little I know. There’s some version of this quote in many places, but I think it’s always a good reminder to remember that we live in an inordinately complex and dynamic world that no one fully understands. If I’ve ever had one strength it’s that I know how much I don’t know (in other words, I know I am pretty stupid about a lot of things). I call it a strength because it keeps me from thinking in ways that get me in trouble. In the financial markets and life in general, thinking you have all the answers is a great way to fall into the trap of taking too much risk or thinking in terms of irrational extremes. The financial markets are particularly good at fooling most of the people most of the time. And it’s usually right when you think you have it figured out that the market trips you up. Remembering that you don’t have it all figured out is why we diversify and take calculated risks. It’s why smart investors think in probabilistic terms and not in absolute terms.
2) Fat tails versus thin tails. Speaking of probabilities and risk…I like this comment by Nassim Taleb on understanding risk:
Evidence of journos not understanding risk (naive comparisons across statistical classes, fat tails vs thin tails). https://t.co/xEPPKgmskO
— NassimNicholasTaleb (@nntaleb) November 24, 2015
He’s highlighting an article about how being killed by terrorists is less likely then being killed by furniture. This ignores the difference in types of risks in fat tails and thin tails. In essence, a lower probability event can have a much bigger impact on outcomes even though it’s less likely to occur. For instance, the probability of a nuclear bomb hitting your house is lower than the probability of your house getting hit by lightning, but that doesn’t mean that the bomb is less risky than the lightning. This is important in portfolio construction because people sometimes forget that low probability outcomes aren’t always equally risky. In other words, tail risk can always be dangerous, but not all tail risks are equal.
3) Momentum is the hot new thing. I’ve noticed a huge surge in the popularity of momentum strategies in the last few years. I’m not sure if this is due to the inconsistent results of so many factor strategies in the last few decades or if it’s due to momentum’s recent successes (such as the strong performance of managed futures strategies which tend to perform well when the markets become turbulent).
I’m obviously very skeptical of factor investing, but open-minded. Well, open-minded to the extent that it can be done in a low fee manner. After all, I think factor investing is basically the hot new form of “active” indexing. And since i think that all indexing is essentially active then I am totally cool with mixing factors. But I’m not yet convinced that low fee factor investing is a superior approach to low fee market cap weighted indexing. But the one thing I am definitely against is when factor investing is sold at a high fee as some sort of superior alternative to market cap weighting. This very often turns out to be high fee salesmanship cloaked as empirical evidence….
NB – Extra bonus addition in this edition. Ralph Nader recently wrote a letter to Janet Yellen complaining about how savers have been hurt by low interest rates. I’ve talked about this at length in recent months noting that, in aggregate, savers have benefited from low interest rates because other assets have performed so well. It is only non-diversified savers sitting in cash who have been hurt.
Well, Janet Yellen wrote a masterful letter to Nader saying the same basic thing. I really like this version of Yellen. Mess with the bull and you get the horns. Consider Ralph Nader gored….