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» Articles - Larry Siegel's Nine Myths of Investing (Siegel’s Myths)
Larry Siegel's Nine Myths of Investing (Siegel’s Myths)
Larry Siegel, Research Director of the CFA Institute’s Research Foundation, Senior Advisor to Chicago-based Ounavarra Capital and AllAboutAlpha.com contributor is always a crowd favorite at a conference since he doesn’t mince his words. In one of his recent talks he urged the audience to pay attention to “Nine Myths of Investing” (Siegel’s Myths).
The Nine Myths of Investing according to Larry Siegel are listed out below.
Myth #1: Asset allocation is the only thing that matters.
* True: asset allocation explains the greatest part of return variation
* But “asset allocation” currently seems to mean market timing. This is a misunderstanding
* Asset allocation = policy mix of betas designed to be the best long-run investment
* Ideally, equal to mix of betas in liability
* Timing away from the liability-defeasing asset mix is an attempt to add alpha, like any other.
* Results from beta timing matter
* Conventional active management (to add alpha through security selection) matters too
Myth #2: Liability-relative investing is good in theory, but interest rates are too low.
* Every pool of assets was gathered to pay a liability (Pensions, endowments, foundations, individual savings, sovereign wealth funds, etc. (liability is less clearly defined))
* Interest rates could go down (stranger things have happened) – you would then be much worse off
* Interest rates could go up, but A & L would decline at same rate if duration matched
* You might eliminate deficits through interest rate timing, but how has that hopey-changey thing worked out for you in the past?
Myth #3: It is a good thing to be an absolute return investor.
* There is no such thing as an absolute return investor
* Except for a very few completely market-neutral hedge funds
* Basically all funds are market-exposed
* All funds have a benchmark (whether the manager likes it or not, whether the fund is liquid, etc.)
* Even a market-neutral fund has a benchmark, cash, which explains much of return variation of this type of fund
Myth #4: Active management only makes sense in markets that are inefficient.
* Well, of course
* But all markets are inefficient to some degree
* Best track record ever (Berkshire Hathaway) was achieved in U.S. large cap
* Active management is a zero-sum game in all markets, no matter how efficient or inefficient
Myth #5: You should try to minimize fees.
* No, you should try to maximize expected return after fees
* Which means maximizing expected alpha after fees if you meet the criteria for selecting active managers
* Minimizing fees would mean a pure index strategy, missing out on some of the most interesting economic opportunities in the world
Myth #6: Alternatives are where the return is, so these managers deserve their high fees.
* Parable of the skilled manager with no capital
* For truly skilled managers, 20% profit share might not be enough!
* But how many geniuses are there?
* Fewer than 200 hedge funds in 1990
* More than 8000 now
* Aggregate alpha available in the market was zero in 1990 (it still is)
* High fees attract mediocre as well as superior managers
* Burden is on fund sponsor to find superior managers from a population that is close to average (i.e., that delivers benchmark return)
Myth #7: Diversification doesn’t work any more.
* Claim is too silly to take seriously, but some people believe it so let’s address it
* The “original alternative asset,” Treasury bonds, provided excellent returns during crash
* So did cash
* Nobody ever said that diversifying among 50 kinds of equities would reduce risk very much
* And credit, private equity, equity hedge funds, etc. are all types of equity!
Myth #8: The endowment model is broken.
* If the endowment model is that “anything worth doing is worth overdoing,” then it’s broken
* But that is not the essence of the endowment model
* Endowment model properly understood:
* Think broadly about diversification
* Take all asset classes, not just public, liquid asset classes, as your opportunity set
* Be a long term investor
* Be willing to sacrifice liquidity for higher returns, if there is a liquidity premium, and only up to the point where liquidity sacrifice doesn’t threaten the financial soundness of the institution
Myth #9: We are in a low return environment.
* Don’t confuse the future with the recent past
* If you’re in a low return environment for long enough, you’re in a high return environment!
* But interest rates are low…
* Wait a while and that will change. Inflation expectations from fiscal policy will become embedded in rates
* Equity return expectations are not low
For more information, or to discuss your specific situation, please contact me directly.
Lisa Rivera
Director of Industry Relations and Outreach
Chartered Alternative Investment Analyst Association
By: Ranjan Bhaduri, AllAboutAlpha.com Editorial Board & Sabah Rehman, AlphaMetrix Alternative Investment Advisors.
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