Kaizen Wealth Management » Asset Classes

Do hedge funds hedge?

Kaizen Wealth Managment — Fri, 04 Jun 2010 16:02:11 +0000

…the experience of the Great Recession

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Source: Vanguard | 06/03/2010

The recent Great Recession provides a unique opportunity to examine the experience of hedge fund investors. Many investors believe that hedge fund managers have the flexibility to avoid the disastrous consequences of extreme market events. However, during the turmoil of the past few years, most hedge fund categories, on average, did not provide significant diversification beyond that of a 60/40 portfolio of stocks and bonds.

Opportunities in International Investing

Kaizen Wealth Managment — Mon, 21 Dec 2009 16:40:25 +0000

More and more, we are finding it easier to justify our higher allocations to international equities. Roughly 55% of the investable equity universe, by market cap, is outside of the U.S. Also, world GDP has outpaced the U.S. GDP every year this decade; moreover, emerging markets have seen average GDP growth since 2000 of 5.9% – compared to 1.8% for the developed economies. International investing may also be a hedge against a weaker domestic currency.

source: J.P.Morgan Asset Management

Bubbles…Is Gold next?

Kaizen Wealth Managment — Tue, 08 Dec 2009 16:25:12 +0000

The WSJ recently published a chart that we thought was worth examining, and then noting here. The chart draws an excellent comparison between the recent surge in gold prices to previous bubbles of the last decade, giving us a cautionary perspective for those pouring money into gold today:

20-year Annualized Returns by Asset Class

Kaizen Wealth Managment — Thu, 05 Nov 2009 17:45:53 +0000

20-year period ending 12/31/08.

S&P 500 Index = 8.4%
Average Investor = 1.9%
The culprit = Investor Behavior

source J.P. Morgan Asset Management

Modern Portfolio Theory

Kaizen Wealth Managment — Tue, 17 Feb 2009 02:17:09 +0000

Modern portfolio theory suggests that a basic element in diversification of risk (with risk defined as the variation of actual returns around an expected return) is allocating the assets in an investment portfolio among categories of investments whose statistical performance correlations to each other are relatively low (or even with no correlation or negative correlation). Statistical correlations measure the extent to which the performance of various asset classes tends to move in the same direction as that of other asset classes (either up or down). A statistical correlation of 0 means there is no relationship in the performance of the two asset classes — they are independent of each other. A positive correlation indicates they tend to move in the same direction. A high positive correlation indicates they tend to move together more closely (to a higher degree), while a lower positive correlation means they tend to move together but to a lesser extent. A negative correlation indicates they tend to move in opposite directions. The statistical correlations are calculated from historical data on the performance (variability) of asset categories. Therefore, as with other historical statistical studies, the historical period used can be significant.

The essential idea is to manage or control portfolio risk (i.e., the variability of returns of the whole portfolio) by allocating the portfolio among uncorrelated asset classes or among asset classes with low correlations. That way, if one asset class, say common stocks, declines, another asset class, say high-yield bonds, may not decline, or may not decline to nearly the same degree, or may actually rise, depending on how correlated the asset classes are.

Thus according to modern portfolio theory, the addition of a higher-return asset class like high-yield bonds to a portfolio which consists, say, mainly of U.S. common stocks and high-grade U.S. bonds will not necessarily increase the overall portfolio risk if there is a low correlation between high-yield bonds and the other asset classes. In effect, this means that the addition of higher-return, more volatile asset classes to a portfolio will not necessarily increase the volatility (risk) of the portfolio as a whole, if the asset classes are uncorrelated or have low correlations.

Modern portfolio theory employs mathematical models to analyze expected returns, volatility, and correlations of individual asset classes. Many sophisticated techniques and investment vehicles can be used to help manage risk within desired parameters and, hopefully, to enhance returns.

Lessons from the Madoff Scandal

Kaizen Wealth Managment — Fri, 09 Jan 2009 03:09:41 +0000

Unfortunately, we are all now too familiar with Bernie Madoff, the once-storied hedge fund manager who was running nothing more than a $50 Billion Ponzi scheme. Undoubtedly, the size and depth of this scandal will bring about needed regulation, but what can the individual investor do now to protect themselves from investment scams? A few suggested guidelines may help.

If It Sounds Too Good to Be True, It Is

Notice that the word probably is not used here. Madoff did not report consistently above-average returns, but he did report consistent returns without fail, in good and bad markets. This should have been a red flag, however investors ignored this and unfortunately are paying handsomely. Any investment that promises anything should be viewed with extreme caution, especially when tauting above-average returns (or in this case, improbable consistency).

Diversify

You must hold a mix of asset classes in your portfolio. Experienced investors and advisors know that today’s winners could be tomorrow’s losers, and that winners rotate, therefore diversifying across many asset classes and market sectors is mandatory for long-term success. Some have learned this the hard way, but nonetheless, if you are not already doing so diversify now.

Avoid Conflicts of Interest

Clearly a major conflict of interest existed with Madoff and the hedge funds that used his firm. We cannot speak for their due diligence, or lack there of, but the main problem lies with the incentive for the funds and their managers to stick with Madoff – that is how they got paid. It’s very important to understand how your advisor is compensated for his or her services. Madoff was very reluctant to disclose information on how his firm was even making money using his “propriatary” trading tactics. We now know what those tactics were. Advisors, like ourselves, who use a fee-only system, free themselves from any conflicts of interest. We are not compensated with commissions, loads, or kickbacks that predominate our industy currently. Our fee arrangement is completely transparent.

Not only will these simple guidelines help you avoid an investment scam, they most likely will help you achive the long-term results you seek.