[AndersB]

This is a bit technical, but I'm sure there are some forum participants that are well able to sort out my ignorance on this matter.

There are a couple of finance theories that have shaped the investment strategies of fund managers for the last couple of decades.

The Capital Asset Pricing Model (CAPM) is one of those:
http://en.wikipedia....t_pricing_model

CAPM theory suggests that assets can be diversified in a portfolio, and that different portfolios will have different return/risk ratios. Risk is measured in return variance. The set of portfolios with the highest return/risk ratios will create the efficient frontier:


When considering a risk free rate of return, it is theoretically not possible to get a higher return/risk ratio of a portfolio of assets than a linear combination of weightings in the risk free asset and the Tangency Portfolio (or market portfolio). By borrowing at the risk free rate you can leverage your investments along the line beyond the Tangency Portfolio. The risk free rate has always been considered to be government bonds!

The second theory (or hypothesis): the Efficient Market Hypothesis (EMH) - says that you cannot beat the market. Well, you can try, but it is nearly impossible. The market adjusts so quickly to any new information that the only rational choice is to just buy the index and try to keep up with the market performance. This is probably why so many super funds perform close to the overall ASX index.

Now, here are my questions:
1) What happens when the government bonds yields go above the so called Market Portfolio? In theory, nobody would hold any asset other than the government bonds. This is clearly false.

2) What happens when the government bond yields go to zero? In theory, this should make investors leverage up like crazy. That doesn't seem to be the case either.

Are CAPM and EMH theories just bovine scatological substance?

This post has been edited by AndersB: 25 November 2011 - 01:54 AM

[AndersB]

Here is a link to a better description of what I was trying to say:
http://en.wikipedia....ortfolio_theory

[boz]

AndersB, on 25 November 2011 - 01:46 AM, said:

This is a bit technical, but I'm sure there are some forum participants that are well able to sort out my ignorance on this matter.

There are a couple of finance theories that have shaped the investment strategies of fund managers for the last couple of decades.

The Capital Asset Pricing Model (CAPM) is one of those:
http://en.wikipedia....t_pricing_model

CAPM theory suggests that assets can be diversified in a portfolio, and that different portfolios will have different return/risk ratios. Risk is measured in return variance. The set of portfolios with the highest return/risk ratios will create the efficient frontier:


When considering a risk free rate of return, it is theoretically not possible to get a higher return/risk ratio of a portfolio of assets than a linear combination of weightings in the risk free asset and the Tangency Portfolio (or market portfolio). By borrowing at the risk free rate you can leverage your investments along the line beyond the Tangency Portfolio. The risk free rate has always been considered to be government bonds!

The second theory (or hypothesis): the Efficient Market Hypothesis (EMH) - says that you cannot beat the market. Well, you can try, but it is nearly impossible. The market adjusts so quickly to any new information that the only rational choice is to just buy the index and try to keep up with the market performance. This is probably why so many super funds perform close to the overall ASX index.

Now, here are my questions:
1) What happens when the government bonds yields go above the so called Market Portfolio? In theory, nobody would hold any asset other than the government bonds. This is clearly false.

2) What happens when the government bond yields go to zero? In theory, this should make investors leverage up like crazy. That doesn't seem to be the case either.

Are CAPM and EMH theories just bovine scatological substance?

It remind me of the financial adviser course I did. Now, like back then, I think it is useless and there are far more important thing to look at.
The only usefull thing is to know what standard deviation mean and how can be used to reduce specific risk (or specific gain, but they don't tell you about specific gains in a Financial advisor course as only when risk is wrong you can be sued by the client...

[firehawk]

AndersB said:

1322185603[/url]' post='54541']

Are CAPM and EMH theories just bovine scatological substance?

IMHO, they are largely so.
I especially do not like the EMH as it implies nobody beats the market which is demonstrably false for some investors ... ahem ... such as Warren Buffett.

[mattau]

There are some proponents of EMH - such as those in academia and even many investment managers. For me, I don't like the theory. I think it's just that - a theory. Like the poster above, it implies that no one beats the market, but there are ways to do so. If you're intelligent...

[Mr Medved]

The markets IMO are like poker. A fraction of players win big; a minority make small wins or break even; the majority lose and some of those lose big time.

You can outperform the market but that is probably only 1-2% of market participants. Like poker it requires a combination of skill, experience, discipline, analysis, timing and luck.

[tor]

Mr Medved, on 25 November 2011 - 09:06 AM, said:

The markets IMO are like poker. A fraction of players win big; a minority make small wins or break even; the majority lose and some of those lose big time.

You can outperform the market but that is probably only 1-2% of market participants. Like poker it requires a combination of skill, experience, discipline, analysis, timing and luck.

I have wondered if the reason super funds meet the market return is because the super funds make the market return. Surely they would be some of the biggest value in the stock market and one of the few of that size that have to try and do something.

[Solomon]

AndersB, on 25 November 2011 - 01:46 AM, said:

This is a bit technical,.....

Shows you how thick I am Anders.
You lost me at this bit.
So investment managers use formula like this to invest money.
No wonder we are in so much trouble.

Thanks to all the technical and savvy guys on here, who have given their best to interpret and respond to Anders query.
Truly, you are amazing guys.
I salute you.

I had enough trouble working out angles for the double helixes, when trying to cut helical gears on a milling machine.
If you've every tried to work out the correct ratios on a dividing head, you will have some idea what I'm talking about.

[tor]

Solomon, on 25 November 2011 - 09:37 AM, said:

I had enough trouble working out angles for the double helixes, when trying to cut helical gears on a milling machine.
If you've every tried to work out the correct ratios on a dividing head, you will have some idea what I'm talking about.

4 jaw chucks for life!

man I hate those things when you have to reset.

[staringclown]

Solomon, on 25 November 2011 - 09:37 AM, said:

Shows you how thick I am Anders.
You lost me at this bit.
So investment managers use formula like this to invest money.
No wonder we are in so much trouble.

Thanks to all the technical and savvy guys on here, who have given their best to interpret and respond to Anders query.
Truly, you are amazing guys.
I salute you.

I had enough trouble working out angles for the double helixes, when trying to cut helical gears on a milling machine.
If you've every tried to work out the correct ratios on a dividing head, you will have some idea what I'm talking about.

We don't grind that stuff from metal anymore sol. We build it using 3d printers. It removes the potential for human error. The only thing that saves me is a deep knowledge of IT speak. So far I'm outflanking my opponents. It's not my idea but it is the way it is. But it's only a matter of time. I write bespoke code - this is a luxury. You do realise we are all going to live out some sort of utopia when we all have 100% leisure time.

[AndersB]

In some ways my two questions are trick questions. I don't think there are any conventional answers to them.

What has happened in the bond markets was never supposed to happen - should never have been possible, even - according to finance theory.

Yet, this is the theory that is taught in universities all around the world. Basically, we are now in unchartered territory. When government bonds are no longer risk free - what is left to invest in? For example, it does not make sense to invest in something else that will have a lower return and higher risk still.

Spain's 10-year bond yield is now 6.7% and Italian 10-year bond yield is 7.3% and the market seems to demand higher yields from all countries, Germany and France included.

The European banks followed the rule book. The Basel accord assumes that AAA government bonds are risk free and therefore require no capital backing. So, when the government bonds prices get re-rated lower, all these banks are caught with their pants down.

In some convoluted ways, what I am trying to point out is that the markets have no idea how this will develop. We have never had this situation before on such a global scale involving Europe, the US and Japan concurrently. Maybe what will happen next really will be the big credit crunch and the nearest thing to a global depression since the 1930s.

[Solomon]

tor, on 25 November 2011 - 09:39 AM, said:

4 jaw chucks for life!

man I hate those things when you have to reset.

You've had some experience!
Yep, resetting was the struggle. A good dial guage is the only answer.
In regard to the gears.
If the dividing head was out by even a .001 of an inch, or (.0254 of a millimetre)the gears never lined up.
Then there was also the problem of wear on the cutter head.
Thankfully, I only cut a dozen or so of them.
Computerised lathes and mills have now taken the agony out of doing it manually.
I was also very thankful for a few engineers who could understand the maths better than me.
For those who don't know what I'm talking about. Here's a picture of the sort of thing.

http://t0.gstatic.co...R0VsX2MCvLRmYcQ


On topic:
I think I actually understand Anders questions after his last post.
So what happens when all the theories disintegrate, and you're left flying by the seat of your pants.
This is where you test the boys from the men Anders.
Adapting to changing environment, is supposed to be our human strong point. That's why we've survived for so long.
We might test that theory in the next couple of weeks.

This post has been edited by Solomon: 25 November 2011 - 01:17 PM

[AndersB]

Solomon, on 25 November 2011 - 01:04 PM, said:

Adapting to changing environment, is supposed to be our human strong point. That's why we've survived for so long.
We might test that theory in the next couple of weeks.

OK, so this is my investment strategy (at the moment):

1) Keeping all money in US$ cash deposits
2) Market crashes and there is a huge credit crunch. The US$ is the worlds most liquid currency and there is great demand for it. The US$ therefore rises - perhaps to US$0.70 cents per AU$.
3) During the GFC gold was smashed as well. Assuming that history will repeat, change investments to gold (hopefully) near the peak of US$ strength.
4) World governments and central banks panic and become the liquidity of last resort - printing $trillions in the process. Gold takes off
5) Inflation rapidly rises, while a severe global recession causes house prices to fall as assets are still sold in further debt deleveraging.
6) Interest rates go up significantly, including mortgage rates, to combat run-away inflation.
7) Further property price falls due to the high interest rate environment.
8 ) Markets stabilise after either global debt restructuring or debt being inflated away.
9) Residential real estate prices are now quite reasonable and it will be a good time to be 50% in real estate and 50% in equities.

But, who knows what the future will bring? This strategy will change as the market conditions change.

This post has been edited by AndersB: 25 November 2011 - 01:27 PM

[tor]

AndersB, on 25 November 2011 - 01:25 PM, said:

3) During the GFC gold was smashed as well. Assuming that history will repeat, change investments to gold (hopefully) near the peak of US$ strength.

Did it? My hazy memory says that January of the GFC gold hit a new high in AU$ - $1000 or something

[AndersB]

tor, on 25 November 2011 - 08:21 PM, said:

Did it? My hazy memory says that January of the GFC gold hit a new high in AU$ - $1000 or something

Here is a good chart:



Lehman Brothers went bankrupt in September 2008 and I was surprised at the time that gold went down at the time. Gold then quickly went up again when the US Fed announced bailouts and quantitative easing programs.

However, in AU$ terms, gold may have held reasonably steady around September-November 2008.

It is interesting that gold had a big price increase just over a year earlier.

[wulfgar]

tor, on 25 November 2011 - 08:21 PM, said:

Did it? My hazy memory says that January of the GFC gold hit a new high in AU$ - $1000 or something

It was only in the USD that the official price fell from a touch under a 1000 to under 800. But it was nonsense because the street price of gold rose to $1100 in the US. I assume there was some very important people riding some big shorts. When interest rates are dropped gold will rise in price and visa versa.

It didn't last that long because the USD price was back up to 1000 by March 2009.

Quote

In some ways my two questions are trick questions. I don't think there are any conventional answers to them.

What has happened in the bond markets was never supposed to happen - should never have been possible, even - according to finance theory.

Yet, this is the theory that is taught in universities all around the world. Basically, we are now in unchartered territory. When government bonds are no longer risk free - what is left to invest in? For example, it does not make sense to invest in something else that will have a lower return and higher risk still.

I wouldn't say that, the sovereign's doing badly are the usual suspects.

[Mr Medved]

tor, on 25 November 2011 - 09:30 AM, said:

I have wondered if the reason super funds meet the market return is because the super funds make the market return. Surely they would be some of the biggest value in the stock market and one of the few of that size that have to try and do something.

A relative used to work in the superannuation industry many years ago. IIRC he said that (at the time) the statistical evidence of fund performances was that if a fund had underperformed/tanked the previous year it was more likely to outperform the top funds for the previous year... a bit like a see-saw. I assume this relates to the rules governing super funds and what they can/cannot invest in.

[AndersB]

AndersB, on 25 November 2011 - 01:25 PM, said:

OK, so this is my investment strategy (at the moment):

1) Keeping all money in US$ cash deposits
2) Market crashes and there is a huge credit crunch. The US$ is the worlds most liquid currency and there is great demand for it. The US$ therefore rises - perhaps to US$0.70 cents per AU$.
3) During the GFC gold was smashed as well. Assuming that history will repeat, change investments to gold (hopefully) near the peak of US$ strength.
...

Is Jim Rogers reading Simple & Sustainable?

http://www.cnbc.com/id/45472311

Quote

Jim Rogers Says Gold Due for Correction; Owns Dollar


Published: Tuesday, 29 Nov 2011 | 6:13 AM ET
By: James Longman

The price of gold is due for a correction and this could be used as an entry point by investors eager to get exposure to the precious metal, while the dollar is likely to strengthen as there has been too much pessimism about it, famous investor Jim Rogers told CNBC Tuesday.
...