# Absolute return funds the US experience



## Marc (12 Jul 2012)

The following article was written by Larry Swedroe on his CBS Money blog and has not been edited at all. Irish investors should note that arguments relating to internal fund taxation relating to long term and short term capital gains tax distributions is not relevant from an Irish taxation perspective.



Absolute return funds fail to deliver
July 12, 2012
by CBNews.com

(MoneyWatch) Investors would love to be able to achieve positive returns in both bull and bear markets. That's the "promise," or at least the idea behind, absolute return funds. The devastating bear market of 2008 increased the demand for these funds. Wall Street is happy to meet that demand with its usual array of high cost vehicles. Morningstar recently reported that since the 2008 crisis,*28 absolute return funds were launched, bringing the total to 41 with an astounding $11.1 billion of assets. Unfortunately, there's a Oreason that the old saying "if sounds too good to be true, it almost certainly is" is a cliché.
Absolute return funds try to accomplish their objective using a wide various strategies. While some invest primarily in stocks and bonds, others use commodities, short selling, futures, options and other derivatives, arbitrage strategies, currencies, credit risk, leverage, and almost anything else you can dream up. That's one of the many problems with these funds -- you just don't know what they own and what risks you're exposed to. Another problem is that the term absolute return is an oxymoron (the only truly absolute return vehicles are a one-month Treasury bill or an equivalent FDIC insured deposit).

Morningstar's analysis of these vehicles found that of the 25 absolute return funds that were launched before 2011, just nine (36 percent) provided positive returns. And this occurred during a year when the S&P 500 Index, the Russell 3000 Index and all major bond indexes produced positive returns! This was virtually the same result that occurred in the 2008 bear market when just nine of the 26 (35 percent) absolute return funds generated positive returns. Morningstar also noted that the absolute return funds that use a long/short strategy (the idea is to have no exposure to the overall risk of the market) still managed to lose an average of 15.4 percent in 2008 -- while better than the market's loss of 37 percent, it's not even close to an absolute return.

One reason for the poor results is that despite claims of having uncorrelated returns (the only way you can produce absolute returns), Morningstar found that about half the absolute return funds with at least a one-year record had a correlation with the S&P 500 greater than 0.6. In other words, they were stock-like strategies carrying much of the risks of stocks. On the bond side, Morningstar found that more than 40 percent of the absolute return funds had a correlation of 0.6 or higher with the Barclays Capital Global High Yield Index. In other words, they were basically credit risk strategies. The implications are that there's really nothing unique about these strategies -- to a great degree their results are explained by exposure to benchmarks (which investors can obtain at low costs).

Other reasons for the poor results are high expense ratios and high turnover. Sixty percent of the funds had expense ratios greater than 1.5 percent, and more than half had turnover rates in excess of 100 percent. And those that engage in long-short strategies have the added burden of the costs of borrowing stock.

But, we're not done yet, as the high turnover rates lead to tax inefficiency. Because most trade so often, the funds are not likely to provide most of their returns in the form of long-term capital gains distributions (if they ever make any money). More likely, a large percentage of their returns will be taxed at the higher short-term capital gains and ordinary income tax rates.

The Hedge Fund World
We can also look at the results of vehicles that use absolute return strategies by examining the data provided by hedgefundresearch.com. Despite the term absolute return in their name, the HFRX Absolute Return Index has lost 0.2 percent for the first six months of 2012. This comes on the heels of four straight years of losses:

Loss of 3.7 percent in 2011 Loss of 0.1 percent in 2010 Loss of 3.6 percent in 2009 Loss of 13.1 percent in 2008
Thus, we can conclude that absolute return funds have demonstrated the ability to lose money in both bull and bear markets. The only thing absolute about these funds is how absolutely bad they are. And while mutual funds that use absolute return strategies are expensive, they're cheap by hedge fund standards, with their typical fee structure of 2/20 (2 percent annual fee plus 20 percent of the profits).

The conclusion we can draw is that the so-called "advantage" of the freedom to choose from a wide range of investments doesn't translate into real world benefits. This is because their strategies are costly to implement, and the market is highly efficient at setting prices.

The bottom line is that no one should invest in absolute return vehicles because they aren't absolute return vehicles, but relative return vehicles. They're just another way Wall Street has found to transfer money from your wallet to theirs.


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## Eithneangela (12 Jul 2012)

Thank you for that, but could you please translate that into common day English. Double Dutch to me, and I can do the IT Cryptic Crossword in less than 30 minutes, usually. Need to ground the article with a few relevant examples, but thank you anyway.


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## Dave Vanian (13 Jul 2012)

All this tells me is that the US marker has been badly served by the choice of Absolute Return funds offered there.  Here in Ireland we have far fewer AR funds to choose from, but they seem to be of better quality.  The returns on, say, the Standard Life GARS fund or the BNY Mellon Real Return fund available from New Ireland have been far better than the returns quoted in this article.


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## Marc (13 Jul 2012)

Dave,

If that was really true I wouldn't be able to do this so easily...

[broken link removed]

What matters for investors is the net exposure to risk and in this case (despite all the fancy marketing) it looks to me like a net 40% exposure to real assets and 60% exposure to cash and fixed interest.

I have therefore suggested that Absolute Return funds are the Emperor's new clothes.

I did a similar analysis for BNY Mellon's absolute return and guess what? Same result

[broken link removed]


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## Dave Vanian (14 Jul 2012)

I think you'll find that most investors are more interested in what the returns are.  

Standard Life GARS to 30/6/2012: - 


YTD +4.14%
1 year +9.96%
Annualised since launch +9.51% per year
Compare these with the returns quoted in the article above for the HFRX Absolute Return Index and it just proves my point.  Not all Absolute Return funds are the same.


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## Marc (14 Jul 2012)

Dave,

I "absolutely" agree with you. But of course the HFRX is a hedge fund index and does not relate to retail absolute return funds. It is in there as a comparison to illustrate the point that hedge funds also underperform a simple buy and hold strategy.

I also agree with you that many investors (and their advisers seemingly) are more interested in past performance despite the required regulatory warning that it is no guarantee of future performance.

Still it doesn't stop some of us from trying to explain what really matters in investing.


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## Dave Vanian (14 Jul 2012)

Marc said:


> But of course the HFRX is a hedge fund index and does not relate to retail absolute return funds.


 
Yet you posted an article that quotes the HFRX Absolute Return Index in a post that you titled "Absolute return funds the US experience".




Marc said:


> I also agree with you that many investors (and their advisers seemingly) are more interested in past performance despite the required regualtory warning that it is no guarantee of future performance.
> 
> Still it doesn't stop some of us from trying to explain what really matters in investing.


 
Oh come now.  You post an article that publishes past performance figures of a US index and yet when I post figures from a fund that's actually available here in Ireland, you're suggesting that they don't matter.  

You can't have it both ways Marc.


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## Marc (14 Jul 2012)

Yes, some hedge funds apply similar strategies to absolute return funds but charge very high fees resulting in poor investor experiences this is much of the argument against absolute return funds and therefore the comparison is valid. Although I will point out that I reproduced the original article in full without editing it so we could say that the hedge fund reference is a distraction in an otherwise valid debate.

The past performance data relates to the failure of an average fund to deliver excess returns above those available for a given level of risk that is available to an investor from an index strategy. Equally , we often hear the time weighted returns of a fund since launch but money weighted returns are rarely reported. Said differently, how many people invested at the launch compared to how many people invested in say the last 18 months? The returns that most people earn are not the same as those reported in the marketing material.

I don't dispute the return figures you provided but my point is that an investor could have had those returns from a simple index strategy as I have already proved.

Absolute return funds are being sold on the basis of these past performance numbers but we have too little data to be certain that this is due to skill rather than luck (the subject of a previous post on this matter)

So with respect, I'm not having it both ways I'm questioning a racket based on a combination of bad benchmarking by the fund managers and a poor understanding of statistics by many advisers and their clients. We don't yet know if the current fad for absolute return funds will lead to bad outcomes for consumers but let's hope not seeing as so few people seem to be willing to say if it looks and quacks like a duck then it's probably a duck.


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## Monksfield (15 Jul 2012)

*Absolute Return*

I think an important point which should be borne in mind in any critique of absolute returns is that they set out with performance and volatility objectives which are much more in line with what individual investors want.In the case of GARS cash + 5% gross over rolling 3 year periods with volatility between 6 and 8% is an investor's dream is it not?

Even if they come up short it may be a more attractive proposition than telling investors that they can expect a return of whatever markets deliver (in the case of equities more of less zero over the last 12/13 years) at whatever volatility the markets serve up. Obviously if Standard Life come up a long way short that is a different matter and certainly the aggregate performance of hedge/absolute funds is bad.


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## Marc (16 Jul 2012)

Monksfield said:


> I think an important point which should be borne in mind in any critique of absolute returns is that they set out with performance and volatility objectives which are much more in line with what individual investors want.



which they can achieve through a long only equity/bond portfolio of index funds in a mix that is appropriate for their need, willingness and capacity for risk. No need for active management, no need for derivatives, counterparty risks etc


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## foxyboxer (16 Jul 2012)

_Thus, we can conclude that absolute return funds have demonstrated the ability to lose money in both bull and bear markets._

That's a sloppy generalisation tbh. If I were to envisage investing in an Absolute Returns Fund it would have to be a Managed Futures CTA (Commodity Trading Advisor) that has that goal (AR) in mind. Particularly one which employs a systematic trend following approach. Over the long term they have been profitable but you're attitude to risk is paramount, particularly as the top funds experience large drawdowns.


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## DK123 (16 Jul 2012)

Are the GARS returns posted above net of tax,annual management fees and any other hidden fees that might apply.?


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## Monksfield (16 Jul 2012)

And what is it that most long only equity-based portfolios have "achieved" for investors over long periods of the last decade or so Marc?

A serious lack of return with huge drawdowns. Not a result in return or risk terms.


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## Dave Vanian (16 Jul 2012)

deskelly said:


> Are the GARS returns posted above net of tax,annual management fees and any other hidden fees that might apply.?


 
No.  They are figures of the performance of the GARS fund.  The tax treatment will depend on what product you choose.  The charges will also depend on what product you choose AND where you go to purchase that product.  Intermediaries have discretion over what charges to apply.  So it would be impossible to quote fund returns that cover all tax or charging variations.


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## ringledman (16 Jul 2012)

Monksfield said:


> And what is it that most long only equity-based portfolios have "achieved" for investors over long periods of the last decade or so Marc?
> 
> A serious lack of return with huge drawdowns. Not a result in return or risk terms.


 
The Western indexes are in a SECULAR bear market. A long grind sideways from the overvalued and speculative bubble of 2000. A bubble that peaked on the highest P/E in history.

Empirical evidence shows that secular bear markets have typically lasted much longer than the 12 years since the last secular bull market popped on each occassion.

The USA indexes are still way overvauled on a CAPE basis compared to the level that all previous historical secular bear markets have ended and commenced a new secular bull.

Time to stay defensive in value stocks.


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## Marc (16 Jul 2012)

Wow! This is turning into a great debate.
Some points to address here:
Firstly, @Managed Futures
This is a fairly good critique of the Managed Futures CTA.
[broken link removed]

"Speculators..are part of a game that has a zero sum outcome and provides no insurance benefit."

@ Monksfield

I don't recommend Managed funds and my proposition is that Absolute Return funds are just Managed Funds with a new marketing slant.

So, I agree that a typical Irish Managed Fund with an overweight bet on Irish Stocks would have performed poorly over the last 10 or so years. But, I have not and never would have put all my clients into managed funds. I also would never have bought into the "consensus" marketing story either.

But, I accept that this is what was being sold and hence the comment is valid in an Irish context. I suppose the question that should be answered is based on my proposition that any investor _could_ have choosen a risk appropriate portfolio of index funds or slightly more damning for the financial services industry in Ireland _*should*_ have been advised to follow this course of action. 

So, the question we could pose is this, "how would an investor who ignored the marketing spin of the product selling financial services companies fared?" Let's ignore the Tech craze, the property craze, the Irish Bank shares and let's not sell everthing and go to cash in 2008. But instead, let's buy a globally diversified portfolio of low cost index funds and see how we did through all that from Jan 1999 through to the end of 2011?


To address the comment about drawdown's I will also list the worst one year return:
These are portfolios with no active management, no long-short strategies, just a strategic asset allocation of indexes of stocks, bonds and real estate annually rebalanced.

Portfolio Average annual return Worst one year return
Cautious 4.83%pa -1.15%
20% Risk 4.89%pa -4.22%
30% Risk 5.13%pa -9.13%
40% Risk 5.71%pa -14.79%
50% Risk 6.58%pa -19.44%
60% Risk 7.21%pa -24.42%
70% Risk 7.43%pa -28.88% 
80% Risk 8.10%pa -33.81%
90% Risk 8.64%pa -38.16%
98% Risk 8.72%pa -41.36%


For reference:
MSCI World 2.04%pa -39.11%
MSCI Emerging Markets 11.77%pa -50.57%
MSCI Ireland (gross div) -7.66%pa -71.40%

Just as an interesting historical aside the BYN Mellon Absolute Return fund used to be called the Newton Real Return Fund. I had a look at the performance of the original fund in Sterling and found the worst 1 year return. Any ideas? The worst one year return was -34.01% for the 12 months ended March 2003. Source: Bloomberg. 


The goal of every investor is to select the portfolio that most closely matches their willingness for risk (that's the drawdown number) their capacity for risk (that's a function of their age, net worth, income ect) and need (that's the expected average annual return that they need to achieve to meet their financial goals.

Matching investors with portfolios based on need. That's the job of the professional adviser - not selling the latest product craze.

Finally, @Ringledman the perpetual SECULAR bear. Unfortunately the evidence doesn't support the statement:

All returns in Euro Jan 2000 to May 2012
Global Core Equity Index 1.58%pa
Global Small Equity Index 4.24%pa
Global Small Value Index 7.66%pa
S&P Global REITS 7.59%pa
Emerging Markets Value Index 11.69%pa

Source: DFA
Note that the Global Indicies above have an allocation of approx 51% USA, 10%UK, 5% Canada, 10% France/Germany/Switzerland so that's what 76% at least invested in the "western indexes" these are just market cap weights, no fortune telling crystal ball gazing, just let the market allocate resources efficiently.

So the way I sort stocks which is based on risk, I have had extremely positive returns from equities even since the supposed secular bear started in 2000.

A simple market cap weighted portfolio of 85% developed equities and 15% Emerging Market equities with a small and value tilt has produced perfectly acceptable positive returns.

There are no bears here boo boo!


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## Monksfield (16 Jul 2012)

Spirited defence Marc but its central pillar is the huge drawdown of the BNY Mellon fund. You either do know better or should know - that is not an AR fund in any commonly understood meaning of that term.

To use GARS again(a proper AR fund) its maximum drawdown was around 13% (don't have the precise data to hand) with volatility of c.7%. This is I would guess,half the volatility of any of the more aggressive strategies to which you refer.


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## Marc (16 Jul 2012)

OK fair comment on the BNY fund, it was more of a managed fund before it was renamed. I just wanted to highlight the need to look at the full picture. Remember that a "typical" managed fund will have an allocation to equities of 60% to 70%. Fund managers can reduce the risk of a fund simply by reducing the exposure to equities (the cautious managed fund and also Distribution Funds in the UK have been around for some time). Absolute return funds could just be low risk managed funds with a fancy marketing spin - GARS for example has a net exposure to real assets of around 40% supporting this line of reasoning.

So, since you raise the question, let's look at GARS. I have the UK Institutional class data here and the worst drawdown based on monthly data was -7.83% for the one year ended Oct 2008. There may be slightly worse periods by using daily data but this works well enough.

In my book from a marketing perspective "absolute return" implies "always positive returns" from the perspective of a consumer. If you can sell prospective investors on the myth that you can always produce positive returns from a low risk strategy, they won't really look much further. 

But a one year drawdown of this magnitude can hardly be described as always positive and my guess is that a significant number of current Irish investors and probably their advisers do not know that this sort of one year loss has happened to GARS and my guess why this might be is that the Euro version wasn't available in November 2007 and so this information isn't reflected in the marketing material.

As an observation the first post on this thread points out that Morningstar identified a large proportion of absolute return funds had correlations of greater than 0.6 in relation to an underlying index return.

GARS has a correlation of 0.63 compared to their own European Corporate Bond Fund over the last 3 years.

Most of the returns can be explained from exposure to the underlying risk factors. The derivative strategies add an extra layer of complexity to the analysis (and costs to the clients) but overall these are just bets. Some will win and some will lose. Overall the expected return from speculation is zero before costs and negative after costs. So, the longer an absolute return fund is in existance the more the underlying long exposure will drive returns, the bets should net out to zero, add costs and detract from returns. 

As I have already observed we won't know for sure if this will happen but we would need about 130 years of data to be certain that good returns were nothing more than luck.


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## ringledman (16 Jul 2012)

Marc said:


> Finally, @Ringledman the perpetual SECULAR bear. Unfortunately the evidence doesn't support the statement:


 
Unfortunately for the index trackers it does – 

http://alphahunt.files.wordpress.com/2011/08/dow-jones-historical-trends1.png

For the market to go on a bull run from here when the market topped out in 2000 on the highest P/E in history and has only regressed 12 years when the past 3 secular bear markets all lasted between 17 and 25 years? 

Secular market lows end on single digit P/E multiples. This is what empirical evidence shows. 

Secular markets are defined by the market grinding sideways as P/E multiples fall from the 'speculative', 'irrational' bubble top and down to 'forgotten' and 'unloved' asset classes.

Rather than concoct a theory such as the EMH to prove the basis of index investing 'at any time' I would rather base my judgement on history and the movement of the valuation of the market over time.

I suggest the CAPE as the best measure. Europe is close to bottoming, however P/E's can stay low for years- 

http://valuestockinquisition.files.wordpress.com/2011/09/sg-europe-pe.png

The US is nowhere near regressing from the largest bubble in history of 2000- 

http://www.theblakeleygroup.com/wp-content/uploads/2012/06/f2june12.jpg

Economics has moved on from the EMH in which it will give you the only free lunch in investing. 

One should delve into the word of Grantham, Montier et al and the secular cycles theory, bubble theory etc. A whole world of behavioral investment theory that is kicking the EMH into the long grass. 

time to stay defensive in the less volatile and less risk value sectors.


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## Marc (17 Jul 2012)

Ringledman,

Your first link is to the Dow Jones. This is made up of just 30 US stocks and is not even market cap weighted but selected by a committee. This has absolutely no bearing on my arguments which clearly show a range of indexes with positive returns and which you seemingly choose to ignore.

There are 5000 stocks on the NYSE. The Dow therefore isnt a meaningful representation of even the  US market let alone Western indexes. Just because it is widely followed doesn't make it representative.

You can't make a general comment like "western indexes are in a secular bear market" and then submit an index of just 30 stocks as your proof.


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## ringledman (17 Jul 2012)

Marc, 

Take a larger market index like the S&P 500, FTSE MIB, Nikkei or the FTSE All Share, etc, etc. 

They all show the same thing - indices that are grinding sideways and unable to breakthrough their previous highs. P/E multiples are regressing lower from the largest bubble in history in 2000. 

This is fact, there are multiple graphs on the internet showing the relationship between price and value for these indices. When price gets irrationally high then subsequently value regresses until the index bottoms on sub 10-15 times the CAPE. This regression puts pressure on the market price which has to fall or grind sideways until value becomes reasonable again.

The dow has the largest historical record of prices and earnings, hence it best represents the double decade secular bears of the past. 

The Emerging markets have not yet reached P/E multiples high enough since the Asian Crisis of the 90s to signify the top that signifies the end of a secular bull market (India perhaps an exception). On this basis it is possible to say that the emerging markets may still be in a secular bull although there the lack of a long enough time frame of recorded prices and earnings for the indices makes this difficult to prove.

Investing in the mainstream western indexes during a secular bear is a 'probable outcome' (google the book) for extremely poor (sub inflation) total returns.

You have to ask oneself,- 

If the stock market has a historical record of returning approx 7% per annum, why on earth has every western index failed to breakthrough the 2000 high?

Why are we still nowhere near many of these highs? Why are some indexes 50-75% down on the 2000 high?

Why did the indices in the late 60s go on a near 20 year sideways movement? 

Would the Japanese worker in the late 90s have done well after his advisor recommended 'go long' the index?

Long term investing in the Western indexes only works during secular bull markets. Unfortunately many have been blinded by the 80s and 90s secular bull as being the ticket to long term positive returns. 

Long term positive returns comes from investing in markets and companies starting on reasonable valuation metrics. 

Many of the western indices are still not yet back to reasonable valuation metrics despite grinding sideways for over a decade whilst earnings rise at 10%+ to pull the P/E CAPE back down to reality.


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## ringledman (21 Jul 2012)

Marc, you may find the attached of interest. Some new research into the secular cycles -

http://www.crestmontresearch.com/docs/Stock-Matrix-Taxpayer-Real1-11x17.pdf

http://www.crestmontresearch.com/stock-matrix-options/

Essentially showing secular cycles of the S&P 500 including real return (inc dividends, transaction costs, taxes). 

Clearly the USA market has gone through decade or double decade periods of negative returns (the red) followed by decade or double decade 'above average' positive returns (the green).

The P/E ratio column is of interest, essentially showing how when the market bubble and irrational sentiment peaks in P/E terms, the market subsequently falls for the next couple fo decades. 

As can be seen from the horizontal axis, investing into the index during the secular bear takes a rough 20 years to get back towards the 7% average annual return that the financial industry believes to be the typical long term return.

Buying indexes during these secular bears of severe P/E regression downwards is a ticket to negative or very low returns for a very long time.

The P/E in 2000 was the highest on record signifying the 'probable' outcome of further poor returns. 

As can be seen, markets bottom on low P/E values. Certainly lower than at present. 

In my view investing for the next decade is about income over buying the market and trying to ride the next uptrend, which could still be some way off.


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## Marc (21 Jul 2012)

February 23, 2011
Seeking the Perfect Wave

New York Times columnist Jeff Sommer, acknowledging recently that he found himself in a "buoyant mood" due to the steady rise in stock prices, sought out someone with a gloomier assessment of the financial markets to provide a counterweight to what he feared could be excessive optimism.

He turned to Robert Prechter, a veteran market analyst who has published The Elliott Wave Theorist in Gainesville, Georgia, since 1979. As Mr. Sommer reported last week in the Times, Mr. Prechter's investment outlook is "as bleak as an ice storm." Based on his interpretation of cyclical wave patterns that he discerns in both financial markets and "social moods," Mr. Prechter believes the current rally is only a minor upswing within a much larger, longer, and punishing downtrend that will "lead the unwary to ruin."

Market forecasters are often accused of doubletalk, couching their predictions in such convoluted language that they can later claim success regardless of the outcome. At least there is little doubt where Mr. Prechter stands—he sees disaster ahead and has been saying so for quite a long time.

In an earlier interview with the New York Times in July 2010, Mr. Prechter suggested the US stock market had entered a decline of "staggering proportions" that would likely see the Dow Jones Industrial Average—9686 at the time—fall well below 1000 over the next five or six years. Although the Dow has surged over 27% since that time to close at 12391 on February 18, Mr. Prechter is unperturbed and argues that the outlook is "much more dangerous today than it was last summer."

Perhaps Mr. Prechter will be proven right. But if not, he appears to have ample reserves of both patience and conviction. If his grim vision of deflation and depression sounds familiar, it should—he was making similar arguments in his book At the Crest of the Tidal Wave, first published in 1995.

Mr. Prechter has made some prescient market calls in the past—notably in the 1982–1987 bull market—but success since that time has proved more elusive. If only we could determine when to follow the advice of a market soothsayer and when to ignore it, we could be exponentially wealthier. But timing the market timers appears to be no easier than timing the market itself.

Jeff Sommer. "Writing 'Danger' in Ever-Larger Letters," New York Times, February 20, 2011.

Jeff Sommer. "A Market Forecast That Says 'Take Cover'" New York Times, July 3, 2010.

Robert R. Prechter Jr., At the Crest of the Tidal Wave (Gainesville, GA: New Classics Library, 1995).


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## Marc (21 Jul 2012)

It's a difficult pill for many of us to swallow, but sooner or later we need to realise that the biggest obstacle to enjoying investment success often is not the market itself, but our own behaviour.

This tough lesson about investment is never more important than in the volatile markets we have seen in recent years. It is at these times, more than any other, that people tend to make dumb mistakes.

Those mistakes include neglecting to diversify, failing to track expenses and ducking in and out of the market in counter-productive attempts to miss the worst of the losses and capture the sweet spot in the rebound.

The fact is that as fallible human beings we tend to over-rate our own abilities and imagine that we can see things that others can't. In an extremely competitive arena such as the financial markets, this can be ruinous.

Just how ruinous poor individual judgement can be to your financial health is revealed in an annually updated quantitative analysis of investor behaviour by the US financial services research group Dalbar.

These surveys find that returns are far more dependent on investor behaviour than on fund performance and that most fund investors who buy and hold typically earn higher returns than those who try to time the market.

Dalbar concludes that investor returns are markedly different from the returns promoted by fund managers because most people try to time their entry and exit points—and often get it wrong. Secondly, the holding periods of individual investors tend to be shorter than those of fund managers.

Interestingly, they find *that investors are more likely to make 'correct' timing decisions when the market is going up. Correspondingly, they are more likely to mess things up when the market is down.

In other words, most people fail to exercise patience in tough markets. The consequence is they fail to secure the rewards available to them.

It seems that you really can be your own worst enemy.


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## ringledman (23 Jul 2012)




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## ringledman (23 Jul 2012)

http://www.crestmontresearch.com/docs/Stock-Secular-PE.pdf

Marc you can't hide from the facts. The empirical evidence is clear. 2000 was the largest stock market bubble in history (excluding the Nikkei in 1990).

You suddenly expect the market to grow when the 1980s-90s bull market produced double digit annual growth (i.e. way above the average long term return of approx 7%).

Are you suggesting that we have entered a new age of above average growth? This must be the case if you don't believe or are willing to view the evidence that markets move in secular cycles from above average growth for a number of years to below average growth for a number of years. 

Are things different this time? Would you buy a market at any price? I assume that with hindsight you still believe that buying the NASDAQ, S&P, FTSE All share, MIB in 2000 would have been a good idea? How about the Nikkei, has this been a good return over the last 22 years?

Market can spend decades in the dolldrums and do so.

We are in a price to earnings regression stage as has occured on every occassion after a major bull market. On every occassion stock indicies have produced extremely poor returns. There is no hiding from this fact. 

It is a fact that markets bottom on single to low double digit P/Es. It is a fact that the market (particularly the USA market) is still in high double digit territory. The USA market is only now, some 12 years since the secular bear started at a valuation level upon which most secular bull markets peak. 

Based upon history, a new bull market is a near on impossibility at this level.

For the market to suddenly rise at a decent rate (say the typical 7%) would both defy economic history and defy logic in that the stockmarket would be entering a new era of significantly above average growth for the past few decades. 

Possible, but highly unlikely.

Market timing has little to do with it. I am still mostly invested in the stockmarket. Very little is in the Western indicies (exception small allocation in Japan and Europe). 

The next 5 to 10 years will be about dividend return (value, solid dividend growth and cover) over capital appreciation from overvalued growth heavy indicies.


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## Monksfield (24 Jul 2012)

I think the key to returns going forward will be what happens with inflation. Bond markets are suggesting that inflation is definitely not a problem but the classic policy response to a debt crisis is to engineer inflation.

Attempts so far have not worked but they will keep trying. If inflation picks up and is sustained I would not like to be owning bonds. Inflation is less bad for equities.

As for the debate about indices I agree (for once) with Marc - the Dow is a very unsatisfactory point of reference. It is an indictment of financial journalists that it is still in use.


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## Rory Gillen (20 Aug 2012)

*Absolute Return Funds*

I tend to side mostly with Marc in this debate. You either buy a business (equity), a property or a fixed interest instrument (bond) or you buy a combination of them in some proportion that suits your risk tolerance.

Value matters as it is the value you buy that delivers the subsequent medium to long-term returns. In that regard, Riggledman's point that the US market remains overvalued relative to history is an accurate one. On the other hand, many of the world's equity markets offer good value at present. The problem is that risks remain above average. Defining those risks is hellish.

Equities and property depend on a healthy economic backdrop. In contrast, hedge and absolute return funds are not dependent on the economic backdrop, so they can generate returns that are uncorrelated to equities and property. But they do not come with a guarantee of that. Strategies employed in hedge and absolute return funds vary but are risky too and my own analysis has found that the hedge and absolute return fund universe has not been able to add much value since 2002. Equities in the developed world have been disappointing in the 2000s but that can be largely explained by the fact that they were grossly overvalued in the late 1990s.

In my view, the Irish private investor's switch to hedge/absolute return funds (such as the Standard Life Gars Fund and others) is a dangerous one. What assets does this or other such funds own (no transparency)? are they trading or speculating in markets - which carries much higher risk - (most likely)? can they repeat the returns from here (no one knows)? 

At the end of the day, returns come from owning assets, not trading them. Over the past 100 years, equities have delivered 9-10% annual returns (before costs and assuming dividends were reinvested). By definition, hedge and absolute return funds must generate less (trading costs, derivative costs and higher than average fund management fees). So what's the appeal - Less volatility? But volatility is not risk!

My conclusion is that they have attracted appeal because the industry is full of sellers and can sell this product at this point in time. But this asset class (hedge & absolute return strategies) carries an above average probability of disappointing investors, who by and large haven't a clue what they are buying. Of course, a large part of the investment intermediary market doesn't know either. But sure what the hell....they get paid by the insuarnce company or bank to sell them!

Rory Gillen
Founder
GillenMarkets.com


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## Monksfield (21 Aug 2012)

*Equity value*

The evidence is that most equity markets are not actually that cheap relative to Shiller PE and accepting that earnings relative to GDP are on high ground. However the classical measure of value is DCF and whatever measure of risk-free rate one would use to discount even a reduced level of dividends going forward would strongly support the valuation of equities.

They may not be cheap relative to their own historical valuations but using most of the discount rates which might be put forward (I dont know what the risk-free rate is any more) you find yourself coming back to equities. Plus there is the superior if imperfect inflation- hedging characteristic.

By the way no post mentioning the EMH or Eugene Fama lately - is there no internet access wherever Marc is holidaying?


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## Complainer (21 Aug 2012)

Marc said:


> The following article was written by Larry Swedroe on his CBS Money blog and has not been edited at all. Irish investors should note that arguments relating to internal fund taxation relating to long term and short term capital gains tax distributions is not relevant from an Irish taxation perspective.
> 
> 
> 
> ...



Is the material copyright?


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## Rory Gillen (23 Aug 2012)

EMH and Fama hypotheses have been de-bunked years ago. They forgot to include human psychology, which of course is completely irrational at the extremes creating many anomolies in valuations.


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## Monksfield (24 Aug 2012)

EMH and Fama hypotheses have been de-bunked years ago. They forgot to include human psychology, which of course is completely irrational at the extremes creating many anomolies in valuations. 

Marc hasn't been persuaded !


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## Rory Gillen (24 Aug 2012)

Buffett says it best;

'The markets are efficient most of the time but the EMH brigade take it a step too far when they suggest it is efficient all the time'.

Nonetheless, supporters of EMH claim that excess returns reflect excess risk. The trouble with this rationale is they define risk as volatility, which of course it is not.

_The mice will play while the cat is away, and no doubt we'll pay later for our cheek!_


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## ringledman (25 Aug 2012)

I like Howard Marks objective view on the subject in his excellent book.

[broken link removed]

A theory that works in practice on occassions but is not the be all and end all theory to invest by. 

Efficient in terms of _'speedy, quick to incorporate information'_ but not _'right'_.


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## Rory Gillen (26 Aug 2012)

Yes, Howard Marks is an exceptional thinker, communicator and investor. He humbles most of us.


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## PMU (3 Sep 2012)

Surely the objective in buying an absolute return fund or funds is to obtain returns with low or no correlation with the returns of the major asset classes that comprise your portfolio, i.e to introduce an uncorrelated alpha strategy to the conventional relative return strategies.  So you are primarily expecting a diversification benefit rather then significant capital growth.   
  The fact that e.g the SL GARS returns can be mimicked (post #4) is somewhat irrelevant unless we know the correlation of these returns with those of the major asset classes. (A more interesting challenge would be to simulate the GARS performance target (and not the GARS returns) with a long only portfolio and to do this with a low or negative correlation to major asset classes.)   Correlation is the major issue here as there is little point buying an AR fund if it marches in step with major asset classes, i.e. does not provide a diversification benefit. 
  The main problem I see with GARS and equivalent AR products is that there  is a lot of information available on targets, performance and volatility but I’ve yet to see any info on how returns are correlated or not correlated with the returns of the other  asset classes that typically make up your portfolio (i.e. euro developed market equities; foreign developed market equities, emerging market equities, etc.).  This makes it difficult to decide what % of a portfolio to allocate to AR funds.   This is  particularly important today as from what I can see Irish financial advisers are currently plugging AR funds as a ‘holy grail’ or investing, suggesting significant allocation to AR funds. 
  One way to decide on a possible allocation to AR funds would be to clone the allocations of others.    The NTMA in its annual report 2011 ([broken link removed])  says that 3.1% of the discretionary portfolio of the National Pensions Reserve Fund is invested in AR funds and David Swensen’s Yale Endowment Fund ([broken link removed]) invests 17.5%. So an IE retail investor it’s probably somewhere between these two allocations, and you would need to question a higher allocation. [Disclaimer: The above is comment / observation and is not a recommendation to follow any particular investment strategy or to buy / not buy any particular fund or stock.]


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## Marc (3 Sep 2012)

PMU

In another post I pointed out that GARS has a .63 correlation with Standard life's own European Corporate Bond fund. 

When I tested it against a simple 60 40 bond equity long only strategy I got extremely close results.

We can therefore conclude that much of the underlying returns are being driven by net exposure to the underlying asset classes.


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## offiah (10 Sep 2012)

Standard Life are more than happy to give correlation data to investors in the fund.
Marc over what period did you test your long only strategy?
Rory Standad Life are very transparent with the assets the fund holds, with the funds turnover low.
GARS aims to deliver cash +5% after the impact of the funds trading expenses


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## Monksfield (10 Sep 2012)

The correlation of GARS with Global Equities has typically been measured at 0.5-0.55. .


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## Rory Gillen (11 Sep 2012)

Absolute Return Funds (and hedge funds) cannot generate returns similar to equities in the long run. That equities have been a poor place to be this past 13 years simply reflects gross overvaluation to start with, and comments about a secular bear market are fair but apply solely to the US - the Eurozone markets are most likely now at their secular low, as is Japan.

I would be on Marc's side in this debate (although I too find the language hard to digest). The stated objective of an Absolute Return Fund, in its truest sense, which I feel Marc captures correctly, is to deliver positive returns each year. You cannot achieve that with risk assets - returns are volatile and that is that. So absolute return funds or hedge funds must exploit other areas of risk such as being long & short or using derivatives to limit or protect the downside. But, as far as I am aware, there is no other risk asset or strategy that has been shown to have delivered the same amount of risk premium as equities, when equities are fairly or averagely valued. As I outlined in a separate piece elsewhere in this section of askaboutmoney, equities have delivered an annual return of 9-10% before costs over the past 100 years. That is some 5-6% above the returns from the risk free alternative - long-dated govrnment bonds. That premium return is referred to as the risk premium. Going long a curency with a high interest rate, and short a currency with a low interest rate has over the years provided a risk premium, to mine and many others' surprise. Equally, going long markets, currencies or other financial instruments that are trending upwards and shorting the opposite has also delivered a risk premium. But none have come close to owning simple equities, at least not without the use of debt.

Hence, the ongoing 9% annual return of the GARS fund is unusual and needs to be understood if one is to either advise a client to buy it or to simply buy it yourself. Marc's observation I think is most relevant here - perhaps the GARS fund is simple benefiting from the boom in long-dated bond prices i.e. it is overweight bonds. That would make it a simple managed fund. But, of course, I can't say that for sure. Either that or it is employing leverage to boost returns and that entails much greater risk. As is probably obvious to us all in this debate, it is pretty hard to look under the bonnet of these funds. If even experiencd practicioners can't see exactly what they are about, then they are opaque and should form only a small part of a risk asset portfolio.

In my travels, I have seen clients with 70% of their pension in such funds. That is naive on the part of the advisor and downright dangerous for the investor.

*Rory Gillen*


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## offiah (12 Sep 2012)

Monksfield you are correct that the monthly correlation of GARS and the MSCI world index in euro is c0.55 however when you use the weekly correlation data the correlation falls to 0.33. 

Rory, only time will tell if absolute return funds can generate long run equity returns. However over the last 6+ years it has. As you state the real return on equities over the long run is 5%. So if an absolute return fund can achieve cash +5% returns then that is the equivalent of this. 
The key for GARS is that it is a diversified fund that is actively managed so it can benefit from returns from a number of strategies in bond markets, credit markets, currencies ad equity markets (including volatility of equities). 
It is actually very easy to look under the bonnet of GARS as the manager is very transparent. Have you made an effort to look at this fund or any absolute fund in details?


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## Rory Gillen (12 Sep 2012)

No I have not examined the fund but I am looking at covering unit-linked funds in general on my website possibly before the end of the year.

My point is that there is no strategy yet uncovered that has been shown to deliver the same risk premium as equities. So whatever GARS is doing is either acting as a closet managed fund (that's grand) and in which case if bonds suffer a sell off to more normal yield levels we will see poor performance. It cannot be an equity fund as the returns are smooth. If it is using derivatives to smooth the returns, fine but that costs so in the medium term the fund will not match the 5% risk premium. Maybe its gearing or leverage. Timing the switch between asset classes perhaps? I doubt that. None of the recognised successful investors has claimed they got outperformance through trading markets (or asset classes). 

So I come back to Marc's point - if it is indeed an absolute return fund, then it will not continue to deliver the returns of the past. That said, a 4-5% annual straight line return might be acceptable also. But that leaves little for marketing and distribution costs. Maybe it's a first class fund manager, and good luck to Standard Life if that is the case, and they deserve to trap the business. 

*Rory*


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## Dave Vanian (14 Sep 2012)

Rory Gillen said:


> No I have not examined the fund...


 
Seems a bit Irish - participating in a critique of a fund that you have not actually examined.


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## Marc (17 Sep 2012)

Interestingly I have looked at the day by day movements of GARs since launch and a key day in it's history was the 20th October 2008.

Between the 20th and 25th Gars appreciated by more than 4% at the same time a comparable 40% risk portfolio declined by nearly 4%. This difference over just a few days explains much of the overall perfornance of GARS over it's entire life. (a cumulative difference of 8.39% since launch compared to the 40% risk strategy)

[broken link removed]


It seems plausible that GARS was just lucky on these few days and bet the right way. The excess return of around 8% represents the full amount of excess return earned by GARS over the whole period of it's existence. Distinguishing luck from skill isn't easy, but surely if there was real skill at work here, we should have seen other examples subsequently - but we haven't.

This view is more credible when we look at the return over the period since the 1st December 2008 where no clear advantage has been demonstrated against the same strategy.

[broken link removed]

I conclude that GARS had a lucky week or so in October 2008 and this hasn't been repeated since, yet the marketing materials continue to bang the same drum. 

Think about this for a moment. How big was GARS in October 2008? How much money was invested then? (note in Jan 2009 it was €975M source Standard life) How big is it now? (€2.256BN source Standard Life as at the end of July 2012) How many people have bought in after October 2008 convinced that they are buying real skill? How few people really benefited from that good period?


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## Dave Vanian (17 Sep 2012)

Marc said:


> I conclude that GARS had a lucky week or so in October 2008 and this hasn't been repeated since, yet the marketing materials continue to bang the same drum.


 
Your conclusion is deeply flawed.    

Take, for example, the 12 months to end July 2012, which had nothing to do with the few days in 2008 you've looked at above.  

GARS performance: +9.79%
Six-month EURIBOR +1.64% (the GARS cash benchmark)
Average Irish Balanced Managed Fund: +9.6%

So in that year the GARS fund outperformed the average of the ten main Irish Balanced Managed Funds but with lower volatility.  

Was that luck too?


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## Dave Vanian (17 Sep 2012)

Out of curiosity, which of the Goldcore target portfolios would you consider to be a suitable alternative for GARS?


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## Monksfield (17 Sep 2012)

Marc - are you allowing for the fact that unit prices on a given day may reflect prices from the day before?

While the pricing of unit-linked funds does not have the transparency we would all like I doubt that the GARS record in that week is anything other than a fair reflection of its performance. As for luck sometimes chunks of cash come into funds at fortuitous times and if one of those happened to a day or days of high volatility the element of luck could have played a part. However as Dave points out the fund has hit its performance target since so hats off to them.

As for the size the GARS strategy is running closer to *€20 BILLION* now.They now claim that they could run the strategy at several times the current size.


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## offiah (17 Sep 2012)

Marc the GARS fund has been available to retail investors in Ireland since September 2008 however it was available to institutional investors in May of that year. All this data is in FinEx. The fund was available to UK institutional investor in June of 2006, over 6 years worth of data.


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## Marc (17 Sep 2012)

> Was that luck too?


No that was *risk*. Let me explain.

Firstly, Gars uses 6 month Euribor as its benchmark. With current low interest rates this is like me saying I've done well because I beat leaving my cash in the attic. Equally short term Euribor is considerably less volatile than Gars. This is simply bad benchmarking on their part. I'd accept 5 years Gilts or similar as a relevant benchmark for GARs.

All that matters is how has it performed compared to a strategy which took a similar level of risk - like this comparison for example which looks pretty similar to me:

[broken link removed]


Secondly, you compare with an average Balanced managed fund over 1 year. Again bad benchmarking. Despite the name, a typical balanced managed fund had 60 to 70% risk exposure whereas Gars is running at more like 40% net exposure.

Finally, you ask which strategy I would consider to be a suitable alternative to GARS and here you have really hit the nail on the head - exceptional work.

Unlike a single one size fits all strategy I believe that the role of a financial planner is to match an investor to the portfolio of investments that best meets their need, willingness and capacity for risk. I can create an infinite number of efficient portfolios for any particular need of any client and exactly match their requirements. GARS or any other packaged product picked off the financial services shelf cannot do that. That's the difference between selling products and matching investors to portfolios.


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## offiah (24 Sep 2012)

6 month Euribor is the benchmark as the fund is looking to get a positive return and beat inflation, however inflation is not priced daily, Euribor is. Cash should and will beat inflation in the long run. Interest rates are currently low but they won't be forever. 5 year gilts or bunds is not a good benchmark for this fund as they will not always be positive!
I think you are looking at GARS over far too short a time period on FinEx (only 4 years). The fund has been running for over 6 years in the UK and that takes in the good period of 2006 and 2007' as well as the equity market sell off fr summer of 2007 to March 2009 and the bull market to today. When taken in this context it has delivered on performance and very importantly kept the funds volatility to about a half to a third the vol of equity markets. 
I agree with you on investors risk tolerance, this is where the regulator is moving advise to. GARS will not suit all investors but it suits most as it has shown that it can deliver equity like returns thru the most volatile of markets and keep volayility at c6%.


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## Marc (25 Sep 2012)

But 6 month Euribor doesn't have the same risk using your own target for volatility.  

The mean annualised volatility of 6 month Euribor over the last decade has been 0.37% yet your target is 6%. This is an apples and oranges comparison which flatters the results for GARS. 

Remember risk and expected returns are related. GARS took more risk and did better. But it is bad benchmarking to compare GARS to EURIBOR and claim a victory.

If you want to target beating inflation then why not just buy inflation linked gilts?

*UK Institutional Class GARS vs Barclays UK Government Inflation Linked Gilts (5-15 years)  July 2006 to August 2012.*(source Bloomberg)

GARS Average annual return 7.94%pa
UK Inflation Linked Gilts  8.27%pa


You say 





> 5 year gilts or bunds is not a good benchmark for this fund as they will not always be positive!


But this suggests and implies that GARS is *ALWAYS POSITIVE* which just isn't true.

Worst 1 year return
GARS -7.83% (11/07 - 10/08)
GILTs -7.58% (12/07 - 11/08)

I can buy the inflation linked GILT strategy for 0.15%pa - why anyone would pay GARS fees is beyond me.


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## peterr89 (26 Sep 2012)

think the key to returns going forward will be what happens with  inflation. Bond markets are suggesting that inflation is definitely not a  problem but the classic policy response to a debt crisis is to engineer  inflation.


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## Marc (16 Nov 2012)

http://www.sensibleinvesting.tv/Default.aspx


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