When diversification doesn’t work

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JBTX
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When diversification doesn’t work

Post by JBTX » Sat Feb 03, 2018 9:09 pm

First of all I could care less if the market goes down 2% in a week.

But I do find it interesting that seemingly everything went down last week. Stocks. International stocks. Bonds. Commodities. Where did it all go, cash?

Soon2BXProgrammer
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Re: When diversification doesn’t work

Post by Soon2BXProgrammer » Sat Feb 03, 2018 9:11 pm

JBTX wrote:
Sat Feb 03, 2018 9:09 pm
First of all I could care less if the market goes down 2% in a week.

But I do find it interesting that seemingly everything went down last week. Stocks. International stocks. Bonds. Commodities. Where did it all go, cash?
actually... it can just "disappear"...

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nedsaid
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Re: When diversification doesn’t work

Post by nedsaid » Sat Feb 03, 2018 9:25 pm

JBTX wrote:
Sat Feb 03, 2018 9:09 pm
First of all I could care less if the market goes down 2% in a week.

But I do find it interesting that seemingly everything went down last week. Stocks. International stocks. Bonds. Commodities. Where did it all go, cash?
This sometimes happens where everything seems to go down at the same time. In the short run, just about anything can happen. What happened last week is that the market got grouchy, it reacts to bad news and doesn't respond to good news that is out there. There were more sellers placing orders than buyers and prices had to drop enough to where buyers were willing to step in and buy. You could say that market value just evaporated. When your house goes up in value, it isn't because somebody drives up in a truck and sticks money in your mail slot. It is a matter of an increase in the perception of value by all the participants in the real estate market.
A fool and his money are good for business.

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Re: When diversification doesn’t work

Post by aristotelian » Sat Feb 03, 2018 9:28 pm

BND went down by 0.8% while stocks were down over 4%. People holding BND weren't jumping for joy, but they were a happier than anyone in 100% stock. That is not to say that diversification guarantees positive performance all the time. Only an annuity does that.

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Re: When diversification doesn’t work

Post by JBTX » Sat Feb 03, 2018 9:37 pm

Interest rates rising and strong wage gains leading to inflationary worries and a stock and bond slide isn’t unusual. But commodities too? Usually they would benefit from inflation worries.

It just gives you the feeling that a lot of money is sloshing around in markets and first hint of bad news investors bail on everything.

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Re: When diversification doesn’t work

Post by nedsaid » Sat Feb 03, 2018 10:03 pm

JBTX wrote:
Sat Feb 03, 2018 9:37 pm
Interest rates rising and strong wage gains leading to inflationary worries and a stock and bond slide isn’t unusual. But commodities too? Usually they would benefit from inflation worries.

It just gives you the feeling that a lot of money is sloshing around in markets and first hint of bad news investors bail on everything.
There is an old saying that when the paddy wagon backs up to the House of Ill Repute, even the piano player gets taken downtown. That is pretty much what happened last week.
A fool and his money are good for business.

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Re: When diversification doesn’t work

Post by heyyou » Sun Feb 04, 2018 12:43 am

There are no sure things nor guarantees on any market components. Risk seems to always be a step ahead of whatever we try to do to avoid it. Often, someone is touting that their product is perfect but history shows that is just a salesperson's pitch. Whatever you learned from the recent event is a good lesson since it was not too expensive.

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Re: When diversification doesn’t work

Post by JoMoney » Sun Feb 04, 2018 5:06 am

JBTX wrote:
Sat Feb 03, 2018 9:09 pm
First of all I could care less if the market goes down 2% in a week.

But I do find it interesting that seemingly everything went down last week. Stocks. International stocks. Bonds. Commodities. Where did it all go, cash?
The money quoted in the market previously never really existed, it was a quotational value people guesstimated at some future point discounted back to present day. If everybody wanted to sell, they couldn't.
When interest rates rise new money invested today is expected to earn a higher rate of return going forward. So any assets purchased in the past based at a lower expected growth/interest rate will be further discounted down to a relatively equivalent present day value.
In the case of bonds, as you get closer to the fixed maturity date any nominal 'losses' will disappear as the bond will have all the initial principal returned. Stocks on the other hand have no maturity date, but their internal growth rate varies, and if that internal rate is now growing faster than previously thought, there's potential for them to catch up faster or to reach the unspecified notional expected return even faster than previously thought.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: When diversification doesn’t work

Post by mjb » Sun Feb 04, 2018 7:49 am

JBTX wrote:
Sat Feb 03, 2018 9:09 pm
But I do find it interesting that seemingly everything went down last week. Stocks. International stocks. Bonds. Commodities. Where did it all go, cash?
A few points. Remember, when we look at all these, we see valuations based on market expectations, not the invested value or the intrinsic value of the asset. While invested value is relatively fixed as a measurable amount of money flowed into assets, the others have many driving variables beyond corporate fundamentals such as investor sentiment and geopolitical effects.

Right now, as U.S. interests rates have risen, cash looks a lot more attractive as an asset on a risk adjusted basis. As all asset classes interact, a drop in bond valuations due to cash can then carry over to bonds looking a little more attractive than stocks right now. As these changes in interest rates have been gradual and planned, the market has been able to adjust rather cleanly, but there may be a few days where all assets move together.

Other drivers are currency fluxuations and international flow of money. These can have a lot of strange effects on a market when viewed in isolation. Cash inflows from the recent tax law, a recently announced new round of tariffs, diverging central bank policies, and strong (and weak) performances by other economies are all adding an unusually high level of uncertainty right now. Not good or bad, just a lot more happening than normal.

My only comment is expect more noise over the coming months. I don't know the outcomes, but many of the current events all contribute to additional noise in the markets.

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Re: When diversification doesn’t work

Post by Call_Me_Op » Sun Feb 04, 2018 8:00 am

Soon2BXProgrammer wrote:
Sat Feb 03, 2018 9:11 pm
JBTX wrote:
Sat Feb 03, 2018 9:09 pm
First of all I could care less if the market goes down 2% in a week.

But I do find it interesting that seemingly everything went down last week. Stocks. International stocks. Bonds. Commodities. Where did it all go, cash?
actually... it can just "disappear"...
Exactly. It is not a zero sum game. If I hold a share of stock worth $50 that was worth $100 yesterday, the ($50) difference has vanished into thin air.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

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Re: When diversification doesn’t work

Post by BuyAndHoldOn » Sun Feb 04, 2018 8:40 am

I had been putting cash to work this month, when suddenly I realized: Maybe cash is the only stable thing at this moment :confused

Some of the shortest of the short term bonds I bought didn't go down much, however. I just wish I hadn't been buying so much earlier in the month! And most of it was bonds!


With Regard To commodities benefiting from higher inflation expectations [and I know many here know this]:

Commodity Futures contracts are traded in a liquid market. They are subject to speculation, and that helps "make a market" for the legitimate hedgers (i.e., actual producers and users of commodities). That means the "price" of a commodity, via its futures contract, can be subject to wide swings and volatility.

[my understanding is] The way to use commodities to hedge against inflation is to own the actual underlying commodity, not a contract that expires in X months. The contract locks in the buy/sell price: it doesn't set you up for anything other than a cash settlement one time, without "rolling it". (Or you could have an actual exchange of the commodity at settlement, but that is quite different).

Google: Backwardation, Contango, Roll Yield
Last edited by BuyAndHoldOn on Sun Feb 04, 2018 8:56 am, edited 3 times in total.

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Re: When diversification doesn’t work

Post by bberris » Sun Feb 04, 2018 8:48 am

JBTX wrote:
Sat Feb 03, 2018 9:09 pm
First of all I could care less if the market goes down 2% in a week.

But I do find it interesting that seemingly everything went down last week. Stocks. International stocks. Bonds. Commodities. Where did it all go, cash?
I think you need to lower your standards for the word "work".

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Re: When diversification doesn’t work

Post by fortyofforty » Sun Feb 04, 2018 8:52 am

The difference between valuing your house and valuing a stock is the fact that your house is, truly, unique. Valuing it is, at best, an estimate based on numerous factors, until the day you put it on the market. Then, supply and demand will tell you the value: the price for which it sells.

A share of stock is fungible and readily traded. The value of a share of stock while it is being actively traded is known, to the penny, at any point in time. The same is true for bonds, more or less. Thus, the value of a portfolio of stocks and bonds can be known to within a few cents.

It is inaccurate to claim that stocks cannot be accurately valued. They are constantly being bought and sold, and the bid and ask prices are publicly available. If a stock drops from $100 to $50, those are the actual prices in play (with the bid and ask factored in). Yesterday somebody was offering you $100 for each of your shares, and today they are only willing to pay you $50. If you aren't willing to sell, somebody else will, until supply meets demand. If everybody wants to sell at any cost, the price will fall to zero, which isn't realistic, but it can get close enough to be nearly worthless.
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Re: When diversification doesn’t work

Post by dbr » Sun Feb 04, 2018 8:59 am

Call_Me_Op wrote:
Sun Feb 04, 2018 8:00 am
Soon2BXProgrammer wrote:
Sat Feb 03, 2018 9:11 pm
JBTX wrote:
Sat Feb 03, 2018 9:09 pm
First of all I could care less if the market goes down 2% in a week.

But I do find it interesting that seemingly everything went down last week. Stocks. International stocks. Bonds. Commodities. Where did it all go, cash?
actually... it can just "disappear"...
Exactly. It is not a zero sum game. If I hold a share of stock worth $50 that was worth $100 yesterday, the ($50) difference has vanished into thin air.
Yes, two or three responses have correctly pointed out that assets in a market can simply disappear. A different way to say that, though, is that no money want anywhere because those market assets are not money.

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Re: When diversification doesn’t work

Post by staythecourse » Sun Feb 04, 2018 9:14 am

JBTX wrote:
Sat Feb 03, 2018 9:09 pm
First of all I could care less if the market goes down 2% in a week.

But I do find it interesting that seemingly everything went down last week. Stocks. International stocks. Bonds. Commodities. Where did it all go, cash?
I never understood comments like this. Diversification DID work. Did everything go down the same amount? Nope. Some more then others. That means the weighted average of a combo. of stocks/ bonds/commodities fell less then 100% stocks. That is diversification. What you are asking about is NOT diversification, but thinking some of those assets are guarantees as HEDGES. There is a difference between diversifiers and hedgers. Diversifiers are not perfectly correlated (sometimes zig while others zag) and hedgers are those that go up when another (usually stocks) go down. Of course, hedgers is the ideal to add to a stock portfolio, but there really isn't a guaranteed hedge asset classes out there. SOMETIMES cash, LTGB, gold fit this criteria, but no guarantee. Campbell and Harvey had a great article awhile ago re: gold in this respect. They looked at some 30+ years of data of SP500 and gold returns and found gold went up and down about 50% of the time stocks went down. Not a guarantee hedger, but more guess without crunching the data is that cash, LTGB, and gold are much better as hedgers when stocks fall a lot (>10% or >20%).

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: When diversification doesn’t work

Post by dbr » Sun Feb 04, 2018 9:18 am

staythecourse wrote:
Sun Feb 04, 2018 9:14 am
JBTX wrote:
Sat Feb 03, 2018 9:09 pm
First of all I could care less if the market goes down 2% in a week.

But I do find it interesting that seemingly everything went down last week. Stocks. International stocks. Bonds. Commodities. Where did it all go, cash?
I never understood comments like this. Diversification DID work. Did everything go down the same amount? Nope. Some more then others. That means the weighted average of a combo. of stocks/ bonds/commodities fell less then 100% stocks. That is diversification. What you are asking about is NOT diversification, but thinking some of those assets are guarantees as HEDGES. There is a difference between diversifiers and hedgers. Diversifiers are not perfectly correlated (sometimes zig while others zag) and hedgers are those that go up when another (usually stocks) go down. Of course, hedgers is the ideal to add to a stock portfolio, but there really isn't a guaranteed hedge asset classes out there. SOMETIMES cash, LTGB, gold fit this criteria, but no guarantee. Campbell and Harvey had a great article awhile ago re: gold in this respect. They looked at some 30+ years of data of SP500 and gold returns and found gold went up and down about 50% of the time stocks went down. Not a guarantee hedger, but more guess without crunching the data is that cash, LTGB, and gold are much better as hedgers when stocks fall a lot (>10% or >20%).

Good luck.
Great explanation. Good emphasis that a hedge needs to be designed to make you whole. That is, not only go up when the other is down but go up as much as the other goes down. "Normal" investors don't own hedges in that specific sense.

What you are talking about is that assets that are on average uncorrelated can still all move in the same direction at the same time. The fact that variability exists implies odds of that happening from time to time.

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Re: When diversification doesn’t work

Post by Alexa9 » Sun Feb 04, 2018 9:26 am

Impossible to tell whether it's a temporary blip or a falling knife. They can't go up forever. Maybe you should use some CD's in your portfolio. Many people have been advocating them instead of or in conjunction with bonds.

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Re: When diversification doesn’t work

Post by cherijoh » Sun Feb 04, 2018 9:44 am

bberris wrote:
Sun Feb 04, 2018 8:48 am
JBTX wrote:
Sat Feb 03, 2018 9:09 pm
First of all I could care less if the market goes down 2% in a week.

But I do find it interesting that seemingly everything went down last week. Stocks. International stocks. Bonds. Commodities. Where did it all go, cash?
I think you need to lower your standards for the word "work".
+1
Diversification is based on different asset classes having historically low correlations (or better yet inverse correlations) over time and a wide range of market conditions. Daily movements are mostly noise so diversifaction hardly comes into play. Drawing conclusions based on 1 day of trading is folly IMO.

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Re: When diversification doesn’t work

Post by Iliketoridemybike » Sun Feb 04, 2018 9:55 am

Floating rate bonds were actually UP. So not every baby went out with the bath water.

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Re: When diversification doesn’t work

Post by JBTX » Sun Feb 04, 2018 10:43 am

BuyAndHoldOn wrote:
Sun Feb 04, 2018 8:40 am
I had been putting cash to work this month, when suddenly I realized: Maybe cash is the only stable thing at this moment :confused

Some of the shortest of the short term bonds I bought didn't go down much, however. I just wish I hadn't been buying so much earlier in the month! And most of it was bonds!


With Regard To commodities benefiting from higher inflation expectations [and I know many here know this]:

Commodity Futures contracts are traded in a liquid market. They are subject to speculation, and that helps "make a market" for the legitimate hedgers (i.e., actual producers and users of commodities). That means the "price" of a commodity, via its futures contract, can be subject to wide swings and volatility.

[my understanding is] The way to use commodities to hedge against inflation is to own the actual underlying commodity, not a contract that expires in X months. The contract locks in the buy/sell price: it doesn't set you up for anything other than a cash settlement one time, without "rolling it". (Or you could have an actual exchange of the commodity at settlement, but that is quite different).



Google: Backwardation, Contango, Roll Yield
Fair point. I had read an article years ago that explained why returns of certain “perishable”’commodities futures / funds can badly lag the underlying spot prices. It really is more of an issue in farm commodities and oil. Not so much commodities you can hold like gold or silver.

As I understood it when the future contract approached expiration traders have to liquidate their future position in order not to take delivery. This is where traders tended to eat the lunch of hedgers as the spreads between futures and spot prices could vary significantly.

Having said all that gold and silver went down too and I don’t think they materially suffer from backward action and contango. But I’m not an expert on the subject.

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Re: When diversification doesn’t work

Post by dbr » Sun Feb 04, 2018 10:52 am

Don't forget that an investment that has a hedge against a certain risk (example: TIPS and inflation) is hardly an investment that hedges the entirety of a portfolio against that risk just by being present in some proportion. True hedges are hard to come by and expensive.

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Re: When diversification doesn’t work

Post by JBTX » Sun Feb 04, 2018 10:55 am

staythecourse wrote:
Sun Feb 04, 2018 9:14 am
JBTX wrote:
Sat Feb 03, 2018 9:09 pm
First of all I could care less if the market goes down 2% in a week.

But I do find it interesting that seemingly everything went down last week. Stocks. International stocks. Bonds. Commodities. Where did it all go, cash?
I never understood comments like this. Diversification DID work. Did everything go down the same amount? Nope. Some more then others. That means the weighted average of a combo. of stocks/ bonds/commodities fell less then 100% stocks. That is diversification. What you are asking about is NOT diversification, but thinking some of those assets are guarantees as HEDGES. There is a difference between diversifiers and hedgers. Diversifiers are not perfectly correlated (sometimes zig while others zag) and hedgers are those that go up when another (usually stocks) go down. Of course, hedgers is the ideal to add to a stock portfolio, but there really isn't a guaranteed hedge asset classes out there. SOMETIMES cash, LTGB, gold fit this criteria, but no guarantee. Campbell and Harvey had a great article awhile ago re: gold in this respect. They looked at some 30+ years of data of SP500 and gold returns and found gold went up and down about 50% of the time stocks went down. Not a guarantee hedger, but more guess without crunching the data is that cash, LTGB, and gold are much better as hedgers when stocks fall a lot (>10% or >20%).

Good luck.
Good points on differences of hedging and diversification.

BTW I actually had Campbell Harvey (one person) for investment and portfolio analysis class 30 hears ago. It may have been the first year he taught. I saw his article on gold years ago. Great article. My recollection is one of his assertions was gold is overrated as an inflation hedge.
Last edited by JBTX on Sun Feb 04, 2018 11:04 am, edited 1 time in total.

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Re: When diversification doesn’t work

Post by JBTX » Sun Feb 04, 2018 11:03 am

dbr wrote:
Sun Feb 04, 2018 8:59 am
Call_Me_Op wrote:
Sun Feb 04, 2018 8:00 am
Soon2BXProgrammer wrote:
Sat Feb 03, 2018 9:11 pm
JBTX wrote:
Sat Feb 03, 2018 9:09 pm
First of all I could care less if the market goes down 2% in a week.

But I do find it interesting that seemingly everything went down last week. Stocks. International stocks. Bonds. Commodities. Where did it all go, cash?
actually... it can just "disappear"...
Exactly. It is not a zero sum game. If I hold a share of stock worth $50 that was worth $100 yesterday, the ($50) difference has vanished into thin air.
Yes, two or three responses have correctly pointed out that assets in a market can simply disappear. A different way to say that, though, is that no money want anywhere because those market assets are not money.
True. In theory on one day just a few people could trade stocks at much lower prices and the markets go down. It isn’t as if all the money flees the market.

Nevertheless what you typically see when some asset classes go down are other asset classes going up.

In recent years stocks and bonds have had low or even negative correlations at times, at least in the short term. My concern is that going forward they will be more highly correlated due to rising interest rates. Longer term they are more correlated as the both are heavily influenenced by interest rates.

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Re: When diversification doesn’t work

Post by staythecourse » Sun Feb 04, 2018 11:16 am

JBTX wrote:
Sun Feb 04, 2018 10:55 am

BTW I actually had Campbell Harvey (one person) for investment and portfolio analysis class 30 hears ago. It may have been the first year he taught. I saw his article on gold years ago. Great article. My recollection is one of his assertions was gold is overrated as an inflation hedge.
That's cool. My bad I think I am thinking of not only him (Harvey), but his coauthor on many of his articles. Think it is ?Erb?

I don't remember the finer points of the article on gold, but do agree it is the best one I have read on gold to this day. I do remember Vanguard's paper on unexpected inflation hedges and they mentioned a small improvement in adding gold in times of UNexpected inflation. Don't think it was any better then TIPS though (if I remember correct).

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: When diversification doesn’t work

Post by JBTX » Sun Feb 04, 2018 11:28 am

staythecourse wrote:
Sun Feb 04, 2018 11:16 am
JBTX wrote:
Sun Feb 04, 2018 10:55 am

BTW I actually had Campbell Harvey (one person) for investment and portfolio analysis class 30 hears ago. It may have been the first year he taught. I saw his article on gold years ago. Great article. My recollection is one of his assertions was gold is overrated as an inflation hedge.
That's cool. My bad I think I am thinking of not only him (Harvey), but his coauthor on many of his articles. Think it is ?Erb?

I don't remember the finer points of the article on gold, but do agree it is the best one I have read on gold to this day. I do remember Vanguard's paper on unexpected inflation hedges and they mentioned a small improvement in adding gold in times of UNexpected inflation. Don't think it was any better then TIPS though (if I remember correct).

Good luck.
Oddly enough the semester before I was going to take the class but dropped after a few days to change my schedule. The guy who taught that class was Robert Whaley, who some years later created the “VIX”

I had some great professors. Too bad the were wasted on the likes of me. :P

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Re: When diversification doesn’t work

Post by dbr » Sun Feb 04, 2018 11:31 am

A comment on money "disappearing": The idea is that these investments are not money. A person with money can give that money to a person with a holding and now the person that had the holding will have the money and the first person will have the holding and not the money. But the money is not in the market; it is/was in the possession of the people making the trade. What is in in the market is assets that have a value, but that value is artificial. The definition is that all shares of a given holding have the value of whatever price the last trade in that holding executed at. So millions of shares of a company are all valued at any moment by whatever price one share of that company traded at three seconds ago. If that trade was at $10 and then a couple of seconds later a trade is executed at $9, then the value of all of those millions of shares is 10% less. 10% of the value "disappeared" in two seconds.

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Re: When diversification doesn’t work

Post by JBTX » Sun Feb 04, 2018 11:31 am

JBTX wrote:
Sun Feb 04, 2018 11:28 am
staythecourse wrote:
Sun Feb 04, 2018 11:16 am
JBTX wrote:
Sun Feb 04, 2018 10:55 am

BTW I actually had Campbell Harvey (one person) for investment and portfolio analysis class 30 hears ago. It may have been the first year he taught. I saw his article on gold years ago. Great article. My recollection is one of his assertions was gold is overrated as an inflation hedge.
That's cool. My bad I think I am thinking of not only him (Harvey), but his coauthor on many of his articles. Think it is ?Erb?

I don't remember the finer points of the article on gold, but do agree it is the best one I have read on gold to this day. I do remember Vanguard's paper on unexpected inflation hedges and they mentioned a small improvement in adding gold in times of UNexpected inflation. Don't think it was any better then TIPS though (if I remember correct).

Good luck.
Oddly enough the semester before I was going to take the class but dropped after a few days to change my schedule. The guy who taught that class was Robert Whaley, who some years later created the “VIX”

I had some great professors. Too bad the were wasted on the likes of me. :P
http://www.nber.org/papers/w18706

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Re: When diversification doesn’t work

Post by nisiprius » Sun Feb 04, 2018 11:58 am

In case you hadn't ever noticed, in addition to the familiar boilerplate about past performance and future results, any investment firm that uses the word "diversification" is likely to have a little footnote saying "Diversification does not ensure a profit or protect against a loss in a declining market."

If by "working" you mean "ensuring a profit or protecting against a loss in a declining market," then, no, diversification doesn't always work.

Even if you believe that "diversification is the only free lunch" (I think it's at best a free snack), that doesn't mean it will protect you against malnutrition. Mathematically, the diversification effects of real-world assets are fairly feeble; they show up as slightly improved average risk-adjusted return over very long periods of time.

There is a saying that "in a crisis all correlations go to 1," which is true but somewhat vacuous. It is just a way of saying crises happen. During 2008-2009 someone in Bogleheads posted, I should take the time to find the posting, that all that diversification means is that in a crisis you can watch all your investments plummeting at different speeds.
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Re: When diversification doesn’t work

Post by staythecourse » Sun Feb 04, 2018 12:02 pm

dbr wrote:
Sun Feb 04, 2018 9:18 am
Good emphasis that a hedge needs to be designed to make you whole. That is, not only go up when the other is down but go up as much as the other goes down. "Normal" investors don't own hedges in that specific sense.
I agree I think it is as I have always described it as the "holy grail" of investing and basically a fool's errand. You have to find that perfect asset class in a long only product available in a cost efficient (fees and taxes) manner available to the general public. The other factor is even if you did find one I don't think one exists that is meant to accomplish this for the passive investor. That concepts of of hedging stock volatility attempt works best for the active investor who is shifting their asset allocation (thus the weighted averages to make up for any potential volatility differences between the hedgers and stocks).

I really do believe once you are a passive investor and choose to ride the wave of volatility up (returns) AND down (losses) you accept you will get hurt when stocks hit the dumps. An active investor, using the same analogy, is always looking to get off the wave to avoid the wave crashing and even hopes to find a different wave that is still going up and rinse and repeat.

The passive investor just accepts the volatility and has the BEST hedge available to them which is also the most cost efficient which is TIME that they utilize when constructing their asset allocation.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: When diversification doesn’t work

Post by nisiprius » Sun Feb 04, 2018 1:32 pm

staythecourse wrote:
Sun Feb 04, 2018 12:02 pm
dbr wrote:
Sun Feb 04, 2018 9:18 am
Good emphasis that a hedge needs to be designed to make you whole. That is, not only go up when the other is down but go up as much as the other goes down. "Normal" investors don't own hedges in that specific sense.
That's right. Even if you believe that you can count on Treasuries as having a perfectly reliable negative correlation with stocks, which is not true, you still need to deal with the fact that Treasuries are much less volatile. So, during 2008-2009, stocks went down 52%, Vanguard Intermediate-Term Treasury Fund goes up 12%... big deal. It's better than a slap in the face with a wet fish, I guess, better than Total Bond if you like, but it wouldn't have offset stock losses unless you had less than 20% stocks, more than 80% Treasuries.

And bonds have been far more powerful in terms of low correlation with stocks than any category of stocks has ever been.

The other thing people miss is that true hedging, something that will re-shape your distribution of outcomes by cutting off the undesired extreme, is costly in terms of return. True insurance has a premium to pay.

"Look, it's less risky" meaning it dropped 48% or 46% in 2008-2009 when Total Stock dropped 52% is... well, it is what it is, but I don't think it's what naïve investors have in mind when someone says "I can lower your risk without bonds."
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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nedsaid
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Re: When diversification doesn’t work

Post by nedsaid » Sun Feb 04, 2018 1:40 pm

nisiprius wrote:
Sun Feb 04, 2018 11:58 am
During 2008-2009 someone in Bogleheads posted, I should take the time to find the posting, that all that diversification means is that in a crisis you can watch all your investments plummeting at different speeds.
If there was a Boglehead's Hall of Fame for best posts, this quote should be in it. We should track down who wrote this and recognize the author. It is so true.
A fool and his money are good for business.

1nv35t
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Re: When diversification doesn’t work

Post by 1nv35t » Sun Feb 04, 2018 3:06 pm

nedsaid wrote:
Sun Feb 04, 2018 1:40 pm
nisiprius wrote:
Sun Feb 04, 2018 11:58 am
During 2008-2009 someone in Bogleheads posted, I should take the time to find the posting, that all that diversification means is that in a crisis you can watch all your investments plummeting at different speeds.
If there was a Boglehead's Hall of Fame for best posts, this quote should be in it. We should track down who wrote this and recognize the author. It is so true.
Is it? Or is it just a sign of inadequate diversification? Some asset allocations saw around +15% in each of 2007/8/9 followed by a relatively good +25% in 2010.

staythecourse
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Re: When diversification doesn’t work

Post by staythecourse » Sun Feb 04, 2018 3:08 pm

nedsaid wrote:
Sun Feb 04, 2018 1:40 pm
nisiprius wrote:
Sun Feb 04, 2018 11:58 am
During 2008-2009 someone in Bogleheads posted, I should take the time to find the posting, that all that diversification means is that in a crisis you can watch all your investments plummeting at different speeds.
If there was a Boglehead's Hall of Fame for best posts, this quote should be in it. We should track down who wrote this and recognize the author. It is so true.
Not true. In 2008 the same usual suspects did just fine: Gold, LTGB, and cash. The bigger issues is NOT what are the possible asset classes to keep your sinking ship afloat, but with the amount of weighted average one has to dedicate to those asset classes to make a huge difference in the total portfolio return and how that much dedicated to those will add a drag on your portfolio the majority of years that stocks outperform every other asset class.

I can bet if one had the PP in 2008 they would have been just fine, BUT many of those folks will have been complaining dragging behind a more heavier equity portfolio almost every other year. You can't have your cake and eat it to.

I have NEVER understood why folks get upset when the market shudders. It is NORMAL. It would be like a midwesterner surprised there is snow in the winter OR a person in Seattle complaining of rain or a person visiting London surprised to see fog. The only risk of equity investing is NOT it tanking which is normal from time to time, but not needing that money for awhile until TIME allows the usual upward trend in the markets.

Liquidity of money under times of market stress is what really what hurts folks when the market shudders. Think about what 401k balances would have been in 2008 if there was no penalty for early withdrawals.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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nedsaid
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Re: When diversification doesn’t work

Post by nedsaid » Sun Feb 04, 2018 4:02 pm

staythecourse wrote:
Sun Feb 04, 2018 3:08 pm
nedsaid wrote:
Sun Feb 04, 2018 1:40 pm
nisiprius wrote:
Sun Feb 04, 2018 11:58 am
During 2008-2009 someone in Bogleheads posted, I should take the time to find the posting, that all that diversification means is that in a crisis you can watch all your investments plummeting at different speeds.
If there was a Boglehead's Hall of Fame for best posts, this quote should be in it. We should track down who wrote this and recognize the author. It is so true.
Not true. In 2008 the same usual suspects did just fine: Gold, LTGB, and cash. The bigger issues is NOT what are the possible asset classes to keep your sinking ship afloat, but with the amount of weighted average one has to dedicate to those asset classes to make a huge difference in the total portfolio return and how that much dedicated to those will add a drag on your portfolio the majority of years that stocks outperform every other asset class.

Nedsaid: Except that cash did not do fine. There was the equivalent of a run on the bank with money market funds. The credit markets froze and there were no buyers for even investment grade commercial paper. The Feds had to slap a guarantee on money market funds.

I can bet if one had the PP in 2008 they would have been just fine, BUT many of those folks will have been complaining dragging behind a more heavier equity portfolio almost every other year. You can't have your cake and eat it to.

Nedsaid: I stayed the course and emerged from the financial crisis in good shape. I had the good sense not to sell my stocks at the trough of the bear market. I put 100% of my new monies for investment into stocks for about a year. When the bear hit, I was at 72% stocks. Last I checked, my stock investments were 66% of my portfolio. The diversifiers that worked in 2000-2002 didn't work in 2008-2009. Most bonds got hit but did recover fairly quickly. TIPS got hit, investment grade Corporates got hit, and of course Junk got hit hard. Nominal treasuries and certain government agency bonds like GNMAs did well.

I have NEVER understood why folks get upset when the market shudders. It is NORMAL. It would be like a midwesterner surprised there is snow in the winter OR a person in Seattle complaining of rain or a person visiting London surprised to see fog. The only risk of equity investing is NOT it tanking which is normal from time to time, but not needing that money for awhile until TIME allows the usual upward trend in the markets.

Nedsaid: Yes, volatility is normal market behavior.

Liquidity of money under times of market stress is what really what hurts folks when the market shudders. Think about what 401k balances would have been in 2008 if there was no penalty for early withdrawals.

Good luck.
A fool and his money are good for business.

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