Larry Swedroe: Rising Rates Increase Worries

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Random Walker
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Larry Swedroe: Rising Rates Increase Worries

Post by Random Walker » Fri Jan 26, 2018 10:58 am

http://www.etf.com/sections/index-inves ... nopaging=1

In this article Larry discusses the widely held expectation that the Fed will increase rates during the coming year. He distinguished between knowledge and information. Information held by everyone else is of no value. Bond market is extremely efficient. Larry makes the point that some investors have increased their equity allocations in the face of low interest rates. It’s worked out well for them. But judging a strategy on outcome is a mistake; an alternative history could have easily played out. One should not let interest rates dictate one’s equity allocation.
At the end of the article Larry discusses how four alternative funds might fit into a portfolio. Currently equities have historically high valuations and low future expected returns. Many are concerned about rising interest rates causing a bond bear. These alternatives have expected returns about same as equities, SD about half that of equities, no correlation to stocks, bonds, or to each other. One can create an alternatives position by taking from equities, bonds, or some of both. It one takes from equities, portfolio expected return about constant, volatility decreased, Sharpe ratio increased. If one takes from bonds, portfolio expected return increased, volatility increased to a lesser extent, Sharpe ratio increase expected. In both cases portfolio efficiency improves.
Larry’s new edition of Black Swans is coming out soon, and he will surely go into some good detail on the potential improved portfolio efficiency obtained through these alternatives.

Dave

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by garlandwhizzer » Fri Jan 26, 2018 12:24 pm

30 year Treasuries yielded 14.8% in 1981 because bond market participants saw more than a decade of ever increasing interest rates and inflation, currently at about 15% in 1981, and they expected that to continue for decades. That, of course, turned out to be totally wrong in spite of all the smart guys' pseudo-insight into the future. How nice would it be today if you could buy a bond that yielded 14.8% a year guaranteed for 30 years by the US government? Alas, those days are behind us. The take home message, however, is that the consensus can be totally wrong at any time about anything. Beware when markets of any type are at historical extremes.

Currently long term inflation expectations are the lowest in history. Today that same 30 year Treasury yields 2.85%, about the lowest rate in 4 decades. The 4 decade average yield rate on 30 year Treasuries is close to 6%, more than twice the current rate. Currently inflation is running at over 2%. Just as in 1981, bond market participants have extreme expectations for long term inflation rates based largely on past history and projecting that past history forward. Taking long bond duration positions looks great now on long term backtesting, just as it looked horrible in 1981 on long term backtesting. There is a real possibility that, as in 1981, the smart guys with their clever historical models will turn out to be wrong again. There are a number of reasons that have developed in recent years why interest rates and inflation may rise from the grave (co-ordinated world-wide economic growth, rising rates and inflation in the US, reversal of QE, massive levels of governmental and personal debt that will need to be financed, full employment but additional fiscal stimulus in terms of tax cuts, fiscal stimulus, etc.,). Whenever in the past all market participants have had a consolidated single point of view on any issue, it has often been the time historically to take the opposing position. I think it is a mistake to assume that inflation will remain in its grave for the next 3 decades. Long duration in the bond market may in the future be a headwind instead of the tailwind as in the past 3+ decades.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by nedsaid » Fri Jan 26, 2018 9:42 pm

garlandwhizzer wrote:
Fri Jan 26, 2018 12:24 pm
30 year Treasuries yielded 14.8% in 1981 because bond market participants saw more than a decade of ever increasing interest rates and inflation, currently at about 15% in 1981, and they expected that to continue for decades. That, of course, turned out to be totally wrong in spite of all the smart guys' pseudo-insight into the future. How nice would it be today if you could buy a bond that yielded 14.8% a year guaranteed for 30 years by the US government? Alas, those days are behind us. The take home message, however, is that the consensus can be totally wrong at any time about anything. Beware when markets of any type are at historical extremes.

Currently long term inflation expectations are the lowest in history. Today that same 30 year Treasury yields 2.85%, about the lowest rate in 4 decades. The 4 decade average yield rate on 30 year Treasuries is close to 6%, more than twice the current rate. Currently inflation is running at over 2%. Just as in 1981, bond market participants have extreme expectations for long term inflation rates based largely on past history and projecting that past history forward. Taking long bond duration positions looks great now on long term backtesting, just as it looked horrible in 1981 on long term backtesting. There is a real possibility that, as in 1981, the smart guys with their clever historical models will turn out to be wrong again. There are a number of reasons that have developed in recent years why interest rates and inflation may rise from the grave (co-ordinated world-wide economic growth, rising rates and inflation in the US, reversal of QE, massive levels of governmental and personal debt that will need to be financed, full employment but additional fiscal stimulus in terms of tax cuts, fiscal stimulus, etc.,). Whenever in the past all market participants have had a consolidated single point of view on any issue, it has often been the time historically to take the opposing position. I think it is a mistake to assume that inflation will remain in its grave for the next 3 decades. Long duration in the bond market may in the future be a headwind instead of the tailwind as in the past 3+ decades.

Garland Whizzer
Garland, great post as always. I will make the same point here that I made in another thread. Government deficits have nothing to do with interest rates. Reagan and Obama ran relatively large budget deficits and interest rates did nothing but fall each time. Reagan's economy started slow and went to a boom, Obama's economy emerged from the financial crisis and slowly recovered. Relatively strong economy vs. a relatively weaker economy, it made no difference, interest rates still fell.

I used to run the basketball scoreboard when I was in high school. When someone scored a basket, all I had to do to add a couple of points was to click the button a couple of times. I didn't have to go into a storeroom to get the points. I never had to tell the referee to stop the game because I ran out of points. Financing deficits is pretty much the same thing. People forget that the government has its own bank and that bank can buy US Government debt anytime it wants. Furthermore, the bank (the Fed) has to turn its profits over to the Treasury. So pretty much, the government can give itself an interest free loan anytime it wants. Another piece of the puzzle is that the private sector is in surplus when the public sector is in deficit. The surplus in the private sector soaks up the deficit in the public sector. The bigger picture is that the books always balance and debits always equal credits. I also read somewhere that larger budget deficits tend towards higher corporate profits.

Remember how the savings rates got so low when the Clinton administration ran surpluses? I know other factors affect savings rates rather than just budget deficits, but the deficits are a large factor. Remember also that in our economy, debt is money. More debt is more money supply and less debt is less money supply. Think of World War II, the greatest stimulus package of deficit spending of all time. The public had jobs and money but little extra to spend the money on as we had wartime rationing. Hence we had a big savings rate and a lot of those savings went into War Bonds.

A couple of anecdotal stories about War Bonds said that the buyers lost about 1/2 of the buying power of the monies used to buy the bonds. Pretty much a combination of economic growth and inflation in effect paid down our debt.

In fact, I have heard the argument that the national debt doesn't finance anything at all, we have debt to back our currency and so that the Fed can target interest rates. That argument seems to be extreme, but it makes sense to me and it might well just be right.

I know this goes against textbook economics, but textbook economics in this matter have been just plain wrong. It is counterintuitive, but it seems that larger deficits can mean higher private sector savings rates, higher money supply, higher corporate profits, and lower interest rates. The standard explanations just never worked for me. The Reagan deficits in the 1980's should have kept interest rates high but instead the rates fell and continued to fall for over 30 years. Somehow, those high deficits were always easily financed. The "crowding out effect" just never seems to happen.

Pretty much what backs currency is productivity. Inflation happens when you have too much money created versus too little increased production. Hyperinflation happens when you create huge amounts of money and productivity collapses. Interest rates on the debt that backs the currency is also a factor in how strong a currency is versus other currencies.

This is why I stated that to me, inflation is the thing to watch. The Fed controls short term rates but inflation expectations control mid and long-term rates. Which brings me to another point, that is governments can always shorten up the average maturities of their debt by increasing the issuance of short term instruments and buying long term instruments off the market.
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Re: Larry Swedroe: Rising Rates Increase Worries

Post by willthrill81 » Fri Jan 26, 2018 9:45 pm

I'll repeat it again: interest rate increases are not a long-term threat to bonds. Inflation, especially when its 'unexpected', is the real threat to bonds.
Last edited by willthrill81 on Fri Jan 26, 2018 11:42 pm, edited 1 time in total.
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Re: Larry Swedroe: Rising Rates Increase Worries

Post by FIREchief » Fri Jan 26, 2018 11:42 pm

Any time I read an article or post that is advertising "equity like returns but less risk/volatility/etc." I just move on to the next thread. I'm actually surprised that he mentions/recommends these "alternatives" without even providing a clue exactly what they invest in. He suggests that they have less term and inflation risk, but then fails to tell us what increased risk there is to drive the equivalent returns (we all know the answer).
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by garlandwhizzer » Sat Jan 27, 2018 12:30 pm

willthrill81 wrote:
I'll repeat it again: interest rate increases are not a long-term threat to bonds. Inflation, especially when its 'unexpected', is the real threat to bonds.
The fact that 30 year Treasuries currently offer a yield of 2.85% tells you that the current market expectations for inflation over the next 3 decades is very low indeed, lower than the 3+% long term historical inflation average in the US. So any significant inflation over the next 3 decades will be "unexpected" and not reflected in the current yield structure. The current yield on 5 year Treasuries is 2.42%, only 0.43% lower than the 30 year bond yield which has an additional 25 years of inflation duration risk. The whole point is that starting from here, no significant long term inflation is anticipated by market participants and therefore any significant inflation that occurs will be unexpected and have negative effects on principal value of long term bonds.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by grayfox » Sat Jan 27, 2018 1:21 pm

I'm not worried. The opposite. I'm cheering on the Fed to raise rates. Rates have been too low for too long. Effective Federal Funds Rate

For Dec-2017, it shows Fed Funds Rate = 1.30%. Right now Vanguard Prime MMF is yielding 1.45%. I would like to see Prime MMF get up to 3+% yield.

Here is the FOMC Summary of Economic Projections for the Fed Funds Rate. It shows 3.1% by 2019.

Go! Go! Go! Higher! Higher! Higher!

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by staustin » Sat Jan 27, 2018 1:53 pm

FIREchief wrote:
Fri Jan 26, 2018 11:42 pm
Any time I read an article or post that is advertising "equity like returns but less risk/volatility/etc." I just move on to the next thread. I'm actually surprised that he mentions/recommends these "alternatives" without even providing a clue exactly what they invest in. He suggests that they have less term and inflation risk, but then fails to tell us what increased risk there is to drive the equivalent returns (we all know the answer).
My sentiments as well. A cursory review of the recommended fund websites isn't helpful really either.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by willthrill81 » Sat Jan 27, 2018 2:15 pm

garlandwhizzer wrote:
Sat Jan 27, 2018 12:30 pm
willthrill81 wrote:
I'll repeat it again: interest rate increases are not a long-term threat to bonds. Inflation, especially when its 'unexpected', is the real threat to bonds.
The fact that 30 year Treasuries currently offer a yield of 2.85% tells you that the current market expectations for inflation over the next 3 decades is very low indeed, lower than the 3+% long term historical inflation average in the US. So any significant inflation over the next 3 decades will be "unexpected" and not reflected in the current yield structure. The current yield on 5 year Treasuries is 2.42%, only 0.43% lower than the 30 year bond yield which has an additional 25 years of inflation duration risk. The whole point is that starting from here, no significant long term inflation is anticipated by market participants and therefore any significant inflation that occurs will be unexpected and have negative effects on principal value of long term bonds.

Garland Whizzer
Very true. That pendulum could swing the other way too though. For instance, if inflation turns out to be less than expected, which I view as unlikely yet possible), bond returns could be better than anticipated.

Unfortunately, most people think of bond returns in nominal terms and the associated drawdowns, which are historically low. But when you examine the real returns, you see that bonds have had some significant drawdowns as well.

Image
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Re: Larry Swedroe: Rising Rates Increase Worries

Post by Random Walker » Sat Jan 27, 2018 2:38 pm

He suggests that they have less term and inflation risk, but then fails to tell us what increased risk there is to drive the equivalent returns (we all know the answer).
I thought I had a pretty good feel for the answer, but don’t know specifically. Your tone indicates I could be off base. Could you please elaborate FIREchief and staustin? I think we are talking about a lot of different uncorrelated risks that can mix pretty well. Thanks,

Dave

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by patrick013 » Sat Jan 27, 2018 2:53 pm

grayfox wrote:
Sat Jan 27, 2018 1:21 pm
I'm not worried. The opposite. I'm cheering on the Fed to raise rates. Rates have been too low for too long. Effective Federal Funds Rate

For Dec-2017, it shows Fed Funds Rate = 1.30%. Right now Vanguard Prime MMF is yielding 1.45%. I would like to see Prime MMF get up to 3+% yield.

Here is the FOMC Summary of Economic Projections for the Fed Funds Rate. It shows 3.1% by 2019.

Go! Go! Go! Higher! Higher! Higher!
Good post, good info, not perfect yet. They could spike the FFR to 5% and
leave it there for 10-20 years. Why not ? No worries here either.

Consumer spending and exports up 3%, Dollar Index expected over 100 !
They're buying everything we're sending sounds like.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by FIREchief » Sat Jan 27, 2018 3:05 pm

Random Walker wrote:
Sat Jan 27, 2018 2:38 pm
He suggests that they have less term and inflation risk, but then fails to tell us what increased risk there is to drive the equivalent returns (we all know the answer).
I thought I had a pretty good feel for the answer, but don’t know specifically. Your tone indicates I could be off base. Could you please elaborate FIREchief and staustin? I think we are talking about a lot of different uncorrelated risks that can mix pretty well. Thanks,

Dave
I was referring to default risk. Since the article didn't give us any idea what these alternatives were, I really don't know. I just firmly believe that there are no free lunches out there. For all we know, they may be investing in bitcoin! :oops:
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by nedsaid » Sat Jan 27, 2018 3:17 pm

FIREchief wrote:
Sat Jan 27, 2018 3:05 pm
Random Walker wrote:
Sat Jan 27, 2018 2:38 pm
He suggests that they have less term and inflation risk, but then fails to tell us what increased risk there is to drive the equivalent returns (we all know the answer).
I thought I had a pretty good feel for the answer, but don’t know specifically. Your tone indicates I could be off base. Could you please elaborate FIREchief and staustin? I think we are talking about a lot of different uncorrelated risks that can mix pretty well. Thanks,

Dave
I was referring to default risk. Since the article didn't give us any idea what these alternatives were, I really don't know. I just firmly believe that there are no free lunches out there. For all we know, they may be investing in bitcoin! :oops:
There have been several threads on these alternative investments. The article does mention specific funds, you can go to Morningstar and other resources to do your research. Plenty of stuff out there on these investments both here on the forum and elsewhere on the internet. I personally do not invest in these type of funds but I have an open mind and have posted in the alternative investment threads.

No, these funds are not investing in bitcoin. Don't know where you come up with this stuff, why not do some research before commenting? I suspect you didn't even read the article.

These funds are interesting but some of them require an advisor to access. I have mentioned what I see as the advantages and pitfalls of these investments. They have their risks.
A fool and his money are good for business.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by RAchip » Sat Jan 27, 2018 3:18 pm

"30 year Treasuries currently offer a yield of 2.85%"

I would be worried. The Vanguard prime MMF is yielding about 1.45% and rising rapidly. Who would tie up money for 30 years now at 2.85% when interest paid for fully liquid ultra short term is 1.45% and is not locked in? It makes no sense to me.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by FIREchief » Sat Jan 27, 2018 3:56 pm

nedsaid wrote:
Sat Jan 27, 2018 3:17 pm
FIREchief wrote:
Sat Jan 27, 2018 3:05 pm
Random Walker wrote:
Sat Jan 27, 2018 2:38 pm
He suggests that they have less term and inflation risk, but then fails to tell us what increased risk there is to drive the equivalent returns (we all know the answer).
I thought I had a pretty good feel for the answer, but don’t know specifically. Your tone indicates I could be off base. Could you please elaborate FIREchief and staustin? I think we are talking about a lot of different uncorrelated risks that can mix pretty well. Thanks,

Dave
I was referring to default risk. Since the article didn't give us any idea what these alternatives were, I really don't know. I just firmly believe that there are no free lunches out there. For all we know, they may be investing in bitcoin! :oops:
There have been several threads on these alternative investments. The article does mention specific funds, you can go to Morningstar and other resources to do your research. Plenty of stuff out there on these investments both here on the forum and elsewhere on the internet. I personally do not invest in these type of funds but I have an open mind and have posted in the alternative investment threads.
The second poster asked me to elaborate on my comments, so I told him more about what my concern was. As I clearly stated my belief in "no free lunches," I have little motivation to further investigate the sources of the aledged free lunches. I was just responding to a question.

No, these funds are not investing in bitcoin. Don't know where you come up with this stuff, why not do some research before commenting? I suspect you didn't even read the article.
Ouch!! I did read the article. How else would I be able to comment on his recommendations of the alternatives and his lack of explanation? I thought the bitcoin comment was clearly a joke (see the :oops: and the "for all we know" comments). I think you need to lighten up a bit here.

8-)
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Re: Larry Swedroe: Rising Rates Increase Worries

Post by nedsaid » Sat Jan 27, 2018 4:04 pm

What I will say is that there are people on this forum that I respect who invest in the alternative funds. There are also people here that I respect who don't invest in such funds. Pretty much it boils down to whether you believe in the theories behind the alternatives. We know there are several schools of thought out there in the investing world. Here on the Bogleheads, most of what you see here are the Indexers vs. the Factor Investors. There seems to be a subset of the factor investors who are considering the alternatives.

Larry Swedroe is talking up the alternatives in his columns and has been doing so for the last 2-3 years. His firm is recommending these products as well. Larry has substantial investments in these funds, so no doubt about his sincerity. He is putting is money where his mouth is. Again, reasonable people can disagree on the merits of the strategies.
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Re: Larry Swedroe: Rising Rates Increase Worries

Post by stlutz » Sat Jan 27, 2018 4:44 pm

I would suggest the best "alternative" investment right now is in one's human capital. With sub-4% unemployment, I think there are better opportunities to grow returns there while opportunities to earn big returns on financial capital look to be pretty muted.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by Random Walker » Sat Jan 27, 2018 6:08 pm

FIREchief,
Equity like returns with half standard deviation is not necessarily a free lunch. There are perhaps risks that are not well measured by standard deviation. The key is how these risks correlate with equity risks. I think your skepticism is well warranted, but perhaps you should take In more information before completely blowing off the issue.

Dave

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by Noobvestor » Sat Jan 27, 2018 6:16 pm

The four alternative funds ...
The four alternatives we use are the AQR Style Premia Alternative Fund (QSPRX) and three funds from Stone Ridge (LENDX, SRRIX and AVRPX). We believe that an equal-weighted portfolio of these four funds has forward-looking return expectations similar to that of a global equity portfolio, but with only about one-quarter of the volatility (5% versus 20%).
Is it just me or did he not really explain what they were?
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Re: Larry Swedroe: Rising Rates Increase Worries

Post by thx1138 » Sat Jan 27, 2018 8:17 pm

I suspect Larry isn't explaining these alternatives because he has explained them other places. There is a word limit to an article and so authors don't rehash previously covered ground.

Here is a bit he wrote about the first fund:

https://www.advisorperspectives.com/art ... with-style

As to claims that it is not correlated with equity risk (i.e. beta) - that is by design. It is a long-short fund. In overly simplified terms if you try to buy a "factor" with a long only fund what you really get is a whole bunch of beta along with a small taste of the factor desired. A long-short portfolio on the other hand can eliminate beta entirely from the mix giving you the "pure" factor.

In fact this is the very definition of a factor - factors all have zero correlation to beta by definition (for equities) and are long-short portfolios by definition. There are of course other investments out in the sea that are not equities (e.g. bonds, commodities, etc.) and so if a fund is also investing in those then those other investments may have partial correlation with equities.

Long-short portfolios have significantly higher costs than long only and indeed the ERs on these funds are high.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by Regressor » Sat Jan 27, 2018 8:36 pm

RAchip wrote:
Sat Jan 27, 2018 3:18 pm
"30 year Treasuries currently offer a yield of 2.85%"

I would be worried. The Vanguard prime MMF is yielding about 1.45% and rising rapidly. Who would tie up money for 30 years now at 2.85% when interest paid for fully liquid ultra short term is 1.45% and is not locked in? It makes no sense to me.
Anyone who thinks that inflation will be lower than expected is getting a great deal with that 2.85% bond.

If I buy a 30y treasury, I'm guaranteed to get 2.85% for 30 years, while if you buy a 30 day treasury at 1.24% you're guaranteed to get that yield only for 30 days. If interest rates drop to zero and stay there, I'll still be getting my 2.85% for 30 years, but you'll be getting zero very soon.
I'm not saying whether long bonds are a good buy now for most people, but they could be for people who need only that 2.85% for a long time - short term bonds do not offer that guarantee.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by AlohaJoe » Sat Jan 27, 2018 10:26 pm

Random Walker wrote:
Fri Jan 26, 2018 10:58 am
http://www.etf.com/sections/index-inves ... nopaging=1

"The four alternatives we use are the AQR Style Premia Alternative Fund (QSPRX) and three funds from Stone Ridge (LENDX, SRRIX and AVRPX). We believe that an equal-weighted portfolio of these four funds has forward-looking return expectations similar to that of a global equity portfolio, but with only about one-quarter of the volatility (5% versus 20%)."
As far as I can tell (based on downloading daily price data from Yahoo, since PortfolioVisualizer and Morningstar don't seem to have it?), equal-weighting those 4 things since June 3, 2016 (when LENDX started) has had a standard deviation of 15%.

It seems strange that they would believe the future standard deviation will be 1/3rd of what the actual historical standard deviation has been.


Never mind. My Excel-fu was weak and, upon review, was calculating the annualised standard deviation incorrectly. The (corrected) spreadsheet is at https://goo.gl/39PJ9Z and now shows a volatility similar to what Swedroe claims in his post.
Last edited by AlohaJoe on Sat Jan 27, 2018 11:16 pm, edited 1 time in total.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by Random Walker » Sat Jan 27, 2018 10:48 pm

AlohaJoe,
I’m not sure, but I wonder if your estimate of SD is off. Price data alone is probably not worthwhile since most of the returns of these tax inefficient funds are in the form of distributions as opposed to share price appreciation. Distributions will lower share prices.

Dave

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by AlohaJoe » Sat Jan 27, 2018 11:01 pm

Random Walker wrote:
Sat Jan 27, 2018 10:48 pm
AlohaJoe,
I’m not sure, but I wonder if your estimate of SD is off. Price data alone is probably not worthwhile since most of the returns of these tax inefficient funds are in the form of distributions as opposed to share price appreciation. Distributions will lower share prices.
I agree that not having distributions sucks, though I'm doubtful it reduces the total return standard deviation that much. It is possible they are measuring something other than daily volatility, as well.

Also, I have my doubts that total return standard deviation is especially meaningful as a measure of risk for real people. Just looking at this forum, it seems like the vast majority of people's stress is about daily/weekly/monthly changes in their portfolio value -- and over those time horizons price return is the only thing that really matters.

SRRIX, for instance, appears to only pay dividends annually, so I think most investors would only be looking at its price level when they're trying to sleep well at night. (I'm trying to imagine an advisor trying to explain to a panicking client in November, "I know the fund has lost 55% of its NAV since the crash began in February but, trust me, the December distributions (which haven't even been announced yet) are (probably) going to be huge so your total return volatility measured on a December-to-December basis won't be that bad!")

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by thx1138 » Sat Jan 27, 2018 11:05 pm

AlohaJoe wrote:
Sat Jan 27, 2018 11:01 pm

I agree that not having distributions sucks, though I'm doubtful it reduces the total return standard deviation that much. It is possible they are measuring something other than daily volatility, as well.
Did you actually look at the time series for QSPRX? The annual distribution in late December is massive and clearly dominates the SD by a huge margin.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by AlohaJoe » Sat Jan 27, 2018 11:17 pm

thx1138 wrote:
Sat Jan 27, 2018 11:05 pm
AlohaJoe wrote:
Sat Jan 27, 2018 11:01 pm

I agree that not having distributions sucks, though I'm doubtful it reduces the total return standard deviation that much. It is possible they are measuring something other than daily volatility, as well.
Did you actually look at the time series for QSPRX? The annual distribution in late December is massive and clearly dominates the SD by a huge margin.
A large distribution would increase the volatility, not decrease it, though. In any case, I've updated my original post because I was dumb and made a dumb mistake.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by garlandwhizzer » Sun Jan 28, 2018 1:50 pm

Regressor wrote:
If I buy a 30y treasury, I'm guaranteed to get 2.85% for 30 years, while if you buy a 30 day treasury at 1.24% you're guaranteed to get that yield only for 30 days. If interest rates drop to zero and stay there, I'll still be getting my 2.85% for 30 years, but you'll be getting zero very soon.
I'm willing to take that chance that interest rates won't drop to zero and stay there for 30 years. There are intermediate choices between 30 day T-bills and 30 year Treasuries, like 5 year Treasuries which currently yield 2.42% and have much, much less long term inflationary risk. The increased duration/inflation risk of 30 year Treasuries IMO far outweighs the benefits of 0.43% extra yield relative to a rolling bond ladder of 5 year Treasuries. I am not aware of any country in the world at any time in history where interest rates dropped to zero and stayed there for 30 years. I am willing to accept the risk for a scenario that has never happened anywhere in the world in recorded history in return for protection from the deep risk of long term inflation which has been quite common everywhere in the world including the USA (late 1960s through 1980s -1990s) and has produced considerable bond losses in real inflation adjusted terms over decades. The only kind of investment returns that matter over the long term for spending needs are not nominal returns but real returns.

Garland Whizzer

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by FIREchief » Sun Jan 28, 2018 3:31 pm

Random Walker wrote:
Sat Jan 27, 2018 6:08 pm
FIREchief,
Equity like returns with half standard deviation is not necessarily a free lunch. There are perhaps risks that are not well measured by standard deviation. The key is how these risks correlate with equity risks. I think your skepticism is well warranted, but perhaps you should take In more information before completely blowing off the issue.

Dave
Thanks Dave. I did just do a quick search for those funds. I found expense ratios for three of the four, and they were between 2.28% and 2.68%. I have no further need for more information than that. If these types of investments help others to stay invested and sleep well at night, then more power to them. They just don't align at all with my simple Boglehead way of thinking (which has served me quite well for decades). To each their own. :sharebeer
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Re: Larry Swedroe: Rising Rates Increase Worries

Post by Random Walker » Sun Jan 28, 2018 8:19 pm

I agree that the Boglehead way of thinking (simplicity, passive, low costs) is perhaps the optimal starting point. But some tweaking as finance progresses and the investment industry evolves could potentially be beneficial to investors. The goal is to increase the likelihood that one’s portfolio will land near the northwest corner of a risk/return plot.
The expense ratios of the alternatives are outlandishly high by Boglehead standards. But the opportunity set considered by most Bogleheads is only stocks and bonds. Expanding the opportunity set beyond that can improve investor portfolios. What matters is returns after expenses, and the quoted expected returns are after expenses. With current equity valuations, the pre tax, after expense, expected returns of the alternatives are greater than equities.
The costs of the Stone Ridge alternatives are high because one is basically entering directly into the banking business in the case of alternative lending and the reinsurance businesses in the case of reinsurance. The investor is not purchasing the equities of banks or reinsurers. With regard to variance risk premium, one is paying for trading expertise: providing liquidity.
There are no free lunches. Cost alone is not what matters, it is cost per unit value added to the portfolio that matters. Expected equity like returns after expenses, no correlation with stocks, bonds, or with each other, makes these investments potential excellent portfolio additions that will likely increase portfolio efficiency.
Also with regard to costs, we are talking small allocations here, perhaps 2-10% of a portfolio. A small allocation to an expensive fund will not have that much effect on the overall portfolio weighted average expense ratio. The positive portfolio effect may well overshadow the increased cost.

Dave

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by stlutz » Sun Jan 28, 2018 8:38 pm

The costs of the Stone Ridge alternatives are high because one is basically entering directly into the banking business in the case of alternative lending and the reinsurance businesses in the case of reinsurance. The investor is not purchasing the equities of banks or reinsurers. With regard to variance risk premium, one is paying for trading expertise: providing liquidity.
Yes, they aren't equities but you still have the single-stock risk with these funds. According to what Swedroe has said, Stone Ridge isn't randomly buying up P2P loans or reinsurance contracts in index-fund fashion. Instead, they have their own analysts who are selecting the "best" ones.

I can look at any number of banks or insurers who claim they are the best and balancing risk and return. If I said I was going to put 5% of my portfolio in say, BofI Holding (NASDAQ: BOFI) you would rightly say that this is not a good approach to take. But how is that different?

Remember, the claim is not that P2P lending and reinsurance as assets classes will provide equity-like returns with bond-like volatility. The claim is that Stone-Ridge managed selections of these types of investments will provide those results. Now, the folks at Stone Ridge might be really good. I honestly don't know how to evaluate that. But I do know that one noted financial writer saying that they are really smart personally doesn't get me there.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by Random Walker » Sun Jan 28, 2018 11:04 pm

Stlutz wrote
Remember, the claim is not that P2P lending and reinsurance as assets classes will provide equity-like returns with bond-like volatility. The claim is that Stone-Ridge managed selections of these types of investments will provide those results.
These funds are highly diversified, I think this IS more akin to investing in the “asset classes” of loans and reinsurance. Perhaps I’m missing something.

Dave

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by nedsaid » Sun Jan 28, 2018 11:42 pm

stlutz wrote:
Sun Jan 28, 2018 8:38 pm
The costs of the Stone Ridge alternatives are high because one is basically entering directly into the banking business in the case of alternative lending and the reinsurance businesses in the case of reinsurance. The investor is not purchasing the equities of banks or reinsurers. With regard to variance risk premium, one is paying for trading expertise: providing liquidity.
Yes, they aren't equities but you still have the single-stock risk with these funds. According to what Swedroe has said, Stone Ridge isn't randomly buying up P2P loans or reinsurance contracts in index-fund fashion. Instead, they have their own analysts who are selecting the "best" ones.

I can look at any number of banks or insurers who claim they are the best and balancing risk and return. If I said I was going to put 5% of my portfolio in say, BofI Holding (NASDAQ: BOFI) you would rightly say that this is not a good approach to take. But how is that different?

Remember, the claim is not that P2P lending and reinsurance as assets classes will provide equity-like returns with bond-like volatility. The claim is that Stone-Ridge managed selections of these types of investments will provide those results. Now, the folks at Stone Ridge might be really good. I honestly don't know how to evaluate that. But I do know that one noted financial writer saying that they are really smart personally doesn't get me there.
The "single stock" issue that you raise is a good one and I had not thought of this before. I have made a similar point that illiquid or semi-liquid investments still fluctuate in value even though they don't trade.

This whole area of alternatives is controversial, even among the subset of the Bogleheads who are factor investors. Pretty much you have to be aligned philosophically with your advisor and with your investment firm. You also have to believe the academic research behind the alternatives. You also have to trust that the firm (Buckingham) has done their due diligence.

Larry Swedroe clearly believes in the alternatives, he has made a substantial personal investment in them. Right or wrong, he is clearly sincere about his recommendations.

Another poster commented on the relatively high expense ratios of a couple of the Stone Ridge funds. My understanding is that you are paying for the actual expenses of running the business since you are a direct owner of the lending, reinsurance, or portfolio insurance businesses.

Pretty much, you are getting access to things like what David Swenson and the Yale Endowment Fund do with their alternative investments. AQR and Stone Ridge have products that retail investors can access through an advisor. How well retail investors actual do in alternatives is another story. We know that most endowment funds that tried Swenson's methods did not achieve his successes.

My belief is that these investments are worthy of consideration, though they are controversial. So far, I have passed on them.
A fool and his money are good for business.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by Dead Man Walking » Mon Jan 29, 2018 12:55 am

The problem with the alternatives that Larry Swedroe suggests is that they require an investment advisor and have a limited history. Many Bogleheads remember his posts about CCFs and are reluctant to jump into his latest theoretical suggestions. The nobody knows nothing crowd haven't weighed in on this post.

DMW

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by FIREchief » Mon Jan 29, 2018 1:01 am

(deleted)
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Re: Larry Swedroe: Rising Rates Increase Worries

Post by Random Walker » Mon Jan 29, 2018 10:01 am

FIREchief,
Larry is a member of an independent investment advisory firm that provides a fiduciary level of care for its clients. The only thing they sell is advice. They have no financial interest to recommend one firm’s products over another’s. Their recommendations are only based on what they consider to be in the BEST interest of their clients. Now one way to measure a financial advisor is if he uses the same investment vehicles he recommends for you. And the advisors at his firm do indeed use the same vehicles that they recommend for their clients.

Dave
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Re: Larry Swedroe: Rising Rates Increase Worries

Post by tc101 » Mon Jan 29, 2018 11:15 am

I'm actually surprised that he mentions/recommends these "alternatives" without even providing a clue exactly what they invest in.
Same here. The whole article seems pointless because of the lack of any information on the "alternatives". Does anyone understand what these "alternatives" invest in? I can't find any info online. I can't even find the expense ratio.
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Re: Larry Swedroe: Rising Rates Increase Worries

Post by Random Walker » Mon Jan 29, 2018 1:42 pm

Tc101,
I think the reason Larry doesn’t go into detail on the alternatives in this essay is that he has discussed them before in other essays and he didn’t want to get too far off his main thesis. I’m sure you can search for other of his articles at the same site with words like alternative lending, reinsurance, variance risk premium, momentum. Also discussions of the funds can be found on this site: LENDX, AVRPX, SRRIX, QSPIX.

Dave

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by Noobvestor » Mon Jan 29, 2018 1:43 pm

Noobvestor wrote:
Sat Jan 27, 2018 6:16 pm
The four alternative funds ...
The four alternatives we use are the AQR Style Premia Alternative Fund (QSPRX) and three funds from Stone Ridge (LENDX, SRRIX and AVRPX). We believe that an equal-weighted portfolio of these four funds has forward-looking return expectations similar to that of a global equity portfolio, but with only about one-quarter of the volatility (5% versus 20%).
Is it just me or did he not really explain what they were?
OK, Larry messaged me with the following summary explanations of the funds mentioned, which was helpful:
SRRIX is reinsurance, pretty intuitive that selling insurance has risks and should have a risk premium, or there would be no insurance industry,
LENDX makes prime loans to consumers, small business and students, again intuitive term and credit risk,
AVRPX sells volatility across four asset classes, again well documented and intuitive risk premiums,
QSPRX is long short four factors across four asset classes with risks well known (any factor can go long time without premium)
Also, as has been pointed out in other comments: he has discussed these elsewhere on Bogleheads and in articles he has written.
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by Random Walker » Mon Jan 29, 2018 3:56 pm

Larry takes attacks on his integrity VERY SERIOUSLY. He emailed me a copy of one of his investment statements to prove he takes his own advice. He has AVRPX, LENDX, SRRIX in a tax advantaged account.

Obviously I’m a highly biased huge fan of his. But just because I’m biased doesn’t mean I can’t be right. For those who haven’t done so, read his books. The clear thinking, internal consistency, and straight forward relaxed enjoyable delivery make his integrity obvious.

Dave

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by Random Walker » Mon Jan 29, 2018 4:05 pm

The above alternatives are very tax inefficient and generally belong in tax deferred accounts. But I think it can be very rational to take a bit from a municipal bond holding to create a position for these alternatives in a taxable account. Their after tax expected return is less than equities and greater than bonds. If someone is willing to increase the risk of their portfolio a bit, taking from muni bonds to create alternative position in taxable account should increase expected return more than it will increase portfolio volatility: improved portfolio Sharpe ratio. The reason is the lack of alternatives correlation to stocks, bonds, and each other.

The expected return of a portfolio is the weighted average expected return of the portfolio components. The standard deviation of a portfolio is less than the weighted average standard deviations of portfolio components due to the correlations being less than 1.

Dave

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by EvelynTroy » Mon Jan 29, 2018 4:51 pm

Random Walker wrote:
Mon Jan 29, 2018 3:56 pm

Obviously I’m a highly biased huge fan of his. But just because I’m biased doesn’t mean I can’t be right. For those who haven’t done so, read his books. The clear thinking, internal consistency, and straight forward relaxed enjoyable delivery make his integrity obvious.
Dave
I too am highly biased, huge fan of Larry and of his firm Buckingham Asset Management - there are many superlatives that describe Larry integrity, honesty, and forthrightness top the list. Ditto for the firm. BAM managed my portfolio for several years - I have nothing but positive to say about everything they did for me. BAM and Fiduciary go in the same sentence. There was a bigger picture than just managing the portfolio that I will always be appreciative of. One story - recall 2009 when market was tumbling big-time - folks everywhere were getting beyond nervous. Larry held a video-conference to reassure folks, i.e. stay the course kind of thing - they opened that up to the public. To me that was a very nice gesture.
Evelyn

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by GibsonL6s » Mon Jan 29, 2018 5:02 pm

I have enjoyed his books and columns since being introduced to his work from this site. It just appears to me to be a shift in philosophy as I remember a column or video where he was saying the risk of corporate bonds was not worth the added return and he just invested in government issues. These funds seem to be much riskier, does he view these as a part of the equity piece of a portfolio?

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by Random Walker » Mon Jan 29, 2018 5:41 pm

GibsonL6s,
The alternatives are distinctly different from both stocks and bonds. And as you say, they are riskier than bonds. They have expected equity like returns and expected volatility about half that of equities. They are basically uncorrelated to both stocks and bonds. When one creates a position in an alternative, he needs to take it from either stocks, bonds, or some of both. Which to do depends on what the investor wants to accomplish. If take from stocks, portfolio expected return stays about same, portfolio SD decreases, Sharpe ratio increases. If take from bonds, portfolio expected return increases, portfolio SD increases, Sharpe ratio increases.

Dave

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by triceratop » Mon Jan 29, 2018 6:09 pm

stlutz wrote:
Sat Jan 27, 2018 4:44 pm
I would suggest the best "alternative" investment right now is in one's human capital. With sub-4% unemployment, I think there are better opportunities to grow returns there while opportunities to earn big returns on financial capital look to be pretty muted.
stlutz,
Excellent post. I agree. I have been thinking the same and something more for Bogleheads in particular, who are often dual income: that given the importance of steady contributions in various market conditions, the 'market' for life partners is inefficiently allocating resources for optimal outcomes. Consider this: an oil and gas technology worker (exposure to tech and energy) with a worker in the healthcare sector (exposure to demographics, healthcare).

What an alternative that would be! What I see currently is increasing social concentration due to less exposure to other sectors of the market.

Oh, rising rates don't worry me at all. I am buying more Intermediate-term treasuries tomorrow.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by thx1138 » Mon Jan 29, 2018 6:45 pm

GibsonL6s wrote:
Mon Jan 29, 2018 5:02 pm
I have enjoyed his books and columns since being introduced to his work from this site. It just appears to me to be a shift in philosophy as I remember a column or video where he was saying the risk of corporate bonds was not worth the added return and he just invested in government issues. These funds seem to be much riskier, does he view these as a part of the equity piece of a portfolio?
The issue isn't riskier or less risky. He advocates small-value which is riskier than plain old beta (total stock market). The issue is forming an optimal mix of different uncorrelated risks.

Corporate bonds are not his recommendation because their risk is too correlated with equities. It is more optimal to stick with treasuries and increase your equities allocation. That mix gives a better risk adjusted return than trying to juice yields by incorporating corporate bonds with a lower equity allocation.

All these various alternatives and factors are about trying to mix uncorrelated risks together so that the amount of risk you take for a given expected return is lower than you might achieve from just a mixture of bonds and equities. The primary objection to using them is typically a lot less data to evaluate what their actual future risk and expected return are along with often higher trading costs. As already pointed out higher trading costs should be expected for many of these alternatives and if their return is high enough then the higher cost is OK. For many bogleheads though they may be skeptical about the expected return while the higher cost is well defined and for certain.

But again - "riskier" isn't a valid objection really. A good portfolio contains a lot of risky stuff. In fact the very simple three fund portfolio has a bunch of very risky emerging markets equities in it after all! The question is does the risk provide a better risk adjusted return when included in a portfolio.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by HomerJ » Mon Jan 29, 2018 6:49 pm

nedsaid wrote:
Sat Jan 27, 2018 4:04 pm
Larry Swedroe is talking up the alternatives in his columns and has been doing so for the last 2-3 years. His firm is recommending these products as well. Larry has substantial investments in these funds, so no doubt about his sincerity. He is putting is money where his mouth is. Again, reasonable people can disagree on the merits of the strategies.
I would never say Larry is insincere.

But it should be pointed out he used to talk up commodities in the past. That didn't work out so well, even though I'm quite sure he was sincere when he was talking about them.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by FIREchief » Mon Jan 29, 2018 7:58 pm

Random Walker wrote:
Mon Jan 29, 2018 10:01 am
FIREchief,
Larry is a member of an independent investment advisory firm that provides a fiduciary level of care for its clients. The only thing they sell is advice. They have no financial interest to recommend one firm’s products over another’s. Their recommendations are only based on what they consider to be in the BEST interest of their clients. Now one way to measure a financial advisor is if he uses the same investment vehicles he recommends for you. And the advisors at his firm do indeed use the same vehicles that they recommend for their clients.

Dave
I think we're dealing with semantics here. Apparently my use of the word "selling" didn't sit well with a few folks. As I understood it, these alternatives funds can only be acquired through a firm such as you mention above. If that's where I buy them, isn't the firm thus "selling" them? At 2% to 3% annual fees, somebody is making a profit. Nothing wrong with selling and profits. It's all a business after all.

I'll withhold my opinions on exactly what constitutes a "fiduciary level of care for clients" for a different thread.... 8-)
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Re: Larry Swedroe: Rising Rates Increase Worries

Post by WhyNotUs » Mon Jan 29, 2018 8:44 pm

Someone talking up something that they would not invest in themselves can be disingenuous
However, that does not make advice from someone who has invested in something automatically credible.

There is a general feeling that the market's run up, the unpredictability of the current administration, and rising rates are going to upset the apple cart of mindless increases in the Dow/S & P 500.

There are countless threads here about that assessment that end in the same place, "Don't just sit there, do something" or "Don't just do something, sit there". One's choice of camps might be adjusted due to life changes or specific circumstances but, in general, mental well-being is served by knowing oneself and understanding the historic math behind the latter strategy over extended periods of time.

I come to this particular place for hand holding on the latter when the inevitable reversal of fortune occurs. The Alpha Seeker in me has to be tamed in order to prepare for retirement income. My personal history of operating from either fear or greed has not borne fruit. YMMV
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Re: Larry Swedroe: Rising Rates Increase Worries

Post by nedsaid » Mon Jan 29, 2018 8:50 pm

HomerJ wrote:
Mon Jan 29, 2018 6:49 pm
nedsaid wrote:
Sat Jan 27, 2018 4:04 pm
Larry Swedroe is talking up the alternatives in his columns and has been doing so for the last 2-3 years. His firm is recommending these products as well. Larry has substantial investments in these funds, so no doubt about his sincerity. He is putting is money where his mouth is. Again, reasonable people can disagree on the merits of the strategies.
I would never say Larry is insincere.

But it should be pointed out he used to talk up commodities in the past. That didn't work out so well, even though I'm quite sure he was sincere when he was talking about them.
What happened is that so much money went into commodities that the markets were distorted. Pretty much the institutional money caused commodity markets to go from backwardization to contango. So investors no longer got a roll return as lower futures prices converged towards the higher spot price. Instead, futures prices tended to be higher than spot prices, so you got a negative return as higher futures prices converged towards the lower spot price. In other words, futures are trading at a premium to the spot price. So this made collateralized commodity futures unprofitable for average investors. This is why Larry changed his mind. Would you rather that Larry not act on the new information?

The thing is, as I learn more, I change my mind. If circumstances change, so should you. This is why I warn against extreme commitment to staying the course at all costs. Staying the course with collateralized commodity futures would have been bad for investors so Larry changed his advice. Markets change, the economy changes. We should be prepared to change along with it.
A fool and his money are good for business.

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Re: Larry Swedroe: Rising Rates Increase Worries

Post by tbradnc » Mon Jan 29, 2018 9:01 pm

HomerJ wrote:
Mon Jan 29, 2018 6:49 pm
nedsaid wrote:
Sat Jan 27, 2018 4:04 pm
Larry Swedroe is talking up the alternatives in his columns and has been doing so for the last 2-3 years. His firm is recommending these products as well. Larry has substantial investments in these funds, so no doubt about his sincerity. He is putting is money where his mouth is. Again, reasonable people can disagree on the merits of the strategies.
I would never say Larry is insincere.

But it should be pointed out he used to talk up commodities in the past. That didn't work out so well, even though I'm quite sure he was sincere when he was talking about them.
PCRIX (PIMCO CommodityRealReturn Strategy Fund) as I recall. It was the rage for a while.

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