grok87 wrote: Whakamole wrote: HomerJ wrote: grok87 wrote:
Random Walker wrote:Grok,
Yes there is Momentum everywhere. The AQR funds invest in equities, bonds, commodities, currencies. Diversifying across asset classes within the Style improves its efficiency lots.
Well the fund hasn't really been through a crisis yet. I guess we'll see then if that diversification helps or not.
The last two times AQR went through a crisis (2000 and 2008), some of their other funds almost went bankrupt. Cliff admitted he was 3 months from closing shop in 2000 if the market hadn't finally crashed (he was short a lot of tech stocks). In 2008, his defense was that he had never seen a market like that. It was outside any models they had.
Those funds were also hedge funds. Invested in multiple factors. With models based on historical data.
I hope the next crisis is something we've already seen, because then it will be accounted for in his models. If it's something new, and/or it lasts 3 months too long, you may lose a ton of money investing with him. It's certainly not riskless, even though he's selling it that way because "diversification"
Or will be something else his models haven't predicted because it hasn't happened before. Wasn't that the mistake that brought down LTCM?
it's even worse than that.
whatever assumptions he and others build into their models and upon which they have constructed their defenses will be the very thing to bring them down.
for example the volatility targeting thing. the assumption is that rising volatility is a signal of coming risk. And their defense is then to start selling, scaling down their positions to manage risk. the trouble is everyone else has the same plan so everyone is going to sell at the same time. the rout will then accelerate in a self-reinforcing downward spiral.
take the run up to the global financial crisis. A massively leveraged financial edifice was built on the assumption that there would never be a nationwide downturn in housing prices. And then guess what happened? (Answer a massive nationwide downturn in housing prices).
Investing is not physics. the bad stuff that happens are not random external shocks. the bad stuff that happens is almost always of our own design. We have met the enemy and he is us.
Grok87, I like what you said that investing is not physics. It reminds me of when Larry Swedroe did a typo and said one of the top people at Buckingham had a PhD in psychics. There were a lot of chuckles over that, and truth be told, Larry's typo contained more truth than we will ever know.
The reality is that the markets have a way of doing the very thing that you never expected. This is why I don't like the leverage and shorting techniques that the hedge funds use. You don't know what the other big market players are doing. You may think yourself the contrarian when in fact a whole bunch of others might be doing exactly what you are doing. This hedge fund stuff gets to be like the spy vs spy and the measure vs countermeasure stuff in the Cold War. What happens is that the "smart people" themselves get outsmarted and perform what seems to us amateurs to be a very fundamental error. Sometimes, "smart money" really does some crazy and stupid stuff and us individual investors look brilliant by comparison.
The thing is, markets are mostly rational but can experience bouts of irrationality. It is human emotion, the greed and fear thing. We are better off having a good understanding of market history, human nature, and human behavior. Trying to reduce all of this to a physics equation is just nuts. There is no theory of everything for investing. Behavioral finance comes the closest.
Of course, some of the quants on this forum think I am an idiot and don't know what I am talking about. They don't understand the limits of accounting, and though the accountants do a good job, the numbers are not exact and contain things like judgment, estimates, and accruals. How can you arrive at precision when the numbers you start out with are not precise themselves? You just cannot explain this to a quant.
I have posted several times about Microsoft. The accountants give it a book value of about $9 a share. The market gives Microsoft stock, last I looked, a market value of about $70 a share. There is a $61 a share difference between what the accountants and what the market values Microsoft. I have explained why this is so and in another thread, Valuethinker made comments along this line as well. And yet the academics use book value per share as one measurement for determining value. Dude, what happened to the $61? This is part of my frustration in trying to explain this stuff to quants.
I am not arguing that book value is a meaningless measurement, I am saying that it has its limitations. As you look at financial data, you realize there is more squishiness to all of this than what is admitted to. Another example of what I am talking about is trying to construct efficient frontiers for your portfolio. Depending on what time periods you use, the efficient frontiers can move all over the place. I am not saying that efficient frontiers are bunk but that there are some pretty severe limitations. An imperfect tool in the toolbox and that is about it.
There gets to be a point where good enough is good enough and close enough is close enough. None of this is precise and even the experts do more eyeballing and educated guesses than what is admitted to. But then again, I am only right about anything around here about every six months or so.
A fool and his money are good for business.