Felix Salmon

The end of asset allocation

Felix Salmon
Jul 13, 2009 22:24 UTC

It’s a pretty solid rule of investing: good ideas tend to become broadly adopted. And once enough people are all doing the same thing, that thing is probably not a good idea any more but rather a bad idea.

Case in point: asset allocation. John Kay seems to have taken a time-travel machine back to 2006:

The basic principles of asset allocation are diversification and contrarianism. Choose securities with returns poorly correlated to each other.

There are two huge problems with Kay’s prescription. The first is measuring correlation — something which turns out, in practice, to be pretty much impossible. And the second is that correlation measures, by their very nature, are always backwards-looking, and that you can be pretty sure future correlation will be very different from past correlation. What’s more, if there’s a crisis in the future, correlations have a tendency to move to 1.
Tom Lauricella takes the opposite tack from John Kay. Asset allocation, he says, is dead: the crisis killed it. And one of the contributing factors to its demise was one of the very things which Kay extols: the ETF. Kay loves ETFs, because they have low fees. But when investors piled into commodity ETFs over the past few years, in the name of diversification, all they really did was massively increase correlations between commodities and other asset classes. As a result, when stocks tumbled, so did commodities:

At Pimco, the firm’s head of analytics, Vineer Bhansali, points to commodities as an example of how diversification strategies can break down. Even as stocks and bonds struggled in early 2008, commodity prices were in the midst of a historic rally. Wall Street rolled out research showing the lack of correlation between stocks and commodities.

But that history didn’t take an important point into consideration. Prior to this decade, investing in commodities was a complicated process due to the complexity of the futures markets. The advent of exchange-traded mutual funds, or ETFs, allowed investors to buy and sell commodities with the click of a mouse. By the summer of 2008, ETF investors had poured billions into commodities in just a few months.

As the financial crisis worsened and stock and bond prices collapsed, ETF investors who needed to raise money found it easy to bail out of commodities, too. That contributed to a 37% drop for 2008 in the Dow Jones AIG Commodities Index.

“When people start buying an asset, the act of them diversifying ultimately makes the asset less of a diversifier,” says Pimco’s Mr. Bhansali.

Rick Bookstaber has dozens of examples along these lines, many of them much less obvious than the link between stocks and commodities. The fact is that if you think you’re invested in an asset class which will zig when the rest of your portfolio zags, you’re probably wrong. Look at the performance of so-called “market-neutral” hedge funds: they all went up in the up market, and they pretty much all went down in the down market. If super-sophisticated hedge-fund managers can’t get correlation right, there’s probably no point in the rest of us even trying.

Ultimately, I suspect that any investment strategy more sophisticated than “buy low, sell high” is doomed to fail eventually. If a certain strategy worked for your grandparents, that’s probably a good reason that it won’t work for you. (And yes, Warren Buffett counts as Gramps for these purposes.) In investing, nothing lasts forever. And the era of asset allocation is in its waning years. The problem, of course, is that no one has a clue what might replace it.


The end of asset allocation? That, my friend, is probably the dumbest statement I’ve read over the last 12 months. Nothing personal, but it doesn’t even make sense. Can’t measure correlations? Do WHAT?

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Antigua sued for $24 billion

Felix Salmon
Jul 13, 2009 21:17 UTC

Latest piece of Stanford idiocy:

A group of R. Allen Stanford-run business investors sued the government of Antigua and Barbuda, claiming the Caribbean nation helped the financier…

The investors are seeking at least $8 billion in damages, which can be tripled under U.S. civil racketeering laws, and claiming the class could include tens of thousands of people.

The population of Antigua and Barbuda is 85,632; if a Texas jury awarded the full $24 billion, that would amount to $282,353 per person, or more than 20 times the country’s GDP. Luckily, thanks to the doctrine of sovereign immunity, this lawsuit is going to go nowhere fast.

Update: Stacy-Marie Ishmael adds her take.


What ill-gotten gains? Have you seen the roads in antigua? The gov’t doesn’t have 1 million dollars..let alone 24 billion. The few who conspired with him are under house-arrest awaiting flights back to the states, or are currently under investigation. A knee-jerk reaction to be sure..but the only ones who will make anything will be the lawyers..and it won’t be much at that.

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When IOUs become currency

Felix Salmon
Jul 13, 2009 20:50 UTC

OK, this is getting REALLY annoying — it’s happened again! Why is Ecto killing my posts when I publish them? Here’s a shorter version of my now-lost IOU post:

Yglesias says California’s IOUs are “arguably” unconstitutional. Babcock demonstrates if they’re not unconstitutional already, they will be if California starts accepting them in payment of taxes. Are we moving towards an alternative currency like the patacón? Will California banks start opening IOU-denominated bank accounts? Will California effectively devalue against the dollar? And how can that possibly be good for the nation as a whole? Geithner should put a stop to all this nonsense once and for all, ban the IOUs, and just bail out California already. It’s inevitable he’ll do it sooner or later, so best do it before Americans’ faith in fiat currency is shaken up too much.


Can’t state enough how important the sacrifices that go into wealth creation are.

Curious if anyone has caught this book yet? “The Richest Man in Town” by W Randall Jones. I’ve read half of it so far and let me tell you it is well worth it. Would like to hear what everyone else thought of it?


More on Taibbi, Goldman Sachs, and squids

Felix Salmon
Jul 13, 2009 19:01 UTC

(Having Ecto troubles: this is the second time I’ve written a blog entry, clicked “Publish” in Ecto, and then only the headline appears, with the entry body being blank. Anybody know how to fix this?)

So, shorter version of what I just wrote but which now is lost:

(1) Taibbi has cleared up the question whether he’s taking a narrow or a broad view, saying that he used “the rhetorical technique of using a specific example of a specific bank like Goldman to tell a broader story about Wall Street in general”.

(2) This piece was a massive own-goal for Rolling Stone: everybody has read it by now, but only in samizdat form. RS could have gotten a good million pageviews out of this; instead it got a handful of extra single-copy sales.

(3) It’s pretty much impossible now to talk or even think about Goldman without a squid springing to mind — Goldman has lost control of its own image for the first time in living memory. And that alone is quite an achievement for Taibbi.


what you’ve lost in rhetorical flourish, you’ve (more than) made up for in succinctness; I wish you’d lose more posts to Ecto! or, at least, provide an Ecto-loss-like (what’d you want to say if you lost your post, but in short form) concise summary ahead of your longer posts :P

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More notes on blogging

Felix Salmon
Jul 13, 2009 16:25 UTC

I got some very interesting feedback on my notes about blogging, in the comments, from other blogs, and from participants at the SAJA seminar I led. Karl, in particular, had some extra questions, which are worth answering:

When and how much should you quote someone vs. a simple link? How much context do you need to give vs. expecting that people are following the conversation?

Quote what’s necessary, and provide a few extra links which provide background if necessary. Make it easy for a newcomer to go back and follow the conversation from the beginning.

When responding to someone do you just focus on the persons best points or address the entirety of their argument?

Great question. In the blogosphere there’s a tendency to treat other comments as part of some kind of debating competition — that results in focusing on your interlocutor’s weakest points, rather than their best ones, and ignoring the ones which are actually pertinent. It’s worth making an extra effort to be intellectually honest and to treat the entirety of the comments made, rather than trying to make yourself look as good as possible.

How worthwhile is it to link and/or quote something you agree with. It seems boring to say “yeah what she said” but if you never agree with anyone are you a douche?

“What she said” is often a great blog entry — bloggers are aggregators as much as they are commenters. (This is one reason why Tumblr and Twitter have caught on so well — they’re as much reblogging services as they are microblogging services.) In general don’t be too afraid to be boring — something which is common knowledge to you might not be to your readers.

On that same note is it arrogant to aggregate or have link dumps when you are obviously small time and most of your readers have probably seen this stuff already?


What’s the etiquette if people much more established than you link to you. Should you thank them? Is that kosher?

I don’t know anybody who objects to being thanked. It’s polite.

On that same subject should you make a concerted effort to link to people who link to you? Or, should you focus on the stuff you read the most?

There’s a natural tendency to read people who link to you, because by definition they’re taking part in your conversation. Once you’ve read them, there’s no need to make any extra effort to link to them. If they’ve said something you want to respond to, then you will; if they haven’t, then you won’t.

I think my points here run counter to what James Kwak is saying:

It’s important to have an original perspective on those issues. Because if Krugman makes an argument on Monday, and you make the same argument on Tuesday, even if your post is better, it’s unlikely be to be cited (unless Krugman triggered an ongoing debate).

James is a great blogger (and his whole post is well worth reading, it’s very good), so he might be on to something, but my feeling is that the aggregate weight of blogospheric opinion is important: a lot of bloggers all saying the same thing can really make a difference these days, and one shouldn’t be afraid to echo the thoughts of others. What’s more, blogging isn’t some kind of competition as to who can be cited the most. Or it shouldn’t be, anyway.

James also links to a comment from Dave Winer, who, in his trademarked curmudgeonly manner, says that (a) he subscribes to James’s Twitter feed instead of his RSS feed, but that (b) he prefers truncated feeds because they make it easier for him to create “rivers” like the one he’s built for the New York Times and which has been copied and improved by the NYT itself. There is a tiny minority of readers who prefer truncated RSS; for them, feel free to create a truncated RSS feed. But it should always be in addition to, rather than instead of, a full RSS feed.

Finally, at the seminar, I met someone who had worked with Bloomberg who explained why Bloomberg is so averse to RSS feeds and to Twitter: the powers that be there think that a huge part of the value they add is in their headlines, and that therefore anything which “pushes” Bloomberg headlines out in real time is a competitive threat to the Bloomberg terminal. Weird.


Great post Felix

Almost like some blog etiquette! ;)

Why Berkshire’s cutting back on reinsurance

Felix Salmon
Jul 13, 2009 13:23 UTC

Scott Patterson reports that Berkshire Hathaway wrote less than half the amount of reinsurance in 2008 as it did in 2006, and that 2009 will be substantially lower still. He relates this development to Berkshire’s credit rating, which was downgraded from triple-A by Moody’s in April:

In its credit opinion, Moody’s also cited the potential volatility of Berkshire’s “catastrophe-exposed business.” Berkshire is a major investor in Moody’s Corp., parent of the ratings group…

A higher book value and a rising cash stockpile could eventually lead to a reinstatement of Berkshire’s Aaa rating, though Moody’s isn’t likely to reverse itself soon.

If and when Berkshire wins back a higher rating, that could pave the way for the company to move aggressively back into the property catastrophe market.

It strikes me that the really important thing here isn’t Berkshire’s credit rating, so much as its CDS spreads. Reinsurers used to feel that they needed a triple-A rating because that connoted utter safety: you could reinsure your catastrophe risk with Berkshire safe in the knowledge that the risk of Berkshire being unable to meet its obligations was significantly lower than the risk of, say, a hurricane hitting New York.

Now that the value of a triple-A rating has plunged, however, in the wake of many formerly triple-A-rated securities defaulting over the past year or two, insurers are going to feel much more need to hedge their counterparty risk when it comes to their reinsurance contracts. As a result, the cost of reinsurance isn’t just the cost of the premiums any more: it’s the cost of the premiums plus the cost of buying credit protection on the reinsurer.

Conversely, from Berkshire’s point of view, every dollar that Berkshire reinsures is another dollar of demand for Berkshire credit protection, and the upward pressure on Berkshire’s CDS spreads will remain. And thanks to delta hedging and capital-structure arbitrage, sellers of Berkshire credit protection will ultimately end up depressing the Berkshire share price.

Berkshire’s shares are looking pretty cheap these days: at $85,000 apiece, they’re lower than they were five years ago. But five years ago, the idea that Berkshire’s insurance products would have to be discounted by its counterparty risk would have been unthinkable. Without its triple-A moat, Berkshire looks much less special than it did back then.

Update: My commenters are saying that insurers don’t hedge their counterparty risk to reinsurers. Either you trust a reinsurer or you don’t; if you do, you don’t hedge counterparty risk, and if you don’t, you don’t do any business with them at all. Maybe insurance regulators should be looking into this.


sorry, Chris, I’m not sure the document you linked us to quite does the trick.

http://slingeek.wordpress.com/2009/07/23  /rating-berkshire/

Why I’m unconvinced by calls for a second stimulus package

Felix Salmon
Jul 12, 2009 23:34 UTC

Brad DeLong has an impassioned plea for further fiscal stimulus under the headline “Fiscal Policy: The Obama Administration Is Not Making Much Sense These Days”. His basic argument is simple: if the $787 billion package was designed using assumptions which turn out to have been overoptimistic, then surely now that unemployment is heading into double digits a second major stimulus is warranted.

But the problem is that spending trillions of dollars is actually extremely difficult, and it’s even harder if you try to front-load it. Government, by its nature, moves slowly, and I get the impression that the “easy” spending — and then some — was all included in the initial stimulus bill. The “shovel-ready projects” have already been funded, and any extra stimulus might well take years to kick in.

In an efficient market, a credible government promise to invest hundreds of billions of dollars in mass transit and nuclear power and smart electrical grids and so on and so forth would have an immediate stimulative effect: people would start spending now, in anticipation of all those government dollars which are going to arrive in a few years’ time. But we’re in a liquidity crunch, and we’re not in an efficient market, and unfortunately government spending only seems to cause any stimulus as and when the checks are written, if then. (Insofar as they go to companies who are running down their inventories, there’s no stimulus at all.)

I don’t think there’s any doubt that there are diminishing marginal returns to fiscal stimulus plans — which brings me to Paul Krugman’s take on the subject, where he asks how an examination of the marginal costs and benefits of deficit spending could possibly come to the conclusion that stimulus of $800 billion was exactly what was needed.

Let me try to hazard an answer to that. Start with the guiding assumption, as stated by Larry Summers when the stimulus bill was going through Congress, that the risks of spending too much paled in comparison with the risks of spending too little. And because the effects of government spending on GDP and unemployment are hard to predict with any accuracy, there was a strong case that a monster $800 billion stimulus bill was in many ways the prudent course of action.

Since then, however, the economy has done much worse than anybody thought it would. Which is one way of saying that the stimulus has not done as well as people thought it would. This is a useful datapoint — and one way of looking at it is to conclude that the stimulus was so big that the last few hundred billion dollars have had virtually no positive effect at all. And that any extra stimulus would similarly achieve very little.

If there is to be a second round of stimulus, then, I think it should certainly go to areas largely untouched by the first round. I like arts spending; DeLong wants an “aid-to-states-that-maintain-effort package”. But unless and until we can demonstrate that the marginal benefit of extra stimulus spending hasn’t already diminished to something negligible, it does seem fiscally reckless to throw good money after wasted funds.

Update: Commenters rightly say that there’s a limit to how much can be done with arts subsidies. Again, they’re the kind of thing where a little goes a long way, but a lot doesn’t go a lot further.

And Brad DeLong responds, saying that of the $787 billion earmarked in the stimulus bill, only $14.5 billion has been spent so far, and that total will barely exceed $50 billion by October. Which seems to me a good reason why we don’t need to increase the total — we’re having a hard enough time spending the money we’ve already got.


Really amazing how many people think the stimulus is the bailout…

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Food TV chart of the day

Felix Salmon
Jul 12, 2009 16:24 UTC

The latest issue of my favorite obscure periodical, Meatpaper, has just arrived in the mail, and features this wonderful chart, in an article by Chris Ying:

Meatpaper chart.jpg

Put the attractiveness of a food-TV host on a scale from 1 to 10, says Chris, and put the repulsiveness of the food that host eats on another 1-to-10 scale. Then the product of the two numbers will always equal 10 — Gianna Giada De Laurentiis, for instance, is a 10 on the attractiveness scale, and eats only beautiful food.

Ying adds, in a footnote, that TV executives could actually use this formula normatively:

If our hypothetical TV host is a 2.1 in attractiveness, and we’ve got him going around the world eating macaroons and tea sandwiches, we’ve got to bring the repulsive level of his food to 4.76 before that show gets off the ground.

Ying never quite answers his own implied question, though: why is it that repulsive food is good for ratings if the host is not attractive, but bad for ratings if the host is attractive?


fancyfastfood.com will tell you how to make repulsive food attractive, but don’t offer any solutions for improving the attractiveness of those doing the preparations

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An income tax is not a wealth tax

Felix Salmon
Jul 11, 2009 22:14 UTC

The WSJ, on both its print and its online front page, as well as in the headline of the article in question, says that the “Health Bill in House Relies on Wealth Tax“.

But the weird thing is that it doesn’t:

Under the Rangel plan, married couples making $350,000 would also be subject to a 1% surtax to cover the health plan. The levy would rise to 2% for those making above $500,000 and 3% for those with incomes of $1 million or more.

This is an income tax, pure and simple, not a wealth tax. Personally I think a modest wealth tax, in conjunction with an income tax, makes a certain amount of sense. Why tax income, which people work hard for, but not unearned wealth? But in any case, this isn’t a wealth tax, and I don’t understand why it’s being characterized as one.

Update: Tom Lindmark says he’s “not quite sure what constitutes unearned wealth”, saying that “the only way to accumulate wealth is to earn it via hard work or diligent investing”. If that’s true, then really a wealth tax is a (delayed) income tax, and so the choice between an income tax and a wealth tax basically just comes down to choosing whether you tax income as it’s earned or only after it’s been accumulated and invested.

On the other hand, I think there’s lots of unearned wealth in this world, most but not all of it in the form of inherited funds. (There’s also all those lottery winners.) To a large degree anybody who became wealthy by selling their home for much more they bought it for can’t really be considered to have been diligently investing, and can be considered one of the few beneficiaries of the housing bubble. So that wealth, too, might well be caught by a wealth tax but never by an income tax.


When I checked the IRS website the accumulated wealth in the USA is about 60 trillion dollars…. so a 1 percent
tax on net worth would pay for health care reform and the budget deficit. We do not tax the rich in this country we tax income…. The rich make the rules that is why this tax is never considered….

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