Thank you for your comments.
Firstly, the posting’s purpose was to put forth several studies undertaken by well-known CTAs that attempted to address how CTAs might perform in a rising rate environment. Not my studies and conclusions; their studies and conclusions. You made no comment about the studies referenced.
As best I understand your comments, you take objection to my premise that traditional equity/bond investors cannot capture/take advantage of the volatility in equities or bonds (…as, it is my contention, they lack an appropriate vehicle or aptitude or disciplines or emotional wherewithal etc.) You take the opposite position as you state that:
1 “Traditional long-only portfolios capture the volatility premium–higher returns that investors in (all) relatively volatile assets earn because other investors want to avoid volatility”
2 “… Long only investors can ride out the volatility and simply collect the premium.”
And to that I take objection. Research does indicate that the hefty equity-volatility premium can be captured by a buy-hold strategy…but this capture (or as you state “simply collect the premium”) can only be expected to be true for investors over a long time horizon. e.g. investors who “can ride out the volatility” over a 25 to 30 year period. This would not be the case for: many retirees, those soon to retire, or pension funds looking to meet commitments within a much shorter period of time e.g. one to five year time periods.
The size of the equity volatility premium is large, 5.95% per year, figured as “the mean of the annual equity (volatility) premium from 1963–2011.” But, as “the standard deviation of the equity premium is also large—17.85%, or three times the mean, …the year-by-year values of the premium are volatile….Fama and French estimate there is almost a one-in-four chance that the average premium for a five-year period will be negative; that is, T-bills will beat stocks. …As the time horizon increases, the standard deviation of the average equity premium drops from 17.85% for a one-year period to 7.98% for five years, 5.65% for ten years, 3.57% for 25 years, and 2.53% for 50 years. (Source: Cardiff Park Investors referencing Fama and French; http://www.cardiffpark.com/portfolio-design/volatility-and-premiums.)
As to your other points…Yes, the typical investor fails to time the market ….as typically their tools, systems, portfolio rules are not technically oriented and they are fundamentally trying to decide peaks and troughs. That is just does not work well for those investors does not mean it does not work well for other types of investors. For CTAs that are algo based, you need to only look at the history of returns (audited and after all fees) to see that the CTA indices are less volatile than stocks and have been able to take advantage of past equity crises.
Lastly, you suggest that portfolios that “actively time the market to take advantage of volatility…. succeed on a gross-of-fees basis but pay out all of the incremental performance in the form of high active management fees.” That is simply not true for the asset class of CTAs and again I reference the histories of several CTA industry indices which are net of all fees.
Jeannette Showalter, CFA
Walsh Asset Management
Branch Office Naples FL
[email protected]
239-571-8896
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