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Why target date funds fail in the one area they're supposed to succeed -- downside protection

SEC recommendations about the inherent risk of target date funds are more controversial than their author's realize, says a veteran risk assessor

Monday, July 22, 2013 – 3:40 AM by Guest Columnist Robert Boslego
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Robert Boslego: There is no guarantee that stocks will recover from a major loss within the time frame the retirement money is needed. [An investor] may literally die waiting for his or her portfolio to recover.

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Alex Potts

Alex Potts

July 22, 2013 — 4:32 PM

Could you please define for the readers what “vertical risk management” is? Without understanding what risks YOU are taking, this article is useless and merely comes across as simply an ad for “black box” management.
Thank you.
-Alex

Joe Gordon

Joe Gordon

July 22, 2013 — 4:44 PM

Agree with Alex…and even add: so many so critcal of TDFs are simply talking their book…agree they are not perfect but what is except a guaranteed annuity which is guaranteed to not hedge inflation, if we ever have it again, and guaranteed to conficate your capital at death.

Stephen Winks

Stephen Winks

July 22, 2013 — 5:13 PM

Ron Surz is widely acknowledged as the industry’s top expert on Target Date Funds, known for his highly lucid, widely read primary research in TDFs.

SCW

Robert Boslego

Robert Boslego

July 22, 2013 — 5:41 PM

The SEC wants people to know their maximum risk exposure in Target Date Funds, especially as they approach retirement. As it turns out, that is not so easy to do. It requires a methodology all TDFs would adapt to calculate Risk Glide Paths. Mine is an objective approach based on historical data. As I say, we don’t know what future risks will be.

The SEC did not see this as controversial, but I think it will be. A lot of assumptions are required in any approach for calculating future risk.

My solution is a risk management strategy where the exposure is decreased when risks rise. I call it Vertical Risk Management. Many corporate clients want to hedge when risks are high, and reduce hedges at other times. This is what I have developed for investment portfolios and can customize it to fit different risk appetites.

VRM is an evidence-based strategy that is designed to overcome behavioral biases through the structuring of rational decisions in advance, under non-crisis conditions. VRM is based on the view that the future is unpredictable. What it does is react to price events in a rational, consistent way, to control risk.

Three theories upon which VRM is based are:
Price-to-Price Feedback
Volatility Feedback
Prospect Theory/Disposition Effect

Price-to-price feedback is explained by Yale Professor Robert Shiller in his paper, From Efficient Markets Theory to Behavioral Finance. ( http://www.econ.yale.edu/~shiller/pubs/p1055.pdf) :

“Faith in the efficient market theory was eroded by a succession of discoveries of anomalies, and of evidence of excessive volatility of returns…Some important developments in the 1990s and recently include feedback theories, models of the interaction of smart money with ordinary investors, and evidence on obstacles to smart money.”

The overall idea is to have a systematic strategy for hedging risk that is well-thought out to avoid the behavioral problems associated with making decisions during a crisis. Anyone wishing to view a presentation of VRM can see it at the bottom of this page (http://www.boslego.com/Resources.html).

I didn’t describe it in the article because the article was intended to discuss the risk methodology and results.

Elmer Rich III

Elmer Rich III

July 22, 2013 — 9:18 PM

We have been making an effort to replace the use of the term “risk” (a known probability of an outcome) with what is accurate or “uncertainty” (unknown probability of outcome). The MIT economist Albert Lo pointed this out years ago.

We have also been pointing out that what is called “evidence-based” in financial services is not. It is theories but there is no double-blind, experimental evidence or data proving these claims. Back-testing is not “evidence” nor are other forms of curve-fitting modeling. The use of the terms “evidence-based” has become a new marketing buzzword – but it has detailed requirements.

Further, the behavioral models and theories also questionable. We are submitting a paper to the Journal of Retirement on the evidence here.

Once we accept that we are talking about true uncertainty – then better models, theories and experimental testing can move ahead. However, uncertainty may not be manageable in financial markets – by definition.

Promising is the discovery in other professions that human behavior is flawed, unreliable and often harmful – at whatever level of expertise. Thus, computers diagnose better than doctors.
But in econ and financial services we are handicapped by:

1. The theoretical and untested nature of the knowledge
2. The flaws in humans building the computer programs

Again the expanding speed, complexity and uncertainty of investing may not be manageable. Nothing says it must be so.

Robert Boslego

Robert Boslego

July 22, 2013 — 9:58 PM

Alex,

In the example using FFVFX, I am taking the same or less risk as an unmanaged position in FFVFX. Again, this is a back-test of a risk management methodology.

Ron Surz

Ron Surz

July 22, 2013 — 10:46 PM

Thanks Steve Winks for your kind words. My efforts have been focused on risk at the target date, whereas it looks like VRM can be applied across the entire glide path. I think risk at the target date is of critical importantance because it’s when lifestyles are at stake. Account balances are at their highest level and there are no second chances. There’s a risk zone spanning the 5 years before & after retirement that make or break lifestyle plans. The critical fact is that most withdraw their savings at the target date, so it’s game over — no “through” funds ever make it to their intended end.

Check out the joint SEC-Dol June 2009 all-day hearing on target date funds. It was entirely about 2010 funds — funds near their target date. Can you guess why?

If VRM can make life better at longer dates, bravo. I’ll stick to my story that no risk — zero — is the only correct risk at the target date.

Robert Boslego

Robert Boslego

July 22, 2013 — 11:42 PM

Yes, VRM can be applied all along the Glide Path. It’s an approach of trying to keep losses within a tolerable range.

Risk management is all about setting goals and trying to manage risks so that the goals can be achieved. All investment strategies involving risky financial assets are essentially risk management strategies.

MPT, by design, is essentially a fixed plan. It does not manage risk.

I suspect that if people were asked, most would agree with Ron that their risk tolerances approach 0% as the target date approaches. If TDFs could lose 35% within 5 years of the retirement date, as the analysis above indicates, this a serious issue. Everyone invested in these TDFs needs to know this, so that they can make a wise decision.

That’s what I think the SEC intends to do. It’s just not going to be easy to get hard numbers for the risk of loss.

Ron Surz

Ron Surz

July 23, 2013 — 12:17 AM

It will take lawsuits, rather than the SEC, to get the attention of fiduciaries, which will likely happen when the next 2008 occurs. In the meantime, the Big 3 will pocket an obscene amount of profit. They control 80% of the assets.

The sort of good news is that class action lawsuits will restore some of the losses the poor beneficiaries will sustain in this next disaster. Fiduciaries should know better. TDFs are the other 401(k) scandal, exacerbating the excessive fee problem. Fiduciaries are complicit in these scandals because TDFs are employer-directed rather than participant-directed.

Is anyone listening?

Robert Boslego

Robert Boslego

July 23, 2013 — 2:04 AM

I would like to be more pro-active and help average investors understand their risks to make informed decisions. Boomers are internet savvy and that doesn’t have to happen.

Brian Murphy

Brian Murphy

July 23, 2013 — 5:59 AM

Great article, Robert. My belief is that things won’t change until consumers themselves force a change based on the advent of a better retirement model. True change won’t come by way of regulation. That’s the way the world works and I applaud all those like yourself and Ron putting forth the effort to “think differently”.

We believe there will be a better model, and at Kivalia we’re working on it ourselves. Why not build an interactive “drawdown” model that captures all this right on a website – and maybe build overlay strategies to manage that risk for employees…hmm. Just thinking out loud. It’s not like someone could actually do that now – is it?

Robert, I’ll try to reach out directly. Thanks.

Robert Boslego

Robert Boslego

July 23, 2013 — 6:37 AM

Thank you, Brian.

I agree that consumers, the public, ultimately can and do bring change that even the most powerful governments and firms can’t control. What people need is good information. The average person is not stupid, though that is how people are often treated by governments and corporations.

I really like your reference to Steve Jobs/Apple to think differently. It reminds me of the Robert Kennedy quote that “some men see things as they are and say ‘ why.’ I dream things that never were and say ‘why not.’?

We don’t have to be powerless.

Elmer Rich III

Elmer Rich III

July 23, 2013 — 12:33 PM

How are investors and consumer ever going to have enough information to make intelligent demands let alone decision? These are critical matters – not consumer goods like an iPhone or amenable to political slogans.

The suggestion would be equivalent to consumers being their own doctors. Investment, and medical, matters are getting much more complicated and much less comprehensible to a lone consumer-investor. Larger and larger teams of specialists are now the norm in other professions – the opposite of “do-it-yourself.”

Just because much more information in available on the web does not mean it is appropriate for decision or more useful.

Idealistic hopes are best not useful for the hard realities of protecting people’s life savings.

Ron Surz

Ron Surz

July 23, 2013 — 1:29 PM

Target date funds are selected by fiduciaries, primarily advisers, who have a duty to understand and vet. They are breaching their fiduciary responsibility, but feel safe because everyone is doing the same lax job.

Elmer Rich III

Elmer Rich III

July 23, 2013 — 1:40 PM

My understanding is that fiduciary duty is following the practices of one’s professional peers and “prudent men” not prudent “experts.”

There is no requirement for a plan sponsor to be expert in the arcane technicalities of economics and finance theory. That would be impossible anyway.

Ron Surz

Ron Surz

July 23, 2013 — 2:37 PM

Your understanding is wrong. Fiduciaries are not protected by the lemming rule. Please see http://www.targetdatesolutions.com/articles/DOL-Release-201302.pdf

Stephen Winks

Stephen Winks

July 23, 2013 — 3:18 PM

The consumer is the arbiter. They trust that their broker is doing the right thing and don’t understand the broker “is doing the best they can” not knowing that it is counter to the best interest of the investing public—certainly legal but unethical. Dodd-Frank makes unethical behavior to retail investors, illegal, as it is now for all other investors.

Elmer is having difficulty reasoning professional standing because it is different from what brokers are doing under a suitability standard. Yet advisors who act in a fiduciary fiduciary capacity achieve professional standing and have won and deserve the trust and confidence of the investing public. The reason why advisors are rapidily growing market share is advisors are actually acting in the client’s best interests—they are literally doing the right thing.

Industry apologist can not reconcile that retail investors are afforded lesser consumer protections than all other investors contrary to equal protection under the law assured by the Constitution. This is the intended outcome of the powerful brokerage industry lobby which indisputably acts counter to the best interests of the investing public.

There are no unintended consequences with Dodd-Frank, the intention is having the consumer’s best interest comming before that of the brokerage industry as the consumer expects as required by fair dealing..

Elmer, as a self professed ethicist and industry apolgist, believes “who cares” about public trust and inconvenient truths like the US Constitution and those pesky statutory requirements for those that serve in a position of trust in handling the funds and investments of investors who have limited investment knowledge and experience. The consumer is counting on us to do the right thing. If that trust and confidence is lost and professional standing is dismissed, the financial services industry will have failed the investing public.

The industry is engaging in self-destruction, while Elmer cheers along..

SCW

Elmer Rich III

Elmer Rich III

July 23, 2013 — 3:40 PM

OK, how is a plan sponsor to become an “expert” in economics and portfolio theory? Even “expert” claims rarely follow real science and evidence as we are learning.

Give the increased speed and complexity of retirement and investment markets, even academics who make their livings studying these things have been caught well behind the rush of events.

Again, fear-mongering deflects real problem solving.

Elmer Rich III

Elmer Rich III

July 23, 2013 — 3:44 PM

Wait. So the supposed PDF posting of DOL language is just a personal opinion and POV piece. Where is independent regulatory language supporting the claims about fiduciary responsibility?

Ron Surz

Ron Surz

July 23, 2013 — 4:12 PM

Where’s the regulatory language that says “Choose T. Rowe, Fidelity or Vanguard?”

Stephen Winks

Stephen Winks

July 23, 2013 — 5:10 PM

Elmer,

The average reasonable man is different from a prudent expert in that it incorporates a more indepth understanding. Prudent experts have professional standing.

With whom would you entrust you money?

If you are to use the reasonable man standard in Uganda, a witch doctor will do. If you are a soverign wealth fund subject to the highest level of discernment, you would prefer a prudent expert. as judgement is required far beyond the average reasonable man. This requires training and at least the acknowledgement of ongoing fiduciary duty. This distinction is not embraced in the retail market but is in the institutional markets.

For example, Modern Portfolio Theory and optimizers are based on the historical performance characteristics of asset classes but when current market conditions contradict historical precedent, optimizers lose their relevence. Not because MPT does not work but because MPT is not effectively executed. During periods like today where current market conditions contradict historical precedence, more informed views shaping capital market assumptions are required which materially impact asset allocation and portfolio construction. This is why retail optimizers do not work as they never go beyond historical performance of asset classes. Access to this type of advanced statistics and daunting mathmatical resources are not available in the retail market but it is for trillions in the Sovereign Wealth space. This the type of world class support brokers is what brokers should be giving up 60% of their gross revenues for, it is just culturally not possible in a brokerage format because fiduciary duty and liability is entailed.

This doesn’t have to be the case, as this intellectual capital can be easily brought to the retail space.

This instititional bias counter to the best interet of the investing public has crippled the brokerage industry in serving the best interests of the investing public, to which Elmer applauds.

Elmer, do we have to belabor every point—you are not looking very good in all of this, but please continue.

SCW

Elmer Rich III

Elmer Rich III

July 23, 2013 — 5:23 PM

Attorneys and plan sponsor experts have told me that the “prudent man” need not be an expert and is not held to those standards.

Thus, acting as peers in similar roles constitutes fulfillment of the standard. Not perfect, of course. But it appears that the, maybe back to common law, proscriptions are following the idea of a “jury of one’s peers” expanded into a “trust” relationship.

Facts, evidence-based knowledge and science is, by definition, independent of local, individual and temporary circumstances. The laws and proven models of gravity, biology, engineering, medicine are not dependent on their application. If the execution of MPT determined it’s predictive usefulness, then MPT is merely a hypothetical model with little value – which may be true.

Finally, if any or all of these theories worked, professional investors wouldn’t need outside money, of course.

As in all professional discussions, we are discussing ideas here – not personalities.

Stephen Winks

Stephen Winks

July 23, 2013 — 5:28 PM

Elmer,

So, you prefer the Ugandan witch doctor, not being able to discern the difference?

SCW

Elmer Rich III

Elmer Rich III

July 23, 2013 — 5:41 PM

With the hyper-transparecy of the web, the immediate access to primary economic research (and all others) and the growing dominance 0f people’s life savings as the assets in the industry we are all forced to be held accountable for claims and statements of fact.

This is a new structural reality forced on everyone. In the past, the evidence, data and research was “locked up” in academic journals and paper documents – no more. Everything is now digitized. So the standards of proof have jumped significantly.

Of course, old theories, ideas and practices will not stand up to the new scrutiny.

Expert, professional knowledge, research and work is very hard, takes a long, long time and is generally not well paid since it is very uncertain and the pay offs come in decades.

But old ideas give way to new and more accurate ones. That has always been true. Why fight the natural process of learning new and better ideas and which old ones to discard?

Stephen Winks

Stephen Winks

July 23, 2013 — 6:01 PM
Elmer,

By your definition of science, brain surgery is complex and not certain, so it is not science.

I think everyone familiar with your logic get the picture. You are clueless.

SCW

Robert Boslego

Robert Boslego

July 23, 2013 — 11:11 PM

Modern Portfolio Theory was mentioned a few comments back. MPT is implemented through the mean-variance optimization process (“MVO”). According to David Swensen, Chief Investment Officer of the Yale endowment:

“Unfortunately, the mean-variance optimization process provides little useful guidance in choosing a portfolio.”

Source: David Swensen, Pioneering Portfolio Management, page 123.

——————————————————————————————————————————————————————————————

In a recent article, the CIO of Ward Loring wrote:

“The usual application of the mean-variance optimizer is a charade, “an absurd pretense intended to create a pleasant or respectable appearance,” according to OxfordDictionaries.com. Charades are fun, but they are not funny when we are blind to their pretense.

“Here is how the charade is played within the context of portfolio theory. We assemble estimates of parameters for the mean-variance optimizer: expected returns, standard deviations, and correlations. We assemble the estimates from historical returns or from seemingly sophisticated methods, such as those invoking Bayes theorem or “resampling.” We place the estimated parameters in the mean-variance optimizer and give it a spin. Out comes an efficient frontier with portfolios such as the one with 70 percent in European stocks and 30 percent in gold. We find this portfolio unappealing, so we push down the estimated return of European stocks or add a constraint that limits European stocks to 10 percent of portfolios. We give the optimizer another spin and get another efficient frontier. We continue spinning until we get an efficient frontier with portfolios that really appeal to us, the ones we wanted all along. The result is that we can now pretend that we have found them on the “scientific” efficient frontier.

“It is time to end the charade.”

http://www.fpanet.org/journal/EndtheCharade/

Robert Boslego

Robert Boslego

July 23, 2013 — 11:13 PM

correction: Loring Ward

Elmer Rich III

Elmer Rich III

July 23, 2013 — 11:31 PM

Right, but all financial and econ modeling suffers from the same lack of true experimental theory testing.

Since econ and finance theories and knowledge is not empirical but driven by classical (centuries old) beliefs about human behavior – there is no way to test them using accepted scientific standards.

However, all animals have economic behavior. Exchange of resources is the basis of life and the principals were solved in other animals long before humans came along. Economics is fundamental just the biology of “getting” behavior. That is real science but will only be fought by econs.

BTW, the “Nobel Prize” in economics is not awarded by the real Nobel Committee and does not meet the evidence standards of the other real prizes. It is awarded by the economists of the Swedish Central bank and merely co-branded with the real Nobel Prizes.

Robert Boslego

Robert Boslego

July 24, 2013 — 12:26 AM

Confirmed: Not a Nobel Prize

The Prize in Economic Sciences is not a Nobel Prize. In 1968, Sveriges Riksbank (Sweden’s central bank) instituted “The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel”, and it has since been awarded by the Royal Swedish Academy of Sciences according to the same principles as for the Nobel Prizes that have been awarded since 1901. The first Prize in Economic Sciences was awarded to Ragnar Frisch and Jan Tinbergen in 1969.

“Nomination and Selection of Laureates in Economic Sciences”. Nobelprize.org. Nobel Media AB 2013. Web. 23 Jul 2013. <http: www.nobelprize.org="" nomination="" economic-sciences=""/>

Robert Boslego

Robert Boslego

July 24, 2013 — 2:25 AM

Elmer,

Do they have to give the prize money back if the theory upon which it was won was disproven, or shown it is not useful?

Elmer Rich III

Elmer Rich III

July 24, 2013 — 2:34 AM

Right, so economics does not meet the standards of evidence necessary for a true science. That is fine.

However, now the weakness of the evidence for these theories is fully available to everyone.
I directed to and read a paper claimed as the basis for the new value tilt being promoted by Dimensional Fund Advisors. I am used to studying neuroscience and biology primary research.

The public claims of DFA and others adopting this new value metric are simply not supported. Glad to provide further details. Again, OK. The study of economics is largely an “analogical”, and not scientific, body of knowledge – as claimed by a chief EU economist well funded by corporations. OK, again.

However, when we move into the arena of investing people’s life savings – as a social necessity we must demand real evidence. DFA has a short video touting their “evidence-based” methodology. It is just a new marketing buzz word. We’re marketers we know.

If we can see the holes in academic research so can a plaintiffs attorney who will claim the asset management marketer/ing was either lying, misrepresenting or incompetent in their business representations to his (class of) clients. Same with regulators.

You simply cannot say the things that the industry used to, and still does, anymore. This is a structural fact and not a personal opinion.

Elmer Rich III

Elmer Rich III

July 24, 2013 — 2:45 AM

It is a marketing implied misrepresentation that should be owned up to now that it is easy to get public knowledge. As an alum of University of Chicago, I contacted them when I found out. As expected, denial was their response. I suppose they believe they can keep it a secret.

It’s a silly pretense for the profession. May it RIP.

Robert Boslego

Robert Boslego

July 24, 2013 — 2:48 AM

My diploma from Harvard says I have a degree of Bachelor of Arts cum laude in Economics…not a Bachelor of Science. I don’t think they confuse economics or psychology with physics or chemistry.

Elmer Rich III

Elmer Rich III

July 24, 2013 — 1:03 PM

Exactly, econ is more of a humanities subject. An important approach to new knowledge but descriptive and not predictive.

The requirement of a science is that it predict measurable events in the future. Now the measurement can be a discreet or continuos dependent variable. But the independent variables must contribute to the accuracy, within an error terms of that dependent variable measurable prediction.

It appears that only with, mainly, double-blind experimental procedures can that kind of accuracy. So Einstein’s original theories were untestable at the time but he made specific predictions. Only in the last 2 years have we had the tools to make the measurements and they have turned out to be accurate within .00000000x or something similar.

He could do that because the math modeling of physical events is very accurate.

Another characteristic of modern science is that progress is generally being made by bigger and bigger groups of people. Groups that constantly exchange, argue and share openly information and data. There is research that the more openly a scientist shares their data, the more professionally successful and experimentally successful they are. This openness and transparency seems a requirement.

Of course, that is anathema to business and industry. Brain research and biological research on behavior is also like this – an area we have studied for years.

So what do we do in financial services? Well, first we accept the truth. We have no choice the truth is now public. Our models are analogical and not predictive. They just aren’t.

Will they ever be predictive? Not in our life times or maybe many lifetimes after us. We just don’t have the methods or perhaps even the data yet. I believe we start with animal behavior and the brain “bottom up” but that is a radical idea, although the science is airtight and very predictive. Econ behavior is, after all, first the exchange behavior of discreet individuals.
Since it is a biological mechanism the processes and medical facts are universal – even across species.

Current econ and finance models are “top down” they start with popular intuitive “higher order concepts” of how the world works and try to prove them out – or do back testing/curve fitting. That’s where the money and demand is – so the supply conforms. But just meeting demand will always hinder discovery of new facts.

By definition, there can be no demand for what is not yet known. But the problems we need to solve demand predictive knowledge we don’t yet have.

Stephen Winks

Stephen Winks

July 24, 2013 — 2:07 PM

So, Elmer,

Because Trust is not measurable and predictive it doesn’t exist ????

I think you have forgotten about a thing called common sense, a trait that primative famer’s in the field in remote lands know far more about than you portray.

SCW

Elmer Rich III

Elmer Rich III

July 24, 2013 — 2:35 PM

In our professional capacities we now have the tools to see inside of a brain and measure the physiological changes that occur when behaviors, that we in our culture label as “trust”, occur. So we have measurable physiological phenomena that we can use to predict behavior we call “trust” in the future.

But more practically we don’t need to use brain scans. We can then also generalize across groups of people using “Big Data,” similar to Nate Silver’s predictions of the elections, and look at what people do rather than what they say — to make predictions about behaviors of individuals and groups of people.

Like we no longer allow doctors to treat patients using common sense or engineers to build airplanes based solely on their intuition of the moment – so it is best to be suspect of common sense without proof to back it up. For example, research shows doctors using their uncommon sense are far less accurate than a simple checklist.

Yes, our brains and our behaviors developed far more to be good subsistence farmers than investors and handle technical long-term matters.

BTW, these are not “my” ideas. I simply report what me and my team have learned from studying primary research that may help investors, especially retirement investors, build and protect their life savings.

We are marketers looking for things that will work today to help clients help their clients.- not scientists. For the first time, this information is now freely available to everyone. We just share what we learn.

Stephen Winks

Stephen Winks

July 24, 2013 — 2:58 PM

Robert Boslego

You description of retail optimizers is absolutely correct:

“, so we push down the estimated return of European stocks or add a constraint that limits European stocks to 10 percent of portfolios. We give the optimizer another spin and get another efficient frontier. We continue spinning until we get an efficient frontier with portfolios that really appeal to us, the ones we wanted all along. The result is that we can now pretend that we have found them on the “scientific” efficient frontier.”

Dick Micheau, would agree. Dick is acknowledged by Markowitz for creating the best approach to global strategic asset allocation existant. This was achieved by Michaud’s five patentented, peer reviewed and proven (by Markowtiz himself in 38 rigorous tests) innovations to MPT.

Retail optimizers are manipulated to the point of not being effective. Michaud proved that a superior optimized beats superior data—to the suprise of everyone to include Markowitz. A perfect illustration of science outdating theory.

SCW

Stephen Winks

Stephen Winks

July 24, 2013 — 4:45 PM

Elmer,

You cannot be serious. Your are deceiving yourself. Even in this space we have repetedly illustrated the error of your thinking. Would any professional or lay person entrust you with their money or practice when you can’t tell the difference between an Ugandan witch doctor and a prudent expert?

So, Markowitz doesn’t know a thing and you are the only person in the world that that can act in the consumer’s best interest, right ? How absurd !

I have never seen the vanity, the absence of humility, or an ego quite as large as yours, with out any accomplishment to base it on..

SCW

Elmer Rich III

Elmer Rich III

July 24, 2013 — 5:03 PM

We don’t respond to hostile personal attacks.

Elmer Rich III

Elmer Rich III

July 24, 2013 — 5:11 PM

Think of it this way. Ben Graham is held up as an authority. Has our knowledge of economic behavior not advanced dramatically since 1934? All other areas of human knowledge have.

Imagine a doctor, engineer, physicist or any other professional stuck with ideas and practices from 1934! But his book and ideas are treated more with the reverence given to religious texts than evidence-based theories. His book is almost literally the “Bible” of the value investor. A recent peer-reviewed paper we recently were given as justification for the new DFA value calculations spent much of the beginning claiming adherence to B Graham’s models.

In 1934, B. Graham’s ideas were no doubt more disciplined than others. That is not true almost 80 years later.

Robert Boslego

Robert Boslego

July 24, 2013 — 6:43 PM

Robert Michaud MPT Optimization

The origins of this strategy are detailed in his book, “Efficient Investment Management,” first published by Harvard Business Press in 1989. His research led to the 1999 launch of New Frontier Advisors. Its managers run portfolios using a novel optimization strategy Michaud and his son, Robert Michaud, developed called “Resampled Efficiency.”

At its core, this resampling technique allows optimizers to consider and incorporate the possibility that the statistical inputs entered into an optimization model are wrong. Simply put, resampling allows managers to assign a greater range of probabilities to various outcomes.

The firm tends to make a bulk of its changes at the beginning of the year. It monitors portfolios each month, and usually by midyear, a few other changes are required, Michaud said. “The portfolios don’t get turned over completely almost ever,” he added. “Tweaks are made from time to time, but this is a low-turnover strategy.”

Source: http://www.indexuniverse.com/sections/features/5810-michaud.html?fullart=1&start=2

What this says to me is that Michaud isn’t managing risk. I don’t think it makes sense to invest money without a risk management strategy for containing maximum loss, at which point measures are taken to reduce the potential for greater losses.

Elmer Rich III

Elmer Rich III

July 24, 2013 — 6:59 PM

So how can an approach like this be independently evaluated. GIPS?

How can losses be managed?

Robert Boslego

Robert Boslego

July 24, 2013 — 10:53 PM

What has worked well with corporate clients for hedging their energy price risks is to project their future income based on oil futures prices (once I develop such a model for them) because future earnings can be hedged in the NYMEX futures markets. They decide in advance how much they want to hedge, based on their risk preferences and future earnings projections.

This approach was independently evaluated by many clients, and a few testimonials are listed here: http://www.boslego.com/Testimonials.html

My approach for risk-managing investment portfolios is described in this presentation:
http://www.boslego.com/Resources.html

I cannot promise future performance, and it’s illegal anyway. I understand that this is not physics or chemistry and market assessments is not a science. It’s a more of a question of what makes the most sense.

Stephen Winks

Stephen Winks

July 25, 2013 — 1:40 AM

Markowitz found Michaud outperformed his conventional optimizer (without Michaud’s MPT enhancements) by 57 basispoints, based on 38 rigorous test to include some with superior information which were peer reviewed and attested by leading academics and practitioners..

I love what Robert Boslego is suggesting as a commodity hedge, reminiscent of the celebrated Victor Sporandeo’s ground breaking work upon which the hedge fund industry is largely built..

Elmer’s point is he would never actually invest in anything entailing risk as performance is not assured to which he equates with science. In that abstract he doesn’t lose money, because he never invests.

While Elmer contemplates the workings of the human mind, he is not adding value for his clients. He does not understand he must take a position which invariably entails risk as there are no guarantees. What does this tell us about Elmer ?

We are dealing with an amature with no experience. There is no common sense as a reference point. By never taking a position entailing risk Elmer deems investing is not a science thus there is no professional accomplishment that would lend credence to his claims of professional standing.

What a waste of time.

SCW

robert boslego

robert boslego

July 25, 2013 — 2:40 AM

Thank you very much, Stephen. But it’s not a suggestion, I implemented that for over 25 years with many major corporations, mostly in the US, but also worldwide. Most were oil or gas companies, but that extended to major end-users, such as airlines and railroads, etc.

The field of economics/finance is not a science, like physics or chemistry. And yet, there can be a high degree of confidence that some things work and are predictable. Supply, demand as a function of price and income, for example.

We’ve had the Fed buying bonds and that has kept interest rates near zero. By the way, Ben Bernanke was one of the 6 econ majors with me at Winthrop House at Harvard in our tutorial, and we each learned something about supply and demand…even though it’s not science… :)

Elmer Rich III

Elmer Rich III

July 25, 2013 — 12:22 PM

That is a fine theory for commercial enterprises in their everyday activities where losses can be made up. It is likely a category mistake to lump commodity trading with long-term portfolio management and protection.

It is not acceptable, and very dangerous, for people’s life savings. The loss of life savings is a societal and governmental crisis – not juts a failure of and economic model. With the recent econ crisis we have seen, however, how dangerous econ models can be – and uninformed about everyday realities – of human behavior.

If supply and demand theories were universal then they should apply to securities markets and individual investing – they don’t.

Stephen Winks

Stephen Winks

July 25, 2013 — 2:14 PM

Robert Boslego

Your contribution is the only thing worth while in the entire thread.

I would love to learn more about your work? Is there a copmmercial application that provides signals that would be available on oil, given your hands on experience, that would be far more valuable than a disconnected analyst trying to formualte an opinion.

SCW
804-643-1075

Elmer Rich III

Elmer Rich III

July 25, 2013 — 2:25 PM

Professionals think critically about hard problems. Sales people flatter. Ho hum.

Stephen Winks

Stephen Winks

July 25, 2013 — 2:32 PM

Elmer,

Professionals are intellectually curious and find what actually works, sales people just talk about complex problems and offer no substantive solutiuons.

Keep talking, nobody is listening.

SCW

Robert Boslego

Robert Boslego

July 25, 2013 — 7:52 PM

Thank you, Stephen.

The analogy to corporate risk management is that they hedge to protect earnings to fund projects to meet goals. Risk management of investments for individuals to protect investments to fund lifestyle goals is conceptually no different.

With corporate hedging, there is a basis risk. for individual portfolios, it makes more sense just to reduce their size instead of introducing hedging complexities.

One died-in-the-wool MPT wealth manager I spoke with likes the idea of applying risk management to a part of a portfolio, as a way to reduce stress during large drawdowns. Many investors find it difficult to see their portfolios losing large amounts and their advisor doing nothing to stem the outflow.

Elmer Rich III

Elmer Rich III

July 25, 2013 — 9:30 PM

The simple view of applying some version of treasury “risk management” to individual portfolios based on claims of simple analogy to what companies may (theoretically) do is inadequate. The arguments are getting less compelling.

Claiming the loss in personal portfolios is similar to corporate treasury activities managing losses is unproven. The anecdotal, personal experience of one consultant seems insufficient evidence. Some of the terms being similar is a LONG way from credibility.

Then we run again into, what seems the real determinant of portfolio strategies, trading behavior and execution.

This is a very, very, really hard and complex problem. We probably can’t even identify all the variables let alone get them into Excel and a graphing program. The claim of one person, alone, figuring it out is implausible.

But ideas a free and we need a lot of ideas. Lord knows.

robert boslego

robert boslego

July 25, 2013 — 9:43 PM

http://www.boslego.com/Testimonials.html

Stephen Winks

Stephen Winks

July 25, 2013 — 10:01 PM

Robert Boslego,

WOW !!

Elmer Rich III

Elmer Rich III

July 26, 2013 — 12:10 AM

So now were into sales tactics. There are numerous testimonials that magic bracelets work and approx 45% of American believe in ghosts.

Independent data is proof. Would anyone get medical treatment based on testimonials or tests?

Robert Boslego

Robert Boslego

July 26, 2013 — 2:10 AM

Medical treatment is generally agreed upon after many tests (and retests) and testimonials, especially from trusted relatives or friends, and they are both usually very important…not your experience? I’m confused about that subject here.

I think we already agreed that finance and economics is not science like physics or chemistry, and so there are no double-blind tests, etc., of that type to do here.

I only put up my testimonials in response to your comment about how could one person figure out these complex things, etc., and I did, and that is the evidence that I can share by agreement with clients.

I am not here to convince you of anything, but I appreciate your good, probing questions.

I don’t mean to ignore your point about magic bracelets and ghosts, but ….:)

Brian Murphy

Brian Murphy

July 26, 2013 — 2:10 AM

Elmer,

Do you have an actual job for which you get paid money, or perhaps other interests. It seems you spend a lot of time arguing about things that are at best tangential to the immediate conversation.

Unfortunately for me I initially left the box checked that said “email me if someone responds to my comment”. i won’t make that mistake again.

Be well until next time I comment on an article. Robert, great meeting you.

Robert Boslego

Robert Boslego

July 26, 2013 — 2:29 AM

Thank you, Brian, likewise.

P.S. Since I wrote the article, I felt a responsibility to respond to questions/comments, and a lot of them were very good, and I had fun with a few. My biggest insight from this exchange is that individual clients might benefit from a common corporate view that once objectives are met, they should reduce risk big-time.

Thank you, RIABiz and contributors.

Elmer Rich III

Elmer Rich III

July 26, 2013 — 12:31 PM

The point is simple – why should any professional consider the ideas in the article? Where is any proof they are likely to be useful for individual portfolios. All we have is argument by analogy – a program called “risk management” works in the corporate world for one consultant therefore it should (might) work for individual portfolios.

OK, that is the proposition – where is the evidence of it working with individual portfolios? Furthermore, risk management ideas have been around a long time. Surely some academic or professional has tried to make this case prior.

Stephen Winks

Stephen Winks

July 26, 2013 — 2:22 PM

Elmer,

If you can not be constructive in making a point, don’t make the point.

If this sort of nagging and criticism of highly accomplished contributors that actually have something constructive to say is trouibling, to the point that you are detracting from the editorial content here.

No one would be disappointed if Brooke banned you from the site.

SCW

Elmer Rich III

Elmer Rich III

July 26, 2013 — 3:08 PM

The most constructive activity for any new idea is hard questions – not flattery. Attempting to censor hard questions is just evasive and defensive. Personal attacks attempting to censor hard questions and cut off debate is unprofessional but the default response.

It is a lot less work to attack the questioner than answer questions. It is also a sales tactic.

Brooke Southall

Brooke Southall

July 26, 2013 — 3:25 PM

Elmer,

You’re at your best when you bring in heartfelt thoughts and hard-earned bits of knowledge. Grand statements from the generic dictionary of wisdom, less helpful.

Brooke

Elmer Rich III

Elmer Rich III

July 26, 2013 — 8:56 PM

This exchange and an article we’re researching/writing on the Biology of Retirement Financial Behavior for The Journal of Retirement – has led us into this world of institutional “risk management.” Interesting, it is clearly a very well developed set of practices. Always fun to learn new technical information.

Now to dig into the research. Stay tuned.

Robert Boslego

Robert Boslego

May 28, 2015 — 1:07 AM

This article was referenced twice by SEC Commissioner Luis A. Aguilar in his speech, “Advocating for Investors Saving for Retirement,” which focused on Target Date Funds, read here: http://www.sec.gov/news/speech/advocating-for-investors-saving-for-retirement.html.

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