Patrick Collins's blog

Investment Basics: Asset Allocation, Diversification and Correlation

Tue, 24 Aug 2010 14:35:57 -0700

Patrick Collins completes Working Paper entitled: “Investment Basics: Asset Allocation, Diversification and Correlation.”

See the working paper here

So you want to buy a bond fund?

Fri, 16 Jul 2010 14:28:04 -0700

An important step in the implementation of investment policy is the acquisition of prudent and suitable investments. Investors choosing to diversify their investment positions both within and across asset classes often select pooled investment vehicles like mutual funds or exchange traded funds. Inevitably they must address the question: “what funds should I buy?”

Each year, SCLC develops an annual fund evaluation report. We refer to this report, somewhat tongue-in-cheek, as the antidote for the Morningstar/Lipper/Money Magazine type of approach that often rates investments as if they were restaurants. The report summarizes our analysis and opinion regarding investments as of December 31st of the previous year. Specific reports detailing individual investment holdings are sent to each client; and, we retain a master list for in-house reference.

Responses (Silly and Serious) to Recent Financial Market Volatility

Thu, 12 Mar 2009 15:14:44 -0800

Given the magnitude of recent declines in the price of financial assets, commodities, and residential real estate, investors are coping with decisions about how to invest on a go forward basis. Our recent paper (appearing in our Investment Quarterly for Quarter 4, 2008] situates decision making within the context of investor ‘utility,’ where utility measures the investor’s aversion to declines in wealth as well as the investor’s satisfaction with gains in wealth.

Static vs. Dynamic IPS

Fri, 23 Jan 2009 10:03:01 -0800

For some investors, risk tolerance changes with increases or decreases in their level of wealth. However, many investment policies mandate a constant proportional weighting between stocks and bonds during both bull and bear markets. A fixed investment allocation is usually termed a “Constant Mix” asset management approach. Such an approach is defensible under a variety of commonly held assumptions; and, is often recommended as a reasonable alternative to the risks of market timing. Advisors advocating that investors “stay the course” during perilous market conditions implicitly assume that investors, in general, benefit from a Constant Mix approach.

Managing Retirement Portfolio Withdrawals in Turbulent Times

Fri, 23 Jan 2009 14:37:26 -0800

Warning! Economic disaster is closer than you think.

Why have an investment reserve? The underlying mathematics of compound return indicate that the more volatile the investment, the lower a portfolio’s long-term growth rate, all else equal. An investment that losses 20% in period one needs 25% in period two in order to get back to even. Periods of negative returns not only decrease portfolio value but, if the portfolio is also funding retirement distributions, the distributions take dollars out of the portfolio at the worst possible time. In a nutshell, distributions multiply the bad consequences of negative returns and cap the benefits of positive returns. The Wall Street term for taking money out of portfolios during periods of economic distress is “feeding the bear.”

Volatility & Equity Risk Premium

Fri, 23 Jan 2009 13:12:37 -0800

By now, you have probably worked up the courage to peek at your October statements. For most investment positions (with the exception of some bond funds) returns were “double-digit” negative. The October decline accounts for approximately half of portfolio year-to-date losses across a broad spectrum of asset allocations. In terms of SCLC’s reporting metrics, October results are at the end of the left-tail of the historical distribution of post 1972 returns—declines of this magnitude have happened before; but nevertheless it comes as a shock.

Here are some observations for your consideration:

Volatility Feedback vs. The "Leverage Effect"

Fri, 23 Jan 2009 11:58:43 -0800

Some have said the attached newsletter contained many “factoids,” others think we’ve been data mining. I say it’s worth reading. If nothing else, it will provide fodder for water cooler conversations, or for your next cocktail party.

Return Series Behavior & Risk Tolerance

Fri, 23 Jan 2009 10:56:35 -0800

As you know, volatility in many financial markets has increased over the past year. It seems that the ‘volatility’ of TV, radio, and print-media news has also increased. This letter is an update on our investment views.

About six months ago, as U.S. equity prices continued to decline, we sent you a letter indicating that the fallout from the residential housing mortgage crisis was spreading to other financial markets. The mechanism for transmitting this contagion was the banking system. In a nutshell, as the banks’ aggressive home loan portfolios came under pressure, regulators demanded that banks shore up their balance sheets. Many money-center banks had large loans out to hedge funds. Sad to say, some hedge funds chose to maintain double-digit rates of return by levering their investment positions. Financial leverage can turn mediocre investment results into attractive returns—but only at the cost of increasing investment risk. As the banks called the hedge fund loans, the funds had to unwind their investment positions by selling securities. Some hedge funds were leveraged 30 to 1, and had to sell large amounts of securities to raise a sufficient amount of cash to repay bank loans. Some hedge funds went bankrupt [proving, yet again, that there is no riskless investment that can forever generate double-digit returns]. Equity prices continue to decline as leverage is wrung out of the system. Given a long-term view, we suggested that this was a good thing despite the obvious fact that nobody enjoys periods of price decline.

Hedge Funds and Their Effect on the Markets

Mon, 28 Jan 2008 14:13:16 -0800

During the last several weeks, world equity markets have coupled and, in general, have moved downwards. Although the magnitude of decline is well within the expected probability distribution of stock prices, nevertheless, some investors may become disconcerted because of a natural human tendency to extrapolate current events into an indefinite future.

One of the basic principles of investing is that the future return on a portfolio of risky assets is a random variable – i.e., not knowable. Over many long planning horizons, under some simplifying assumptions, actual portfolio return converges towards a number that is greater than the risk-free rate available through U.S. Treasuries or bank CDs. Likewise, over a single life’s long-term planning horizon, it is also reasonable to expect that a portfolio of risky assets will outperform a risk-free investment.

Patrick Collins releases a working paper "Multifactor Asset Pricing Models and the Rationale for Investing in Value Stock".

Tue, 18 Sep 2007 14:38:48 -0700

Patrick Collins, Ph.D, CLU, CFA has released a working paper on the topic of Multifactor Asset Pricing Models and the Rationale for Investing in Value Stocks.

This article summarizes academic research into multifactor asset pricing models, with specific emphasis on growth and value stocks. The article notes that empirical studies observe that value stocks typically generate superior risk-adjusted returns relative to growth stocks, and addresses implications for the Efficient Market Hypothesis if value stocks, in fact, represent an improperly priced risk factor.

SCLC's Patrick Collins releases a working paper "The Decision to Replace Trust Owned Life Insurance Policies".

Tue, 18 Sep 2007 14:37:53 -0700

Patrick Collins, Ph.D, CLU, CFA has released a working paper on the topic of The Decision to Replace Trust Owned Life Insurance Policies. Reprinted from the November / December 2005 issue of The Banking Law Journal

There may be many valid reasons to consider life insurance policy replacement. However, the focus in this article is on replacing an existing life insurance contract with a new contract that provides superior financial results. The trustee takes replacement action based on the expectation that the new policy offers a financial instrument better suited to the terms, purposes, distribution requirements, and other circumstances of the trust — a prudent decision-making process. It also addresses the quantitative nature of the analysis (and difficulties therein) and provides an approach which allows the trustee to demonstrate the requisite levels of care, skill, and caution.

SCLC's Patrick Collins and Josh Stampfli release a working paper "Risk, Return and Rebalancing".

Tue, 18 Sep 2007 14:36:28 -0700

Patrick Collins, Ph.D, CLU, CFA, and Josh Stampfli MS (EESOR), have released a working paper on the topic of portfolio rebalancing. The paper begins with an overview of the surprisingly extensive research on the topic, including a survey of various rebalancing strategies and results from several empirical and mathematical studies. The authors go on to explain exactly how portfolio rebalancing can either enhance returns, control risk, or both. In the process they touch on issues both practical, such as taxes, and cerebral, as in Utility Theory. To gain further insight into the economic consequences of rebalance elections, Collins & Stampfli developed a simulation model with which they test nine different rebalance strategies under both portfolio accumulation and decumulation conditions. The results are instructive.

SCLC Discusses Planning for Retirement Income

Wed, 19 Oct 2005 09:57:37 -0700

In the second quarter edition of Investment Quarterly we focus on two critical questions investors face when planning for financial security in retirement:

What level of monthly income can be systematically withdrawn from the retirement portfolio, without incurring too great a risk of depleting the portfolio completely?

How should the portfolio be invested?

Our lead article explains the challenges investors face in answering these questions and describes an advanced form of analysis that yields particularly insightful results.

Download PDF

TIPS (Treasury Inflation Protected Securities) Promises and Pitfalls

Wed, 19 Oct 2005 09:58:09 -0700

As a companion to our article “Planning for Retirement Income”, the second quarter edition of Investment Quarterly offers a piece on inflation indexed bonds (TIPS). The structure of TIPS makes them a potentially useful asset for producing retirement income, but much depends on the investor’s specific goals and objectives.

Download PDF

Financial Planning magazine quotes Collins on Total Return Trusts and Monte Carlo Simulation

Fri, 3 Jun 2005 22:41:26 -0700

From Balancing Act, by Donald Jay Korn, September 2003 Financial Planning magazine.

“A total return trust operates without the safety net of enforced conservatism,” notes Patrick Collins, a financial analyst in San Francisco who has written extensively about such trusts. “Therefore, it is vital to shape carefully the language of distribution provisions, lest the corpus run out of money prior to the end of the planning horizon. Distribution provisions both reflect and govern reasonable spending expectations, which in turn provide the targeted return for asset allocation and asset management decisions. Grantors and beneficiaries must determine a suitable balance between growth expectations [reward], failure rates [distributions below an acceptable dollar amount], and bankruptcy risk [portfolio value approaching zero].”