Schlenkler’s investment principles

itwasntme001

Linton said:

itwasntme001 said:

Adjusted for risk, bonds and stocks should return the same.  Because markets are efficient.

Isnt that somewhat circular as that is the definition of adjustment for risk?   Or do you have another definition?

However I am not convinced in this instance.    Most large buyers of bonds would not see equity as a satisfactory alternative so for them there is no price competition.

It does not really matter how you define it.  The point is if you believe in an efficient market, and there is no reason to believe it is not true, then risk adjusted returns MUST BE the same across all asset classes.

That is not the same as saying a bond and a stock has to have the same risk profile.  Of course they do not hence why some prefer stocks and others prefer bonds.  Objectives and risk tolerance is what makes you decide.

itwasntme001

The interesting thing is that we know rebalancing is a good thing for the long term between asset classes.  But what about within asset classes?  Is rebalancing a good thing within equities say, so you always have a set allocation for US, UK etc for example?  Historically not because otherwise you would have remained under invested in the US for quite some time and would have been detrimental.  But we know across asset classes it works such that a 60-40 equity/bond portfolio not only produced superior risk adjusted returns but also returns relative to 100% equities (the latter was only possible since equities and bonds have had a -ve correlation for quite sometime which may not hold in the future....).

Investing is not meant to be easy...

Thrugelmir

itwasntme001 said:

Is rebalancing a good thing within equities say, so you always have a set allocation for US, UK etc for example?  

Indexes are constantly modified to reflect the changing nature of global economies and stock markets. 

Secret2ndAccount

itwasntme001 said:

If you own 6000 companies, you are making sure you own those few companies that may end up doing really well long term compared to the 200 you own that can easily miss these same companies. 

If you own 6000 companies, you are making sure you own those few companies like Kodak and Enron that go bankrupt and make your money disappear, compared to the 200 you own that can easily miss these same companies. 

Secret2ndAccount

itwasntme001 said:

The other way to think of it is that say on day 1 you had 50% stocks 50% bonds.  Due to stocks rising a lot and bonds being flat, by the end of the year you have 75% stocks, 25% bonds.  If you do not rebalance, you are saying you got your original allocation wrong.  You should have been 75% stocks 25% bonds in the first place, and you would have had better results.  Because to think any different would mean you are easily swayed by the market - i.e. you are simply a momentum trader. I.e. a market timer.  i.e. you will get burnt eventually.

Not that I disagree with anything you have said here, but how do you pick your allocation in the first place. Maybe 75-25 would have been better than 50-50. And is whatever allocation you choose locked in for life, or how should we re-decide the right mix each year or 5 years or whatever?  There is no historical data where gilts return 0.5% and will continue to do so for some time, so how do we back-test or optimise our decision?

MK62

True, but the opposite is also true......if Enron and Kodak were in both funds, you'd take a bigger hit in the "200" fund than in the "6000" fund.....

[Deleted User]

Secret2ndAccount said:

itwasntme001 said:

If you own 6000 companies, you are making sure you own those few companies that may end up doing really well long term compared to the 200 you own that can easily miss these same companies. 

If you own 6000 companies, you are making sure you own those few companies like Kodak and Enron that go bankrupt and make your money disappear, compared to the 200 you own that can easily miss these same companies. 

Very true. It also ensures you have MarketAxess Holdings, which returned over 3000% in the last 10 years. And TransDigm (over 2000%).  Think back to 2009. Did you foresee that MarketAxess would outperform just about everything? 

Most companies perform badly. Performance is always driven by a minority of firms. The trouble is, we don’t know in advance which will be which.
And long term investing is a game which is won by staying in the market and not losing. Betting and trying to pick a few winners is not the way to win it. 

Secret2ndAccount

A thought regarding the 'efficient markets' assumption. Even if you believe that markets quickly achieve 100% efficiency in reflecting risk/reward, that efficiency is based on a different expenses basis available to the large players who dominate the market. It might be worthwhile for a large institution to hold a bond that pays 0.5% because it's costs are almost zero. To someone paying 1% per year in fees, the risk reward of a 0.5% bond is not the same as holding a higher risk/higher reward equity - you need some growth (and therefore some risk) to pay the fees.

Your personal definition of a 100% efficient market is not the same as the market's definition

Linton

Secret2ndAccount said:

itwasntme001 said:

The other way to think of it is that say on day 1 you had 50% stocks 50% bonds.  Due to stocks rising a lot and bonds being flat, by the end of the year you have 75% stocks, 25% bonds.  If you do not rebalance, you are saying you got your original allocation wrong.  You should have been 75% stocks 25% bonds in the first place, and you would have had better results.  Because to think any different would mean you are easily swayed by the market - i.e. you are simply a momentum trader. I.e. a market timer.  i.e. you will get burnt eventually.

Not that I disagree with anything you have said here, but how do you pick your allocation in the first place. Maybe 75-25 would have been better than 50-50. And is whatever allocation you choose locked in for life, or how should we re-decide the right mix each year or 5 years or whatever?  There is no historical data where gilts return 0.5% and will continue to do so for some time, so how do we back-test or optimise our decision?

Two reasons to choose a particular  split, performance is not one of them:

1) Direct risk managment: How  large a fall in equity prices can you accept? Presumably the % equity should remain constant unless your psychology or circumstances change.

2) Driven by objectives.

Non-equity must be held for a positive benefit other than it simply being non-equity.  My portfolio is now about 55-60% equity the rest is government bonds, corporate bonds, infrastructure, cash both UK and foreign and no doubt many other things besiders.  It's anything that my income funds and wealth preservation funds happen to choose.  So the 55% equity is not through direct choice but simply comes about from the amount of money I wish to allocate to meet my various higher level objecives.

Linton

Secret2ndAccount said:

A thought regarding the 'efficient markets' assumption. Even if you believe that markets quickly achieve 100% efficiency in reflecting risk/reward, that efficiency is based on a different expenses basis available to the large players who dominate the market. It might be worthwhile for a large institution to hold a bond that pays 0.5% because it's costs are almost zero. To someone paying 1% per year in fees, the risk reward of a 0.5% bond is not the same as holding a higher risk/higher reward equity - you need some growth (and therefore some risk) to pay the fees.

Your personal definition of a 100% efficient market is not the same as the market's definition

Also, the efficient markets hypothesis is based on a free market.  The somewhat hybrid equity+bond market is not free in that many institutions that hold bonds do so as they represent the most cheapest, safest and most easily liquidised repository for large amounts of cash.  Equities are not an alternative, no increase in their returns would make them attractive.  In fact buyers of bonds are willing to accept a loss - how much of a loss we will see in the next few years.