The Finance Professionals' Post

How Do You Know the Volatility Risk Premium Exists?

Any option contract can be replicated with cash and a series of trades in the underlying asset. Given a perfectly priced option, a trader who buys the option and transacts the offsetting trades in the underlying will have no gain or loss at expiration (before transaction costs).

Compliance issues weigh on social media use

Social media use is exploding, especially among the over-50 crowd. The typical image of social networking as a tool primarily used by teenagers couldn’t be more wrong: social media use is growing the fastest among older Americans, according to the Pew Internet and American Life Project.

So your clients are using social media; if you’re not there, you may have trouble distinguishing yourself from the crowd. While social media is a rapidly evolving space, the major venues—at least currently—are Facebook, Twitter, LinkedIn, and YouTube. Each has an individual identity, with the most business friendly site, at least ostensibly, being LinkedIn.

Humor: Geometric vs. Arithmetic Attribution

NYSSA member and FPP contributor David Spaulding put together this humorous little cartoon about the debate over geometric versus arithmetic attribution. 

Check out David's primer on value at risk and his article about its pitfalls.

Personal Financial Planning: Making the Transition

Investment professionals contemplating—or desperately seeking—a change of career may want to take a look at the field of financial planning, in which employment is growing robustly and money management skills are key to success. Within that field, however, are a number of niches, one of which is the fee-only financial planner, or what we’ll call the “PFP” or “personal financial planner.” A PFP operates solo or in a small firm, with clients whose assets under management are usually less than $1 million. The PFP position represents one of the most rapidly expanding and least well-known segments in financial planning.

Financial Reforms, Future Risk Management, and Developing Investment Opportunities

The financial bubbles and crises that have affected the world’s markets and economies during the past five years have created many credit-related investment opportunities. Looking ahead, the dislocations that still exist will have to be resolved in some way. With good analysis, investors can benefit from the likely realignments associated with the imminent “global reset.”

Click here to read the full article. 

MRCI December/May Cotton Spread Study

Previously we looked at the spread and how it cut volatility in an otherwise very strong directional market. The spread itself was flat when all the contracts were off about 7 points. Today, we’ll look at how to trade that spread courtesy of my friends at Moore Research Center, Inc (MRCI).

Building a Worldwide Network with CFA

For those of you slogging your way through the CFA study materials, here's an uplifting reminder of what all of your hard work is for. Anna Nemeth, vice president and senior portfolio manager at TD Waterhouse Private Investment Counsel, talks about the elation she felt when passing the exam and the advantages of becoming a CFA charterholder. This audio slideshow is part of an excellent series of charterholder profiles recently compiled by the CFA institute. 

Reprogramming the Mind: A Cognitive View of Stress, Performance, and Treatment for Wall Street’s Wounded

The financial industry is an ideal crucible for studying psychological stress and its effects upon performance. Few professions involve such routine exposure to risk and uncertainty; even fewer measure performance success so tangibly. The recent deleveraging and the contraction of the industry have brought a variety of personal and professional stresses to investment professionals.

Consider the following scenarios, each of which is drawn from recent conversations with workers in the finance sector:

Investing in Indonesia: The Tune of the Gamelan

INDONESIA IN CONTEXT | ECONOMIC AND POLITICAL HISTORY | ECONOMIC STRUCTURE AND RECENT PERFORMANCE | ECONOMIC, POLITICAL, AND NATURAL RISKS

The post-crisis performance of Indonesia has been phenomenal. With its overall economy virtually untouched by the financial crisis and its equity markets rapidly rebounding, Indonesia has outperformed virtually all major emerging-market competition, including Brazil. What characteristics have brought about this growth and expansion, and to what extent are these trends likely to continue?

Book Review: The Age of Deleveraging

As the US recovers from its longest and deepest recession since World War II, financial practitioners and economists have varying opinions on the future of the global and American economies. In  The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation, A. Gary Shilling argues that the global economy is experiencing a prolonged period of deleveraging and muted growth that will make deflation a likelier and greater threat to investors than inflation. Shilling is president of A. Gary Shilling & Co., an economic consulting firm and a registered investment advisor, and a former economist at Merrill Lynch.

Commentary: As Goes Egypt . . .

I am no Middle East expert, and clearly there are a multitude of factors beyond a humiliated fruit cart vendor in Tunisia that have triggered the revolutions playing out on our nightly news. Certainly decades of repression and unfathomable corruption (Mubarak is thought to have in excess of $40 billion invested securely outside Egypt) are the primary drivers. But I would like to focus on food and energy. A consensus is emerging that dramatic increases in food prices are also a root cause of the revolutions in Tunisia and Egypt, as reflected by an article in Scientific American titled: “Are high food prices fueling revolution in Egypt?”

Novo Nordisk's Annual Report Stresses Value Creation In a Resource-Stressed Economy

Corporations frequently report that one of their biggest frustrations is that their social and environmental sustainability initiatives are largely ignored by a mainstream investment community focused on short-term financial performance. At the same time, stellar short-term performance often masks hidden risks that are being ignored internally when sustainability goals are not imbedded in a company’s business model.

To counterbalance this short-sighted short-termism, and in the run-up to NYSSA’s Second Annual Healthcare Conference, it might be worthwhile to highlight the activities of Novo Nordisk, a global pharmaceutical company that has not only made a long-term commitment to sustainable practices but is also using a new way of reporting to raise the investment community’s awareness of the strong linkages between sustainable practices and value creation.

Should You List Your Hobbies on a Resume? Yes, With Caution

To hobby or not to hobby? That's the question of many candidates. On the one hand, including an “interests” section on your resume can add dimension beyond your experience. A mention of marathon running shows your drive. Volunteer makes you seem human and gives the interviewer something to chat about. On the other hand, you run the risk of appearing unprofessional—or worse, an offer by irking someone with your passion.

While horror stories abound, many recruiters and hiring managers vote in favor of including a well-edited selection on a finance resume, but only if your interests are genuine and not too kooky.

Click here to read the full article.

Book Review: Bust—Greece, the Euro, and the Sovereign Debt Crisis

In his new book, Bust: Greece, the Euro, and the Sovereign Debt Crisis, Matthew Lynn provides a thorough and fast-paced account of Greece’s role in the decline of the euro and the impact felt by the rest of Europe. Lynn, a financial commentator and writer for Bloomberg Television, Bloomberg News, MoneyWeek, and Spectator, is well equipped for the task.

The reader will find it astonishing that Greece was ever admitted into the euro and lent money. Rife with economic dysfunction, governmental incompetence, and corruption, Greece has been “stuck in the past, and largely unable to compete in the modern world.” The annual household budget for bribes to get anything done is estimated at 1,500 euro. Lenders were well aware of Greece’s situation.

Michael Covel on Trend Following

Accepting the inevitability of change is the first step to understanding trend following philosophy. One trend follower described it:

“But what won’t change? Change. When a period of difficult performance continues, however, most investors’ natural conclusion is that something must be done to fix the problem. Having been through these draw downs before, we know that they are unpleasant, but they do not signal that something is necessarily wrong with the future. During these periods, almost everyone asks the same question in these exact words: ‘Have the markets changed?’ I always tell them the truth: ‘Yes.’ Not only have they changed, but they will continue to change as they have throughout history and certainly throughout our 19 years. Trend following presupposes change. It is based on change.”

Markets go up, down, and sideways. They trend. They flow. They surprise. No one can forecast a trend’s beginning or end until it becomes a matter of record, just like the weather. However, if your trading strategy is designed to adapt to change, you can take advantage of the changes to make money.

Update on Egypt: The Price of Unrest

The recent protests in Egypt have taken a toll on the country's businesses and short-term economic growth:

• The government shuttered the stock exchange after unrest caused the benchmark index to plummet by 17%.
• Moody’s, Fitch Ratings, and Standard & Poor’s have all downgraded the country’s ratings and outlook. 
• Billions have been lost in tourism, which accounts for more than 10% of the Egyptian GDP.  
• Even the entertainment industry in Egypt—known as the “Hollywood of the Middle East”—is suffering, according to the Hollywood Reporter.

While many Egyptian business executives fear that they will be made scapegoats, Naguib Sawiris, head of the Mideast's largest telecom company, told BusinessWeek that the turmoil will ultimately foster a better business climate. It remains to be seen whether recent events will result in a democratic, business-friendly government, but the following video provides in-depth economic analysis of what is coming to be known as “the battle for Egypt.”  

Recent Research: Highlights from February 2011

“Policy Portfolios and Rebalancing Behavior.” The Journal of Portfolio Management (Winter 2011). Martin L. Leibowitz and Anthony Bova.

An institutional fund typically has a multi-asset allocation—the policy portfolio—that is maintained over time. When allocations shift, the fund rebalances back to the policy portfolio. The discipline of the policy portfolio has many benefits: simplicity, convenient benchmarking, and a minimum of organizational frictions. Its very routine nature can lead, however, to an overemphasis on relative returns and an insensitivity to fundamental changes in fund status and market structure. In 2003, the late Peter Bernstein questioned whether rigid adherence to the policy portfolio made sense, given frequent market dislocations and high levels of volatility. In this article, Liebowitz and Bova attempt to shed further light on the Bernstein question by analyzing the risk tolerance and return assumptions of a basic two-asset (equity and cash) fund. One key finding is that policy portfolio rebalancing implicitly assumes that the risk tolerance and return premiums remain fixed over time. But few funds have the sponsorship, liquidity, or organizational conviction to keep such a constant risk tolerance in the face of severely adverse markets. One argument for the policy portfolio rebalancing is that assets become “cheaper” after a decline, but this is inconsistent with a constant return premium. Moreover, “cheaper” assets should actually call for rebalancing beyond the original policy portfolio to a more aggressive allocation. One idea for a more pro-active, market-sensitive process is to develop pre-planned contingency actions for various market scenarios.

Four Investing Fundamentals Everyone Needs

The majority of investors—even those who swear they follow fundamental indicators—tend to act on and react to the market chaos seen in the daily action of the DJIA and stock prices. The short-term price movement in the market is always chaotic and, as confusing as this is, it can become your greatest advantage.

If you pick stocks based on the identification of four key fundamental indicators, you narrow down your list to the best companies. If you then time your entry on the price dips in the market, you can buy those companies at bargain prices. Two key rules should always be kept in mind. First, pick companies and stocks based on sound fundamental analysis. Second, time your purchase based on value and avoid relying on passing fads.

Book Review: Fallen Giant

Though the title would suggest that Fallen Giant dissects the collapse of AIG, nearly two-thirds of this book is given over to a chronological analysis of how AIG became an insurance powerhouse.

Author Ron Shelp, who worked for AIG and served on a number of the company’s boards, does a great job of delving into individual personalities and their motivations, leaving the reader with a front row seat to AIG’s genesis, growth, and fall from grace.

Refactoring Research: The New Model of Information

The computer science process of “refactoring” makes an interesting parallel to certain recent developments in investment research. In the software world, engineers will refactor a computer program when they want to overhaul the interior—change the internal code, reduce cost, increase efficiency, swap in new modules—but leave the external behavior, the functionality, the same.

Something similar is now under way in the redesign of research for the buy side. The end goal is the same as it has always been—excellent and differentiated insight into investment strategies—but the research process is evolving in the face of changes in the industry structure, regulations, and information access.

2011 P&C Industry Outlook: Mixed

Dodging a bullet in the form of a relatively uneventful hurricane season in the Atlantic and Gulf of Mexico, the property and casualty insurance agency enjoyed decent profits amid declining investment yields. Going forward, analysts such as Fitch Ratings and Morningstar predict industry profits will soften in 2011, but overall industry conditions will remain stable barring some type of natural disaster or other catastrophe.

Humor: What's the Connection Between Alcohol and the CFA?

Last week the CFA Institute posted results from the December 2010 Level I exams. Of the 46,644 candidates who took the exam worldwide, only 36% passed. Whether you passed or failed, candidates will probably appreciate the humor in this commercial from South Africa. 

Iron Condor Options: Placing a Trade

Indexes are probably the best instruments to trade condors, and the SPX, RUT, and NDX are the best of this group. The two main reasons are liquidity and their use of European-style options. The greater the liquidity, the easier it is to execute the trade, and European-style options increase your safety by eliminating the risk of early exercise.

The buying and selling of contracts takes place through an auction process. The bid represents what the buyer wants to pay, and the ask is the price the seller is seeking. There is no right way or wrong way to approach the bid-ask spread, but how you negotiate the price will result in different outcomes in your trading.

The Seat Belt Problem: A New Approach to Calculating Risk-Adjusted Returns

“People don’t perceive that they are going to be the one in a crash,” laments Russ Rader, media director at the IIHS (Insurance Institute for Highway Safety). “They believe that they are in control when they’re behind the wheel. They don’t sense how high the risk actually is.” The IIHS, a Virginia-based, national nonprofit that has helped significantly increase seat belt usage in the last twenty years, has a simple objective: lessen the risk taken in everyday driving behavior. The risk-measurement approach it employs has the potential to revolutionize how the investment community evaluates manager performance.

In our industry any credible performance comparison is risk adjusted. It makes no sense to equate the returns of two funds that take different amounts of risk. The challenge has always been how to measure the risk taken by managers—mathematically speaking, what to stick in the denominator.