Last week I attended and participated on two panels at Information Management Network's 13th Annual Super Bowl of Indexing.
This conference drew a wide range of pension managers, index providers (such as
) exchange-traded fund sponsors, investment managers, exchanges (such at
Tokyo Stock Exchange
), and such financial academics as Harry Markowitz, Robert Shiller and Robert Whaley.
Here are a few of my key takeaways from the event.
The Silent Majority: Index Investors and Long-Term Portfolio Managers Matter
We live in a market era dominated by "fast money" traders, leveraged hedge funds, credit default swaps and technical analysts. These market participants
attend the conference and barely a word was mentioned about any of them, other than an occasional reference to hedge funds (when the relationship between asset liquidations and volatility was raised). Attendance at this index-focused conference rose year over year. I suspect the same thing cannot be said for the hedge fund conferences that took place this fall. (I attended many of those festivals in years gone by.)
While the market is currently controlled by this fast money crowd, they represent a very vocal
in the investment word. Indexed investments, pension plans, mutual funds, exchange-traded funds (or ETFs) and other "slow money" investors are, in fact, the silent majority that controls more assets than hedge funds and day traders. The indexed/pension investor has such a long-term horizon that they see this year as just a pot hole in a very long road.
Someone at the conference mentioned that they have a 15-year time horizon. The response from the crowd was that they were too short-term oriented. There is a common misconception that long term focused investors (which is my general approach) are "buy and hold." Quite the opposite is true, as they use a wide variety of asset allocation techniques and are active portfolio managers.
Index Investing and Volatility Can Get Along
Index investors are just as interested in volatility as are short-term traders are. However, like me, they take a far more academic approach to the concept and will more likely use volatility
as a trading tool, but a hedging tool.
Dr. Robert Whaley of Vanderbilt University gave an excellent presentation that covered volatility from the perspective of the
CBOE Volatility Index
). Here are a few of his points and conclusions:
VIX is predictive of expected realized stock market return volatility over the next 30 days.
VIX is predictive of expected range of stock market returns over 30 days.
The historical mean level of the VIX is about 18%. Note: Based on data I compiled, the VIX mean is 19.61 since Jan. 2, 1990.
VIX can be used for index option writing and as a new asset class (e.g., you can buy VIX futures and use a traditional mean variance asset allocation framework). The best buy write strategy would be engineered on a rolling monthly basis, by utilizing one-month slightly out-of-the-money calls on the S&P 500.
That presentation was followed up by a panel discussion on volatility. One of the panelists was Jerry Moskowitz, President of FTSE Americas (with whom I also shared the stage for an earlier panel discussion on international asset allocation). Moskowitz eloquently explained that in the United Kingdom there was no equivalent to the VIX. Instead, independent book makers will create markets for volatility.
While I think that the VIX is proper in its construction, I believe the perception of the VIX is flawed. So my question to the panel was (to paraphrase): Is it market volatility that is responsible for the VIX? Or is it the VIX itself that creates market volatility?
Unfortunately, the issue was danced around and I did not receive a satisfactory response. In a subsequent private conversation with Prof. Whaley he agreed with my opinion that the media may be exacerbating volatility by construing it as the "fear index," rather than what it truly is: the supply/demand curve for options insurance. He also agrees with my notion that individual stocks may be manipulated by sector-specific ETFs and their related options, as I covered in "
Modern Portfolio Theory Matters
1990 Economics Nobel Laureate Harry Markowitz was the keynote speaker at the luncheon on the first full day of the conference. Markowitz is legendary for his pioneering work in the field of modern portfolio theory, which began with an article that he published in March 1952 in the
Journal of Finance
(Volume 7, Number 1), while working for the Rand Corporation.
Modern portfolio theory states that:
Investors should select portfolios and not individual securities.
There is a trade-off between risk (volatility) and return.
The efficient frontier (or "Markowitz bullet") is a set of optimal portfolios that maximizes expected returns, given different levels of risk. It is from this concept that Jim Cramer derives his mantra that "diversification is the only free lunch."
In the conclusion to his presentation, Dr. Markowitz stated that it is up to everyone to determine what the market is. The implication of this conclusion is that each of us has a different perspective of what market we are participating in and/or have access to. Thus, by extension, we all have different efficient frontiers.
The Super Bowl of Indexing provided me with a wealth of information, which I will incorporate into my asset management activities and academic pursuits. Here are a few things
can do to get a better understanding of some of the topics covered in this article:
Learn more about modern portfolio theory. You can do this by taking an investment class at a nearby accredited university, reading a book on modern portfolio theory or getting a cursory overview from various Internet-based sources.
Learn more about the VIX. You can get up to speed on the CBOE Web site and by searching "volatility" on The Street.com. Plus, read Dr. Whaley's paper titled Understanding VIX.
Determine if you are a fast money trader or a long-term investor stuck in a fast money environment. If you have a long-term time horizon, make sure that you don't succumb to current market volatility by turning from an investor into a short-term trader.
At the time of publication, Rothbort had no position in the stocks mentioned, although positions can change at any time.
Scott Rothbort has over 20 years of experience in the financial services industry. In 2002, Rothbort founded LakeView Asset Management, LLC, a registered investment advisor based in Millburn, N.J., which offers customized individually managed separate accounts, including proprietary long/short strategies to its high net worth clientele.
Immediately prior to that, Rothbort worked at Merrill Lynch for 10 years, where he was instrumental in building the global equity derivative business and managed the global equity swap business from its inception. Rothbort previously held international assignments in Tokyo, Hong Kong and London while working for Morgan Stanley and County NatWest Securities.
Rothbort holds an MBA in finance and international business from the Stern School of Business of New York University and a BS in economics and accounting from the Wharton School of Business of the University of Pennsylvania. He is a Term Professor of Finance and the Chief Market Strategist for the Stillman School of Business of Seton Hall University.
For more information about Scott Rothbort and LakeView Asset Management, LLC, visit the company's Web site at
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