When I started my asset management business, I did not know what I was doing.? I probably still don’t, though finally I have a little more assets under management than I have of my own assets managed by my strategies.? I learned that I needed to manage both stocks and bonds, in order to provide both enterprising and safe investments, respectively.
But in an environment like this, where bonds are overvalued in general, is the safe option safe?? My methods of bond management produce rather blah yields at a time like this, because I am trying to preserve capital.
But then potential investors talk to me, and they ask two things of me.
1) Can’t you create a strategy that shifts between your stock and bond strategies, such that we can minimize losses and maximize gains?
2) Can’t you create a bond strategy that provides more yield on average, while still preserving capital?
I am tempted to say, “If I had such a strategy, I would be employing it from my yacht.”? Then again, the last time I went out on he open seas, I was as sick as a dog.? Time for a new analogy.? Okay, I am searching for the Holy Grail.? Not likely to find that… and as Calvin noted, if all of the alleged relics from the days of Christ were real, the amount would be a large multiple of what was there.
All that said, there are some cofactors for each problem that might work.? With bonds (problem 2), there are momentum effects, as well as mean-reversion effects.? Those can complement the intelligent bond manager who looking at the situation may see risk and return out of line, or fairly priced.
I may have a solution to this problem, which partially benefits from the ideas of Mebane Faber.? Buy the bond classes where the prices are above their 200 day moving averages.? This is an oversimplification, but it seems to work.
But stocks are more difficult, and I do not know whether I will end up with a solution here or not.? Here’s the trouble:
- Stocks are driven by earnings expectations
- Stocks are driven by valuation
- Valuation is drive by cost of capital, as well as yield spreads.
- Cost of capital is on average similar to BBB bond yields.
- There are still momentum effects, as well as mean reversion effects
I don’t have a solution to the first problem, though I am struggling with it.? Truly if anyone had a good timing algorithm, would he share it?
Speaking of cost of capital, I wonder if you would care to share any methods you use to calculate cost of capital for equity. I have seen many of the academic models (CAPM, built-up method, bond-yield+RP, etc.) and the problem that I continue to see in all of them is the large degree of estimation involved (except bond yield plus).