Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.
Support MFO
Donate through PayPal
Common Sense Strategies For Mitigating Risk In Your Retirement Portfolios: Part 2
For whatever interest it may hold. One can access Part 1 in the series via a link provided in the first paragraph. The author is one of a handful of contributors to SeekingAlpha that I have found to be knowledgeable and helpful.
I found this article truly a gem, and should be read by not only the novice, but the experienced investor as well. The portion on bonds was especially enlightening. Thanks for posting!
Thanks for your reference to the risk assessment article by Chuck Carnevale.
Overall, it is very extensive as it examines several dimensions of the risk landscape. For all its widespread specific examples and quotes from respected investment giants, it completely failed to offer portfolio level risk mitigation techniques.
On many postings, MFO members have proffered far more informative presentations on how to control portfolio risk factors. Certainly MFOer Charles emphasizes risk considerations in his discussions and in the construction of his excellent mutual fund Tables.
Mr. Carnevale invested a lot of ink describing both complete bond and stock failures. Later in the article, he admitted that these were both very rare events and these few failures took considerable time to actually happen. In essence, it’s a low probability likelihood with sufficient time to escape when the investment turns ugly. It is not an important risk factor.
By way of contrast, he elected not to mention overarching portfolio risk, and how relatively easily it can be attenuated with a judicious selection of investment categories and/or specific holdings that exhibit low correlation coefficients.
Sequentially, he should have identified how low correlation coefficients lower portfolio standard deviations, and how lower portfolio standard deviations improve a portfolio’s compound return. Further, he failed to mention how end wealth depends on compound return and not directly on average annual return without the standard deviation correction.
On the positive side, I did like his observation that diversification, without a meaningful expected return coupled to that diversification decision, is usually not in the best interest of the individual investor.
Common sense must always be integrated with any analytical effort when making an investment decision. I was disappointed with the article's failure to address portfolio perspectives, at least in Part 2. Perhaps the author addressed this issue in other writings.
Reply to @MJG: With all due respect the title of the article was not "Everything You need to Know About ..........." Perhaps, as you noted, the author has addressed the issues you raised in other writings but to say that he 'failed' to do something that he never set out to do seems a little out of whack. To me that's like Ralph Lauren or Martha Stewart telling me that the house I built is a disaster because the room colors don't match.
It might also help to know that Mr. Carnevale writes from the perspective of one who builds portfolios from individual stocks rather than mutual funds.
You are far too generous at forgiving Mr. Carnevale for his omission of the impact of risk on total portfolio performance. It is not a minor, inconsequential consideration.
I disagree with your assessment that Mr. Carnevale did not promise more than he delivered. Please reread the opening 3 paragraphs in his Introduction section. Just about every sentence referred to portfolio construction. Given that Introduction, I anticipated that he would address component correlation coefficients.
Yet in the main body of his text he never mentioned the individual holding’s price interactions that should be characterized when assembling the numerous components of the entire portfolio. There is a huge impact on overall portfolio performance and risk depending if these components are tightly coupled or loosely coupled.
The concept of using loosely coupled, lower correlation coefficient holdings to reduce portfolio level volatility is paramount in any risk mitigation plan. It would only take a paragraph or two to introduce the correlation concept, to identify the historical correlation levels between major investment categories, and to demonstrate their impact on portfolio volatility.
A few words on how a mix of fixed income and equity holdings could reduce portfolio volatility by a factor of two without seriously reducing returns would have made the article more meaningful, especially for novice investors.
The fact that Mr. Carnevale focused on individual stocks and not mutual funds is not relevant. The governing principle is not changed. Risk is mitigated by choosing financial products with low correlation coefficients. That salient point could have been driven home with the proven illustration of how two very volatile products (like gold and equities) could be combined such that the composite portfolio is less risky than either single element.
I would have closed with some cautionary warnings about the dynamic nature of all market statistics, including correlation coefficients. That too is a risk contributor, so large financial safety factors (the shadow of Benjamin Graham looms huge here) are the order of the day.
From my perspective, Mr. Carnevale failed to satisfy my expectations. More importantly, for the neophyte investor, he omitted a significant tool in the risk mitigation toolbox. The referenced article gave too much weight to issues of lesser importance while ignoring far more influential risk factors entirely.
Portfolio holding linkages matter in controlling risk.
Mark, I thought the article was very well written, laying-out some interesting ideas from an experienced "pro". The Ben Graham quotes are gems. A look down the MFO page will reveal many different points of view on various investing topics from many different sources (and a fair share of non-investment related as well). I doubt it was your original intent to defend everything the writer says. Who'd ever post "off-beat" or controversial articles under such a requirement?
Can't speak for others, but I come here looking NOT for "answers", but for interesting ideas to munch on. Give me enough different ideas and I'll arrive at my own answers. Your article more than satisfies that need. Thanks for posting.
"...Therefore, with this article, I will attempt to list, and define what I believe to be the most important investing risks that investors must face and deal with. Additionally, I will offer brief introductions into what I feel are the most effective ways of dealing with the many faces of investment risk. Of course, the reader should be aware that the best that can be accomplished in one simple article is to provide a brief overview and introduction to investment risk and its management emphasis added by me. But every journey starts by taking the initial step."
Further into the article he also touches on Concentration (Diversification) Risk
I still think it's a durn good first step article.
Reply to @Mark: Best to just ignore his eminence when he mounts his pulpit. I quoted the meaning of "hubris" once for his benefit, but it didn't take... couldn't see the connection, I guess.
Interestingly enough, in part 1 of his article Mr. Carnevale makes the following comment:
"It is my view that overly zealous academics, enthralled with complex mathematical theorems and statistical expressions suffered from a well intended but misguided form of intellectual hubris."
Additional choice quotes:
"Instead of an efficient market, I contend that the market is always seeking efficiency. If Eugene Fama had not conjured up the EMH (theory) the whole MPT house of cards was destined to collapse. Question: how could you run Standard Deviation, Beta, R-squared or the Sharpe ratio if there were no standard to measure them against? Statistical analysis had to hold the concept that markets are efficient or their formulas would be useless.
A theory based on a flawed underlying premise is both illogical and inaccurate. As Warren Buffett so eloquently put it: "I'd be a bum on the street with a tin cup if the markets were always efficient."
"you cannot run valid regression analysis or variance without an established standard to base the analysis on. EMH provided MPT theorists the standard they had to have. But alas it is a flawed standard based on a flawed concept as it relates to markets being efficient."
"The great recession of 2008 shot gaping holes in the utility of MPT and its many tenets and theorems. But the industry goes on embracing it, undaunted by mounting evidence of its lack of real-world utility."
Shades of Louis Rukeyser. No wonder Mr. Carnevale riles his eminence.
I found the article to be interesting re: the information and considered thoughts being shared, even if the style/presentation was a bit uninteresting, boring. It is clear and thorough, and the writer is clear about the parameters he is covering. I see that he is not so fond of MPT as some other may be. He likes the more old-fashioned approach. ...And the advice about not diversifying for its own sake is solid. Buffett's words in that regard are spot-on. You need to have an idea of what you're trying to do, rather than diversify arbitrarily, just covering bases for the sake of doing it. Yes, that's certainly a good lesson! Thank you!
Comments
Regards,
Ted
Thanks for your reference to the risk assessment article by Chuck Carnevale.
Overall, it is very extensive as it examines several dimensions of the risk landscape. For all its widespread specific examples and quotes from respected investment giants, it completely failed to offer portfolio level risk mitigation techniques.
On many postings, MFO members have proffered far more informative presentations on how to control portfolio risk factors. Certainly MFOer Charles emphasizes risk considerations in his discussions and in the construction of his excellent mutual fund Tables.
Mr. Carnevale invested a lot of ink describing both complete bond and stock failures. Later in the article, he admitted that these were both very rare events and these few failures took considerable time to actually happen. In essence, it’s a low probability likelihood with sufficient time to escape when the investment turns ugly. It is not an important risk factor.
By way of contrast, he elected not to mention overarching portfolio risk, and how relatively easily it can be attenuated with a judicious selection of investment categories and/or specific holdings that exhibit low correlation coefficients.
Sequentially, he should have identified how low correlation coefficients lower portfolio standard deviations, and how lower portfolio standard deviations improve a portfolio’s compound return. Further, he failed to mention how end wealth depends on compound return and not directly on average annual return without the standard deviation correction.
On the positive side, I did like his observation that diversification, without a meaningful expected return coupled to that diversification decision, is usually not in the best interest of the individual investor.
Common sense must always be integrated with any analytical effort when making an investment decision. I was disappointed with the article's failure to address portfolio perspectives, at least in Part 2. Perhaps the author addressed this issue in other writings.
Once again, thank you for the reference.
Best Wishes.
It might also help to know that Mr. Carnevale writes from the perspective of one who builds portfolios from individual stocks rather than mutual funds.
You are far too generous at forgiving Mr. Carnevale for his omission of the impact of risk on total portfolio performance. It is not a minor, inconsequential consideration.
I disagree with your assessment that Mr. Carnevale did not promise more than he delivered. Please reread the opening 3 paragraphs in his Introduction section. Just about every sentence referred to portfolio construction. Given that Introduction, I anticipated that he would address component correlation coefficients.
Yet in the main body of his text he never mentioned the individual holding’s price interactions that should be characterized when assembling the numerous components of the entire portfolio. There is a huge impact on overall portfolio performance and risk depending if these components are tightly coupled or loosely coupled.
The concept of using loosely coupled, lower correlation coefficient holdings to reduce portfolio level volatility is paramount in any risk mitigation plan. It would only take a paragraph or two to introduce the correlation concept, to identify the historical correlation levels between major investment categories, and to demonstrate their impact on portfolio volatility.
A few words on how a mix of fixed income and equity holdings could reduce portfolio volatility by a factor of two without seriously reducing returns would have made the article more meaningful, especially for novice investors.
The fact that Mr. Carnevale focused on individual stocks and not mutual funds is not relevant. The governing principle is not changed. Risk is mitigated by choosing financial products with low correlation coefficients. That salient point could have been driven home with the proven illustration of how two very volatile products (like gold and equities) could be combined such that the composite portfolio is less risky than either single element.
I would have closed with some cautionary warnings about the dynamic nature of all market statistics, including correlation coefficients. That too is a risk contributor, so large financial safety factors (the shadow of Benjamin Graham looms huge here) are the order of the day.
From my perspective, Mr. Carnevale failed to satisfy my expectations. More importantly, for the neophyte investor, he omitted a significant tool in the risk mitigation toolbox. The referenced article gave too much weight to issues of lesser importance while ignoring far more influential risk factors entirely.
Portfolio holding linkages matter in controlling risk.
Best Wishes.
Can't speak for others, but I come here looking NOT for "answers", but for interesting ideas to munch on. Give me enough different ideas and I'll arrive at my own answers. Your article more than satisfies that need. Thanks for posting.
"...Therefore, with this article, I will attempt to list, and define what I believe to be the most important investing risks that investors must face and deal with. Additionally, I will offer brief introductions into what I feel are the most effective ways of dealing with the many faces of investment risk. Of course, the reader should be aware that the best that can be accomplished in one simple article is to provide a brief overview and introduction to investment risk and its management emphasis added by me. But every journey starts by taking the initial step."
Further into the article he also touches on Concentration (Diversification) Risk
I still think it's a durn good first step article.
Interestingly enough, in part 1 of his article Mr. Carnevale makes the following comment:
"It is my view that overly zealous academics, enthralled with complex mathematical theorems and statistical expressions suffered from a well intended but misguided form of intellectual hubris."
Additional choice quotes:
"Instead of an efficient market, I contend that the market is always seeking efficiency. If Eugene Fama had not conjured up the EMH (theory) the whole MPT house of cards was destined to collapse. Question: how could you run Standard Deviation, Beta, R-squared or the Sharpe ratio if there were no standard to measure them against? Statistical analysis had to hold the concept that markets are efficient or their formulas would be useless.
A theory based on a flawed underlying premise is both illogical and inaccurate. As Warren Buffett so eloquently put it: "I'd be a bum on the street with a tin cup if the markets were always efficient."
"you cannot run valid regression analysis or variance without an established standard to base the analysis on. EMH provided MPT theorists the standard they had to have. But alas it is a flawed standard based on a flawed concept as it relates to markets being efficient."
"The great recession of 2008 shot gaping holes in the utility of MPT and its many tenets and theorems. But the industry goes on embracing it, undaunted by mounting evidence of its lack of real-world utility."
Shades of Louis Rukeyser. No wonder Mr. Carnevale riles his eminence.