10.29.2018

You Walk Away, student loan edition

Back in the housing crash, there was a phenomenon known as "jingle mail" or "you walk away" where sad, underwater homeowners solved their problems by defaulting.

Now You Walk Away comes to student debt.
He now lives in a concrete house in the village of Uchakkada for $50 a month. His backyard is filled with coconut trees and chickens. “I saw four elephants just yesterday,” he said, adding that he hopes to never set foot in a Walmart again.

His debt is currently on its way to default. But more than 9,000 miles away from Colorado, Haag said, his student loans don’t feel real anymore.

“It’s kind of like, if a tree falls in the woods and no one hears it, does it really exist?” he said.

10.11.2018

What's wrong with Wealthfront's Risk Parity Fund? Sleuthing using regression analysis

In January, robo-advisor Wealthfront launched a risk parity fund. Risk parity means investing in multiple asset classes, and using leverage to increase the returns from the less volatile asset classes such as bonds.

The fund immediately attracted criticism for its high fees, which it soon cut. But it turns out there's more wrong with Wealthfront's risk parity fund than the fees. In April, I noted that the fund was already trailing both stocks and bonds, and trailing AQR's risk parity fund (AQRIX) by 4%. I suspected they had way too much leverage to bonds in a rising interest rate environment, and I investigated using a very simple regression analysis.


You can do regression analysis like this with a number of programs from Excel to more sophisticated tools like Python and Matlab. You take a series of daily returns to the fund, the series of daily returns to different asset classes, dump them into the regression engine and it will tell you how much the fund's performance is driven by those asset classes. Putting just two asset classes into the regression, the S&P and a broad bond index, quickly revealed that the fund was highly exposed to bonds.

That's not where you want to be if rates keep rising. And that's exactly what's happened in the 5 1/2 months since. As rates have risen, the fund has underperformed even more, and is now down 14% for the year and is more than 7% worse than AQR's fund.

With more days of trading data, we can now run a more complete regression analysis to see what the heck is in Wealthfront's fund. As a baseline, let's look at AQR's fund first. Here's the regression output using a lot of common asset classes (I tried a few others, but these were the best fit).


Now that is a beautiful regression. The high R-Square means that with 8 generic asset classes, we have explained 88% of the returns of AQRIX. The high t-values and low p-values ("Pr > |t|") mean that each of these asset classes is highly certain to be a driver of AQR's returns. The parameter estimate ("beta") means how much AQRIX is expected to trade up with a 1% move in each asset class. So the biggest betas are to bonds ("agg"), high-yield ("junk"), commodities ("comx" is the return to Pimco's commodity fund with the returns to oil and gold backed out), and the S&P 500 ("sp"). If you add all the betas, you get 2.11, meaning for every dollar you put in the fund, you're effectively getting $2.11 worth of exposure to the asset classes.

Now let's look at Wealthfront.


Just 5 asset classes explain 82% of the return, with bonds ("agg") having the greatest beta by far. Note that Wealthfront's pure bond interest-rate bet is greater than AQR's bond, high-yield, and REIT exposures combined.

The portfolio managers are a couple of Ph.D.s who I suspect suffer from Menzie Chinn Syndrome -- i.e. too much math, too little common sense. If your backtest period is during the past 37 years of historically declining bond yields, you shouldn't count on that trend continuing forever.





10.03.2018

Greenspan visits the Emerald Isle

Irish Examiner:
Insolvency experts are warning that mortgage arrears are still leading some homeowners to thoughts of suicide as the level of insurmountable household debt remains stubbornly high.

The Association of Personal Insolvency Practitioners (APIP) also says the ongoing problem of mortgage arrears is going to exacerbate the homelessness crisis as lenders lose patience and push for repossession.

Eugene McDarby, APIP chairman, said the crisis is clear to the 80-plus PIPs operating across the country.

“In the past week alone, I have met three clients who have admitted to giving consideration to taking their own lives,” he said.

“To wake up every morning knowing that you are in danger of losing your home would take its toll on the most mentally tough person.

Most recent Central Bank figures show that almost one in every 11 residential mortgages — representing 66,479 households — was in arrears at the end of June this year.

Thoughts on a #TradeWarTuesday

1) We're going to need to decouple from the evil Chinese regime. This started as a crazy Trump position but is now bipartisan consensus....