Canadian Capitalist

24 responses so far ↓

• 1 CanadianInvestor // Sep 8, 2008 at 8:20 am

  One issue that affects people like me with RRSP, LIRA (two of them in fact) and regular trading accounts is the complexity of rebalancing many asset classes across those multiple accounts. That’s one reason I’ve kept my own to 16 asset classes and/or holdings, including two that are hedged versions of US index ETFs.

• 2 Neil // Sep 8, 2008 at 8:25 am

  You should check out this book: http://books.google.ca/books?id=JmcQVbCcu0IC

  “The Intelligent Asset Allocator”

  I think his central thesis is to find asset classes that are poorly correlated, but he goes into a lot of detail about diversifying.

• 3 Canadian Capitalist // Sep 8, 2008 at 10:57 am

  Canadian Investor: Good point. My personal portfolios are similar to the Sleepy Portfolios and rebalancing across them (with only eight asset classes) is already a headache. Every new asset class will simply add to the complexity.

  Neil: I’ve just picked up that book from our local library (I had it on request).

• 4 Andrew Baechler // Sep 8, 2008 at 11:02 am

  I haven’t read Swenson’s book, but it sounds like a good read.

  I have to disagree with the point that adding additional asset classes would decrease the Sleepy Portfolio’s expected returns. Risk and return are related and there are a number of higher-risk asset classes that could be added to the portfolio. Top of mind are an allocation to frontier markets, small-cap, and value companies. As these are higher risk asset classes vs. those already in the Sleepy Portfolio, the expected return of the portfolio would increase. Two key considerations though are:

  • A higher expected return does not necessarily mean actual higher realized returns.
  • These asset classes will increase the volatility and risk profile of the Sleepy Portfolio and may net be inline with the portfolio’s objectives.

• 5 DAvid // Sep 8, 2008 at 11:09 am

  There are long standing suggestions on the number of stocks to hold in a portfolio, depending on the value. These would suggest a small number of diversified stocks in a smaller portfolio, rising to not more that 20 stocks in million dollar plus portfolios. The purpose being that you need to keep track of your holdings. This parallels your suggestion, and while you may need less focus on Index funds than individual stocks, letting your portfolio become unmanageable no matter the vehicle is unwise.

  DAvid

• 6 Canadian Capitalist // Sep 8, 2008 at 11:25 am

  Andrew: “… likely to have diminishing returns”.

  By “returns”, I didn’t mean the expected returns from a portfolio. I meant the law of diminishing returns. Once a certain level of diversification is achieved, adding more asset classes may not give more benefits.

  There is no question that there is support in historical data for slicing and dicing equity components into small and value. But, this is hardly a settled debate and I prefer to keep it simple with broad index funds.

  DAvid: That’s exactly the comparison I had in mind. There are plenty of studies on how many stocks a portfolio needs but I couldn’t find any research into how many asset classes. The key is to diversify the portfolio enough, while keeping it simple.

• 7 NN // Sep 8, 2008 at 11:43 am

  In theory, the more asset classes are held, the closer the portfolio will come to the limiting efficient frontier. However, the incremental amount of risk reduction decreases exponentially with the number of holdings, so that the reduction in portfolio volatility by addition of another holding quickly approaches zero for all practical purposes. In theory, the increase in number of holdings will thus not decrease returns, but in practice trading fees and the increase in time required to manage a portfolio may very well accomplish just that.

  In the above, ‘risk’ is assumed to be the commonly accepted measure of portfolio volatility. In this regard, the diversification argument suffers from some flaws, as the variance-covariance characteristics of asset classes is dynamic over time, so a portfolio may very well be more volatile than would be expected from historical data. (This is not an attack on diversification, investors should just take note of the possible deviation from ideal behaviour their portfolios could exhibit in the short term).

  I hold that volatility is the accepted measure of risk simply because it is mathematically conveniant. True risk is not reaching your financial goals in your given investment horizon (much too subjective for generalized mathematical models)- this is the basis for my asset allocation decisions.

• 8 Optiosforstocks // Sep 8, 2008 at 12:57 pm

  Over -diversification is like betting on all the horses in a race coarse. Moreover, if one half of assets classes are perfectly non-correlated to other half of classes then expected return tends to be zero or at most equal to market index. Optimal way to pick up best stocks (based on fundamentals) in any class that tend to outperform the overall class itself.

  One way to increase return on your portfolio in RRSP is to sell covered call options. It will not only increase your returns on investments but will protect the downward fall to a greater extent.

• 9 optionsforstocks // Sep 8, 2008 at 1:41 pm

  One comment in “sleepy portfolio”. It carries 400 units of VTI and 100+ units of VWO. If you have covered calls for VTI for three months@ a strike price of 65.00 you may have netted an additional return of 2.50×400= $1000.oo and covered calls for VWO for 1.25×100=125.00. That means that you have earned 1125.00 to 1250.00 on your portfolio i.e., about 1% of total portfolio.

  Secondly, all sector tend to rotate in cycles unless and until whole market is bullish where all sectors are on the rise. For example, financial sector had its bearish run for ten weeks and now it has taken positive. The ETF “XLF” is better bet in this quarter. Materials sector had a big run five weeks ago and and is in bearish territory for past five weeks. SLX and USO are the ETF in next five weeks till they started increasing and are in bullish territory. An adjustment in portfolio every quarter may be necessary to take advantage of cyclical nature of sector adjustments.

  P.S. Never leave your ETFs or stocks unprotected without covered calls.

• 10 Canadian Capitalist // Sep 8, 2008 at 2:58 pm

  optionsforstocks: Covered calls don’t give you a free lunch. In return for the premiums you collect, you are limiting your upside. Also, if there is one strategy that is totally discredited, it is market timing. We simply opt not to play this game.

• 11 Optionsforstocks // Sep 8, 2008 at 4:46 pm

  Thank you for your comment. In neutral and bearish market, a covered call strategy not only provides a hedge against losses but enhances the returns on non-performing assets portfolio. Moving away from stocks and getting behind curtains of ETF does not protect the portfolio from falling behind. The stocks with great fundamentals and research enhances the value and a covered call strategy works as hedge as well as return enhancing tool.

• 12 Canadian Capitalist // Sep 8, 2008 at 6:06 pm

  optionsforstocks: Do you have studies that show a covered call writing strategy is better than a buy-and-hold after accounting for all the costs? The trouble with strategies such as this is that neutral or bearish markets are apparent only in hindsight.

• 13 Optionsforstocks // Sep 8, 2008 at 7:26 pm

  CC: I do not have any empirical studies to refer to you at this time. However, I can make an analysis to demonstrate the point how one can benefit from Covered Call Strategies?

  For the past five years (Sep. 12,2003 to Sep. 08, 2008), S&P ETF Spyder (SPY) has increased 24.16 points (23.5%) and year to date it has lost 19.22 points (-13.15%). Average Covered call premium on SPY is 1.5-2% per month. A SPY investments with “covered call strategy ” in last year or last five years could have generated far better results then investing in the index with “buy and hold strategy” alone.

  I sometime refer this strategy as: “RENT YOUR STOCKS LIKE YOUR REAL ESTATE INVESTMENTS”.

  P.S. Can I link your web to my webblog? http://optionsforstocks.blogspot.com/

• 14 Canadian Capitalist // Sep 8, 2008 at 10:30 pm

  Optionsforstocks: Now, if I can pick and choose a specific time period, I can show you any number of strategies that in hindsight would have done better than buy-and-hold. Still, your analysis omits important and relevant details. In rising markets, the options written will be exercised, limiting your returns vis-a-vis a buy-and-hold strategy.

  I did go looking for some research into this area and I found one closed-end fund that adopts a passive covered call strategy called BEP. Its 3-year annualized total returns is 4.02% compared to 3.58% for SPY (as of 8/31). The total returns are nowhere close to what you claim.

• 15 optionsforstocks // Sep 8, 2008 at 11:19 pm

  First of all, let us discuss your discovery. 4.02% vs 3.58% that is 12.22% more than if CC strategy not applied. What I am saying is that It enhances the return or increases the downward protection. Covered call strategy has its own limitation. You do not want to apply every month if you are already in hole. For example, If you bought a a stock (or say SPY) @ 125.0. First month, you will be able to sell covered call @2.5-2.8 per share. Next month scenario changes:

  a) If it falls to 120.00 as it happened in January then $125.00 will call will give nothing or pennies and you do not want to sell cc for 120.00 either. So you are stuck with buy and hold policy. No extra returns.

  b) If it remains in the neighborhood of 124.00 +2.50. The call will be expired or you will rollover to take advantage increasing your return then buy and hold policy is not optimal strategy.

  c) If market is bullish then you sell out of money calls and still enhances your return not as mush if market remains neutral.

  One cannot reject “covered call strategy” against “buy and hold strategy” because there is nothing superior in the strategy that can guarantee overall better returns.

• 16 Canadian Capitalist // Sep 8, 2008 at 11:44 pm

  Optionsforstocks: There is a reason that “buy-and-hold” is a gold standard. A know-nothing investor can easily replicate the strategy for less than 10 basis points. When you claim there is a better strategy that provides better risk-adjusted returns, you should back it up with data — the longer, the better and account for all expenses and look at different time periods. Also, the history of “strategies” that worked in the past but don’t anymore is long. Which means that you should also explain why you think covered-call writing would continue to provide better risk-adjusted returns than buy-and-hold.

• 17 optionsforstocks // Sep 9, 2008 at 8:55 am

  I will continue to explore pro and cons of covered call strategy at my weblog:

  There is an interesting article on BEP fund by “Thestreet.com that is self explanatory and addresses your questions.
  http://us.rd.yahoo.com/finance/external/tsmfe/SIG=129m0j199/*http://www.thestreet.com/_yahoo/funds/mutualfundinvesting/10413136.html?cm_ven=YAHOO&cm_cat=FREE&cm_ite=NA

• 18 Optionforstock // Sep 9, 2008 at 9:39 am

  Hi Canadian Capitalist:

  I cannot continue to this thread because you have put my name in spam filter.

  This is very unfortunate that rather than carrying on healthy discussion on the covered call strategy, you choose to shut it down. I thought Web blogs are open forums meant to have meaningful and healthy discussion for general community. It appears that it is meant for praising for only. Very good CC… very good article CC, etc.

  I do not want to hurt your feeling but everyone is not expert in everything.

• 19 Canadian Capitalist // Sep 9, 2008 at 10:24 am

  optionsforstocks: We *never* moderate dissenting opinions and welcome open and informed debate on every post on this blog. But occasionally, comments do get caught in the automatic spam filter (just to illustrate, the volume of spam compared to genuine comments is 30x). Thanks for letting me know that your comments were. I’ve recovered your comments and I want to assure you that there is no malicious intent.

• 20 Optionsforstocks // Sep 10, 2008 at 4:24 pm

  Thanks CC:

  I will continue to post healthy comments.

• 21 Optionsforstocks // Sep 14, 2008 at 11:05 pm

  A study Barry Feldman and Dhruv Roy, cleraly shows the BXM Index (CBOE S&P 500 BuyWrite Index), a benchmark for an S&P 500-based covered call strategy, had slightly higher returns and significantly less volatility than the S&P 500 over a time period of almost 16 years, despite the fact that covered calls have a truncated upside in the short term.

• 22 Friday LinkStuff // Sep 19, 2008 at 4:59 am

  [...] Capitalist wrote about investment asset classes - is there such thing as too much of a good [...]

• 23 Canadian Capitalist // Sep 23, 2008 at 4:33 pm

  Optionsforstocks: Is the study available online? Are returns calculated by accounting for expenses? What about taxes? Also, does the study cover one single period or multiple periods?

• 24 optionsforstocks // Sep 29, 2008 at 3:22 pm

  Here is the link:

  http://corporate.morningstar.com/ib/documents/MethodologyDocuments/IBBAssociates/CBOE_SPBuyWrite.pdf

  It was published in prestigious “The Journal of Investing” (Summer 2005)

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