Case-Shiller index

The Case-Shiller index for house prices shows a marked difference between the 10 cities with the highest returns between 2002 and 2005, and the 10 cities with the lowest returns over that period. (Index values as released at 24 Feb 09)

It's obvious that in the "non-boom" cities the price declines have been much more muted than in the boom cities. What is worrying is that the recession has now hit the prices of cities that didn't boom. Declines in these prices is now as fast as for the boom cities.

But the behaviour of the non-boom cities was also more muted back in the early 1990s. We definitely have a heterogenous group of cities.

Copies of spreadsheet available for those interested.

Keynes and the Great Depression

With all the mention of JM Keynes and his analysis of the 1930s Depression, it's interesting to note that his father was on a Royal Commission analysing the 1890s economic depression.

Qualitative and quantitative information

Another question from LinkedIn - Performance & Risk Analysis group

How do you integrate qualitative and quantitative information in a systematic way?
In mathematics, there exists the Bayesian approach. Related to that, we know the Black/Litterman approach. In medicine and other disciplines, there are "evidence-based" approaches - what is your take on enhancing quantitative with qualitative information in a structured manner?

First, there is no way we can know what is the optimum portfolio. Estimation error means we have a distribution of portfolios that could be optimal.

Secondly: We can use resampling or bootstrapping to give us an idea of this distribution.

Thirdly: Choose a portfolio in this cloud of possible optimums that is line with your qualitative information. By the very nature of qualitative information, this has to be subjective.

Fourthly: Be prepared to have to defend this approach from people who think that it lacks rigour. When I've seen the arguments of such people I find that what is lacking is a rigourous knowledge of the statistical underpinnings of portfolio arithmetic.

Indexing portfolios

I saw this question on LinkedIn

Anyone know how I can reconcile the difference between two benchmarks?
I am trying to reconcile the returns of the S&P600 Citi Growth (-11.10% YTD) with the Russell 2000 Growth (-5.80% YTD). What I would like to find out is what fundamental and/or economic factors caused the difference in these small cap indexes. Any insight would be appreciated.

My response:
Embrace the difference!

What this difference reinforces is the arbitrariness of benchmarks. Fundamentally, we want to know a representative return of the small(ish) end of the stockmarket. Well we have a big question of definition - what do you mean by small caps? And what do you regard as a representative return. Because these questions are vague we should not be concerned if we get a vague answer - in this case a return of between -11.10% and -5.80%. Or maybe wider.

What it also shows is that if we want a passive small cap portfolio to reduce investment costs and tax, then having a tracking error limit of about 5% might be OK. Allowing your portfolio to passively drift away from your benchmark up to such a level will drastically reduce your costs, while still achieving your objective of having a return similar to the market segment as a whole.



More comment
This question is one whose kind comes up quite often in funds management and shows that the basic idea of indexation has lost its focus over the years. Instead of being a method for running a low cost portfolio its been turned, in many cases, into a way in which IM companies can show off how good they are by having a low tracking error. The final beneficiaries don't really want low tracking error, they want low cost. IM firms and consultants need something that they can sell and consult on, so they go for something you can easily measure and that sounds good, even if it's useless.

Falling behind

Why can't Australia be moving rapidly towards requiring companies to report in XBRL format?

See EDGAR report.