Success in a Low-Return World (eBook)

Michael J. Oyster, CFA, CAIA is an investment strategist, researcher and creator of the Options Income Index. He began his professional investment career in 1994 with options advisory firm Schaeffer’s Investment Research. As Schaeffer’s senior quantitative analyst, he conducted detailed analysis of options and volatility metrics while managing product offerings including an S&P 500 Index options spread strategy. Upon joining Fund Evaluation Group, LLC (FEG) in 1999, Michael began researching traditional, hedge fund and options-based investment strategies as well as conducting and publishing independent research. As FEG’s Chief Investment Strategist, he served as a thought leader and frequent presenter on markets and the economy. His first book, Mission Possible, was published in 2005, and he was twice commissioned by the Chicago Board Options Exchange (Cboe) to conduct research on and provide summary analysis regarding suites of their proprietary options indexes. He serves as a board member on the Freestore Foodbank Foundation and on the Lincoln W. Pavey Educational Foundation.

Dedication 5
Preface 6
Acknowledgments 9
Contents 11
List of Figures 16
List of Tables 18
Part I: Challenges in Investing 19
1: The Future Isn’t What It Used to Be 20
Stock Market Performance Building Blocks 21
P/E Ratios and the Bull Market of the 1990s 23
Future Returns 28
2: An Obsolete Fundamental Philosophy 32
Mutual Funds Have Disappointed 33
Equity Mutual Funds 34
Stock Picking 35
The Bottom Line: Market Efficiency 38
3: As a Group, Professional Investors Are the Market 40
Just Because Everybody Else Is Doing It 41
Mutual Fund Industry Growth Hurts Investors 43
4: The Specifics of Market Efficiency 47
What the Research Says About Efficiency 47
Weak Form EMH 49
The Semi-Strong Form EMH 50
The Strong Form EMH 52
A Surprising Quote from Benjamin Graham 53
5: Fund Manager Fees 57
How Fees Combined with Behavioral Errors Can Impact Returns 59
Hedge Fund Fees 61
6: To Err Is to Be Human. To Make a Behavioral Error Is to Be a Human Investor 64
Too Much Information (TMI) 65
Not Enough Meaning 66
Need to Act Fast 67
What Should We Remember? 68
Behavioral Finance 68
Anchoring and Overconfidence 70
Illusion of Control 71
Gambler’s Fallacy 72
In-Group Favoritism and FOMO 73
Agency Friction 74
Prospect Theory 75
Conclusion 76
7: How Regulations Impact Investment Managers 78
The Volcker Rule 79
Regulations and the Stock Picker 81
The Impact of 2002 81
Enron 82
The Sarbanes-Oxley Act 84
WorldCom 85
The Fallout for Securities Analysts 88
Regulation FD 89
Conclusion 91
8: Performance Doesn’t Tell the Whole Story 92
Skill or Luck? 94
Equity Styles 95
Tracking Error 97
The Variables Behind Past Performance 98
Changes in the Manager’s Philosophy 98
Cash Inflows 99
Personnel Turnover 99
Business Decisions Above Investment Decisions 99
New Products 100
Who Outperforms the Benchmark? 100
Part II 102
9: Intuition 104
The Role of Trust 105
Intuition Defined 106
Intuition Versus Instinct 107
Red Flags and Green Lights 108
Suggestions to Consider Practicing 109
The Evolvement of Intuition 112
Mathematical Viewpoint 113
Psychological Analysis 114
Personality Typing: Myers-Briggs Take on Jung 114
Additional Research 118
Using Intuition in Decision Making 121
Final Five Take-aways 122
Conclusion 123
10: Focus on Asset Allocation 124
Asset Allocation and Portfolio Construction Philosophies 129
The Endowment or Yale Model 129
The Norway Model 130
The Factor or Canada Model 131
Manager-Centric or MIT Model 132
Conclusion 134
11: Indexing 136
Skill or Luck? 138
An Alternative to Active Management: Indexing 139
Types of Indexed Securities 141
The Future for ETFs 143
A Fundamental Truth of Investing 144
12: Active Share and Private Equity 147
Active Share 148
Private Equity 153
Conclusion 160
13: Momentum 162
Background, the Evolution of Momentum 163
Evidence of Momentum 165
A Basis in Behavior 166
Applying Momentum 167
Independent Research 168
Conclusion 171
14: Smart Beta 174
Fundamental Indexing 175
The Beginning of the Arnott/Asness Rivalry 177
Factor-Based 179
Factor Timing 182
Has/Will Smart Beta Survive Discovery? 184
Conclusion 185
15: Risk Management 187
Risk, the Only Path to Outperformance 190
Mean-Variance Optimization 190
It’s All About Equity Risk 192
If Equity Risk Is the Problem, Let’s Hedge It Out, Right? 194
Costless Collar 197
Conclusion 200
16: Buy-Write 202
An Alternative: Buy-Write 202
An Example: One Hundred Shares of Procter & Gamble
Stock Versus Index Options 207
The Vehicles Exist 208
A Strategy That’s Malleable 212
The Impact of Falling Rates 212
Bonds 213
Diversification in Bonds 214
Stock-Like or Bond-Like? 215
Buy-Writing as a Stock-Like Strategy 215
Buy-Writing as a Bond-Like Strategy 218
Structuring Buy-Write Correctly 221
The Downside 223
Conclusion 223
17: Put Selling 225
Put-Call Parity 227
Delta Hedging 231
Selling Puts for Rebalancing Purposes 232
Conclusion 234
18: The Options Income Index 235
Introduction 235
Questions Lead to Answers 237
What About Weeklys? 241
Questions Answered, Now Construction 246
What Can Go Wrong? A Case Study from 2008 246
Performance of the OICX 249
Conclusion 253
19: Portable Alpha 255
Leverage 257
The Costs 258
The Cost of Carry 258
Creative Portable Alpha 259
Portable Alpha with Less Liquid Alphas 261
Swaps 261
Factor Portable Alpha 262
Volatility-Based Strategies 264
Portable Alpha Using Volatility 266
Conclusion 267
20: Epilogue 268
Index 272