Weekend reading roundup for investors
1) The Last Quarter of the Guidance Game
"The recent news that Pfizer is considering walking away from issuing quarterly earnings guidance is only the latest evidence of what may become a sizable exodus. Indeed, the trend of abandoning frequent guidance has been gaining momentum. Just this year, Motorola, Citigroup, and Idexx Laboratories have announced plans to stop providing quarterly guidance. And a handful of companies, including GE and Google, have eschewed guidance altogether."
Continue reading here.
2) "... the Network of the Future..."
Another fascinating commentary from Robert X Cringely re the possibility that satellites solve the bandwidth problem. Continue reading here.
3) This comment re risk is from Dorsey Wright. I quote it in full because it is brief (within the allowed boundaries of quoting three paragraphs allowed as a citation) as well as especially pithy.
"The definitions of risk are many, but few are any good. The most common measurement of risk is standard deviation. It is a statistical measure of the dispersion of returns around the mean value whereby a larger variance or standard deviation indicates greater dispersion. The idea is that the more disperse the expected returns, the greater the uncertainty of those returns in any future period. It is another way of addressing the volatility of the returns. The word volatility causes many investors to run for cover, but to the trend follower, volatility is the precursor to profit. If there is no volatility there is no profit. Therefore, simply observing that a strategy has a relatively high standard deviation, without further examination, is meaningless. A measure that only considers deviations below the mean is the semivariance. That is a measure much more useful to investors because few are bothered by volatility when it is manifested in positive returns above some target rate. Investors are concerned about minimizing the damage. Of course, investors would prefer no damage (ever) and all outperformance. Unfortunately, trend followers require volatility to generate profits, and drawdowns are an inevitable part of a trend following approach. A key selling point of a systematic trend-following approach is that trend followers have greater upside volatility and less downside volatility than traditional equity indices such as the S&P, because they exit their losing trades quickly. This results in many small losses, and large long-term gains that result from staying on winning trends.
"Furthermore, risk cannot be eliminated or even minimized. It can only be managed or shifted. If one tries to eliminate the risk of a drawdown, the risk of not generating enough profits to meet one’s financial goals is the result. (emphasis mine -- dmg) The fear of drawdowns should be secondary to the fear of not following a proven strategy. Of course, any strategy must take into consideration the effect the volatility will have on the investor. As investment professionals, we have a very important responsibility to educate our clients up front about what they can expect from an investment strategy. Also, a strategy that generates phenomenal long-term results, but does so while scaring the investor to death is no good. A balance must be struck between a strategy that generates high returns and a strategy that allows the investor to stay in long enough to reap the benefits...
"A proper evaluation of risk involves weighing the probabilities of the various outcomes. It also involves the realization that where there is no risk, there is no reward. Adhering to a proven trend-following approach gives the investor a very high probability of positive outcomes over time. Our goal is to manage risk, and allow volatility to work in our favor over time."
4) This next item is an excellent definition of VWAP. Moreover, its embedded example is excellent and crucial, as it shows that not all investors invest with simple directional, arbitrage, or hedging strategies. The comment comes from an Internet group (of which I am a reader) that has as its participants many insightful investors; it might be best of breed. Unfortunately the writer is anonymous, so I am unable to attribute properly his or her comments. (Readers of my newsletter might recall my feeble attempt to define VWAP. If you would like a copy of that specific issue, please email your request to davidmgordon@gmail.com.)
"... I expect you know about Value-Weighted Average Price(VWAP), but for those reading this post who don't let me give a quick summary of the way thebig houses execute bulk trades on behalf of the fund world:
"Having secured a large order from a big investor, say a Fidelity fund, the broker (Goldman, UBS, Morgan, etc) is paid a nominal commission of 1 to 2 cents per share and then encouraged to spread the orders out over the course of the day by splitting (usually 40% to the broker) any improvement over the trade weighted average price of the day withthe investor. For example, if at the end of the day the trade weighted price (take each price times the volume at that price divided by the shares traded that day) was $50 and the execution price was $49.75,the customer will pay the broker dealer an extra 10 cents a share($.25 x 40%).
"It is obvious that the broker dealer is greatly incented to beat the VWAP and they have figured out how to maximize this. When they get alarge order, especially one where the amount is larger than a good percentage of the average daily volume (this allows them to control price), they buy a little in the morning and throughout the day, but save a good portion of the trade for the end. This statistically givesthem the best chance of driving up the price of the stock at high volume, creating a higher VWAP than would otherwise be the case: the higher the VWAP, the greater the chance for the spread over actual execution.
"When money is coming into the market, most if not all of these VWAP programs are buy programs. This is why you see buying in the morning,then a stall, and then buying into the close. When money is leavingthe market, the action is more or less the converse.
"Now to the rhetorical question. Do you really think that Goldman's traders are blissfully ignorant of what their own VWAP desks are doingon the day? Or for that matter what the UBS desks are doing? As fortheir asset managers, well, perhaps I am revealing too much about myown inner Gordon Gecko but were I in such a job I'd have turned anyChinese wall into Swiss cheese long ago. And if the SEC came calling I'd blame the termites."
As always, I welcome your thoughts on any of the above comments.
-- David M Gordon / The Deipnosophist
"The recent news that Pfizer is considering walking away from issuing quarterly earnings guidance is only the latest evidence of what may become a sizable exodus. Indeed, the trend of abandoning frequent guidance has been gaining momentum. Just this year, Motorola, Citigroup, and Idexx Laboratories have announced plans to stop providing quarterly guidance. And a handful of companies, including GE and Google, have eschewed guidance altogether."
Continue reading here.
2) "... the Network of the Future..."
Another fascinating commentary from Robert X Cringely re the possibility that satellites solve the bandwidth problem. Continue reading here.
3) This comment re risk is from Dorsey Wright. I quote it in full because it is brief (within the allowed boundaries of quoting three paragraphs allowed as a citation) as well as especially pithy.
"The definitions of risk are many, but few are any good. The most common measurement of risk is standard deviation. It is a statistical measure of the dispersion of returns around the mean value whereby a larger variance or standard deviation indicates greater dispersion. The idea is that the more disperse the expected returns, the greater the uncertainty of those returns in any future period. It is another way of addressing the volatility of the returns. The word volatility causes many investors to run for cover, but to the trend follower, volatility is the precursor to profit. If there is no volatility there is no profit. Therefore, simply observing that a strategy has a relatively high standard deviation, without further examination, is meaningless. A measure that only considers deviations below the mean is the semivariance. That is a measure much more useful to investors because few are bothered by volatility when it is manifested in positive returns above some target rate. Investors are concerned about minimizing the damage. Of course, investors would prefer no damage (ever) and all outperformance. Unfortunately, trend followers require volatility to generate profits, and drawdowns are an inevitable part of a trend following approach. A key selling point of a systematic trend-following approach is that trend followers have greater upside volatility and less downside volatility than traditional equity indices such as the S&P, because they exit their losing trades quickly. This results in many small losses, and large long-term gains that result from staying on winning trends.
"Furthermore, risk cannot be eliminated or even minimized. It can only be managed or shifted. If one tries to eliminate the risk of a drawdown, the risk of not generating enough profits to meet one’s financial goals is the result. (emphasis mine -- dmg) The fear of drawdowns should be secondary to the fear of not following a proven strategy. Of course, any strategy must take into consideration the effect the volatility will have on the investor. As investment professionals, we have a very important responsibility to educate our clients up front about what they can expect from an investment strategy. Also, a strategy that generates phenomenal long-term results, but does so while scaring the investor to death is no good. A balance must be struck between a strategy that generates high returns and a strategy that allows the investor to stay in long enough to reap the benefits...
"A proper evaluation of risk involves weighing the probabilities of the various outcomes. It also involves the realization that where there is no risk, there is no reward. Adhering to a proven trend-following approach gives the investor a very high probability of positive outcomes over time. Our goal is to manage risk, and allow volatility to work in our favor over time."
4) This next item is an excellent definition of VWAP. Moreover, its embedded example is excellent and crucial, as it shows that not all investors invest with simple directional, arbitrage, or hedging strategies. The comment comes from an Internet group (of which I am a reader) that has as its participants many insightful investors; it might be best of breed. Unfortunately the writer is anonymous, so I am unable to attribute properly his or her comments. (Readers of my newsletter might recall my feeble attempt to define VWAP. If you would like a copy of that specific issue, please email your request to davidmgordon@gmail.com.)
"... I expect you know about Value-Weighted Average Price(VWAP), but for those reading this post who don't let me give a quick summary of the way thebig houses execute bulk trades on behalf of the fund world:
"Having secured a large order from a big investor, say a Fidelity fund, the broker (Goldman, UBS, Morgan, etc) is paid a nominal commission of 1 to 2 cents per share and then encouraged to spread the orders out over the course of the day by splitting (usually 40% to the broker) any improvement over the trade weighted average price of the day withthe investor. For example, if at the end of the day the trade weighted price (take each price times the volume at that price divided by the shares traded that day) was $50 and the execution price was $49.75,the customer will pay the broker dealer an extra 10 cents a share($.25 x 40%).
"It is obvious that the broker dealer is greatly incented to beat the VWAP and they have figured out how to maximize this. When they get alarge order, especially one where the amount is larger than a good percentage of the average daily volume (this allows them to control price), they buy a little in the morning and throughout the day, but save a good portion of the trade for the end. This statistically givesthem the best chance of driving up the price of the stock at high volume, creating a higher VWAP than would otherwise be the case: the higher the VWAP, the greater the chance for the spread over actual execution.
"When money is coming into the market, most if not all of these VWAP programs are buy programs. This is why you see buying in the morning,then a stall, and then buying into the close. When money is leavingthe market, the action is more or less the converse.
"Now to the rhetorical question. Do you really think that Goldman's traders are blissfully ignorant of what their own VWAP desks are doingon the day? Or for that matter what the UBS desks are doing? As fortheir asset managers, well, perhaps I am revealing too much about myown inner Gordon Gecko but were I in such a job I'd have turned anyChinese wall into Swiss cheese long ago. And if the SEC came calling I'd blame the termites."
As always, I welcome your thoughts on any of the above comments.
-- David M Gordon / The Deipnosophist
posted by David M Gordon | 9:07 AM
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