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February 14, 2012 - Vol 6 Issue 7
Dear Reader,
The 7th Annual MIT Sloan Investment Management Conference will be held Friday, March 9th, 2012 at The Charles Hotel. This year's conference on "Fundamental and Quantitative Strategies for Turbulent Markets" will feature Rep. Barney Frank, and keynote addresses from Donald Sussman, Ron O'Hanley, and Professors Roberto Rigobon and Alberto Cavallo. Industry experts will lead panel discussions on emerging markets, the crisis in Europe, high frequency trading, low volatility strategies and other topics. Please visit here to register and find more information.
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 'The Greatest Anomaly in Finance:' Understanding and Exploiting the Outperformance of Low-Beta Stocks
By Geoff Considine
If I told you that there is an easy-to-exploit market anomaly that has enabled investors to consistently and substantially outperform the market with less risk for more than four decades, your first instinct might be to roll your eyes. After all, the unending quest to improve returns while lowering risk has yielded countless methods with initial promise that subsequently collapse under further scrutiny.
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The Safety-first, Goals-based Approach to Financial Planning
By Wade Pfau
Little of what is taught in traditional investment textbooks is of value in personal financial planning. Risk is not standard deviation; it is the probability and consequences of not meeting one's goals. That real-world perspective animates a new book by Zvi Bodie and Rachelle Taqqu that implores advisors and their clients to lock in the funding of their essential expenses before worrying about their discretionary goals.
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Boosting the Liquidity of the Market Engine: Horsepower vs. Torque
By Robert A. Jaeger, Ph.D.
Everything you need to know about market liquidity you can learn from the engine of your car. Liquidity is often viewed as market lubrication, but lubrication isn't everything, and, even more importantly, horsepower is different from torque. This fact leads us to appreciate the importance of contrarian investing and enables us to think more clearly about the impact of potential regulatory changes, such as the Volcker Rule and the Tobin Tax.
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How to Measure Customer Loyalty
By Dan Richards
Perhaps more than in any industry, advisors know the importance of customer loyalty and the role it plays in client retention and referral generation. But few advisors have ever tried to systematically measure the client loyalty in their practice. Here's a way to do that.
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The Dividend Yield Love Affair
By Michael Nairne
Employee share-based compensation is now a significant expense deduction for public companies and hence, is already accounted for on the financial statements. Concerns that options-related stock issuance nullifies the impact of stock buybacks are accordingly overstated. This bolsters the view that you need to look at stock buybacks as an additional form of cash remittance to shareholders and not simply at dividends.
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Recession: Just How Much Warning is Useful Anyway?
By Dwaine van Vuuren
In December 2011, ECRI dialled down the urgency of the timing of their call to 'within six months.' That raised the question of just how much recession warning is useful when it comes to forecasting equity market performance.
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Is a Picture Worth a Thousand Basis Points?
By Mariko Gordon
Lately I'm seeing twins everywhere - both the human kind and in the investment patterns of our business. I will explain why the positive results we've seen when selling stocks after a big break in price can often lead to equally negative results - a mirror image twin - when applied on the buy side.
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Letters to the Editor
A reader responds to Larry Siegel's article, Jeremy Siegel, Rob Arnott and Other Experts Forecast Equity Returns, and another reader responds to Joe Tomlinson's article, An Innovative Solution to Retirement Income, both of which appeared last week.
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Our Most Read Article from Last Week:
Jeremy Siegel, Rob Arnott and Other Experts Forecast Equity Returns
By Laurence B. Siegel
A forecast of the equity risk premium (ERP) tells you how much to save, how to allocate assets between equities and fixed income, and how much you can consume. Given its great importance, the CFA Institute recently convened a group of top-level academics and practitioners to forecast future ERPs - and to reflect on similar predictions they had made a decade ago.
Errata: This article originally said that Cliff Asness was the most pessimistic of the authors in the 2011 book, Rethinking the Equity Risk Premium. He forecast a 4% equity total return in excess of inflation (not an equity risk premium in excess of bonds). However, we overlooked the fact that Rob Arnott forecast a 2.5% to 3% equity total return in excess of inflation, making Arnott, not Asness, the most pessimistic author in 2011. Arnott was also the most pessimistic author in 2001. This error was corrected in the on-line version on February 10.
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Highlights from Market Commentaries
 Notes on Risk Management - Warts and All
Presently, there seems to be an unusually wide gap between hindsight and foresight, both in the financial markets and in the economy. In both cases, forward-looking evidence suggests weak outcomes, but recent trends encourage optimism and risk-taking. Rather than sugar-coat these uncertainties and minimize the messy divergences in the data, I think the best approach is to review the evidence, warts and all, including economic risks, market conditions, and the strengths and limitations of our own investment approach.
 What the Bond Market Knows That You Dont
On the back of improving US economic data, equities have rallied off of autumn lows, and yet US Treasury yields have continued to surf bottom with the 10-year note trading below 2% for the first time on record. Why havent interest rates recovered in support of improving data? Do US Treasury investors know something that equity investors dont? The answer may lie across the pond in Europe. The European crisis intensified significantly in the fall, causing equity markets (and most risky assets for that matter) to sell off and US Treasury rates to fall, despite the August downgrade.
The Answer We Dont Want to Know
This election is ultimately about dealing (or not dealing) with the deficit, and putting the country on a path to a sustainable budget deficit, one that is less than the growth rate of the country. As I have argued elsewhere, and will argue in future letters, that is the paramount issue. Not dealing with the deficit runs the very real risk of the bond market treating us just as it is treating Italy and any other country that gets to the point where its debt is unsustainable.
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