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Investment Research

Forecaster builds the most accurate forecast, refuses to believe itFeatured

The man behind the USC/L.A. Times poll that predicted Trump winning: ‘To be honest, I was surprised’

The USC/L.A. Times poll saw what other surveys missed: A wave of Trump support

As election returns rolled in Tuesday night, the creator of the USC/Los Angeles Times Daybreak tracking poll was in Washington for a speaking engagement…

“[Election night 2016]… was an odd experience,” Arie Kapteyn said Wednesday morning.

The same might be said of the furor that surrounded the Daybreak poll during the campaign. It was the only major public survey that consistently showed Donald Trump winning. As a result, it drew frequent and loud denunciations from many Democrats, especially as Election Day neared and passions rose.

But on Wednesday, as many other pollsters struggled to explain why their surveys seemed blind to Trump’s support, Kapteyn and his colleagues were among the few who could say their work got the basic issue right.

“To be honest, I was surprised,” said Kapteyn, a USC economist and expert on public opinion.

In an interview several days ago with a radio station in Holland, where he grew up and received his doctoral degree, Kapteyn had predicted that “Clinton is going to win, but I think it’s going to be a lot tighter than people think,” he recalled.

That prediction, he said, highlighted the problem with most efforts at political analysis.

“When you look at pundits and their predictions, the correlation is zero” between what they forecast and how things actually turn out, [Kapteyn] said, citing work done by Daniel Kahneman, the Nobel Prize-winning behavioral economist. (emphasis added)

“You have to trust the numbers,” he said. “Don’t get distracted by all the things you think about plausibility.”

“What you think personally doesn’t matter,” he added. “I thought Clinton would win. But that shouldn’t change the numbers.”

The tracking poll was not perfect, of course; it projected Trump to win in the popular vote by slightly more than 3 percentage points, but in reality Hillary Clinton seems set to gain a slender popular vote majority, currently about 0.2%. Her margin could expand as late ballots are counted in heavily Democratic California.

That result, however, was well within the poll’s margin of error. The more crucial point was that the poll correctly detected Trump’s appeal to a key bloc of voters: conservative whites who had sat out the 2012 election but intended to vote this year. That group strongly favored Trump, the poll found.

The poll’s ability to pick up those voters, Kapteyn said, stemmed from its approach, which differs notably from the one used by most major surveys.

Instead of asking people to simply choose between the candidates, the Daybreak survey asked respondents to rate, on a scale from 0 to 100, their chance of voting for Trump, Clinton or some other candidate. The poll also asked people to use the same 0-100 scale to rate their likelihood of voting.

That method, which Kapteyn had used four years ago to accurately forecast President Obama’s reelection, “is the most important part” of what the poll demonstrated, he said.

By asking people to give a probability, the poll avoided forcing voters into making a decision before they were truly ready. As a result, it may have more accurately captured the ambiguity many people felt about their choice.

Moreover, by asking participants to rate their chance of voting, the poll could take advantage of information from everyone in its sample group, rather than cast aside those who do not meet a test for being a “likely voter,” as most traditional surveys do.

“One of the ways in which other polls may have gone wrong is that they have a hard time defining who is going to vote,” he said. Polling firms “should look at their likely voter model” and think about whether they are excluding too many potential voters, he said.

The polling profession plans to review why so many of this year’s general election polls were inaccurate. The American Assn. for Public Opinion Research, the professional group for pollsters, has set up a committee to study the polls and report back by May.

Unlike many pollsters, Kapteyn, 70, is neither a political scientist nor a political activist. His work on predicting election results is an outgrowth of his main research interest on how people make decisions on their finances.

The fact that he could approach the poll as a science project provided some mental insulation from the criticism the poll drew during the last few months.

“There was some flak,” he said. Among other researchers, however, the response all along had been more appreciative, he said.

“People would say, ‘You may be wrong. We think you’re wrong, but we understand what you’re doing,’” he said.

“In science, you don’t have to be right to do something useful,” he said, noting that even if the test of a new method fails, researchers can learn from it.

This time, however, as was the case in 2012, the test succeeded. It was not, however, the outcome he wanted.

“I’m very unhappy” about Trump’s victory, he said. “But that’s the way it is.”

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Planning's Future, Practice Management

Price discovery Vs. Values discovery: Should Advisors Search for Alpha or Gamma?Featured


head-hunters-hire-your-competitors-top-sales-people claw machinePrice discovery: the alpha-seekers dilemma

In his recent Financial Analysts Journal article ‘The Rise (and Fall) of Performance Investing[i]”, Charles Ellis among other things, frets that improving market efficiency increases the difficulty of locating managers who will produce consistent alpha. He reminds us “Price discovery is the skillful process of identifying pricing errors not yet recognized by other investors.” Ellis observes”… the skill and effectiveness of active managers as a group has risen for more than half a century, producing an increasingly expert and successful (or “efficient”) Price discovery mechanism.”

Image link

The article postulates;”As the skill of competitors converges, luck becomes increasingly important in determining the increasingly meaningless performance rankings of investment managers.” It warns “Investment professionals know that any long term performance record must be interpreted with great care.” As evidence, Ellis offers a study of investment performance produced using manager selection consultants. “Despite considerable time and effort and access to managers’ data, the self-chosen task of investment consultant firms has proved far more difficult than expected. As a group, selection consultants have caused their clients to underperform by 1.1% of assets.”[ii]

keep-calm-and-set-meaningful-goals dnldValues discovery: bold proposition or capitulation?

Given the uncertainty of finding managers who will consistently add alpha, Ellis suggests we re-emphasize “Values discovery” in our client relationships; which he defines as “…the determination of each client’s realistic objectives with respect to various factors, including wealth, income, time horizon, age, obligations and responsibilities, investment knowledge and personal financial history, and designing the appropriate strategy.”



Does Values discovery produce measurable results?

Happily, according to recent Morningstar research, Ellis’ “Values discovery” earns our clients, large, tangible returns. In their Morningstar paper “Alpha, Beta, and Now … Gamma”, authors David Blanchett and Paul D. Kaplan[iii] “… introduce a concept called “Gamma,” which is designed to measure the additional expected retirement income achieved by an individual investor making intelligent financial-planning decisions.

“Measuring Gamma: Although financial planning spans a tremendously broad range of potential decisions, in this paper, Blanchett and Kaplan start out by measuring Gamma for five specific retirement-based planning issues: determining asset allocation based on total wealth; applying a dynamic safe withdrawal rate strategy; incorporating guaranteed retirement income products (e.g., annuities); making tax-efficient allocation (i.e., asset location) decisions; and optimizing the portfolio by treating client cash flow needs as liabilities and matching investments and their risks appropriate to manage (and hedge) those liability needs”[iv].

Values Discovery is more powerful than price discovery

Surprise: Values discovery is more accessible and powerful than Price discovery

To gauge planning’s contribution; the research compares a base case – what investors do on their own, against against a set of retirement planning strategies. While the improvement varies with client circumstances, the authors found the planning strategies make a significant difference;”… a Gamma of 28.8%, meaning $1.29 for every $1 generated by the base set of assumptions.[v]” So taking a smarter approach to generating retirement income (by working with a planner) earns investors substantial tangible rewards. Unlike Alpha, everyone can earn Gamma because better planning is not a zero-sum game.

Values plus Price discovery create a viable client planHolistic approach: blend Values and Price discovery

Based on evidence that used alone, each yields much less benefit than the combination, orthopedists prescribe a combination of surgery and exercises to treat an injured limb. Similarly, Ellis describes the practice of investment management as “two hands clapping”; “…one hand based on the skills of Price discovery and the other based on Values discovery.” Advisors employing the two-handed approach blend Alpha and Gamma consistent with their firm philosophy and appropriate to each client.

Ellis concludes “[Values discovery] is an admirable way forward that would inspire client loyalty—with all the attendant long-term economic benefits—and would provide practitioners with deep professional satisfaction. Although not as exciting as competing on Price discovery, investment counseling based on Values discovery is greatly needed by most investors—institutional investment committees as well as individual investors—and surely offers more opportunities for real long-term success to both our profession and our clients.”


[i] Charles D. Ellis, CFA; “The Rise and Fall of Performance Investing”, Financial Analysts Journal, July/August 2014 pages 14-23 Article Link see also Article Link

[ii] According to Tim Jenkinson, Howard Jones, and Jose Martinez, “Picking Winners? Investment Consultants’ Recommendations of Fund Managers,” Article Link

[iii] David Blanchett and Paul D. Kaplan; “Alpha, Beta, and Now … Gamma Measuring the importance of intelligent financial planning decisions.”, Morningstar Advisor December/January 2013 pages 60 -63 Article Link

[iv] Morningstar Tries To Quantify The Value Of Financial Planning – 1.8% Gamma For Retirees?, Posted by Michael Kitces on Monday, November 12th, 12:01 pm, 2012 in Planning Profession. Article Link

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Excerpts from “Beating the market has become nearly impossible”

By Julie Segal  Institutional investor Sept 18,2013

Intense competition, technological advances and regulatory changes have left [institutional] investors struggling; raising the question “is alpha dead?”

Article link

man digging in the desert 2013-09-Julie-Segal-Is-Alpha-Dead-article-page-1










Alpha continues to shrink and become more rare


The margin between the best and the average manager is narrowing, so the results get narrower

…Michael Mauboussin, head of global financial strategies at Credit Suisse in New York, had shown me statistics that he had prepared for a Columbia University class on security analysis that he was teaching, illustrating that the margin of out performance – that is, alpha – of US large-cap mutual funds has been steadily shrinking for 40 years. “The difference between the best and the average manager is narrowing, so the results get narrower,” says Mauboussin.

Trend of US Large-cap fund manager performance and distribution anotated










There’s been a big decline in the % of managers beating their benchmarks

[Suzanne Duncan, the 40-year-old global head of research for State Street Corp’s.Boston – based Center for Applied Research]…cites a joint paper from the Center for Applied Research and the Fletcher school of Law and Diplomacy at Tufts University that found less than 1% of 2,076 US mutual funds tracked between 1976 and 2006 achieved superior returns after costs. She also refers to a working paper from the University of Maryland that reports that before 1990, 14.4% of equity mutual funds delivered alpha, whereas in 2006 only .6% of the managers could say the same thing. The authors define funds that produce alpha as those having stock – picking skills sufficient to provide a surplus beyond recovering trading costs and expenses.

Increasingly, luck may be the factor separating today’s top-performing manager from their equally skilled peers

… [The Paradox of Skill], a concept developed by the late biologist Stephen Jay Gould to explain that in many fields, as people become more skilled, luck ironically becomes more important in determining outcomes. “Absolute skill rises, but relative skill declines, leaving more to luck,” Mauboussin explains.

… In investing the paradox of skill means that many managers are producing similar results. In other words, alpha is going down.

Was alpha more plentiful in the ‘good old days’?

…For [Peter] Lynch [manager of Fidelity Magellan fund] alpha was easier to get in the beginning than at the end. Mauboussin points me to the work of finance professors Jonathan Burke and Richard Green, which shows that between 1977 and 1982, when the market was still below its 1966 high, Lynch produced a mind – boggling two percentage points of gross alpha per month. During his last five years managing Magellan, Lynch delivered 0.2% monthly in gross alpha, as the fund had grown from about $40 million when he started to $10 billion in assets.

Some of the low-hanging fruit has been plucked

…Investors benefited from the profits to be had in whole new categories of investments, such as high – yield bonds and the ability to tap international markets. “Some of the low – hanging fruit has been plucked,” says Robert Hunkeler, who has overseen International Paper Company’s pension fund for more than 16 years. “When I think back to the 80’s and early 90’s, it wasn’t uncommon that a large allocation to international equities would have given you a big leg up over your competition. High – yield bonds were still called junk bonds, and many people didn’t invest in them because of that. Those were what I call cakewalks.”

Fiercer completion makes it harder to produce extraordinary returns

[Mark Lasry , co-founder of New York – based Avenue Capital Group, a $12.3 billion alternative – investment firm that specializes in distressed investing] …makes the point that fiercer competition has made it harder to deliver returns. He says that debt that he buys at 65 or $.70 on the dollar today might have been purchased for 60 or even 50 cents years earlier. “As people understand what we do, sellers hold out for higher prices,” he says…

Harder to detect alpha when market returns are subdued?

…Investing in a low – return environment is extremely difficult. Returns for both stocks and bonds are expected to be in the single digits, at best, for the next several years, if not for the rest of the decade. Even a great alpha generator will deliver less if the pie is smaller.

Is alpha buried under near-zero risk-free rates?

… With the risk – free rate at a record low, it’s more difficult than ever to produce alpha. But it’s a great time to be writing about how difficult it is to find alpha, because investors rarely think about the increased risk that low interest rate’s present, Mark Lasry insists. “It’s just mathematically harder to find alpha because the risk-free rate is now essentially zero,”… Asset managers… measure potential investments against what they could earned by taking no risk, such as sitting on cash. At the start of 2008, the three – month LIBOR rate was 5%. Investors were paid 5% to sit on cash, or Lasry could take two times the risk-free rate to make a 10% return. Now, with three month LIBOR at 25 basis points, he has to take 40 times that risk to earn the same 10% return, which is what investors are demanding today.

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