Alex White

Articles from Alex White

  • SHOULD YOU RELY ON THE P/E RATIO WHEN INVESTING?

    Clients often ask us to what extent our expected returns should adjust to changing market conditions. For an investment grade bond, this is relatively easy - you will earn the credit spread less any defaults. So it’s quite straightforward and objective. For equities, it is much harder to say whether the market is over or under-valued. There are lots of measures that appear to work historically, but interpreting the evidence is fraught with subtleties. One commonly used metric is the Shiller P/E ratio- but does the evidence hold up? Shiller P/E Ratio Click to tweet >> T ... ..read more
  • CAN LONG-TERM INTEREST RATES GO NEGATIVE?

    Negative interest rates don’t seem to make a lot of sense.   Why?   People value money now, more than potential money in the future. You need to pay people to deposit their money longer-term. Think about it... This means interest rates should always be positive. The lognormal distribution is often used for interest rate moves. This does not allow negative rates1. Besides, if it costs money to lend money, it seems likely that people will stop lending.   That’s the theory; what’s the reality? Like a great many arguments this is ... ..read more
  • WILL INTEREST RATES RISE AND DO THEY MEAN-REVERT?

    Are Rates Low? Above all else, the mark-to-market value of long-term liabilities is determined by long-term interest rates. The relentless fall in interest rates over the last few years has hit pension funds hard. However, many argue that such valuations are misleading because interest rates are artificially low, and will rise back up soon. To say interest rates are low, compared to history, seems eminently fair. Using data on US 10yr rates from Professor Robert Shiller, current rates are just above the 10th percentile; so for nearly 90% of the last 144 years US 10y rates were high ... ..read more
  • STYLE PREMIA AND BACKTESTING – HOW TO MITIGATE THE DANGER

    Previously I wrote about the dangers of unscientific backtesting, and promised to show how it might be mitigated. Because the ideas are quite abstract, and because it’s where this issue arguably poses the greatest risk, where relevant I will use style premia as an illustration of the basic idea. The first, and arguably most important mitigant, is to recognize that we do not start knowing nothing[1]. As such, we should need less evidence to convince ourselves of sensible ideas than ridiculous ones. A newspaper article would convince me that a celebrity had died of a heart attack, bu ... ..read more
  • STYLE PREMIA AND THE DANGER OF BACKTESTING

    There are some topics that grab your imagination, and demand immediate attention and interest: things like war, recession, and the World Cup. Unless you share my particular personality quirks, however, the risks of unscientific backtests are unlikely to be among them. This is a shame, however, as unscientific backtesting poses a pervasive, insidious and largely unquantifiable hazard. There are many reasons why backtests may turn out to be unscientific, but in principle the mistake is always the same - where there is a lot of noise in a data set, and one can try lots of models, it is easy ... ..read more
  • SMART BETA AND THE POWER OF LANGUAGE

    Have you ever thought of the perfect retort, but only done so too late to actually use it? The French have a phrase – l’esprit d’escalier (literally, the wit of the staircase) to describe just this predicament, yet we don’t have an obvious equivalent in English. In a similar vein Korean has a word, nunchi, to describe the intuitive ability to gauge how people are feeling, and to know what not to say. Angdai, in Hindi, refers to the lazy morning stretch you do when you wake up in the morning. However my favourite word that English could really use has to be t ... ..read more
  • CHALLENGES OF LONG-TERM RISK MODELS - PART 2

    In my previous blog, I outlined when it would be worth using a long-term risk model, and identified three fundamental reasons why you might need one. Taking a step back, how this applies in any situation will vary depending on what you’re trying to do. To frame the discussion, I shall use the example of a DB pension scheme. For a DB pension scheme, the risk is being unable to pay the pensioners, and the point of a model is to make better investment decisions. There is a simple framework for doing this: using a deterministic model, solve for the returns required to reach investment ... ..read more
  • CHALLENGES OF LONG-TERM RISK MODELS - PART 1

    Finance is, somewhat to my chagrin, not a science. This is in part a reflection of the complexity and chaotic nature of the system: a thorough, bottom-up understanding of how everything worked would include psychology, geography, and technology, to name but a few of the many, many factors that ultimately drive the markets. Moreover, even if that were possible, any successful model of the markets would soon have to include itself in its own predictions, and thus either be able to be simplified without being too significantly changed, or else be more complex than itself1. Neither seems part ... ..read more
  • WHAT DOESN’T DISCOUNT YOU MAKES YOU STRONGER

    Funding plans and contribution schedules are often set on a technical provisions (TP) basis. This is a value broadly expected to represent the amount of assets needed today to be able to pay off all the liabilities. These bases can vary enormously form scheme to scheme, and there is a lot of flexibility in choosing the valuation assumptions; however there are certain reasonably common assumptions which create an underlying drift upwards in the liabilities and scheme deficit. One simple example is the inflation risk premium. The argument here is that investors will only take inflation ris ... ..read more
  • INVESTING WITH STYLE – NEXT GENERATION RISK MANAGEMENT

    Active managers have a mixed track record; some have done very well, others significantly less well, and some have simply slipped off the records, unable to generate or retain capital in the wake of poor returns. One thing is reliable, however; if a manager’ performance is consistently better, they are probably doing something consistent. And if they’re doing something consistent, then it should be possible to emulate them. Explaining managers’ performance is too big a job for one blog; for now I will simply note that a number of people are doing it with some success ... ..read more
  • AN INFINITE MOMENT – ESTIMATING EQUITY VARIANCE

    It may surprise my readers to discover that I am a fan of equity investments. I think they are likely to offer higher returns to a long-term investor than most other asset classes. The issue is that you cannot rely on the returns. To invest in anything, it’s important to know the risks involved; and I worry that many investors have vast allocations, 50% or more of their portfolios, in an asset class they don’t fully understand. For instance, investors wary of leverage often have few qualms investing in leveraged companies. For this blog though, I’m going to focus on a p ... ..read more
  • DO EQUITIES MEAN-REVERT AND ARE THEY ALWAYS UP OVER THE LONG-TERM?

    A common argument in favour of equity investments is that, even though they go down, and go down hard, they will bounce right back up again. Effectively, the argument goes, equity returns will revert to a mean. But mean reversion is a strange concept - like the soul, there are more people saying it does or doesn’t exist than there are people saying what they think it means. My plan is to resolve the debate, once and for all; and do so in the next few hundred words. There is, as mentioned, no single accepted definition of mean reversion1 ; since the issue is quite subtle, we br ... ..read more
  • MODEL REVIEW AND VALIDATION

    In 2012, the “London Whale” trades resulted in losses of $6billion. JPMorgan were widely renowned as among the best managers of banking risk in the world, and had navigated the financial crisis far better than most; yet these losses resulted from inappropriate use of a risk model that seems not to have been fit for purpose. There was nothing new in this. In 2007, David Viniar of Goldman Sachs famously described seeing “25 standard deviation events, several days in a row”. To put this in perspective, for a normal distribution this is equivalent to buyi ... ..read more
  • ESTIMATING THE EQUITY RISK PREMIUM 2 - WHAT DO WE MEAN BY A MEAN?

    Let’s open with a question- what is the mean excess return earned by US equities (over short-term interest rates) since 1870? Data Source: Professor Shiller, http://www.econ.yale.edu/~shiller/ The simple answer is to take the average, which is 5.4%- this is the arithmetic mean (AM). The trouble is, that’s not what you’d have earned. An investment that returned 5.4% excess every year would have earned 7.5 times as much as the equities over the period. The equities earned the same as an investment that returned the much lower 3.9%- this is the geometric mean (GM). Cl ... ..read more
  • ESTIMATING THE EQUITY RISK PREMIUM

    The last ten years have not gone quite the way most textbooks said they should have. Two colossal equity bubbles have burst, leaving many people with the same view of the stock market the French must have adopted after the failure of Law’s Mississippi Company in 1720. Indeed, anyone estimating the equity risk “premium” based on the last ten years would have to conclude that it was sizeably negative, around -3 percentage points. But in reality, the whole idea of the risk premium is that it is uncertain. It’s the concept of chasing the two in the bush instead ... ..read more

Alex joined Redington in 2011 as part of the award-winning ALM team. He now runs the research function within that team, designing and improving models. He is one of 6 members of the firm on the Investment Committee, and also specializes in LDI.

He holds a diploma in actuarial techniques, and an MA(Hons) in Mathematics from Robinson College, Cambridge. In his spare time, Alex trains Fujian White Crane Kung Fu and static trapeze.

Connect with Alex on Twitter and Linkedin.