Archive for the ‘Modern’ tag
Editor’s note: Paul Pfleiderer is the C.O.G. Miller Distinguished Professor of Finance at the Stanford Graduate School of Business and co-founder of Quantal International.
A few weeks ago, TechCrunch published a piece arguing software is better at investing than 99% of human investment advisors. That post, titled Thankfully, Software Is Eating The Personal Investing World, pointed out the advantages of engineering-driven software solutions versus emotionally driven human judgment. Perhaps not surprisingly, some commenters (including some financial advisors) seized the moment to call into question one of the foundations of software-based investing, Modern Portfolio Theory.
Given the doubts raised by a small but vocal chorus, it’s worth spending some time to ask if we need a new investing paradigm and if so, what it should be. Answering that question helps show why MPT still is the best investment methodology out there; it enables the automated, low-cost investment management offered by a new wave of Internet startups including Wealthfront (which I advise), Personal Capital, Future Advisor and SigFig.
The basic questions being raised about MPT run something like this:
- Hasn’t recent experience – i.e., the financial crisis — shown that diversification doesn’t work?
- Shouldn’t we primarily worry about “Black Swan” events and unforeseen risk?
- Don’t these unknown unknowns mean we must develop a new approach to investing?
Let’s begin by briefly laying out the key insights of MPT.
MPT is based in part on the assumption that most investors don’t like risk and need to be compensated for bearing it. That compensation comes in the form of higher average returns. Historical data strongly supports this assumption. For example, from 1926 to 2011 the average (geometric) return on U.S. Treasury Bills was 3.6%. Over the same period the average return on large company stocks was 9.8%; that on small company stocks was 11.2% ( See 2012 Ibbotson Stocks, Bonds, Bills and Inflation (SBBI) Valuation Yearbook, Morningstar, Inc., page 23. ). Stocks, of course, are much riskier than Treasuries, so we expect them to have higher average returns — and they do.
One of MPT’s key insights is that while investors need to be compensated to bear risk, not all risks are rewarded. The market does not reward risks that can be “diversified away” by holding a bundle of investments, instead of a single investment. By recognizing that not all risks are rewarded, MPT helped establish the idea that a diversified portfolio can help investors earn a higher return for the same amount of risk.
To understand which risks can be diversified away, and why, consider Zynga. Zynga hit $14.69 in March and has since dropped to less than $2 per share. Based on what’s happened over the past few months, the major risks associated with Zynga’s stock are things such as delays in new game development, the fickle taste of consumers and changes on Facebook that affect users’ engagement with Zynga’s games.
For company insiders, who have much of their wealth tied up in the company, Zynga is clearly a risky investment. Although those insiders are exposed to huge risks, they aren’t the investors who determine the “risk premium” for Zynga. (A stock’s risk premium is the extra return the stock is expected to earn that compensates for the stock’s risk.)
Rather, institutional funds and other large investors establish the risk premium by deciding what price they’re willing to pay to hold Zynga in their diversified portfolios. If a Zynga game is delayed, and Zynga’s stock price drops, that decline has a miniscule effect on a diversified shareholder’s portfolio returns. Because of this, the market does not price in that particular risk. Even the overall turbulence in many Internet stocks won’t be problematic for investors who are well diversified in their portfolios.
Modern Portfolio Theory focuses on constructing portfolios that avoid exposing the investor to those kinds of unrewarded risks. The main lesson is that investors should choose portfolios that lie on the Efficient Frontier, the mathematically defined curve that describes the relationship between risk and reward. To be on the frontier, a portfolio must provide the highest expected return (largest reward) among all portfolios having the same level of risk. The Internet startups construct well-diversified portfolios designed to be efficient with the right combination of risk and return for their clients.
Now let’s ask if anything in the past five years casts doubt on these basic tenets of Modern Portfolio Theory. The answer is clearly, “No.” First and foremost, nothing has changed the fact that there are many unrewarded risks, and that investors should avoid these risks. The major risks of Zynga stock remain diversifiable risks, and unless you’re willing to trade illegally on inside information about, say, upcoming changes to Facebook’s gaming policies, you should avoid holding a concentrated position in Zynga.
The efficient frontier is still the desirable place to be, and it makes no sense to follow a policy that puts you in a position well below that frontier.
Most of the people who say that “diversification failed” in the financial crisis have in mind not the diversification gains associated with avoiding concentrated investments in companies like Zynga, but the diversification gains that come from investing across many different asset classes, such as domestic stocks, foreign stocks, real estate and bonds. Those critics aren’t challenging the idea of diversification in general – probably because such an effort would be nonsensical.
True, diversification across asset classes didn’t shelter investors from 2008’s turmoil. In that year, the S&P 500 index fell 37%, the MSCI EAFE index (the index of developed markets outside North America) fell by 43%, the MSCI Emerging Market index fell by 53%, the Dow Jones Commodities Index fell by 35%, and the Lehman High Yield Bond Index fell by 26%. The historical record shows that in times of economic distress, asset class returns tend to move in the same direction and be more highly correlated. These increased correlations are no doubt due to the increased importance of macro factors driving corporate cash flows. The increased correlations limit, but do not eliminate, diversification’s value. It would be foolish to conclude from this that you should be undiversified. If a seat belt doesn’t provide perfect protection, it still makes sense to wear one. Statistics show it’s better to wear a seatbelt than to not wear one. Similarly, statistics show diversification reduces risk, and that you are better off diversifying than not.
Timing the market
The obvious question to ask anyone who insists diversification across asset classes is not effective is: What is the alternative? Some say “Time the market.” Make sure you hold an asset class when it is earning good returns, but sell as soon as things are about to go south. Even better, take short positions when the outlook is negative. With a trustworthy crystal ball, this is a winning strategy. The potential gains are huge. If you had perfect foresight and could time the S&P 500 on a daily basis, you could have turned $1,000 on Jan. 1, 2000, into $120,975,000 on Dec. 31, 2009, just by going in and out of the market. If you could also short the market when appropriate, the gains would have been even more spectacular!
Sometimes, it seems someone may have a fairly reliable crystal ball. Consider John Paulson, who in 2007 and 2008 seemed so prescient in profiting from the subprime market’s collapse. It appears, however, that Mr. Paulson’s crystal ball became less reliable after his stunning success in 2007. His Advantage Plus fund experienced more than a 50% loss in 2011. Separating luck from skill is often difficult.
Some people try to come up with a way to time the market based on historical data. In fact a large number of strategies will work well “in the back test.” The question is whether any system is reliable enough to use for future investing.
There are at least three reasons to be cautious about substituting a timing system for diversification.
- First, a timing system that does not work can impose significant transaction costs (including avoidable adverse tax consequences) on the investor for no gain.
- Second, an ill-founded timing strategy generally exposes the investor to risk that is unrewarded. In other words, it puts the investor below the frontier, which is not a good place to be.
- Third, a timing system’s success may create the seeds of its own destruction. If too many investors blindly follow the strategy, prices will be driven to erase any putative gains that might have been there, turning the strategy into a losing proposition. Also, a timing strategy designed to “beat the market” must involve trading into “good” positions and away from “bad” ones. That means there must be a sucker (or several suckers) available to take on the other (losing) sides. (No doubt in most cases each party to the trade thinks the sucker is on the other side.)
What about those Black Swans? Doesn’t MPT ignore the possibility that we can be surprised by the unexpected? Isn’t it impossible to measure risk when there are unknown unknowns?
Most people recognize that financial markets are not like simple games of chance where risk can be quantified precisely. As we’ve seen (e.g., the “Black Monday” stock market crash of 1987 and the “flash crash” of 2010), the markets can produce extreme events that hardly anyone contemplated as a possibility. As opposed to poker, where we always draw from the same 52-card deck, in financial markets, asset returns are drawn from changing distributions as the world economy and financial relationships change.
Some Black Swan events turned out to have limited effects on investors over the long term. Although the market dropped precipitously in October 1987, it was close to fully recovered in June 1988. The flash crash was confined to a single day.
This is not to say that all “surprise” events are transitory. The Great Depression followed the stock market crash of 1929, and the effects of the financial crisis in 2007 and 2008 linger on five years later.
The question is, how should we respond to uncertainties and Black Swans? One sensible way is to be more diligent in quantifying the risks we can see. For example, since extreme events don’t happen often, we’re likely to be misled if we base our risk assessment on what has occurred over short time periods. We shouldn’t conclude that just because housing prices haven’t gone down over 20 years that a housing decline is not a meaningful risk. In the case of natural disasters like earthquakes, tsunamis, asteroid strikes and solar storms, the long run could be very long indeed. While we can’t capture all risks by looking far back in time, taking into account long-term data means we’re less likely to be surprised.
Some people suggest you should respond to the risk of unknown unknowns by investing very conservatively. This means allocating most of the portfolio to “safe assets” and significantly reducing exposure to risky assets, which are likely to be affected by Black Swan surprises. This response is consistent with MPT. If you worry about Black Swans, you are, for all intents and purposes, a very risk-averse investor. The MPT portfolio position for very risk-averse investors is a position on the efficient frontier that has little risk.
The cost of investing in a low-risk position is a lower expected return (recall that historically the average return on stocks was about three times that on U.S. Treasuries), but maybe you think that’s a price worth paying. Can everyone take extremely conservative positions to avoid Black Swan risk? This clearly won’t work, because some investors must hold risky assets. If all investors try to avoid Black Swan events, the prices of those risky assets will fall to a point where the forecasted returns become too large to ignore.
A third and arguably pathological response to the Black Swan problem is to say that nothing is safe. An extreme event could significantly reduce the value of any asset (“We may not have seen it, but this doesn’t mean that it couldn’t happen”). I doubt anyone has gone to this nihilistic extreme, and I mention it to make it clear that being aware of the potential for unknown unknowns is useful, but not at the cost of decision-making paralysis.
Of course, if you are that privileged investor with a reliable enough crystal ball, by all means use it. The problem lies in knowing whether it is reliable enough.
Although unknown unknowns and Black Swan events make evaluating investment risks more challenging, they don’t change the value of diversification and controlling the risks we do know about.
It’s particularly important that young people at the beginning of their investing careers understand why the sloppy arguments against MPT are so dangerous. With its insights about diversification and controlling risk, MPT provides the best foundation for developing low-cost portfolios like the ones being used by the Internet startups to “eat the personal investing world.”
Five people were charged by local police and are now on trial for allegedly removing one of the 17-year-old boy’s kidneys, transplanting it into another individual, and giving him cash that he used to buy Apple products.
If there could be a worse part to this tragic story, it’s that the teenager received only about 10 percent of the total amount realized from the sale of his kidney. He used his share of the proceeds, about $3,500 U.S., to buy an iPad and an iPhone.
When his mother asked him where he got the money to buy his expensive new toys, he told her that he had sold his kidney.
iPads and iPhones sell extremely well in China, where Apple actually enjoys higher tablet market share than in the U.S. Recently, a former colleague of mine who works for Intel in Shanghai shared on a Google+ post that Apple products are in high demand not primarily due to their reputed simplicity and reliability but for their social cachet. ”The key reason why Apple has done so well in China – status. Having an Apple product is a status symbol,” they said.
Organ harvesting is illegal in China, and 137 people have recently been charged in a crackdown on the practice. However, since the Chinese Ministry of Health estimates that 1.5 million in China need transplants, and since only 10,000 organs are donated annually, a thriving illegal market for organs exists.
Those illegally donated organs are not always removed or transplanted safely, and unfortunately, the boy is now suffering renal failure and is too weak to appear in court to face the accused organ harvesters. He is reportedly seeking damages of up to 2 million yuan, about $350,000 U.S.
The accused, who split about $32,000, include the surgeon who performed the surgery, a hospital official, and an alleged mastermind who prowled Internet chat rooms to find possible donators.
They face up to 10 years in prison, and four others who participated in minor ways have already been fined.
Image credit: Lightspring/ShutterStock
Hey Microsoft, this whole new-name-for-Metro thing? It’s getting a little ridiculous. Just give us the new name already.
Last week, Microsoft ditched the “Metro” interface name for Windows Phone, Windows 8, and other products after nearly two years of use. The company lamely said Metro was just a “code name,” but it’s most likely due to a trademark dispute.
Since then, speculation has run high over what Microsoft will call the user interface. Yesterday, ZDNet’s Mary Jo Foley reported that Microsoft workers are being told the name is now just “Windows 8 user interface.” It’s a terrible name, and it ignores the fact that the “Metro” design is found across other Microsoft products, including Windows Phone, Xbox, Office 2013, and the new Outlook.com.
Today’s rumor, per The Verge, is Microsoft employees have switched to calling the interface the “Modern UI Style.” The “Modern UI Style” name does have some traction because a Thursday blog post from Microsoft even calls it that. “Modern UI” would be better than “Windows 8 UI,” but we’d prefer something more distinctive.
I asked Microsoft if the company would indeed be changing to “Modern UI,” but a spokesperson said the company “had nothing to share.” Surprise surprise.
Why is a design name is causing such a stir? Because Microsoft and CEO Steve Ballmer (pictured) have been touting it for so long. Most of its products are taking on elements of this clean and refreshing look, and it’s a big bet for a normally conservative business. But now that bet has no name.
Microsoft, it’s time to step up.
Steve Ballmer photo: Aanjhan Ranganathan/Flickr
Filed under: VentureBeat
Activision Blizzard, the largest independent game publisher and maker of games like Call of Duty, reported its second quarter earnings for the period ending June 30, beating expectations for both earnings and revenue. The company also raised its guidance for the full year.
Activision Blizzard’s results are a bellwether for the traditional video game industry, which has been in a slump as retail games slow down and social, mobile, and online games take off.
In the second quarter, the company reported non-GAAP revenues of $1.05 billion, up from $699 million a year ago. Earnings per share were 20 cents, compared to 10 cents in the prior year. Analysts had predicted non-GAAP revenue of $832 million and non-GAAP earnings per share of 12 cents. Analysts were expecting Activision to guide to revenue of $805 million and earnings per share of 10 cents for the third quarter.
Bobby Kotick, the chief executive of Activision Blizzard, said, “Our performance was driven by strong audience demand for our great games. We are very excited to have announced our expanded investment in China through Activision Publishing’s agreement with Tencent to bring the Call of Duty franchise to the Chinese market.”
Kotick said that Skylanders Spyro’s Adventures, Call of Duty: Modern Warfare 3, and Blizzard Entertainment’s record-setting Diablo III were the top three games so far this year in North America and Europe.
“For the remainder of the year,” said Kotick, “we are excited about our product slate which includes Activision Publishing’s Skylanders Giants and Call of Duty: Black Ops II and Blizzard Entertainment’s World of Warcraft: Mists of Pandaria. While we are increasing our financial outlook for full year 2012, we remain cautious given economic uncertainty, risks to consumer spending — especially during the holiday season — and the recognition that the majority of our key franchise launches are still ahead of us.”
In a conference call, Kotick noted that the perception is the game industry has been weak, but he noted that sales for the top 5 games are up 11 percent on average for the past couple of years. Since Activision Blizzard has numerous top-five hits, it hasn’t been hurt as much by the weaker overall industry sales.
Activision Blizzard’s stock was down 2.29 percent in after-hours trading at $11.50 a share. Activision’s stock closed at $11.77 a share, down 5 cents, before the news went public. Colin Sebastian, an analyst at R.W.Baird, said that the stock may have fallen after-hours because trading is tied to World of Warcraft numbers, which were down. Blizzard said World of Warcraft, which has dominated online games for almost eight years, lost some subscribers from the previous quarter, falling from 10.2 million to 9.1 million.
The business is still riding high from sales of big franchise games, including Call of Duty: Modern Warfare 3. Activision also has a new hit with Skylanders, which features both a multiplatform video game and a line of toys. And the company’s World of Warcraft, which has dominated online games for almost eight years, lost some subscribers from the previous quarter, falling from 10.2 million to 9.1 million.
Michael Pachter, analyst at Wedbush Securities, had expected the company to beat estimates. In a note issued before the earnings were announced, he said that the combination of Diablo III, Call of Duty, Skylanders, and World of Warcraft was expected to be a big contributor to earnings. Activision Blizzard’s Blizzard Entertainment had previously announced that it sold more than 6.3 million copies of Diablo III in its first week. Now the number has topped 10 million through July. Blizzard is launching its next major upgrade to World of Warcraft, Mists of Pandaria, on September 25.
Activision is expected to release Call of Duty: Black Ops II (pictured at top) on November 13. Pachter expects the game to sell 25 million units in its lifetime. At $60 each, that’s a gross sale of $1.5 billion. Rumors persist that parent company Vivendi Universal, which owns a majority stake in Activision Blizzard, plans to sell the division. But Pachter thinks the likelihood of that happening is low, as there aren’t many buyers who could pay $13 billion or more for the acquisition.
During the third quarter, Activision expects to release Transformers: Fall of Cybertron and Call of Duty: Modern Warfare 3 Content Collection #3 and #4. It also expects to release Ice Age: Continental Drift — Arctic Games, Wipeout 3, and Angry Birds Trilogy for the consoles. Based on the better second-quarter results, Activision is raising its calendar year revenue and earnings-per-share outlook. The company didn’t raise the earnings outlook dramatically, because the outlook for the industry is “choppy,” said chief financial officer Dennis Durkin, in a call with analysts. Kotick added that is is a tough macro-economic picture with high unemployment and instability in Europe. There is also a lot of competition for entertainment time. He thinks that high-quality games are winning because players are turning to games with high replayability. For the rest of the industry, he says the next few years will be challenging.
Answering a question, Kotick said, “You have seen a stream of products that are less than adequate from our competitors.”
Eric Hirshberg, president of Activision Publishing, said that Skylanders has the potential to be the next billion-dollar franchise for the company. On October 19, the company will release the next installment, Skylanders: Giants. Skylanders Spyro’s Adventure was the No. 1 console and handheld game for the first six months of the year, counting accessory packs and figures, and it was the No. 1 action-figure toy line in the U.S. in the first six months of the year as well.
“It will be a huge launch,” he said in a conference call with analysts.
He also said that the next Call of Duty game, Black Ops II, is trending ahead of Modern Warfare 3, which was the fastest-selling video game of all time. Activision closed the quarter with $2.7 billion in cash.
Mike Morhaime, president of Blizzard, said on the call that the quarter was Blizzard’s biggest ever. About 16.9 million players have logged into Battle.net in the past month to play Starcraft 2, Diablo III, or World of Warcraft. He acknowledged that the launch of Diablo III was so big that it stressed the company’s systems and resulted in issues for players trying to get online in the game.
The World of Warcraft number was down due to declines from the East, presumably due to people taking a break to play Diablo III, as well as a drop off before the launch of Mists of Pandaria.
Filed under: games
When Fanhattan launched its iPad app last year, it had just four content sources to choose from. With the latest release of its app, being launched today, Fanhattan’s now got content from 14 different providers, including some new cable TV offerings from networks like NBC, HBO, The CW, and Cinemax.
The whole point of the Fanhattan app is to provide a way for users to search for and browse content across a wide range of content providers without jumping back and forth through their apps. Fanhattan seeks to defeat fragmentation by aggregating content from multiple sources and displaying it side-by-side.
To do that, it hooks into different content providers’ iPad apps — like apps from Netflix, Hulu Plus, and now cable networks like HBO GO — and lets viewers find the shows or movies they want to watch, without worrying which apps that content is available through. So if you search for Modern Family, for instance, Fanhattan will show you available episodes from Hulu Plus, ABC, and iTunes.
With new content, Fanhattan is also adding new ways to discover and access the movies and shows you want to see. Altogether, there’s more than 175,000 movies and TV shows available through Fanhattan, so managing what you want to watch becomes a new challenge. For the first time, the Fanhattan app lets users add content to a watchlist, which they can use to save content for later.
Interestingly enough, it doesn’t even have to be content that is available on the iPad for viewers to add it to a watchlist. You can add future movies, for instance, like movies that are coming out next year. When they become available, either in theaters or through various online services, you’ll receive a notification telling you where you can watch those titles.
The Fanhattan app also lets you browse through content that your friends have liked or added to their own watchlists, thanks to integration with Facebook’s Open Graph. And when you add a movie or TV show to your watchlist, it will be shared with Facebook friends, so long as you’ve tagged social sharing on.
I got a demo of the new app from Fanhattan CEO Gilles BianRosa in the video above. If you want to see how the app actually works, check it out!
Android: Touchscreen keyboards, or even miniature ones, are not necessarily the ideal surface for getting things done. A physical keyboard and computer are just simply faster for many tasks, but there are a number of things they can’t do that a mobile phone or tablet can. AirDroid bridges the gap by allowing you to control your device from pretty much any modern web browser. More »
Stuck between two smartphones and can’t decide which to buy? Versus IO will compare them side-by-side, spec-by-spec, and even offer a suggestion on which one to buy. More »
When Coca-Cola decided to teach the world to sing, in perfect harmony, I’m sure they hoped it would catch on and help them sell a few bottles of soda. They didn’t set out to create one of the world’s most iconic advertising images but that’s just what they did and forty years later we’re still talking about it.
Project Re: Brief is a Google-backed documentary that revisits those classic campaigns of the past with an eye toward inspiring a new generation of advertisers on the internet.
Harvey Gabor (Coca-Cola’s “Hilltop); Amil Gargano (Volvo’s “Drive it like you hate it”); Paula Green (Avis’ “We try harder”); and Howie Cohen and Bob Pasqualina (Alka-Seltzer’s “I can’t believe I ate the whole thing”) all come out of retirement to help reinvent the campaigns they were known for. Through the use of modern technology, these old ads get new life as interactive campaigns for the internet and the tablet.
Alka-Seltzer’s famous over-eater becomes a character viewers can play with, call and influence as he moves through his day.
Avis tries harder with a campaign that instantly turns customer stories into animated videos they can share.
The new Coca-Cola ad, literally lets you buy the world a Coke with the press of a button.
These reimagined ads show us what we can do, and what we aren’t doing, with the technology we have available. They’re about involving consumers in the process through the use of interactive features, video, and social sharing. But they also, and maybe more importantly, acknowledge where we’ve come from.
One of my great loves in life is film and TV production. And there is nothing that gets me more excited than talking to the pioneers who got it done with nothing but sweat and passion. Sometimes I think we let technology get in the way of creativity and you can see that in this documentary. Long before CGI, and digital cameras, and script software, ad men were turning out amazing works. Shouldn’t we be able to equal that and more with what we have today?
Watch Project Re: Brief and get inspired, because when it comes to internet and mobile advertising, we’re not even close to doing all we can do.
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Modern marketers have the ability—and one may argue, the obligation—to track and tie marketing activities to bottom-line business results.
Driven by three change catalysts identified by PR 20/20 CEO Paul Roetzer (@paulroetzer) in The Marketing Agency Blueprint—change velocity, selective consumption and success factors—we can no longer hide behind soft “data” like impressions, ad equivalency, or big-hit campaigns (Whassup?). Nor should we rely solely on outputs—such as number of emails / mailers sent, number of blog posts published or frequency of social status updates—to showcase our worth.
Rather, it’s time for marketers to hold ourselves accountable for having a true impact on business success, and tie all activities to metrics that matter. The following may vary by organization, but we’re talking about data and results, such as:
- Website traffic
- Conversion rate
- Customer referrals
- Venture funding
The following slideshow, from my recent presentation at the DMA Cleveland and Web Association event, Using Data to Understand, Prove and Increase Marketing ROI, provides a deeper overview of the marketing-measurement shift, including:
- The need for change in marketing measurement
- How to make the move
- Sample tactics that drive results
- What you need to make it happen
I’d love to hear your thoughts on marketing measurement in the comments below.