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VTWNX: This Is A Great Option For The Investor Nearing Retirement

Summary The Vanguard Target Retirement 2020 Fund has a simple construction and a low expense ratio. Despite being a very simple portfolio, they have covered exposure to most of the important asset classes to reach the efficient frontier. I would like a very slight modification to increase the allocation to higher credit quality bonds at the expense of lower quality bonds. This is quite simply one of the best constructed portfolios I’ve seen for a worker nearing retirement. Lately I have been doing some research on target date retirement funds. Despite the concept of a target date retirement fund being fairly simple, the investment options appear to vary quite dramatically in quality. Some of the funds have dramatically more complex holdings consisting with a high volume of various funds while others use only a few funds and yet achieve excellent diversification. My goal is help investors recognize which funds are the most useful tools for planning for retirement. In this article I’m focusing on the Vanguard Target Retirement 2020 Fund Inv (MUTF: VTWNX ). What do funds like VTWNX do? They establish a portfolio based on a hypothetical start to retirement period. The portfolios are generally going to be designed under Modern Portfolio Theory so the goal is to maximize the expected return relative to the amount of risk the portfolio takes on. As investors are approaching retirement it is assumed that their risk tolerance will be decreasing and thus the holdings of the fund should become more conservative over time. That won’t be the case for every investor, but it is a reasonable starting place for creating a retirement option when each investor cannot be surveyed about their own unique risk tolerances. Therefore, the holdings of VTWNX should be more aggressive now than they would be 3 years from now, but at all points we would expect the fund to be more conservative than a fund designed for investors that are expected to retire 5 years later. What Must Investors Know? The most important things to know about the funds are the expenses and either the individual holdings or the volatility of the portfolio as a whole. Regardless of the planned retirement date, high expense ratios are a problem. Depending on the individual, they may wish to modify their portfolio to be more or less aggressive than the holdings of VTWNX. Expense Ratio The expense ratio of Vanguard Target Retirement 2020 Fund Inv is .16%. That is higher than some of the underlying funds, but overall this is a very reasonable expense ratio for a fund that is creating an exceptionally efficient portfolio for investors and rebalancing it over time to reflect a reduced risk tolerance as investors get closer to retirement. In short, this is a very solid value for investors that don’t want to be constantly actively management their portfolio. This is the kind of portfolio I would want my wife to use if I died prematurely. That is a ringing endorsement of Vanguard’s high quality target date funds. Holdings / Composition The following chart demonstrates the holdings of the Vanguard Target Retirement 2020 Fund: This is a fairly simple portfolio. Only five total tickers are included so the fund can gradually be shifted to more conservative allocations by making small decreases in equity weightings and increases in bond weightings. The funds included are the kind of funds you would expect from Vanguard. The top 4 which carry almost all of the value are extremely diversified funds. The Vanguard Total Stock Market Index Fund is also available as an ETF under the ticker VTI . I have a significant position in VTI because it carries an extremely low expense ratio and offers excellent diversification across the U.S. economy. Volatility An investor may choose to use VTWNX in an employer sponsored account (if their employer has it on the approved list) while creating their own portfolio in separate accounts. Since I can’t predict what investors will choose to combine with the fund, I analyze it as being an entire portfolio. Since the fund includes domestic and international exposure to both equity and bonds, that seems like a fair way to analyze it. (click to enlarge) When we look at the volatility on VTWNX, it is dramatically lower than the volatility on SPY. That shouldn’t be surprising since the portfolio has some large bond positions. Over the last five years it has significantly underperformed SPY, but that should be expected given the much lower beta and volatility of the fund. Investors should expect this fund to retain dramatically more value in a bear market and to fall behind in a prolonged bull market. Opinions I find this to be a very solid fund, but if I could make two adjustments it would be to slightly increase the amount of domestic equity at the expense of international equity and to increase the percentage of long term government debt by adding a small position in the Vanguard Long-Term Government Bond Index Fund (MUTF: VLGSX ). The long term government bonds have a negative correlation to equity markets and a high level of volatility. Due to the strong negative correlation they make the resulting portfolio less volatile than it would be without them. The ideal allocation would be fairly small, but I would prefer to a small inclusion of that (say 5%, maybe as high as 10%) at the cost of total bond index funds that will hold more corporate debt. Corporate debt can be a great investment, but because it is has more credit sensitivity the diversification benefits are weaker. This inclusion would be expected to drop the annualized volatility a little further. Conclusion VTWNX is a great mutual fund for investors looking for a simple “set it and forget it” option for their employer sponsored retirement accounts. It is ideally designed for investors planning to retire around 2020, but can also be used by younger employees with lower risk tolerances or older workers with higher risk tolerances. Disclosure: I am/we are long VTI. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

How To Tell The Difference Between The Graham Formula And The Graham Number

This article will aim to help you as a reader understand the difference between the Graham Formula and the Graham Number. The Graham Formula is the formula which Benjamin Graham provided in his classic book The Intelligent Investor. The Graham Number is a figure used by some investors as an upper limit to how much an investor should pay for a stock. The Graham Number formula was never actually provided by Benjamin Graham. Even though the Graham Number isn’t used in the ModernGraham approach, the figure is now provided with each individual ModernGraham valuation. (click to enlarge) Often I get questions about the Graham Formula versus the Graham Number. There seems to be some misunderstanding out there between the two concepts, and this article will aim to help you as a reader understand the difference between the Graham Formula and the Graham Number. Both figures can be useful in their own ways, and can be combined in the ModernGraham approach. What is the Graham Formula? The Graham Formula is the formula which Benjamin Graham provided in his classic book The Intelligent Investor . Specifically, the formula Graham recommended is: According to Graham, this formula resulted from a study of various valuation methods and is to be considered an effective shorthand way of estimating the intrinsic value of stocks. The formula should result in figures “fairly close to those resulting from the more refined mathematical calculations.” Where does the Graham Formula Come From? Graham placed the Graham Formula in Chapter 11 of The Intelligent Investor , titled “Security Analysis for the Lay Investor: General Approach.” This chapter deals specifically with finding ways to simplify some of the complex mathematical analysis methods which have grown in popularity over the years. After dealing with analyzing bonds and preferred stocks, Graham addresses the issue of valuing stocks, beginning with the sentence “The ideal form of common-stock analysis leads to a valuation of the issue which can be compared with the current price to determine whether or not the security is an attractive purchase.” Graham then went into some detail regarding how many valuation methods utilize future estimates of various figures such as sales, operating margin, etc. in order to then capitalize those figures back to the present in order to determine a value based on the future earnings of the company. However, he then said that “The reader will note that quite a number of the individual forecasts were wide of the mark.” Further, the present value of future earnings is widely dependent on various factors such as: General Long-Term Prospects. Management. Financial Strength and Capital Structure. Dividend Record. Current Dividend Rate. Discussion of each of those factors is beyond the intended scope of this particular article, but together those items constitute items that an analyst must consider when determining an intrinsic value. With all of that in mind, it makes sense that Graham then proceeded to provide the Graham Formula as a way to simplify some of the process for the lay investor. Analysts can spend a lot of time considering each and every little detail about what they think a company is going to do, generating complex mathematical formulas and scenarios in order to determine a value, but Graham’s formula is intended to help the average Intelligent Investor to estimate a value while making as few assumptions about the company as possible. What about the Footnote? Immediately after listing the formula itself, Graham stated that “The growth figure should be that expected over the next seven to ten years.” He also included a footnote on that sentence. The footnote reads: Note that we do not suggest that this formula gives the “true value” of a growth stock, but only that it approximates the results of the more elaborate calculations in vogue.” Some have taken that footnote to mean that the Graham Formula should not be used for estimating an intrinsic value, but I consider the footnote to be more of a reminder from Graham that the calculation of an intrinsic value is not an exact science and cannot be done with 100% certainty. Rather, the investor can only estimate at the intrinsic value due to the vast number of variables involved. Graham provided this formula specifically as a way to approximate the more complex formulas used in an analysis in order to give a “foreshortened and quite simple formula for the valuation of growth stocks, which is intended to produce figures fairly close to those resulting from the more refined mathematical calculations.” Therefore, the Graham Formula is to be used for estimating intrinsic value within a margin of safety which will accommodate the possibility of error in calculation. What is the Graham Number? The Graham Number is a figure used by some investors as an upper limit to how much an investor should pay for a stock. Here’s an example of how some investors use the Graham Number when analyzing dividend aristocrats. The Graham Number is calculated using this formula: According to the Graham Number calculation, the price must be below the square root of the product of 22.5, the Earnings Per Share, and the Book Value Per Share. Where does the Graham Number Come From? The Graham Number formula was never actually provided by Benjamin Graham. Rather, it seems to be engineered out of one of Graham’s recommended requirements for the Defensive Investor. In Chapter 14 of The Intelligent Investor , Graham provided a list of suggested criteria to help the Defensive Investor find quality securities for consideration. Those criteria are as follows: Adequate Size of the Enterprise A Sufficiently Strong Financial Condition Earnings Stability Dividend Record Earnings Growth Moderate Price / Earnings Ratio Moderate Ratio of Price to Assets In the seventh criteria, Moderate Ratio of Price to Assets, Graham says that “Current prices should not be more than 1.5 times the book value last reported. However, a multiplier of earnings below 15 could justify a correspondingly higher multiple of assets. As a rule of thumb we suggest that the product of the multiplier times the ratio of price to book value should not exceed 22.5.” The 22.5 number comes from the product of his suggested maximum price to earnings ratio of 15 and the suggested maximum book value of 1.5. Somewhere along the line, analysts took this suggestion from Graham and extrapolated it into the Graham Number. The Graham Number is Only a Shorthand Version of the Graham Requirements for Defensive Investors. It is my belief that the Graham Number is only a way to easily and quickly screen companies to be used by individual investors not interested in applying all of Graham’s suggested investment techniques. In some ways it seems to be a figure created to simplify Graham’s work into a single recommendation, which to me seems to miss the overall point Graham is trying to make altogether. The Defensive Investor requirements are intended to assist the investor in narrowing down his potential list of investments to only those that are of the highest quality. Graham provided a list of suggested requirements to achieve that purpose, while he specifically provided the Graham Formula as a metric for estimating the intrinsic value of companies. Why would Graham have listed the suggested criteria in an area separately from the formula if he did not intend both items to be used? What Approach Does ModernGraham Use? Here on ModernGraham, I’ve developed our approach to utilize the full breadth of Graham’s recommendations. This is through utilizing both the suggested selection criteria to narrow down the list of potential investments and through the use of the formula to estimate an intrinsic value. Doing this allows the investor to narrow down the focus to a select number of companies and then generate an estimated intrinsic value based on the Graham Formula for comparison to the current price. Each ModernGraham valuation of a company begins with determining whether it is suitable for either the Defensive Investor or the Enterprising Investor, based on a modernized version of Benjamin Graham’s suggested selection criteria for each investor type. Here’s a great post on how you can determine which type of investor you are. After that step is completed, the valuation continues to determining an estimated intrinsic value for the company based on the ModernGraham formula. The ModernGraham formula has been modified slightly from the Graham Formula, only in the sense that it uses a weighted-average of five years of earnings data (EPSmg). The rationale is that Graham suggested using a normalized earnings per share figure in order to smooth out the effects of the business cycle, and also specifically suggested taking an average of earnings per share data when using the figure in analysis. You can learn more about how to estimate a growth rate in this post. Here’s the ModernGraham Formula: This formula is specifically intended to provide only an estimate of the company’s intrinsic value and must be utilized in tandem with a margin of safety because it does not provide an exact figure but only approximates some of the more complicated valuation methods. ModernGraham utilizes multiple layers of safety margins including: Maximum possible estimated growth rate of 15% Estimated growth rate is reduced by 25% To receive a rating of “undervalued” a company must be trading at 75% or less of its intrinsic value. To receive a rating of “overvalued” a company must be trading at 110% or more of its intrinsic value. Each valuation is intended to be a useful source for investors to utilize when conducting research into investment opportunities, and after the first two steps of the ModernGraham analysis, investors are encouraged to continue their research in order to determine if the opportunity is right for their own individual situation. Where Can You Find the Graham Number? Even though the Graham Number isn’t used in the ModernGraham approach, the figure is now provided with each individual ModernGraham valuation. In addition, as of today all new valuations will include a chart showing the Graham Number over time in comparison to the stock price. For those investors who place an emphasis on utilizing the Graham Number, this can be a great tool to see how the strategy has performed over time with respect to the specific company. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Are Risk Parity Funds ‘Mad, Bad And Dangerous To Know?’

Summary Various people from both the sell- and buy-sides have blamed risk parity funds as well as trend-following CTAs and certain “smart beta” practitioners for recent market volatility. While these techniques certainly could contribute to volatility in crisis periods — there are few investment techniques that couldn’t — to single them out is misleading and self-serving. Risk parity has its place in the markets, and its place may well be increasing, as investors understand it better. But it still is not fully tested. In particular, how it behaves in crisis situations is not fully understood. Its behavior over the last few weeks has, however, been reassuring. There is mounting and quite vocal criticism of risk parity and other investment techniques that seem to display option-like sensitivity to changes in market volatility. The argument against them is that, in certain conditions they can destabilize the market: as volatility increases, they may respond by trading in ways that increase volatility further. While this accusation may not be entirely unfair, this characteristic is hardly unique to these funds, and it is unreasonable to single out these investors for recent market volatility. Feedback loops between volatility and selling pressure have been built into many aspects of modern markets as well as human nature. The contribution of risk parity and similar products to the recent spasm of market volatility was not even a fraction of the tip of the iceberg. Without further investigation, this might have been ascertained simply by looking at risk parity AUM. In addition to somewhere between $400 and 600 billion in worldwide institutional assets managed according to risk parity principles, there are a handful of publicly-available mutual funds practicing variants of this technique, none of them very large. These include Salient Risk Parity Fund ( SRPAX ), Putnam Dynamic Risk Allocation Fund ( PDRFX ), AMG FQ Global Risk-Balances Fund ( MMAFX ), Invesco Balanced Risk Allocation Fund ( ABRZX ), and Columbia Active Risk Allocation Fund ( CRAAX ) and the AQR Risk Parity Fund ( AQRIX ). Background There are numerous bells and whistles that can be incorporated with risk parity techniques, so that the concept has become rather diffuse and easily slips over into “smart beta.” The basic idea grew out of dissatisfaction with the standard, mean variance optimization approach to portfolio construction, with its paraphernalia of efficient frontiers, etc . The objection was simple: optimization relies on return forecasts that are rarely realized by actual asset class behavior, and it tends to craft portfolios in which the most volatile asset class ─ typically the equity component ─ accounts for the overwhelming majority of their volatility. This suggests that diversification according to the standard formula is doing little to mitigate risk. Since it is precisely the returns on the most volatile component that have most consistently confounded forecasters, proponents of risk parity argue that mean variance optimization has led consultants, trustees and CIOs astray. They claim that portfolios with more consistent performance can be constructed by targeting volatility rather than targeting forecast returns. Assumptions must still be made about future standard deviations and coefficients of correlation among assets, but at least the shakiest assumptions, about returns, can be eliminated. In its simplest implementation in a two asset portfolio, this insight would drastically reduce equity exposure and substantially boost fixed income holdings compared to the rule-of-thumb 60/40 portfolio: to contribute the same level of volatility to the portfolio as fixed income holdings, equity exposure would have to be cut back to about 24%. Without leveraging the portfolio, however, in most circumstances this implementation would also produce drastically reduced returns and would attract few buyers. Naturally, things become more complicated as more assets are included in the mix, but the principal remains essentially the same: each component is weighted and if necessary leveraged so that it contributes the same amount of volatility as each of the other components. If expected returns for a targeted level of volatility are not satisfactory, performance is boosted not by overweighting the riskier assets, but by including more risky asset classes or leveraging the less volatile ones, for instance through the futures market. Thus risk parity portfolios often include commodities and real estate as well as equities, and are typically leveraged 1.5x to 3.0x. The example shown below on the left is unleveraged, which accounts for its somewhat lower expected returns than the example of mean variance optimization on the right. (click to enlarge) There is no agreement among risk parity practitioners as to how return objectives should be set, and consequently, what the “appropriate” level of portfolio leverage is. This is hardly surprising: any such decision is completely exogenous to the theory, as it should be . Theory is getting into dangerous territory when it attempts to dictate investors’ risk tolerances. It is clear, however, that reasonable leverage of the less volatile components of this sample portfolio could raise its projected returns to the levels expected of the portfolio on the right. The Root of Recent Criticism Obviously, a proposal as radical as risk parity has attracted considerable criticism from virtually all sides ─ after all, it rejects most of the basis of Modern Portfolio Theory, dating back to 1952 and enshrined in all finance curricula. It is not my intention to review these criticisms, which is far too technical an undertaking for a short article, and many of them are unpleasantly contentious or self-serving. Rather, I confine myself to discussing the recent criticisms offered by Chintan Kotecha and Marko Kolanovic, sell-side analysts at Merrill Lynch and J.P. Morgan respectively, as well as some investors, including the well-known hedge fund manager Lee Cooperman of Omega Advisors. Their criticism has been given wide currency through the attention they have attracted in The Financial Times , Barron’s , Bloomberg , the Wall Street Journal and elsewhere. The issue involves rebalancing in crisis conditions. If the volatility of one asset class included in a risk parity or similar portfolio suddenly jumps, while that of the others remains more or less as before, this will inevitably trigger sales to rebalance the portfolio. The critics argue that these sales are destabilizing for the asset that is already suffering from heightened volatility. The implicit warning is that further increases in assets managed according to risk parity principles, in addition to those managed according to trend-following and some (but not all) “smart beta” strategies, could result in a death spiral of rebalancing giving rise to liquidations, which raise volatility, catalyzing further liquidations which in turn raise volatility and so on. The critics claim to have seen evidence of precisely this sort of behavior during the recent market drama; Mr. Cooperman goes so far as to blame some of his fund’s weak August performance on it. Otherwise, it would be difficult to see why this alleged problem should so suddenly crop up as an issue. After all, trend-following strategies are at least as old as Dow Theory, and I have found evidence for them in Dutch trading practices in the first half of the seventeenth century. While the commissars of MPT orthodoxy were never able completely to stamp out technical analysis and similar heresies, they drove them into narrow and secretive corners, out of sight of polite society for most of a generation. A few firms, such as Merrill Lynch, even continued to employ technicians in their research departments. Their return to respectability is something comparatively new to equity markets, developing gradually since the introduction of equity index futures in 1982 attracted people who had never had much use for portfolio theory (after all, Fisher Black did not believe that commodities are investments) into the equity community. The modern instantiation of trend following as algorithmic trading strategies is only a difference in degree rather than in kind from the days of eyeshades, sleeve garters and three New York baseball teams. “Smart beta” is an even more amorphous concept than risk parity, embracing portfolio construction techniques from equal weighting to fundamental indexing (for detailed discussion see this article ). However, the critics are presumably directing their fire toward those strategies which focus their efforts on maximizing a portfolio’s Sharpe Ratio. Since the denominator of the Sharpe Ratio is standard deviation, the sensitivity of such approaches to changes in volatility is obvious. Even though they may differ significantly from risk parity strategies, they share the need to rebalance if heightened volatility manifests itself in one portion of the portfolio but not the rest. Analysis of the Criticism The critics have, in fact been rather equivocal in their criticism: they do not make it clear what asset allegedly suffered from a feedback loop between its volatility and sales, nor do they make it clear when this allegedly occurred. Detailed data on the trading of the recently most volatile assets of all, Chinese ‘A’ shares, is unavailable. But surely some of the attempt to rebalance risk parity portfolios must have occurred in U.S. markets. And since there are claims that such sales affected other funds’ August performance, some of must have occurred while volatility was particularly high and markets most vulnerable to forced sales. The August spike in volatility was certainly dramatic, but it was by no means a record, nor has volatility remained at highly elevated levels as it did in 2008/9, 2010 and 2011/2. Coming as it did after an extended period of relative market quiescence, however, the return of volatility came as a considerable shock, for which many investors were unprepared. (click to enlarge) The VIX peaked at 40.74 on August 24th. At what point the alleged forced selling due to rising volatility occurred is unclear, since no one except their managers knows the details of risk parity funds’ rebalancing protocols. Some of the critics’ comments imply that these sales may not even have occurred yet, two weeks after that peak, although this begins to look implausible. In any case, the behavior of that portion of U.S. volume reflected in NYSE statistics, while reflecting the usual sharp increase in trading that accompanies a volatility event, does not suggest an abrupt, destabilizing flood of selling:   Average Value of Transactions % Change in NYSE Volume % Change in SPY ETF Volume 8/14/2015 $8,739     8/15/2015 $8,863 3% 9% 8/18/2015 $8,511 0% -9% 8/19/2015 $8,370 22% 141% 8/20/2015 $8,677 9% 12% 8/21/2015 $9,599 41% 78% 8/24/2015 $7,937 26% 46% 8/25/2015 $8,332 -23% -27% 8/26/2015 $7,754 4% -8% 8/27/2015 $8,056 -5% -19% 8/28/2015 $8,158 -20% -41% 8/31/2015 $8,937 5% 2% sources: NYSE, State Street Granted, it is not clear to me how a flood of volatility-induced selling is to be distinguished from rising volatility as a result of a flood of selling. But the evidence I can see for U.S. stocks does not suggest that, this time around, things were notably different from what has occurred during other sudden bouts of heavy selling. The decline in the size of the average trade on the day of maximum volatility suggests that the selling pressure was not, or at least not entirely institutional. This view is reinforced by changes in the trading activity of the SPDR S&P 500 Spider ETF (NYSEArca: SPY ), which of course attracts a great deal of retail attention. The critics do not mention this, but volatility-induced ETF liquidation is likely to be at least as destabilizing as the behavior of the trading strategies with which they are at pains to find fault. And without the aid of algorithms it is as likely to result in a toxic feedback loop, as dropping prices encourage panicky holders to sell, pushing prices down further. During the period shown in the chart above, SPY suffered $10.2 billion in net redemptions ─ and that was just from a single ETF, albeit the world’s largest. Other ETFs, and some conventional mutual funds, had similar experiences. Different risk parity, “smart beta” and trend-following CTAs are each likely to handle portfolio rebalancing in different ways. Some may even apply judgment to the problem: Salient says that its portfolio management “…attempts to capitalize on momentum…” which it does through algorithms, but this suggests an overlay on the rebalancing signals it receives. More explicitly, AQR notes that it reserves for itself “…the ability to exploit tactical opportunities by making modest adjustments, or “tilts,” toward assets that we believe are relatively attractive…,” a practice that might even involve human beings. However, second-guessing can create difficulties of its own ─ as a systematic investor once remarked to me, “If I ignore the machine, from where will I receive the signal to pay attention to it again?” It is likely that all these sorts of investors build some measure of tolerance for changes in relative asset volatilities into their thinking, if only to keep transaction costs in check. A few, such as Columbia, engage in periodic rebalancing ─ once a month, in its case ─ rather than responding immediately to every observed change in volatility. How the critics purport to disentangle these threads is unclear to me ─ I frankly doubt that they can. And if volatility-induced selling only occurs well after the maximum volatility event, it is unclear to me how it can be especially destabilizing. Conclusions, Cautions, and a Thought from Lord Byron I am always willing to bow to contrary evidence, but I have seen none that really suggests that risk parity, either on its own or in combination with trend-followers and “smart beta” aficionados, is any more responsible for recent equity market volatility than other instruments that, in a crisis, are likely to be forced to sell portions of their portfolios. Mr. Cooperman in particular should be aware that restrictions that Chinese authorities imposed on sellers may have forced some of his hedge fund brethren to sell elsewhere, simply in order to meet margin requirements. And I am not aware of any touchstone by which a forced sale can reliably be identified as such from outside the premises of the seller. The unfortunate truth is that panicky human beings are quite able to destabilize the markets without help from machines ─ they have managed to do so since markets were first invented, and doubtless will continue to do so. Risk parity, trend-following and “smart beta” have attracted criticism because they are easy targets: generally misunderstood if they are known at all, mysteriously computer-driven and, worst of all, associated with hedge funds. Risk parity is the brainchild of Bridgewater Associates, the largest hedge fund of all. Since the Crash, populists have ensured that anything that they feel requires discrediting need only be associated with any one of these bogeymen. Stock-pickers such as Mr. Cooperman feel unappreciated, after a long period during which their undoubted talents have gone comparatively unrewarded. And they have a right to object to the fact that markets have been so unrewarding for them, if not perhaps to feel bitter. The markets depend on them: if fundamental values are not ultimately recognized, there is no rational basis for investment at all. But as Keynes noted, macro conditions can swamp the influence of security-specific fundamentals over surprisingly long periods of time, and that has been our unfortunate situation for most of the period since the Crash. Global fiscal irresponsibility, regulatory overstretch, mounting social and military tension, ever more imaginative monetary experimentalism and a host of other issues: why should investors be surprised that their investments have tended to react more to the exogenous market environment than to their own fundamentals? Yet this cannot last forever: fundamentals will out, even if it is a matter of a company surviving Fall of Rome conditions when hundreds of others fail to. Before the China crisis broke out there were signs that the returns to stock-picking were increasing relative to macro trading strategies. I believe that China is merely an interruption in, rather than the death-knell for the recovery of fundamentally-based investment strategies. Not the least of the gifts that recent market volatility has given us is a general reduction in valuations. Judicious picking among them, rather than frantic trading in and out of risk, is the way forward for investors. Which may include risk parity investors. The technique is a method for allocating among various asset classes, and for heuristic purposes is usually discussed in terms of indices for each asset class, but that does not mean that it actually requires a passive investment approach within any given asset class. Asset allocators can be stock-pickers, too, and in fact few of them, in normal conditions, are very active traders. The Putnam Dynamic Risk Allocation Fund provides an example of an active investment implementation of something resembling risk parity, while Salient, AQR, AMG, Invesco focus their portfolios primarily on derivatives, and Columbia combines derivatives with a fund of funds approach. Of all these managers, Sapient and AQR have the “purest” approach to risk parity, which would cause me to favor their funds over the others, all of which apply various tweaks and twists to the basic risk parity insight. But AQR is not accepting new investors, and of course, they and Salient will both miss out on any alpha to be obtained from stock-picking. I think a dose of risk parity or similar “smart beta” strategies will benefit most portfolios, although I would take a wait-and-see attitude toward total conversion of a portfolio to these techniques. The criticisms, however tendentious, indicate a real, if only potential problem for such strategies, and I would like more evidence on how they behave during crises before committing the entire portfolio to them. My preference for a “pure” approach to risk parity is in the spirit of empirical investigation: I want to learn more about how the strategy behaves. August has been tough, and it does not look as though the rest of the year will be a great deal easier. Some readers may recognize that my title borrows from a reference to Lord Byron. Among that poet’s many valuable pieces of advice was, “Always laugh when you can. It is cheap medicine.” Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.