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Roundtable continued from page 39
cast. In economic terms, that means, if inflation is currently
3 percent, you project 3 percent. In other words, they were
no better than monkeys throwing darts.
He found that even the forecasts from the people who impact
the outcome—the Congressional Budget Office, the Council of
Economic Advisers and the Federal Reserve—and therefore have
some degree of controlling it, were not more accurate.
However, a recently published paper found that taking a
consensus forecast—while it’s not a good forecast—is better
than most. The Philly Fed Survey forecasts inflation of roughly
2.5 percent. And, by the way, there is a swap market for inflation;
it was also at about 2.5 percent not too long ago.
JOI: Have you adjusted your investment philosophy during the
last two years?
Swedroe: [We have adjusted] nothing. For 15 years we had
exactly the same investment philosophy because our advice
is based upon what I would call the science of investing and
evidence-based investing. The evidence today is—if anything—
stronger that passive management is the strategy most likely to
allow you to achieve your financial goals. The only thing that
we’ve done in the last 15 years is added recommendations that
investors consider adding a small allocation to commodities.
With the advent of TIPS, we began to strongly recommend
that people use TIPS as the dominant portion of their fixedincome
portfolio in tax-advantaged accounts. Another minor
thing is that we have adjusted our international allocation
over time. Fifteen years ago, I think we were recommending
30 percent U.S. Now we are recommending 40 percent. If we
were pure market-cap weighters, we would be at 60 percent
international. But we think there are logical arguments for
having some home-country bias.
JOI: What’s the biggest danger/opportunity that you see ahead
for investors during the next five years?
Swedroe: I think the biggest danger for investors is what
they see when they look in the mirror.
The second [biggest danger] is ignorance, because they
don’t know the science of investing. They are tempted by
the wolves of Wall Street and their advice. The third thing I
would say is, if they can’t resist watching CNBC, they should
do it with the mute button on. Because what they are likely
to hear could only cause damage by stirring the emotions
of fear and envy in bear markets, and greed and envy in bull
markets. The best strategy is what Warren Buffett advises:
“Invest in index funds and stay the course.”
Moran continued from page 14
return was improved by 3.5 percentage points and the portfolio
standard deviation was cut by one-third. If there were
a 3 percent allocation to 25 percent-out-of-the-money long
VIX calls during that time period, the portfolio’s annualized
returns were increased by 10.4 percentage points. 2
VIX and the S&P 500 often have had a negative correlation
of returns, and investors have been intrigued by the possibility
that VIX could provide value because there often has
been high volatility of volatility in difficult investing environments
(the historic volatility of VIX daily returns in 2008 was
127 percent). Investors who are bullish on VIX and bearish
on stocks might consider: (1) long VIX call options, (2) long
VIX call spreads, (3) short VIX put credit spreads, or (4) long
VIX futures. Investors who are bearish on VIX and bullish on
stocks might consider: (1) long VIX put options, (2) long VIX
put spreads, (3) short VIX call credit spreads, and (4) short
VIX futures. One cautionary note is that sometimes VIX and
stock prices move in the same direction.
Conclusion
A triple whammy of record-high correlations, very high
volatility and huge losses for dozens of indexes made the
year 2008 a very challenging one for most investors. In the
past two years, investors were disappointed to see that correlations
for the S&P GSCI and the MSCI EAFE vs. the S&P
500 reached 40-year highs, and all these indexes experienced
drawdowns of more than 50 percent. Indexes for gold, managed
futures, volatility and Treasury bonds actually rose in
2008, and investors could explore the possibility of whether
limited allocations to these indexes might be effective for
diversification and risk management purposes in the event
of a future financial crisis.
Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of
Characteristics and Risks of Standardized Options; this publication and supporting documentation for any claims, comparisons, recommendations,
statistics or other technical data in this paper are available by calling 1-888-OPTIONS, or contacting CBOE at www.cboe.
com/Contact. Past performance does not guarantee future results. The views expressed in this article are the views of the author and do
not necessarily represent the views of Chicago Board Options Exchange, Incorporated (CBOE). CBOE ® , Chicago Board Options Exchange ® ,
CBOE Volatility Index ® and VIX ® are registered trademarks and BXM, PUT and SPX are servicemarks of CBOE. All other trademarks and
servicemarks are the property of their respective owners.
Endnotes
1 Harry M. Markowitz, “Crisis Mode: Modern Portfolio Theory under Pressure,” The Investment Professional (spring 2009).
2 Edward Szado, “VIX Futures and Options: A Case Study of Portfolio Diversification During the 2008 Financial Crisis,” The Journal of Alternative Investments (fall 2009), vol. 12,
no. 2, pp. 68-85.
62 January/February 2010