Coming on the heels of the tech bust which by itself would have pissed the shareholders off, Janus decided to settle in centi-million chunks, thus keeping the villagers from storming the castle.
Today (Sept. 2012) Janus Capital Group's subsidiaries manage $163.8 billion.
The author of this piece had nothing to do with the late nineties shenanigans (he joined the firm in 2012) and is probably known to our readers as a Mother Merrill MD or wearing his academic researcher hat as an expert on portfolio construction, risk management, hedge funds etc. He is a pro's pro.
From Institutional Investor:
Andrew Weisman is chief investment officer and portfolio manager for the liquid alternatives division at Denver-based Janus Capital Group....
I FIRST PRESENTED THE IDEAS CONTAINED IN THIS article at an Institutional Investor conference in January. Before taking the podium I struggled to come up with something that would convey the importance of what was to follow. I decided to inform this audience of professional pension fund and endowment managers that their luck had run out: They were going to learn about investing in risk, either from me or from someone else, but — not unlike having dinner with the in-laws — it was going to happen, so they would be well served to get it over with. The doors were locked, the audience lost hope, and we pushed forward.
For most of the audience, 2008 had been a shock, characterized by a serious loss of self-esteem and devastatingly poor performance that had been exacerbated by a fundamental lack of risk diversification. But such an outcome was not inevitable. In what follows I describe and substantiate how, through the use of a novel, rational allocation process, investors can achieve significant improvements in portfolio diversification, thereby potentially increasing the return and decreasing the risk of their portfolios.
Post-2008 most investment portfolios have remained one-trick ponies, effectively possessing a single source of variance, a typical proxy for risk. In the case of private investors, with a “standard” 60-40 stock-bond portfolio, roughly 97 percent of the portfolio’s variance can be explained by the equity allocation. Perhaps surprisingly, the typical U.S. pension fund doesn’t fare much better, despite a more broadly diversified asset allocation, full-time investment professionals and, in many cases, externally hired experts — variously referred to as “guys from out of town” or “guys with shiny shoes.” Accordingly, the typical U.S. pension fund has in excess of 90 percent of its variance explained by a single risk factor.
There are three basic reasons for this. First, when the bulk of an investment allocation is directed toward its most volatile component, then the emergence of a single dominant risk factor is a virtual certainty. Second, many investors mistakenly assume that nominal, or apparent, diversification is the same as real diversification. This is, of course, not true. To understand why nominal is not real diversification, we must pause for a moment to consider the three basic allocations in a typical diversified institutional portfolio: equities, fixed income and alternatives. With respect to the equity allocation, when you own every stock on the planet, you have in effect eliminated any sources of idiosyncratic risk and now own a single, rarefied risk factor: systematic equity market risk.
With respect to fixed income, when a typically underfunded U.S. pension plan decides to target a 6 percent rate of return on its bond portfolio in a world where ten-year U.S. Treasuries are yielding an anemic 1.8 percent, it is forced to acquire a potpourri of below-investment-grade bonds. In so doing, it has effectively converted the portfolio of daddy-needs-a-new-pair-of-shoes bonds and its associated duration risk (that is, the sensitivity to changes in interest rates) back into equity risk. Conceptually, this happens because default probabilities on corporate debt are typically calculated by the market using a model developed by Nobel Prize–winning economist Robert Merton. The Merton model structures the problem as a call option on the assets of the company issuing the debt; a decrease in the portfolio’s credit quality, therefore, effectively represents a transformation of fixed-income duration risk back into equity risk.
Then there’s the curious case of so-called alternatives. Spoiler alert: These investments are also highly correlated with equities. As an example, the HFRI Global Hedge Fund Index has been correlated versus the S&P 500 index at greater than 0.9 for approximately the past two years. For those of you now defensively pointing out that you have both real estate and private equity, I say, “Whatever helps you sleep at night.” Were it not for the fact that these assets possess neither frequent nor accurate pricing, they would both correlate above 0.9. The bottom line is that the typical U.S. pension fund is diversified in name only, with the broad equity market representing most of the risk.
The third explanation for concentrated risk factor exposure is the inertial effects of outmoded thinking. Investment professionals have historically been trained to think of portfolio construction as an optimal, sign-constrained (that is, long-only)allocation to a collection of assets; the effect of this is to concentrate portfolio risk within a single factor. The failure of both individual and institutional investors to achieve adequate diversification is a direct consequence of the failure to recognize that, contrary to conventional wisdom, investing should not be a process of selecting assets; rather, it should be a process of selecting and accepting risks....MUCH, MUCH MORE
