Do you consider convertible bonds a separate asset class? -- Subscriber, Italy
This is a question we have debated for years. On the one hand, since convertibles are a combination of a fixed rate bond and a call option on a stock, regressing their returns on the returns on bonds, equity, and equity volatility (which is embedded in the convertible's call option) generates a very high "R-squared" (i.e., the three independent variables largely explain the dependent variable's return). On the other hand, there are quite a few actively managed convertible bond funds out there, and converts are also much beloved by hedge fund managers. However, there are not, to our knowledge, any retail funds available that attempt to track a convertible bond index. On balance, these considerations have led us to conclude that we will not treat convertible bonds as a separate asset class.
Do you consider my defined benefit pension or Social Security as a separate asset class? -- Subscriber, USA
This is a very interesting issue, about which reasonable people can disagree. One approach would be to treat a pension as a fixed income asset. However, it cannot, like a bond, be traded in a market, since the payment stream it provides is tied to the lifetime of the pension beneficiary and, in some cases, his or her surviving spouse. While some annuities are structured with minimum payment periods and enhanced transferablility features, most pensions are not. Hence, our approach is to subtract expected pension income from an investor's target post-retirement income as part of the process of arriving at the investors goal for the amount of income that he or she wants his or her portfolio to provide after retirement.
I notice in the August issue that you have an exchange rate table showing that going from one country (A) to another country (B) was listed as the same as going from country(B) back to (A) with only a sign change. However, when I ran those numbers, I found that's not the case. Am I crazy? -- Subscriber, USA
No, you aren't crazy. The fact that exchange rate changes look slightly different from either end of the transaction is called "Siegel's Paradox." In developing our model portfolios, we take this into consideration, so that the perspective, say, of a Euro based investor on the Euro/US Dollar exchange rate isn't just the opposite of the U.S. investor's view. However, in the example at the beginning of last month's article we decided to keep things simple, and avoid confusing people with Siegel's Paradox.