Why the Kailash Equity Duration Tool is a Must Have for Managers

A Brief Contemplation of Duration & Inflation: The Duration Crisis for Investors & Asset Allocators

This paper extends on our last piece, The Great Inflation. Our research indicates investors and asset allocators face a “duration crisis.” This paper seeks to hammer home:

  • Equities in aggregate have high sensitivity to rates based on history
  • The aggregate duration is heavily skewed by a group of outliers
  • There are still a large number of low duration equities that can help mitigate duration risk for Asset Allocators, Portfolio Managers and Investors

Kailash has spent months working to build a tool to provide credible estimates of equity durations. For a walk- through on the academic underpinnings and the numerous modifications Kailash employed to calculate Equity Duration, please click here. Kailash believes certain equities can help manage duration risk while providing a valuable inflation hedge.

Figure 1 below shows the equity duration for the S&P 500. Using a constant 6% discount rate over history, the broad S&P 500 Index now has an equity duration of 40 years. The prior all-time high was at the very peak of the internet bubble when the Index duration hit 43 years.

While Kailash’s proprietary equity duration tool estimates any given security’s sensitivity to interest rate shocks, we find the index figures to highlight the risks of traditional asset allocation strategies. Kailash first wrote about the dangers in our piece 60/40 Asset Allocation: Buying a Ticket on the Titanic based on the common-sense observation that bonds, at current yields, offer negligible income and enormous risks. With this new tool, Kailash can now create approximate calculations for any set of US equity funds and bond funds.

IN 2000, THE LAST TIME EQUITY DURATIONS HIT 40 YEARS, 5 YEAR TREASURY BONDS YIELDED 6%, TODAY THEY YIELD 1.5%. Today’s same mix of assets provides a very different risk/return profile than the one suggested by many backwards-looking asset allocation models. To see how different discount rates impact aggregate equity duration, click here. At a time when high volume in stocks means investors are chasing performance, we encourage diligence, research, and the adoption of a salient but notably absent risk tool that helps manage duration risk.

YOU ARE NOW READING BASIC MEMBER LEVEL CONTENT

Ask a Fortune 500 manager where his corporation stands on that famous list and, invariably, the number responded will be from the list ranked by size of sales; he may well not even know where his corporation places on the list Fortune just as faithfully compiles ranking the same 500 corporations by profitability.[1] -Warren Buffett, 1981

If our readers are wondering how the above quote from Warren Buffett’s letter to investors from 1981 ties into the below chart….it actually does not.  We infused our prior paper and this paper with his timeless, hard-fought, and real-world wisdom that came from successfully managing money through a great inflation.  The quote above resonates with us because there really isn’t anything new under the sun.  Kailash believes many stocks have inflated valuations at the hands of investors enchanted by management teams focusing on sales growth at the exclusion of profits.  Buffett saw the exact same thing….in 1981.

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  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.

The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra reading for anyone seeking out more information related to the topics above.

  1. Click the following to read more about stock speculation

Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

Nothing herein shall limit or restrict the right of affiliates of Kailash Capital, LLC to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein shall limit or restrict affiliates of Kailash Capital, LLC from buying, selling or trading securities or other investments for their own accounts or for the accounts of their clients. Affiliates of Kailash Capital, LLC may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. Kailash Capital, LLC shall have no obligation to recommend securities or investments in this publication as result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.

April 8, 2021 |

Categories: White Papers

April 8, 2021

Categories: White Papers

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