Reversion To The Mean
Q: In the case of investments, there are certain instruments, particularly conservative, low-yielding ones, that are DESIGNED to maintain a roughly stable price and spin off dividends or interest, and history shows that they do. The prototype of this sort of investment is the money market sweep fund, designed to hold a dollar and pay interest.
A:
Now, look at some issues that actually HAVE a standard deviation.
Treasuries, AAA rated insured munis. The funds that hold them tend to
hold prices that are +- 10% from their mean OVER A PERIOD OF YEARS. Not
surprising, Very predictable investments. Not as predictable as money
markets, but pretty predictable. Treasuries don't fail, and the
rate of AAA munis is not much worse. Like the money markets, it takes a
severe market dislocation to toss them out of their trading range, and
when that occurs, other economic forces intervene to push them back
where they belong. (Example -- in the case of the AAA munis, it's pretty
obvious to me that the government, rightly or wrongly, is not going to
let more than a tiny fraction of stressed munis default on their bonds,
if any at all, at if any are permitted to default, it's going to be a
few small non-investment-grade issues. So, there's your "economic force"
intervening to hold the price.)
So, let's recap. I bought a bunch of bank rate, muni, and safe corporate
CEFs because (!!!!) they were spinning off nice dividends. If
that's all they do in this market, I'm probably ahead of the game.
HOWEVER, because these are very safe investments that have huge
repercussions to institutions and people if they don't hold price, I
suspect they will also revert to their historical means (meaning 20-40%
appreciation over a couple of years) as the market dislocations heal.
That's it. Key point is that as standard deviations increase, the entire
concept of "reversion to mean" becomes useless because there is no
"historical mean" that is relevant. Volatility is way too high. Is COP a
45 dollar stock or a 100 dollar stock, traditionally? No way to answer
that, because it's too volatile. It could be a 45 dollar stock under one
set of conditions, and a 90 dollar stock on another. People disagree on
the value, so it moves. Not so with conservative investments. There is
underlying value backed, at its root, by a dividend stream.
So: After five years of spinning out dividends while trading in a range
from 15.1 to 12.6, IMT started to get frothy around in '08 (MBIA
controversies) dropped to 12.39 on 9/5/08, and over the next month,
dislocated to 7.91 on Oct 10. This is what we do as traders, isn't it?
To wait for an extreme swing, and try to determine if the swing was
rational or not? Well, they skipped a dividend in Nov, sent out a double
dip in Dec., and went right back to paying 6c a share monthly. Now it's
back up to 11 (went to 12, then pulled back this last week and half).
Nice. I was in at 8 and change, and I'm still getting half a percent a
month. (I should say also that I was considering shorting Treasuries
when they bubbled, because they've inverted the behavior of IMT (to me,
indicating that money was flowing out of AAA munis looking for even
safer havens) but this is a better deal, for now.)