Tag Archives: alternative

Are Alternative Mutual Funds Eating From The CTA Pie?

It seems like everywhere you look, you see a chart showing the upward AUM growth of liquid mutual funds, as well as the number of new funds. These charts left us with one main lingering question that we think is on the mind of many in the Managed Futures space. How big is the Liquid Mutual fund compared to the rest of the industry? And is that growth in addition to, or at the expense of, the rest of the industry? We explored this question in the latest article featured in CTA Intelligence , seen below. Are alt mutuals eating from the CTA pie? There’s no doubt that the packaging of managed futures into liquid mutual funds (’40 Acts’ as they’re called in the biz) has changed the managed futures space forever. It just depends which side of this particular aisle you’re on whether you view that as a good or bad change. On one hand, you can argue the $11bn AQR which has been brought into the space is good for the industry (in a sort of rising tide lifts all boats argument). On the other hand, there were the snickers and jeers in the audience at last year’s managed futures Pinnacle Awards when Cliff Asness won a lifetime achievement award. Many said he should have won the lifetime damage award for undercutting everyone on fees and essentially switching $11bn in money from 2/20 to 125bps). So which is it? Are managed futures mutual funds good for the industry as a whole? This may all seem like semantics, but it is surely important for those playing their particular brand of managed futures to investors. If mutuals are grabbing assets at the expense of others, then that’s surely not helpful to the grand majority of fund managers out there, not to mention the exchanges, brokerage firms, and the rest of the industry which need new money brought into the space to grow, not just the same money switching to mutual funds. Which brings us to the numbers. We gathered the data on the assets in managed futures mutual funds to trace the growth of the category since 2013. Then, we looked to compare that growth to the growth of managed futures as a whole from the BarclayHedge database. Now, a few details to consider: One, we made one big assumption, that all of the managed futures mutual fund AuM is included in the BarclayHedge CTA database, to make the math as simple as subtracting the ‘liquid AuM’ from the BarclayHedge AuM to arrive at the ‘non-liquid AuM’. Second, we subtracted Bridgewater’s AuM from the BarclayHedge numbers ( we don’t consider them to be managed futures ). And finally, we’re talking growth of assets here and sort of commingling that with inflows and outflows, as that term is known in the mutual fund world. Our methodology is considering the change in assets, so the growth or decline is both inflows/outflows and performance. As for what we would anticipate to see if there’s a rising tide effect, we would expect both curves to be up varying amounts. If there is ‘liquid’ growth at the expense of private funds, we would expect sort of mirror image curves, with private on the bottom and liquid on top. So what did we find – more of the mirrored look, albeit with private funds more mirrored than just mutual funds would explain – meaning they didn’t lose a dollar in assets for every one mutual funds brought in – they appear to have lost more. Going with BarclayHedge numbers, private funds lost around $40bn in assets through the middle of 2014 before pulling in around $20bn to end the period down roughly $19bn. Meanwhile, their liquid alt counterparts showed a slow but consistent growth of around $13bn over two years (amazingly, AQR was about $7.5bn of that amount according to Brightscope ). All in all, the managed futures mutual funds in the Morningstar managed futures mutual fund category outgrew private funds by $33bn. Click to enlarge This is interesting but it doesn’t completely answer the question we are after. Growth in assets are a good indicator of which vehicle investors are adding or subtracting from, but it doesn’t quite tell us how much of the industry is controlled by each type. Here’s a look at the percentage of managed futures assets controlled by mutual funds compared to the amount that is not. In 2013, our estimation of the total assets in managed futures through both private and liquid funds was about $206bn. The Morningstar category had around $9.6bn of that number, meaning 4.7% of the managed futures pie was controlled by mutual funds (cue pie chart): Click to enlarge Click to enlarge Fast forward to 2015, and we estimate managed futures overall actually went down in AuM by about $8.1bn to $198bn, while mutual funds grew by $13.9bn over the same time to a new high of $23.7bn, meaning managed futures mutual funds now represent 12% of the industry. The last two years have seen mutual funds share of the managed futures pie jump from 4.6% to 12%. That’s sort of impressive, but not as big of a jump as we might have thought before crunching the numbers. Perhaps, it’s important to apply context to what was going on during this growth. Managed futures was experiencing its worst drawdown in a generation throughout 2013 and the first half of 2014, then following it up by posting its best performance since 2008 in the second half of 2014.Grabbing a bigger slice of the pie with what’s generally considered ‘hotter’ money investing in mutual funds is certainly a feat. There’s no denying mutual funds are making up more of the managed futures space, but private funds still control There’s no denying mutual funds are making up more of the managed futures space, but private funds still control nine tenths of AuM – that’s a big number. The question is, what does the future trajectory look like? You would think mutual funds would continue making hay and taking a bigger and bigger slice of the pie, and indeed more and more managers we talk to are asking when, not if, they should consider switching to a mutual fund format. But then there are reports that institutional investors are looking to increase their exposure to private funds in 2016. And last but not least, it’s not a wide open road ahead for liquid alts products with new SEC derivatives rules on the horizon , potentially meaning you would need millions of dollars to trade a single Euro Dollar future, effectively putting the managed futures mutual fund complex out of business. Stay tuned…this is one battle definitely worth watching

Energy Sector Crushes Conventional Wisdom

By Ronald Delegge Never mind the abysmal results of first-quarter earnings for the depressed energy sector. It doesn’t matter. And never mind the conventional wisdom of group-think and scary analyst warnings like, “Energy stocks are in deep trouble because Q1 losses will mark the first time any sector in the S&P 500 has reported an aggregate loss since Q4 2008.” Again, who cares? Price is what counts – not rigid EPS statistics – and right now energy stocks (NYSEARCA: XLE ) have ripped higher, making them the best performing S&P 500 (NYSEARCA: IVV ) industry sector year to date (YTD). ETFs like the Direxion Daily Energy Bull 3x Shares ETF (NYSEARCA: ERX ) that magnify the performance of energy stocks with triple daily leverage have delivered strong results by gaining almost 30% YTD. In other words, group-think would’ve caused you to miss this trade. And that’s why following conventional wisdom is a time honored recipe for failure. Click to enlarge Contrary to the nearly universal view that energy stocks are untouchable, on March 7 via ETFguide PREMIUM, we saw a great opportunity in oil and gas producers (NYSEARCA: XOP ) and issued the following alert: “XOP is right up our contrarian alley. It’s lost money over the past 1, 3, and 5 years with annualized losses of -9.45%. Who wants to puke? Despite proclamations that everyone will be driving Teslas by 2020, we don’t believe or agree that oil and gas demand will evaporate to zero as certain Kool-Aid drinking clean energy analysts envision. We’re buying XOP at current prices ($29.70).” XOP owns a basket of oil and gas companies like Continental Resources (NYSE: CLR ), Devon Energy (NYSE: DVN ), and WPX Energy (NYSE: WPX ). We added: “Although contrarian trades like XOP usually take longer to develop, they can be far more profitable compared to other types of trades. However, the problem of realizing profits is largely psychological. Why? Because most investors grow impatient and end up selling a great investment before it has time to blossom.” XOP has risen over +19% since our time stamped alert compared to just a +3.39% gain for the S&P 500 (See chart above). Oil and gas producers have also outperformed the broader energy sector. Much of this bounce is attributable to recovering crude oil prices (NYSEARCA: USO ), which now trade in the $45 per barrel range. Nevertheless, buying out-of-favor sectors before they start turning up is a perennial battle for most investors. Too few people do it. Why? Because they’re too scared a bottom hasn’t been reached. Bottom line: Contrarian trades – although often grueling – have a proven track record of success for patient traders and investors. It’s also why I salute all contrarians on this final day of Financial Literacy month! P.S. Contrarian trades are just one of four primary trading strategies we use at ETFguide for non-core investment portfolios. Original Post

The Power Of Quantifying Market Expectations For McDonald’s And Williams Companies

” It’s difficult to make predictions, especially about the future. ” This quote has been repeated so many times that no one quite knows who said it first. Perhaps it was baseball player Yogi Berra. Or humorist Mark Twain. Or Danish physicist Niels Bohr. The point is, this quote has become a part of our cultural fabric, and it has done so because it expresses a simple and fundamental truth. Accurately forecasting what’s going to happen in the future is incredibly difficult, almost impossible. Few areas illustrate this difficulty more profoundly than financial markets, where analyst projections of earnings are regularly off by 10+% . Sometimes, even the most well recognized experts make shockingly bad predictions . No one truly knows (legally) what the market is going to do next, and the risk involved in that uncertainty is what creates the potential for significant returns. The Alternative To Making Predictions Of course, those returns are only available to those that participate in the stock market, and participating in the market implies some sort of prediction about the future. Even if you just buy a broad-based index fund, you’re predicting the broader market will go up. Otherwise, why make that (or any) investment? However, there’s a better way to invest. Instead of making your own prediction about the future, you can analyze the market’s prediction by quantifying the cash flow expectations baked into the market’s valuation of a stock. Then, you can make a more objective judgment about whether or not those expectations are realistic. This method, termed ” Expectations Investing ” by Alfred Rappaport and Michael Mauboussin in their book of the same name, can be incredibly effective. It’s effective because it removes the need to make precise predictions about the future. By quantifying market expectations across thousands of stock as we do, it’s easy to find pockets of irrationality and identify companies that are over or undervalued. How To Quantify Market Expectations There are a couple of methods we use to quantify market expectations. One of the simplest is to calculate a company’s economic book value , or the no-growth value of the business based on the perpetuity value of its current cash flows. This value can be calculated by dividing a company’s LTM after-tax profit ( NOPAT ) by its weighted average cost of capital ( WACC ), and then adjusting for non-operating assets and liabilities. Figure 1: Why We Recommended McDonald’s Click to enlarge Sources: New Constructs, LLC and company filings. The ratio of a company’s stock price to its economic book value per share (PEBV) sends a clear message about market expectations for the stock and can be a very powerful tool for investors. Figure 1 shows how PEBV influenced our decision to recommend McDonald’s (NYSE: MCD ) shares to investors in late 2012. Shares at that time were trading at a PEBV of 0.82, an unprecedented discount for a company with MCD’s track record of growth and profitability. The market’s valuation suggested that MCD’s NOPAT would permanently decline 18% and never recover. Those expectations seemed overly pessimistic to us. As it turned out, MCD did end up struggling significantly after our call. Increased competition from fast casual restaurants like Chipotle (NYSE: CMG ) and Panera (NASDAQ: PNRA ) that appealed to health-conscious diners compressed MCD’s margins and sent its sales slumping. Despite its struggles, however, things never got quite as bad for MCD as the market predicted. Between 2012 and 2015, NOPAT fell by only 16%, not the 18% projected by the stock price, and recent signs of a recovery have sent shares soaring to all-time highs. Figure 2 shows how MCD has delivered significant returns to investors since we made our prediction despite lackluster financial results. Figure 2: Disappointing Profits No Obstacle To Shareholder Returns Click to enlarge Sources: New Constructs, LLC and company filings. Though MCD’s poor results caused it to miss out on the bull run of 2013-2014, its surge over the past twelve months has it at a 51% gain since our initial call, outperforming the S&P 500 (NYSEARCA: SPY ) on a capital gains basis while also yielding a higher dividend. We didn’t know exactly how McDonald’s was going to perform when we made the prediction in 2012. We simply knew that the expectations baked into the market’s valuation were so pessimistic that even if the company’s profits significantly declined, as they did, investors could still earn healthy returns. Delayed Gratification As Figure 2 shows, basing investment decisions off a quantification of market expectations doesn’t always deliver immediate results. In the case of MCD, it took nearly three years for our call to come to fruition. Short-term sector trends and market forces can allow a company to stay valued at irrational levels for quite some time especially when we know that very few people practice Expectations Investing these days. Roughly three years ago, we warned investors to stay away from Williams Companies (NYSE: WMB ), calling it an example of the “sector trap.” Analysts excited about the company’s exposure to the rapidly growing natural gas sector were pumping up the stock, ignoring its low and declining return on invested capital ( ROIC ), significant write-downs indicating poor capital allocation, and the high expectations implied by its stock price. Specifically, our discounted cash flow model showed that the company would need to grow NOPAT by 13% compounded annually for 15 years to justify its price at the time of ~$37/share. Those expectations seemed to be clearly unrealistic given the company’s 7% compounded annual NOPAT growth over the previous decade and a half. For a time, WMB continued to gain in value despite the disconnect between its current cash flows and the cash flows implied by the stock’s valuation. As recently as mid-2015, the stock was up nearly 60% from our original call. However, as Figure 3 shows, WMB crashed hard when the market turned more volatile. It now has fallen nearly 60% from our original call, and it has significantly underperformed the S&P 500, the S&P Energy ETF (XEP), and peers Spectra Energy (NYSE: SEP ) and Enterprise Products Partners (NYSE: EPD ). Figure 3: Short-Term Gains, Long-Term Declines Click to enlarge Source: Google Finance Stocks with overly high expectations embedded in their prices can still perform well in the short-term, but they tend to face a reckoning eventually. Stocks Due For A Correction Roughly a year ago, we put engine manufacturer Briggs & Stratton (NYSE: BGG ) in the Danger Zone . Back then we argued that BGG’s history of value-destroying acquisitions, significant write-downs, and declining profits made it unlikely that the company would hit the high expectations set by the market. Specifically, our model showed that the company needed to grow NOPAT by 10% compounded annually for 17 years to justify its price at the time of ~$20/share. BGG actually did manage to meet this goal in year 1, growing NOPAT by 14% in 2015. However, we think this growth rate is unsustainable, as the company’s ROIC remains mired below 5%. Moreover, the company keeps spending money it doesn’t have on acquisitions, dividends, and buybacks, so it now sits with almost no excess cash and $660 million (68% of market cap) in combined debt and underfunded pension liabilities. Despite the balance sheet concerns, the market only seemed to pay attention to the GAAP earnings growth, and BGG is up 13.8% since our call. At its new price of ~$23/share, the market expects 10% compounded annual NOPAT growth for the next 11 years . Despite one good year in 2015, there’s no reason to suspect that level of growth is sustainable for BGG. High market expectations mean this stock should drop hard the moment growth slows down. On the other side of the coin, we still believe last year’s long pick Fluor Corporation (NYSE: FLR ) has significant upside. Despite slumping commodities prices affecting its oil, gas, and mining businesses, FLR still managed a 21% ROIC in 2015 and finished the year with a larger backlog than it had at the end of 2014. Investors only saw the downside though, and they sent FLR down 11% Due to this decline, the market continues to assign FLR a low PEBV of 0.9, just as it did last March when we made our original call. Given the recent rebound in commodities, we don’t think a permanent 10% decline in NOPAT from these already low levels seems likely. Strong profitability and low market expectations lead us to believe an investment in FLR will pay off sooner or later. Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, style, or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.