Tag Archives: alternative

Quarterly Update: Portfolio Rebalancing – A Potentially Golden Opportunity

For a variety of reasons, gold is a widely held asset class within investment portfolios. Many investors include gold in their asset allocation mix for its perceived ability to act as both a diversifier and as a potential store of value in times of uncertainty; these perceptions contribute to the concept of gold as a “core holding” in many diversified portfolios. Indeed, with the notable exception of Warren Buffett, 1 some of the investment community’s most distinguished names currently maintain investments in gold 2 . Like any investment, gold is subject to rebalancing or reallocation when its value relative to other portfolio components shifts significantly. Examining quarterly data from the beginning of 1976 (the year that gold started trading freely in the United States) through the quarter ended March 31, 2016, suggests that gold is overvalued relative to historical price relationships with the major agricultural crops of corn, wheat, soybeans and sugar. 3 In fact, the gold/soybean ratio is nearly at its all-time high. At quarter end March 31, 2016, the gold/corn ratio, defined herein as the number of bushels of corn an investor could buy with the proceeds from selling one troy ounce of gold, was 351 bushels, versus a 39-year average value of 170 bushels. Gold investors attempting to maximize portfolio performance through disciplined quarterly or annual rebalancing, may want to consider adjusting their gold holdings in tandem with their existing or anticipated agricultural sector portfolio investment mix. For example, the historical data for the gold/corn ratio suggests that a mean reversion 4 from March 31, 2016 levels of 351 bushels to the 39-year mean value of approximately 170 bushels of corn for each ounce of gold (bu/oz), could benefit an investor rebalancing gold for corn within their portfolio. Click to enlarge As illustrated in the chart on page 1, at 351 bu/oz the gold/corn ratio is approximately 107% above its nearly four-decade average of 170 bu/oz. Hypothetically, if an investor sold gold and purchased corn at the current 351 bu/oz level, and the ratio subsequently retraced to its historical mean value of approximately 170 bu/oz, the investor would then be able to sell the corn and buy back 107% more gold than was originally sold, to make the temporary reallocation from gold into corn. The gold/corn ratio may have been within 6% of its all-time high at the end of Q1 2016, but both the gold/wheat and gold/soybean related ratios were also very near historic highs over the same time period. The gold/wheat ratio was within 3% of its all-time highest value, and the gold/soybean ratio was within 1%, or virtually at, its all-time high value. The gold/sugar ratio is 41% below its all-time high. Charts for the gold/wheat, gold/soybean, and gold/sugar ratios are shown below. Click to enlarge Click to enlarge The current availability of both futures contracts and futures-based exchange traded products for gold, corn, wheat, soybeans, and sugar make rebalancing the gold and agricultural components within a portfolio easier than ever before. Investors and advisors need to make an assessment of the relative value of gold versus their other portfolio constituents, including agriculture, and appropriately adjust their allocations to suit their individual investment needs and objectives. 1 “Why Warren Buffet t Hates Gold.” NASDAQ 15 Aug. 2013: Web. October 9th, 2014. 2 Based on the 13-F filings for holders of GLD, the SPDR Gold Trust, as of 3/31/16 and found using Bloomberg Professional, April 12th, 2016. 3 Analysis & corresponding charts were prepared by Teucrium Trading, LLC, using Bloomberg Professional, April 12th, 2016. All supporting detail available upon request. 4 Mean Reversion: A theory suggesting that prices and returns eventually move back towards the mean or average. This mean or average can be the historical average of the price or return or another relevant average such as the growth in the economy or the average return of an industry. Disclosure: I am/we are long I AM/WE ARE LONG CORN, WEAT, SOYB, CANE, TAGS. Business relationship disclosure: Sal Gilbertie is the Founder, President, and CIO of Teucrium Trading, LLC, the Sponsor of the Teucrium CORN Fund ETP (NYSE Ticker “CORN”) and other agricultural ETPs listed on the NYSE under the ticker symbols “WEAT” “SOYB” “CANE” and “TAGS.” Additional disclosure: I have held in the near past, and may purchase in the near future, shares of DGZ as a proxy for short gold against my long agricultural holdings of corn, wheat, soybeans and sugar.

REITs Provide A Surprisingly Big Head Start Over Real Estate Direct Investment

If you’ve decided you want to allocate some of your savings to real estate, you may want to compare the merits of publicly listed REITs, like BlackRock’s REIT ETF (NYSEARCA: IYR ), versus investing in buildings directly through private investment partnerships. 1 The many individual benefits of REITs add up to a surprisingly big head start over private investment vehicles. While discerning private investors should be able to identify individual properties with higher returns than the average REIT-owned property, they need to generate returns about 4% higher just to catch up with the efficiencies of REITs. As detailed in the table below, this 4% comes from four main sources: higher costs, higher taxes, less diversification and lower liquidity of private investments. This 4% hurdle translates into an 8% hurdle for return on equity when the property investment is 50% leveraged with debt. 2 A major worry of REIT investors is that it’s impractical to analyze all of the REIT’s individual holdings, resulting in the risk of buying real estate at a substantial premium to fair Net Asset Value [NAV]. Unfortunately, US REITs are not required to give an estimate of their NAV and so we have to rely on several specialist research companies to make those estimates. As you can see in the chart below, over the past 25 years, REITs have averaged a 4% premium to NAV, within a wide range of a 45% discount in 2009 to a 35% premium in 1997. Given the enormity of the task of valuing thousands of properties without specific, inside details about each property, we shouldn’t expect these third party NAV estimates to be very accurate. Indeed, it appears that the divergences may be exaggerated by the NAV estimates lagging public market price moves. Making a simple adjustment for this lag reduces the volatility of the divergence from NAV by about 40%, and brings the average to a 1% premium, as shown by the black bars. I didn’t list this as a cost or benefit of REITs vs. private holdings, because, depending on timing, this could reduce or enhance returns. To flesh out a plausible negative scenario, let’s assume an investor bought REITs at a 10% premium and sold them 15 years later a 10% discount. That would cut the REIT head start of 4% a year down by only about 15%, in terms of the required return on the underlying unleveraged property investment. The return reduction could turn out to be even less than that, because when REITs trade at a premium to NAV, it is possible for them to add to their property portfolios by issuing shares to private sellers, and thus the premium to NAV can come down without harming returns. I’d be remiss if I didn’t list any benefits of holding property directly. Some argue that illiquidity can be a blessing in disguise, forcing investors to hold for the long term. Ignorance of daily price fluctuations may make the private investing experience more blissful too. Indeed, it may be that many large fortunes have arisen from people feeling ‘locked’ in to the companies they built or the properties they bought. Property investors also derive comfort and psychic value from the tangibility of their property investments, and the ability to touch and see their investments may make their investments feel less risky than more abstract and indirect holdings through REIT ETFs. Finally, while REITs may be the dominant structure for delivering passive real estate exposure 3 , private capital may remain the preferred structure for certain activities such as development and aggregation, even if ultimately for sale to REITs. The benefits of REITs are already well known. Investors have been enthusiastically voting for REITs with their investment dollars for a long time, bringing the value of REITs close to $1 trillion. REITs currently own about 1/8 of commercial real estate in the US, up from less than 1% in 1990. 4 REITs are on track to own over 50% of all US commercial real estate by 2040 even if these trends slow down by half. I hope this note has been helpful in cataloguing and attempting to quantify the relative merits of REIT vs. private ownership, summing up to a 4% hurdle that privately owned properties need to exceed relative to REITs. At Elm Partners, we use REIT ETFs, particularly Vanguard’s (NYSEARCA: VNQ ), for property exposure in our globally diversified portfolios. In a future note, I’ll address the more fundamental question of the long-term expected return of real estate given today’s valuation levels. Table: Comparison of REIT vs. private real estate investing 0.7% Avoiding transactions costs . Typically, when buying a building, an investor will incur about 5% as brokerage, legal, transfer tax and other fees, and loan arrangement fees of 2%, which together equate to about 0.6% pa over the 15-year investment horizon we assume throughout this analysis. 5 When investing in a REIT, these costs have already been paid. 0.5% REITs typically have lower borrowing costs. I assume REITs can borrow about 1% more cheaply from banks than private borrowers on individual properties. 0.9% REITs generally benefit from lower management costs due to economies of scale, and lack of carried interest. This calculation assumes REITs have 0.5% lower management fees and no 15% carried interest. The cost savings can be much higher in the case of small properties managed by the investor, if the investor were to accurately bill himself for the value of his time. 0.6% Tax savings will vary depending on the characteristics of the investor and the site of the property. One benefit of ownership through a REIT is that income that is passed out as dividends are not subject to state (or city) tax, in most states. For high tax sites, like NY or CA, this can amount to a tax saving of 10% of income, assuming that the ultimate investor is in a low or no tax state. REITs allow for longer-term holding than private investments, as the manager usually has an incentive to realize gains to be paid his incentive fee. A further potential saving is that private ownership structures usually throw off miscellaneous itemized deductions which many high rate US taxpayers cannot deduct. 6 For non-US investors, the tax savings of REITs over direct investments might be 0.8% greater. 7 1.0% Substantial diversification is provided by REIT ETFs, such as SCHH and RWR , which hold over 100 individual equity REITs. These REITs in turn provide ownership in thousands of properties in different locations and of different types, many of them large properties in prime locations that would be hard for most investors to access through private ownership. I estimate this effect perhaps over-simplistically by assuming a private portfolio will be 25% riskier than a diversified REIT ETF, and so the investor would need to get 25% more return for bearing that risk. 0.5% Liquidity : REITs are liquid. Private property takes time to transact, and the decisions to buy or sell may depend on the desires and personal circumstances of the manager of the property or other investors in the private deal. REITs are easily marginable, which allows investors to efficiently raise temporary liquidity. Listed options markets that have developed around REITs give investors even greater flexibility. An overview of the academic literature on pricing illiquidity [link prompts PDF download; see page 27 especially] by A Damodaran of NYU suggests a number much higher than 0.5%, but I am sympathetic to the notion that liquidity is valuable but overpriced by the market. 4.2% Total Head Start of REITs vs. Private Ownership Click to enlarge Notes 1 In this note, I am using the term REIT to refer to publicly traded equity Real Estate Investment Trusts in the US. There are other types of REITs and also there is a large and growing non-US REIT market. 3 REITs are one of the most indexed of all market segments, with Vanguard, BlackRock and StateStreet owning about 30% of the large REITs, twice the ownership level in other large US equities, mostly for their index broad market and REIT index offerings. StateStreet recently created a new sector fund just for real estate, XLRE. Expense ratios for REIT ETFs range from 0.07% for Schwab’s to 0.43% for iShares. 4 Size of US commercial real estate market according to this study was $10T in 2009, which I assume has grown to $12T today. Size of REIT market cap and leverage ratio from reit.com . REIT market ownership from 1991 based on the rate of growth of market cap of REITs being 22% and the NAREIT REIT price index growing at 4.7% pa over the period. 5 Further assumptions are 5% initial property yield, growing 2% a year, and leverage of 50% at a rate of 4%. 6 For this calculation, I assumed 5% lower tax rates and that 33% of management expenses are non-deductible for the private investor. 7 Investing through a REIT ETF such as IDUP LN can eliminate capital gains tax, reduce the income tax rate by over half to 15% and eliminate the drag of non-deductible miscellaneous itemized deductions. This should not be taken as tax advice. Acknowledgments Thanks to Chip Parkhurst, who did much of the research for this note as a summer intern at Elm Partners; my friend Larry Hilibrand, for invaluable help from start to finish; and my colleagues at Elm Partners. Disclosure: I am/we are long VNQ, IYR, VNQI. 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.

The One Way To Stay ‘Long’ In A Down Market – Un-Beta Part III

No one knows if this market will continue to move ahead or stall out. But I think it bears considering a bit of perspective on what we mean when we discuss “this market.” With a capitalization-weighted index like the S&P 500, the market can consist of deceptively few issues and provide a poor benchmark against which to measure your own results. In 2015, for instance, four S&P tech stocks – Facebook (NASDAQ: FB ), Amazon (NASDAQ: AMZN ), Netflix (NASDAQ: NFLX ), and Google (NASDAQ: GOOG ) (NASDAQ: GOOGL ) (the “FANGs”) were responsible for $450 billion of growth in market cap. Pretty wonderful! You don’t remember that? You thought 2015 was a wasted year in terms of gains, with the S&P 500 finishing almost flat? You’re correct. But the four stocks above did contribute $450 billion in market cap growth. That’s because, as a group, the other 496 stocks in the S&P collectively lost even more in capitalization. If you owned just the four FANGs, you had a mighty fine year. If you owned none of them, but all the others – not so much. Let’s use AMZN as an example. Amazon’s market capitalization today is over $325 billion, larger than the combined market values of Wal-Mart (NYSE: WMT ), Target (NYSE: TGT ), and Costco (NASDAQ: COST ). These three “old economy” firms reported trailing twelve-month GAAP net income of just under $17 billion, while Amazon’s net income was… an underwhelming $328 million. Of course, I think we can all agree that we buy stocks for what we believe they will be worth in the future, and I imagine Amazon the company will show increasing revenue in the future! However… As of today, Amazon trades at 501 times earnings per share. While I believe AMZN will continue to earn more revenue every year and may translate that into earnings, if the P/E it is rewarded with for that future growth slips to only, say, 400 times earnings per share without any increase or decrease in actual earnings, that would mean a 20% drop in stock price from 626 to 501. Heaven forbid if, in a down market, it would slip to only 300 times earnings; that would take the share price in this example to 375. It gets worse. As of April 1, 2016, the aggregate price/earnings ratio for stocks in the small cap Russell 2000 index is zero; those 2000 stocks (taken as a group) effectively had no earnings over the past 12 months. On the off chance that current valuations, combined with current revenues and real earnings, might not end well, we placed roughly half our assets into the above-mentioned yield and fixed income alternatives. But of course, there is a sucker born every minute and we’ve seen greater fool markets before that lasted beyond any reasonable connection to reality. (It seems the supply of Greater Fools is bigger than anyone imagined back in, say, 1998.) So in the event this one does continue, roughly half our asset base is still long – sort of. Just as for Mr. Clinton, for whom it depended on what your definition of “is” is, our portfolio is long, depending on what your definition of “long” is. My definition consists of the following: “Flexible funds:” These are long-only funds with excellent flexibility to go to cash, select different sectors or asset classes, or choose different capitalization sizes, world markets, or cash while awaiting reasonable entry points. “Long / short funds:” These are funds whose charter allows them to go long the issues they believe offer the greatest return or defensive characteristics and simultaneously short those they believe are most vulnerable to a decline. “Liquid Alternative funds:” Liquid alternative funds come in all sizes and flavors but their basic premise and promise is that they don’t limit themselves to buying common stocks, so they are an “alternative” to the benchmark investing so in vogue these days (as it always has been after a few years of good general market appreciation.) They might invest in or short currencies, commodities, bonds, stocks, options, futures or any of a half dozen other offerings. Our favorite flexible funds are those offered by Leuthold Weeden Capital Management. These are all no-load funds, have good track records, and are helmed by managers that are both transparent and humble. By “humble” I mean lacking in hubris and quite candid about their mistakes as well as their successes. Fortunately for us, the latter have outnumbered the former. The two we have in our portfolios are Leuthold Core Investment (MUTF: LCORX ) and Leuthold Global (MUTF: GLBLX ). Here’s LCORX, in their own words, from the Leuthold Funds website: The Leuthold Core Investment Fund differs from most other mutual funds by investing in stocks, bonds, money market instruments and certain foreign securities. When appropriate, as disciplines dictate, the Core Fund may also hedge its market exposure. We adjust the proportion of each asset class to reflect our view of the potential opportunity and value offered within that sector, as well as the potential risk. Although there are no guarantees, it is our belief that successful investing demands skill both in making money and attempting to preserve any gains. Flexibility is central to the creation of a core portfolio that you can depend on in a variety of market conditions. We possess the flexibility and discipline to invest where we see value and to sell when we believe there is undue risk.” Most recently, LCORX has been 18% in various bonds, 52% in select sectors, and 17% hedged, with the rest in cash and smaller positions. In a rip-snorting bull market, I’d go more for aggressive funds like former holding Akre Fund (MUTF: AKREX ). For this market, nothing beats LCORX. Leuthold’s sister fund for global investing, GLBLX, is invested in a similar ratio, but with a global bent, holding a little less cash and a few more longs. I consider these two funds as fine bookends for a conservative defensive portfolio. Then there are funds that are long-only and equities pretty-much-only that simply refuse to buy anything unless they have great faith in the future of a particular company and can buy it at a reasonable valuation. If they can’t, they stick to cash and cash equivalents. The best example of such a fund today is the Intrepid Endurance Fund (MUTF: ICMAX ) which is currently holding a whopping 67% in cash. They’ve experienced significant outflows, of course, because too many investors who claim they are in it for the long haul really aren’t. Indeed, today’s typical investor, institutional and individual alike, just want to beat the S&P – basically every month and certainly every quarter. The best way to do that is to not beat the S&P at all, but to at least equal it. That’s why so many gurus advise that you just buy an index fund and never sell it until you retire, at which time you can sell part of it to buy bonds. I say phooey to that hooey. Cap-weighted index funds like the S&P 500 are, by their very nature and composition, avenues to buy a chunk of whatever’s been working most recently, regardless of valuation or quality. The highest-capitalization stocks get the most money newly devoted to purchases and lower capitalization stocks, regardless of their investment value, get the least. Then we have most “professional” investors, a term that merely means that they do it from 9 to 5 every day, not necessarily that they do it more professionally or better. Their livelihood, vacations, mortgage, and children’s higher education depends on them never under-performing the index their mutual fund, pension fund or whatever is benchmarked to. See even most allegedly “active” managers never stray too far from the benchmark. As we get closer to a real bear market bottom, I’m guessing it is the managers of funds like ICMAX that we’ll be suggesting for your due diligence – because that’s when they will be buying at (finally!) reasonable valuations. Moving on to long/short funds, let me remind you about Boston Partners (Robeco) Global Long-Short ( BGLSX Institutional/ BGRSX Retail.) Since the fund publishes its largest holdings monthly (in an age of advanced information technology, why don’t more funds do this???), I can see that as of 31 March, their biggest longs were GOOG, BRK.B , AAPL , OTCQX:IMBBY and PHG . Their biggest shorts were on TSLA , CAT , BLL , OTCPK:GEAGY and NFLX . In uncertain times, I like this kind of flexibility. We also own the Boston Partners Long/Short Research fund ( BPRRX Investor class/ BPIRX Institutional class.) As of 31 March, their biggest long holdings are PE , ORCL , MSFT , XOM and JPM . The largest short positions? ITRI , NATI , TXRH , EQIX and WIT . And finally, we own another long/short fund, the AQR Long/Short Equity (MUTF: QLEIX ) This one has beaten all the benchmarks this year so far but be aware (!) of this caveat about this fund family: all classes of all their funds I own have a $1 million or $5 million minimum purchase, depending upon class of issue, unless you buy through an RIA or financial advisor with an agreement with the fund company. Fortunately, our firm has such an agreement so we can buy in quantities as low as $10,000. See if your broker or advisor can do the same. It’s important to gain this edge because my best choice in the liquid alternatives area is the “managed futures” fund called AQR Managed Futures Fund ( AQMIX institutional/ AQMNX investor.) This fund provides a liquid alternative to solely relying on US stocks for your returns. It does so by investing in a combination of stocks, bonds, commodities and currencies across a spectrum of different time frames. It provides virtually zero correlation with the S&P 500, yet it gives us the ability to profit from global macro investing trends in over 100 markets. (Indeed, this fund alone has proven so popular to our readers that we recently lowered our assets under management minimum from our standard $500,000 to $100,000, as long as we manage only mutual funds and ETFs!) Finally, we can offer, for those who prefer ETFs to funds, one long we own, the QuantShares US Market Neutral Anti-Beta ETF (NYSEARCA: BTAL ). It is basically a hedge fund, packaged as an ETF, that places the bet that boring predictable value will outperform the S&P in any down market. BTAL shorts the highest-Beta stocks (those that move in concert with or at a greater rate than the benchmark) and buys the stocks least sensitive to the benchmark move (the lowest-Beta stocks.) BTAL’s aim is to mute market moves over time and protect capital far better than simply buying an index fund. BTAL actually has a lower correlation to the S&P 500 than other typical hedges than either gold or utility stocks. You can see why I placed the word “Long” in my headline in parentheses. We’re still long. We are long some things and short others but on balance long. And we may not be in equities, but we’re still long other assets. Finally, we’re long – but not too much! And we are invested with managers we know and trust and have given them free rein to rebalance the percentage long and percentage short. This may give them some sleepless nights. Us? Between our munis, preferreds, REITs, flexible funds, long/short funds and liquid alternatives, we sleep very soundly, thank you! Disclaimer: As a Registered Investment Advisor, I believe it is essential to advise that I do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as “personalized” investment advice . Past performance is no guarantee of future results, rather an obvious statement but clearly too often unheeded judging by the number of investors who buy the current #1 mutual fund one year only to watch it plummet the following year. I encourage you to do your own due diligence on issues I discuss to see if they might be of value in your own investing. I take my responsibility to offer intelligent commentary seriously, but it should not be assumed that investing in any securities my clients or family are investing in will always be profitable. I do our best to get it right, and our firm “eats our own cooking,” but I could be wrong, hence my full disclosure as to whether we or our clients own or are buying the investments we write about.