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The Great Temptation, Greatest Danger

“If we survive danger it steels our courage more than anything else.” – Reinhold Niebuhr I am often bewildered that what passes for analysis is really a focus on recent performance, rather than process. Yet, so little attention is given to the investor return/behavior gap, a well-documented phenomenon that proves that “on, average, investors sacrifice a substantial portion of their returns by incorrectly timing when to enter or exit investments”. In correct timing tends to come from chasing performance, getting in after a major up move has already taken place, and then, of course, exiting when the drawdown is likely near its end. The below chart sums up some of the research on this which, in my opinion, is a “must know” when considering where to put money to work. Click to enlarge The best returns in the future come from those parts of the marketplace that have not done well in the past. Yet despite the overwhelming evidence which supports this, strong recent performance is often the core catalyst to make an investment. In reality, it should be the exact opposite. High past performance and continuous visibility of that performance is a temptation too strong for many to ignore, and that temptation unequivocally results in sub-optimal returns going forward on average. Take that truism on mutual funds, and magnify it by a billion when it comes to Exchange Traded Funds (ETFs). Yes folks – I would argue to you that ETFs are the greatest danger to investors. Why? Because ETFs provide an even greater temptation to chase recent performance, day by day, hour by hour, and minute by minute. Overtrading is the ultimate source of the investor return gap, and the temptation to get “in and out” of the market has never been higher thanks to these investment vehicles. Now, don’t get me wrong here. We ourselves use ETFs to execute across our quantitative strategies in mutual funds and sub-advised separate account strategies we run. However, following a systematic, backtested, and quantitative approach using ETFs as the vehicle of choice for execution is NOT what the vast majority of ETFs “investors” do. The pattern of behavior remains the same. Assets for ETFs grow when the ETF has strong recent performance, and collapse after, with a lag, when losses have already occurred. In our case, we rotate based on leading indicators of volatility (click here to learn more). The majority rotate based on old leaders that have had continuously low volatility. The greatest danger is in using past strong performance to make an investment decision. ETFs like the S&P 500 SPDR ETF (NYSEARCA: SPY ) may be the greatest temptation of all that results in exactly that. *Join us this week for our live webcast on the 2016 Dow Award paper, hosted by the Market Technicians Association. Registration available by clicking here . This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing. 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.

The V20 Portfolio: Week 33

The V20 portfolio is an actively managed portfolio that seeks to achieve an annualized return of 20% over the long term. If you are a long-term investor, then this portfolio may be for you. You can read more about how the portfolio works and the associated risks here . Always do your own research before making an investment. Read the last update here . Note: Current allocation and planned transactions are only available to premium subscribers . Over the past week, the V20 Portfolio rose by 3.8% while the SPDR S&P 500 ETF (NYSEARCA: SPY ) increased by 0.4%. Portfolio Update Conn’s (NASDAQ: CONN ) was responsible for most of the gains this week, rising 15.8% from $10 to $11.58. There were no major events other than a credit facility amendment on Friday, so much of this rally can be attributed to shifting sentiment in the market. Some of the amendments relaxed covenants while others were more restrictive. Let’s go over the restricting amendments first. Distributing restricted payments (e.g. dividends, buybacks) will now require a 2.5x interest coverage ratio for two quarters. Borrowing base was reduced by $15 million, which will be waived if interest coverage ratio exceeds 2x for two quarters. Finally, margin on the loan was increased by 25 bps (i.e. making the revolver a bit more expensive). While none of the amendments were crippling, the amendment concerning restricted payments will prevent Conn’s from making any share repurchases in the coming months, as the interest coverage ratio was less than 2.5x for Q4. The positive amendments included eliminating the minimum interest coverage ratio covenant for Q1 and lowering the total coverage ratio to 1x from 2x. Overall, this was a slight setback as buybacks will not be a possibility in the near future. Last week we discussed how Intelsat (NYSE: I ) was buying back bonds at a discount. For whatever reason (possibly the increased likely hood of a rate hike), the bonds in question declined in value from $70s to high $60s. As such, Intelsat lowered its consideration accordingly, lowering the offer by around 500 bps. Our helicopter company was the portfolio’s major laggard. There was no major development. As discussed in last week’s update, the oil and gas division will continue to battle industry wide headwinds, though the recent bounce in commodities may cushion the fall. However, it is unlikely that revenue will suddenly recover to its previous level as the oil and gas industry overall is still at a cost cutting stage. The medical segment should continue to generate profits, as it will not be affected by the commodity downturn. Risk Management Due to additional capital being allocated to Conn’s and its subsequent rally, the position now accounts for more than 10% of the entire portfolio. For a position to account for such a significant portion, it must fulfill two criteria: high expected rate of return and low probability of permanent capital loss. As we’ve seen with Dex Media, even though the shares were undervalued, 100% of the investment will likely be written off. But by allocating a small amount of capital to this speculative position, it only had a tiny impact on the overall portfolio. Conn’s on the other hand fulfills both criteria. It is not under any significant financial distress and is still growing its business. While short-term results have dampened its profitability, its long-term outlook remains bright. Performance Since Inception Click to enlarge Disclosure: I am/we are long CONN, I. 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.

Bond ETFs To Play If Fed Hikes In June

With the U.S. economy on the mend after a lukewarm Q1, a Fed rate hike possibility in June is back on the table. At least, the latest Fed minutes suggest that. A spate of stronger U.S. economic data in the field of retail, consumer sentiment, inflation and housing must have boosted the Fed’s confidence. The labor market and the manufacturing sector also seem sound. However, the June hike possibilities came as a shock to investors as they grossly shifted back the timeline of a hike in the wake of moderation in U.S. growth. Whatever the case, further Fed rate hikes are likely to bring in changes in investing sentiments. Against this backdrop, those who have started speculating a sooner-than-expected hike in the Fed interest rates must be worrying about the stability of their fixed income holding. Investors should note that yields on short-term bonds started to move higher since the release of the minutes. The yield on three-month bonds was 0.31% on May 19, 2016, up 3 bps from the yield recorded on May 17, 2016. Fixed-income investing has enjoyed a great show so far in 2016, especially in the longer part of the yield curve. However, the prospect of rising rates and risks to capital gains of bond holdings have left investors jittery about the safety of their portfolio. Given the situation, many investors are definitely pulling their money out of the bond market. At a time like this when investors are extremely cautious about rising rate risks and stock market volatility, investments in the below-mentioned bond ETFs can be intriguing bets. WisdomTree BofA Merrill Lynch High Yield Bond Negative Duration ETF (NASDAQ: HYND ) If investors are worrying about interest rate risks, negative duration bonds may come to rescue. Plus, this fund offers substantial yields which can easily beat out the benchmark yield. In addition, risks over junk bond investing are easing now with the ongoing energy sector recovery. This fund tracks the BofA Merrill Lynch 0-5 Year U.S. High Yield Constrained, Negative Seven Duration Index. The benchmark is a combination of the long and short portfolio. The long portfolio mirrors the BofA Merrill Lynch 0-5 Year U.S. High Yield Constrained Index, targeting non-investment grade corporate debt securities issued in the U.S. and maturing in five years. The short portfolio holds the short positions in U.S. Treasuries that surpasses the duration of the long portfolio, resulting in a targeted total duration of about negative 7 years. The fund puts heavy focus on junk bonds. It has a fee of 48 bps. The fund yields 4.55% annually (as of May 19, 2016). Sit Rising Rate ETF (NYSEARCA: RISE ) The ETF looks to track the performance of a portfolio comprising exchange-traded futures contracts and options on futures on two-, five- and 10-year U.S. Treasury securities weighted to attain the targeted negative 10-year average effective portfolio duration. Through this method, the ETF would see a 10% price appreciation with a 1% rise in U.S. Treasury yields. SPDR DoubleLine Total Return Tactical ETF (NYSEARCA: TOTL ) TOTL, an actively managed fund, has its foundation based on the principles of the DoubleLine’s sought-after investment research. The product seeks total return, while emphasizing income by investing in a global portfolio of fixed income securities of various maturities and ratings, though more-or-less 10% of the portfolio goes to the international arena. The fund looks to utilize various investment strategies in a broad array of fixed income sectors. It puts about 55% of assets in mortgage-backed securities. The fund charges 55 bps in fees. The fund has a modified adjusted duration of 3.90 years while its current yield stands at 2.58% (as of May 19, 2016). VanEck Vectors Investment Grade Floating Rate ETF (NYSEARCA: FLTR ) Floating rate notes are investment grade bonds that do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of issuers. Since the coupons of these bonds are adjusted periodically, these are less sensitive to an increase in rates compared to traditional bonds. Investors can thus play the theme with FLTR. Effective duration of the fund is as low as 0.13 years. SPDR Barclays 1-10 Year TIPS ETF (NYSEARCA: TIPX ) The fund looks to track the Barclays 1-10 Year Government Inflation-linked Bond index. Since the inflation picture is improving in the U.S. and a solid inflationary outlook is a prerequisite of the Fed tightening policy, this TIPS ETF can be considered a good bet. The fund has moderate interest rate risk as noted by modified adjusted duration of 4.71 years. SPDR Nuveen Barclays Capital Build America Bond ETF (NYSEARCA: BABS ) Investors should note that the short-term bond ETFs would be under greater pressure if the Fed acts in June. The yield on the 10-year U.S. Treasury note actually fell 2 bps to 1.85% on May 19, 2016 from the earlier day while the yield on three-month treasury notes increased by one basis point. This pattern should help long-term bond investing. For this reason, we chose this muni bond ETF which yields about 3.15% annually (as of May 19, 2016). These bonds are safer than high-yield corporate bonds. Original Post