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GMOM: Momentum Swings From Bonds Back To Stocks

Summary GMOM shifted from stocks to bonds in late August, but was too late to protect itself from the summer market plunge. GMOM missed the October snap-back relay in stocks, but has recently repositioned itself to be overweight in equities. The recent whipsaws has not been kind to GMOM, but it may regain its lustre in strongly trending markets. The Cambria Global Momentum ETF (NYSEARCA: GMOM ) is an actively managed ETF that seeks to exploit the momentum factor across different asset classes. Essentially, GMOM invests in the top 33% of a target universe of 50 ETFs based on measures of trailing momentum and trend. Assets include domestic and foreign stocks, bonds, real estate, commodities and currencies. The fund rebalances monthly into ETFs with strong momentum and are in an uptrend over the medium term of approximately 12 months with systematic rules for entry and exit. Seeking Alpha author Left Banker has penned an excellent pair of articles describing the construction of this ETF, and thus these details will not be rehashed here. Instead, this article seeks to highlight the fact that GMOM has just recently switched from a bond-heavy portfolio back into stocks. Locating the previous switch to bonds In his last feature article on GMOM in Feb. 2nd, 2015, Left Banker found that GMOM was broadly diversified across numerous asset classes, with about 46% in equity, 31% in bonds, 18% in real estate (including mREITs) and 6% in commodities. Fast-forward to Nov. 3rd, 2015, and the situation is drastically different. Nearly 94% of the portfolio was in bonds , with the remaining 6% or so in REITs. GMOM holdings on Nov. 3rd, 2015 iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) 17.56% iShares 3-7 Year Treasury Bond ETF (NYSEARCA: IEI ) 17.12% Vanguard Short-Term Bond ETF (NYSEARCA: BSV ) 17.08% iShares 1-3 Year Treasury Bond ETF (NYSEARCA: SHY ) 12.11% Vanguard Total Bond Market ETF (NYSEARCA: BND ) 10.93% Vanguard Total International Bond ETF (NASDAQ: BNDX ) 6.44% iShares Residential Real Estate Capped ETF (NYSEARCA: REZ ) 6.22% Vanguard Short-Term Corporate Bond ETF (NASDAQ: VCSH ) 6.01% iShares MBS ETF (NYSEARCA: MBB ) 6.00% Total 99.47% As GMOM does not publish its historical holdings, I do not know the exact time that it made the switch from bonds to stocks. However, given the significant underperformance of both U.S. (the SPDR S&P 500 Trust ETF (NYSEARCA: SPY )) and international stocks (the iShares MSCI ACWI ex-U.S. Index ETF (NASDAQ: ACWX )) stocks compared to their respective bond counterparts, the Vanguard Total Bond Market ETF [BND] and the Vanguard Total International Bond ETF [BNDX] over the summer, I infer that change to the better-performing bond ETFs was made sometime during those months. To narrow down the precise timing of the switch further, I compared the total performance of GMOM with SPY and BND over the past three months. We can see that the stock market plunge in late August was acutely felt by GMOM, suggesting that GMOM was still heavily invested in equities at that time. However, GMOM did not track the market fluctuations experienced by SPY in the month of September, nor the snap-back rally in stocks in October. This suggests that the switch from equities to bonds took place sometime at the start of September. We can see from the graph above that while moving to a bond-heavy portfolio protected GMOM from the market gyrations experienced by SPY in September, it also caused GMOM to miss out on the fantastic rally in stocks the following month. This illustrates a general observation: momentum strategies tend to underperform in whipsaw situations. A similar set of circumstances was chronicled for the AlphaClone Alternative Alpha ETF (NYSEARCA: ALFA ), which uses the 200-day MA in order to time its hedges (which is a type of momentum strategy), in my recent article entitled ” ALFA Underwhelms As Hedge Fund Darlings Crater Plus An Untimely Hedge .” From bonds back to stocks Checking the holdings of GMOM a few days later, I discovered that a massive shift had taken place in the constituents of this ETF. The portfolio had shifted from 94% bonds to only 29%. REITs increased from 6% to 17%. Stocks increased from a measly 0% to 53% (70% if you include REITs as stocks). GMOM holdings on Nov. 6th, 2015 iShares Global Tech ETF (NYSEARCA: IXN ) 10.61% iShares Global Consumer Discretionary ETF (NYSEARCA: RXI ) 10.60% Vanguard REIT ETF (NYSEARCA: VNQ ) 10.60% Cambria Shareholder Yield ETF (NYSEARCA: SYLD ) 10.59% iShares Global Consumer Staples ETF (NYSEARCA: KXI ) 10.59% Vanguard Total Stock Market ETF (NYSEARCA: VTI ) 10.57% PowerShares Emerging Markets Sovereign Debt Portfolio ETF (NYSEARCA: PCY ) 10.56% Vanguard Total International Bond ETF BNDX 6.43% iShares Residential Real Estate Capped ETF REZ 6.17% Vanguard Short-Term Corporate Bond ETF VCSH 6.02% iShares MBS ETF MBB 6.00% Total 98.73% The recent change in the portfolio is also shown graphically below. Obviously, the recent move back into equities is a direct consequence of the ferocious rally in the stock market over the past month and a half. With stocks knocking again on the door of all-time highs, one has to ask the question, is this really the best time to be overweight equities? If you answered “yes” to that question, then you are likely a momentum investor, and GMOM might be an ideal fund for you. If you answered “no,” you would do well to sell GMOM now that it has shifted again back into stocks (and you should also ask yourself why you were invested in this fund in the first place?). Summary The recent whipsaws in the stocks, and to a lesser extend bond, market has not been kind to a momentum fund such as GMOM. Indeed, while having performed comparably with U.S. and international stocks and bonds in the first six months or so of its lifetime since inception, it now trails all four major asset classes by a wide margin. If this whipsaw behavior were to continue, GMOM will likely continue to underperform. On the hand, strong trending markets (both bull and bear) in various asset classes should allow GMOM to focus on what it does best: exploiting the momentum premium. GMOM Total Return Price data by YCharts For more information about other momentum ETFs, see my previous articles ” Comparing 4 Tactical/Momentum ETFs ” and ” An Update On 4 Tactical/Momentum ETFs “.

ALFA Underwhelms As Hedge Fund Darlings Crater Plus An Untimely Hedge

Summary ALFA’s hedge was triggered for the first time at the start of last September. Unfortunately, ALFA’s recent performance has been uninspiring. This analysis reveals two likely reasons for ALFA’s underperformance since the hedge was activated. In my Aug. 31, 2015 article entitled ” ALFA: A Market-Beating ETF About To Go Market-Neutral ” I reported that the AlphaClone Alternative Alpha ETF (NYSEARCA: ALFA ) was about to go market-neutral for the first time since its inception due to the S&P 500 closing below its 200-day moving average at month-end. I also commented on the fact that ALFA has had significant wire-to-wire outperformance vis-a-vis the SPDR S&P 500 Trust ETF ( SPY) since inception (see chart below), suggesting that investors in ALFA benefited from being able to “invest with the best.” Recall that ALFA uses a proprietary “Clone Score” methodology in order to aggregate the ideas of hedge funds which have strong historical performance. Alas, ALFA can no longer lay claim to this achievement. Its total return performance since inception now trails SPY by some 15% (55% vs. 70%). ALFA Total Return Price data by YCharts Zooming up to the time frame since the hedge was triggered at the start of September (it was actually activated at the market close on Sep. 2nd) reveals that most of the relative underperformance occurred over the last month. ALFA Total Return Price data by YCharts Reconstructing ALFA’s return without the hedge Recall that when the hedge is triggered (caused by the S&P 500 closing below its 200-day moving average at month-end), ALFA shorts the S&P 500 in an amount equal to the notional value of its long holdings. In other words, ALFA becomes market-neutral. Obviously, given that SPY has (as of last week) reclaimed its 200-day moving average in a brief span of two months, the hedge appears to be ill-timed. Nevertheless, investors in ALFA must be prepared to accept the fact that this hedging strategy will likely underperform in whipsaw situations, such as what was observed over the past two months, as part of the cost of protecting oneself from the worst of bear markets. I wanted to see whether the severe underperformance of ALFA was due to the hedge being triggered, or something else. Therefore, I reconstructed the total return of ALFA since the start of September to visualize what the return profile of ALFA would have been if the hedge had not been activated. We can see from the chart above that had the hedge not been activated, the hypothetical 100% long ALFA (denoted ALFA-L in the graph above) would have returned -1.95% since Sep. 1st, compared to -8.14% for the actual ALFA. While this alleviates the underperformance a bit, it is still far below that of SPY at 8.69%. So what can the rest of ALFA’s underperformance be attributed to? Hedge fund darlings crater In my previous article, I compared the top 10 holdings of ALFA and SPY. ALFA SPY Stock Ticker % Assets Stock Ticker % Assets Apple Inc. (NASDAQ: AAPL ) 7.25 Apple Inc. AAPL 3.75 Valeant Pharmaceuticals (NYSE: VRX ) 7.19 Microsoft Corporation (NASDAQ: MSFT ) 2.03 Celgene Corporation (NASDAQ: CELG ) 2.55 Exxon Mobil Corporation Common (NYSE: XOM ) 1.78 Horizon Pharma plc (NASDAQ: HZNP ) 2.53 Johnson & Johnson Common Stock (NYSE: JNJ ) 1.49 Allergan PLC (NYSE: AGN ) 2.41 Wells Fargo & Company Common St (NYSE: WFC ) 1.46 The Priceline Group Inc. (NASDAQ: PCLN ) 2.36 General Electric Company Common (NYSE: GE ) 1.41 Transdigm Group Incorporated Tr (NYSE: TDG ) 2.22 Berkshire Hathaway Inc. Class B (NYSE: BRK.B ) 1.4 Oracle Corporation Common Stock (NYSE: ORCL ) 2.05 JPMorgan Chase & Co. Common St (NYSE: JPM ) 1.37 Biogen Idec Inc. (NASDAQ: BIIB ) 1.79 Pfizer, Inc. Common Stock (NYSE: PFE ) 1.19 Skechers U.S.A., Inc. Common St (NYSE: SKX ) 1.5 AT&T Inc. (NYSE: T ) 1.15 How have the top 10 stocks of ALFA fared over the past two months? Answer: not pretty. AAPL Total Return Price data by YCharts As can be seen from the graph above, only 2 of ALFA’s top 10 holdings at the start of September, PCLN (+12.44%) and AAPL (+10.55%), have outperformed SPY. There are three massive losers: SKX (-30.5%), HZNP (-41.2%) and VRX (-48.2%). Assuming that the weightings of those three stocks did not change over this time period, they would have contributed a total of -6.24% to the total return of ALFA over this time period. That actually accounts for over half the entire difference between the hypothetical unhedged ALFA-L (-1.95%) and SPY (8.69%) during this time! Now, I am aware that ALFA’s holdings are not static, and hence the above calculation is merely an estimate. Nevertheless, it is clear that ALFA has been hit by a “doubly-whammy” of an untimely hedge, plus the underperformance of hedge fund darlings such as Valeant Pharmaceuticals (see this comically-timed Forbes article ” Hedge Fund Superstars Stocking Up On Valeant Pharmaceuticals ” that was published the day before VRX’s price came crashing down). This illustrates an important fact: even the best and brightest in the industry can sometimes get it (very) wrong. Due to ALFA’s heavy concentration in tech and biotech, one might say that SPY is not an appropriate benchmark for ALFA. The following chart therefore also shows the total return of the PowerShares QQQ Trust ETF (NASDAQ: QQQ ) and the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB ) since the start of September, as well that of another hedge fund-following ETF, the Global X Guru Index ETF (NYSEARCA: GURU ). Unfortunately, ALFA still lags the other four ETFs, although the hypothetical ALFA-L (-1.95%) would have outperformed IBB (-5.12%) and closely trail GURU (-0.37%). ALFA Total Return Price data by YCharts Summary The last two months has not been kind to ALFA holders. Not only was the timing of the hedge unfortunate, but a number of the fund’s largest holdings have suffered tremendously, particularly VRX and HZNP, whose pricing practices have come under intense scrutiny. Will ALFA rebound in the future? I don’t know. As of today, VRX and HZNP are still two of ALFA’s top 10 holdings, at 3.30% and 2.00% weights, respectively, suggesting that ALFA’s future performance may still be somewhat tethered to the fates of those two specialty pharmaceutical companies. Moreover, note that while ALFA is currently in market-neutral mode, this will change if the S&P 500 manages to remain above its 200-day moving average for one more week, as the end of the month is near.

Another EXG-ETW Pairs Opportunity Presents Itself

Summary Mean reversion in CEFs can be exploited for small gains in portfolio performance. A previous article successfully capitalized on a premium/discount discrepancy between EXG and ETW. The current article identifies another potential opportunity to buy EXG (and sell ETW). Around one year ago, I wrote an article entitled ” Should You Sell ETW And Buy EXG? ” that described a pairs trading opportunity for these two funds. The Tax-Managed Global Buy-Write Opportunities Fund (NYSE: ETW ) and the Tax-Managed Global Diversified Equity Income Fund (NYSE: EXG ) are both global option income close-ended funds (CEFs) from Eaton Vance (NYSE: EV ). The main difference between the two CEFs is that ETW has around 100% option coverage while EXG has around 50% option coverage, with ETW therefore being the more defensive of the two funds. Both funds seek to achieve “current income with capital appreciation through investment in global common stock and through utilizing a covered call and options strategy.” See my previous article for further comparison regarding those two funds. The thesis of the pairs trade was based on the fact that ETW’s discount had narrowed to -3.31% (1-year premium/discount: -7.71%), while EXG’s discount remained high at -8.45% (1-year premium/discount: -8.33%). As was seen in a follow-up article ” Closing The EXG-ETW Pairs Trade “, the discount for ETW had widened from -3.31% to -3.93% while the discount for EXG had narrowed from -8.45% to -5.60%, leading to a gain of ~3% in 6 weeks (~23% annualized). While ~3% over six weeks doesn’t seem much, keep in mind that i) this works out to be ~23% annualized , and ii) this was a “dollar-neutral” trade , in that I merely sold my existing holdings of ETW and used the proceeds to buy EXG, while keeping the total dollar value of the investment constant. Had I held onto the trade for a bit longer, the EXG:ETW pair could have returned even more, up to ~12%. (click to enlarge) The mean reversion of CEF premium/discounts is something that has been documented in the literature (e.g. Patro et al. ). At the same time, a pairs trading strategy reduces risk by making dollar-neutral trades. Indeed, the similarity of EXG and ETW has made the EXG:ETW ratio trade within a tight range of ~10% for the past five years, as can be seen from the graph below. Highs in the graph represent good times to sell EXG and buy ETW, while lows in the graph represent good times to buy EXG and sell ETW. (click to enlarge) Current opportunity The chart above shows that the EXG:ETW ratio has again sank to the lower bound of the trading range. Why has this happened? As can be seen from the chart below, despite tracking each other closely for around ten months since October of last year, there has been a sudden dislocation of the price of the two funds over the past two months. EXG data by YCharts Most of this price disconnect is due to differential premium/discount behavior of the two funds. Over the past 3 months, EXG’s NAV total return was -4.74%, while its price total return was -10.44% (source: CEFConnect ). On the other hand, ETW’s NAV total return was -4.12%, while its price total return was “only” -5.42%. Another way of stating this data is that EXG’s discount has expanded more than ETW’s. EXG has a current discount of -11.08% (1-year average: -6.24%) while ETW has a current discount of -6.70% (1-year average: -5.03%). This means that EXG is more attractive from a valuation standpoint compared to ETW. Note that world stocks (via the iShares MSCI ACWI (All Country World Index) Index ETF ( ACWI)) suffered a 3-month total return of -8.55%, meaning that both EXG and ETW outperformed their benchmark, as would be expected for option-income funds during stock market downturns. The 1-year premium/discount history of EXG is shown below (CEFConnect). We can see that its current discount is at its widest point for the past one year. (click to enlarge) The 1-year premium/discount history of ETW is shown below (CEFConnect). Based on the above analysis, a pairs trading strategy would entail selling ETW and buying EXG. Given that both funds have very similar 5-year average discount values (-9.45% for EXG and -8.90% for ETW), a reversion of EXG’s current discount of -11.08% and ETW’s current discount of -6.70% would allow investors to profit from the trade. Risks In my previous article, I wrote: More defensive funds (the ones with higher option coverages) are getting more expensive relative to the less defensive funds…What could one take away from this? One might infer that market participants are worried about an impending market correction, and are bidding up more defensive option income funds. It appears that the same phenomenon may be happening right now. As ETW has 100% option coverage, it is more defensive than EXG at 50% option coverage. Indeed, in 2011, ETW eked out a positive NAV total return performance of +0.98%, while EXG declined by -3.33%. By comparison, ACWI fell -7.60%. Thus, a risk of this pairs strategy is that if a market correction were to occur, ETW will likely fall less than EXG. Still, the high current discount of EXG does provide a margin of safety whatever happens. Top holdings The top holdings of EXG and ETW as of 7/31/2015 are shown below (source: CEFConnect). EXG Google Inc (NASDAQ: GOOG ) $109.01M 3.49% Ev Cash Reserves Fund 0.12 06 Aug 2015 $67.98M 2.18% Nike, Inc. B (NYSE: NKE ) $64.89M 2.08% Apple, Inc. (NASDAQ: AAPL ) $64.18M 2.06% Exxon Mobil Corporation (NYSE: XOM ) $58.57M 1.88% Home Depot, Inc. (NYSE: HD ) $56.87M 1.82% Roche Holding AG ( OTCQX:RHHBY ) $53.33M 1.71% Walt Disney Co (NYSE: DIS ) $52.62M 1.69% Prudential Financial (NYSE: PRU ) $51.89M 1.66% Medtronic, Inc. (NYSE: MDT ) $51.25M 1.64% Nippon Telegraph and Telephone Corp. (NYSE: NTT ) $50.25M 1.61% ETW Apple, Inc. $62.02M 4.61% Microsoft Corporation (NASDAQ: MSFT ) $36.47M 2.71% Amazon.com Inc (NASDAQ: AMZN ) $25.20M 1.87% Nestle SA ( OTCPK:NSRGY ) $24.41M 1.81% Novartis AG (NYSE: NVS ) $22.71M 1.69% Roche Holding AG $21.95M 1.63% Google Inc $20.61M 1.53% Gilead Sciences Inc (NASDAQ: GILD ) $20.32M 1.51% Fast Retailing Co., Ltd. ( OTCPK:FRCOY ) $19.59M 1.46% Google, Inc. Class A (NASDAQ: GOOGL ) $18.76M 1.39% Comcast Corp A (NASDAQ: CMCSA ) $17.91M 1.33% Summary I really like both EXG and ETW as option-income funds. Over both past 3-year and 5-year periods, both funds have achieved comparable total return performances with ACWI, but with lower volatility, resulting in higher Sharpe ratios compared to the benchmark ETF. Investors who own both EXG and ETW can consider further “juicing up” their portfolio returns by taking advantage of mean reversion in premium/discount values of the two CEFs. The current discount of -11.08% for EXG is more attractive than ETW’s at -6.70%, which suggests that investors could swap existing holdings of EXG for ETW. However, one risk of this strategy is that in a prolonged market correction, ETW will perform better than EXG, being the more defensive of the two funds.