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Despite The Market Rout, U.S. Fund Investors Pull Out Just $5.5 Billion For The Week

By Tom Roseen During the fund-flows week ended August 26 world markets were whipsawed by concerns of slowing global growth, the devaluation of the Chinese yuan, fears about China’s slowing economy, and the continuing plunge of commodity prices. Oil prices slid below $40/barrel for the first time since February 2009 as a result of a decline in global demand and a glut in oil supply. An early measure of China’s factory activity declined to a six-and-half-year low in August, putting additional pressure on the market. As a result the CBOE Volatility Index (VIX) jumped almost 99%-from 15.25 on Wednesday, August 19, to 30.32 on Wednesday, August 26 (but down from a closing high of 40.74 on Monday, August 24), after the main indices posted their largest weekly declines in four years. During the week the U.S. broad-based indices were down at least 10% from their recent market highs, entering what many define as a market correction. At one point on Monday the Dow Jones Industrial Average declined more than 1,000 points before bouncing back slightly, but it still closed down 588.47 points (3.6%) for the day (its largest one-day percentage decline since August 2011). Despite the People’s Bank of China’s cutting its benchmark interest rate 0.5 percentage point on Tuesday and injecting 150 billion yuan into the financial system to prop up China’s market, the Shanghai composite lost 22.85% during the flows week. Nonetheless, on Wednesday U.S. stocks broke a six-day losing streak and witnessed their largest one-day gain in nearly four years as investors pushed stocks higher on news of the PBOC’s new easing efforts, better-than-expected economic news, and comments by New York Fed President William Dudley that the case for a rate hike in September is less compelling, given the volatility in global markets. As one might expect, given the meltdown in the global markets, fund investors were net redeemers of fund assets (including those of conventional funds and exchange-traded funds [ETFs]); however, they redeemed only a net $5.5 billion for the fund-flows week ended August 26, 2015. Investors redeemed some $17.8 billion from equity funds, $2.6 billion from taxable bond funds, and $345 million from municipal bond funds, but they were net purchasers of money market funds, injecting $15.2 billion for the week. For the first week in three equity ETFs witnessed net outflows, handing back $15.2 billion (their largest amount since the week ended August 6, 2014). With concerns about a slowing global economy, authorized participants (APs) were net redeemers of domestic equity funds (-$10.4 billion), withdrawing money from the group for a sixth consecutive week. They also redeemed money from nondomestic equity funds (-$4.9 billion) for the first week in four. Given the selloff in domestic equities, APs turned their attention to the beleaguered small-cap space and safe-haven plays, with the iShares Russell 2000 ETF (NYSEARCA: IWM ) (+$467 million), the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ) (+$342 million), and the SPDR Gold Trust ETF (NYSEARCA: GLD ) (+$333 million) attracting the largest amounts of net new money of all individual ETFs. At the other end of the spectrum the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) (-$4.3 billion) once again experienced the largest net redemptions, while the SPDR Dow Jones Industrial Average ETF (NYSEARCA: DIA ) (-$1.0 billion) suffered the second largest redemptions for the week. For the second consecutive week conventional fund (ex-ETF) investors were net redeemers of equity funds, redeeming $2.6 billion from the group. Domestic equity funds, handing back $1.4 billion, witnessed their seventh consecutive week of net outflows. Meanwhile, their nondomestic equity fund counterparts witnessed $1.2 billion of net outflows-handing back money for the first week in six. On the domestic side investors lightened up on mid- and large-cap funds, redeeming a net $0.5 billion and $0.4 billion, respectively, for the week, while equity income funds attracted some $0.7 billion of net inflows. On the nondomestic side international equity funds witnessed $1.0 billion of net outflows, while global equity funds handed back $0.2 billion. For the fifth week in a row taxable bond funds (ex-ETFs) witnessed net outflows, handing back a little less than $4.7 billion (their largest weekly outflows since the week ended August 5, 2014). Corporate investment-grade debt funds suffered the largest net redemptions, witnessing net outflows of $2.2 billion (for their fifth consecutive week of redemptions), while government-mortgage and government-Treasury & mortgage funds were the only fixed income groups attracting net new money for the week, taking in $452 million and $270 million, respectively. For the fourth week in five municipal debt funds (ex-ETFs) witnessed net outflows, giving back $406 million this past week.

These Country ETFs Benefit From Oil Rebound

It’s truly been a roller-coaster ride for oil. The liquid commodity plunged to a six-and-a-half year low at the start of the week only to record the highest single-day gain in over six years to end the week. While pockets of weakness in most global superpowers including the Euro zone, China and Japan have resulted in weaker activities and weighed on crude oil prices so far, the recent rout in the Chinese market following its currency devaluation and grave economic situation slaughtered the already weak oil prices (read: 4 Ways to Short the Energy Sector with ETFs ). However, after a week-long losing streak, jittery investors worldwide saw some relief on Wednesday as China slashed rates to boost its economy and repeatedly intervened into the stock market to contain the relentless slide. Also, hunt for bargain took center stage. To add to this, the U.S. economy grew at 3.7% in Q2, which breezed past the initial reading of 2.3% growth and 0.6% expansion recorded in the seasonally weak Q1. A strong rebound in the U.S. economy, which is in fact the world’s largest economy, ruled out the demand-related fear out of the oil space. Plus, as per the American Petroleum Institute (API) crude stock piles declined by 7.3 million barrels in the week ending August 21,whcih is way lower than analysts’ projection of a rise of 1.9 million barrels in crude inventories. This overall bullish sentiment showered massive gains on oil prices on August 27 as oil advanced around 10%. Both WTI and Brent crude benefited from this unexpected surge. As a result, key oil producing and exporting countries that were on a downtrend so long, saw a sharp rise on Thursday trading. As we all know, ETFs offer a great opportunity while it comes to playing a particular nation. In light of this, we have highlighted a few country ETFs that could see a turnaround in the days ahead should oil price continue to rise ( see all energy ETFs here). Market Vectors Russia ETF (NYSEARCA: RSX ) Things have been pretty tough for Russia for last one-and-a-half year. If the tussle between Russia and the West on the Ukraine issue bothered the country, oil – seemingly the main commodity of the nation – posed further risks to its economy (read: 3 Russia ETFs at Bargain Prices Right Now ). RSX is the most popular and liquid option in the space with an asset base of $1.6 billion and average trading volume of more than 11 million shares a day. The fund tracks the Market Vectors Russia Index to provide exposure to the Russian equities. The energy sector accounts for about 43% of RSX with Gazprom and Lukoil – the Russian energy giants – taking more than 15% share of the fund. RSX charges 63 basis points as expenses. The fund was up 6.7% on August 27. iShares MSCI Malaysia Index Fund (NYSEARCA: EWM ) The Malaysian equity market has been also been a weak spot lately as its neighboring country China devalued its currency in mid August. Also, falling oil price hurt the stocks of the oil-rich Malaysia, which happens to be one of the largest Asian crude exporters. Political crisis is another cause of concern for Malaysia (read: 3 Country ETFs Impacted By China Currency Devaluation ). The $256 million-fund EWM looks to track the performance of the Malaysian equity market. EWM charges investors 48 basis points a year in fees and was up 5.2% on August 27 both on oil price recovery and the return of risk-on trade sentiment into the market. iShares MSCI UAE Capped ETF (NASDAQ: UAE ) Oil-rich OPEC nations (Organization of Petroleum Exporting Countries) must be the big beneficiary of this sudden surge in oil. UAE is such a country. The fund provides exposure to 32 stocks by tracking the MSCI All UAE Capped Index. The ETF has accumulated $27.5 million in AUM so far while charging investors 62 bps in annual fees. Volume is paltry trading in about 15,000 shares a day on average. The fund returned 5.5% on August 27. Another OPEC nation Qatar also got mileage out of this jump. Its pure play ETF, MSCI Qatar Capped ETF (NASDAQ: QAT ) soared 8.1% yesterday while yet another Middle East fund Market Vectors Gulf States Index ETF (NYSEARCA: MES ) added over 4.7%. iShares MSCI Canada ETF (NYSEARCA: EWC ) Canada is also among the world’s top 10 oil producers. The best way to invest in Canada is through iShares MSCI Canada ETF, a product that has nearly $1.88 billion in assets. The fund tracks the MSCI Canada Index, holding just under 100 stocks in its basket. Although financials takes the top spot at about 40%, energy makes up a huge chunk of assets accounting for about 20% of the total. The fund gained over 3.6% on August 27, 2015. EWC charges 48 bps in fees. Original Post

The Sky Seems To Be Falling. What Now?

Summary Understanding portfolio risk in the context of net worth. Assessing the cause of current distress. Discussing what to do in times of distress. Every successful investor should have a good idea of his asset allocation and risk tolerance in order to manage active market exposure accordingly. I consider an affluent investor with 40% net worth in real estate, 40% in an actively managed portfolio, and 20% in cash and other liquid assets to be prudent and well balanced. But in times of distress like the past few days, the actively managed portfolio becomes the center of focus. Understanding portfolio risk in the context of net worth I find volatility of a portfolio best describes its risk. Most commonly used volatility is in fact the annualized standard deviation of portfolio returns on a daily or monthly basis. I personally run an enhanced equity portfolio with roughly 30% volatility, which is about twice of the S&P 500 index volatility, and has generated about 40% annualized returns in the last six years. Assuming returns are normally distributed, an easy way to quantify 30% volatility is the following: With 68.2% probability, the annual portfolio return will be in the range of up +30% and -30%; With 13.6% probability of each, the annual portfolio return will be between +30% and +60% or between -30% and -60%; With 2.3% probability of each, the annual portfolio return will be up or down more than 60%. As you can see, with volatility of an actively managed portfolio at 30%, the chance of a significant drawdown within a year is still fairly high. However, keep in mind, you ought to view your net worth as a whole when determining risk tolerance. With the portion of an actively managed portfolio at 40% of the net worth, assuming other assets are relatively stable, the actual volatility of your net worth is only 12%, significantly lower than viewing the active portfolio as an isolated entity. We all enjoy upside volatility, but sporadic downside volatility is fair play. Most market participants are prepared to endure such risk in search of long-term profitability. Assessing the cause of the current distress I believe the current selloff has sentimental, rather than fundamental, drivers. Aside from some weakness in the Chinese economy, the global economy is tracking reasonably well with Europe finally starting to emerge from the shadow of sovereign debt crisis. However, U.S. equity markets had sustained several years of stellar performance without correction. Wary of the sustainability of global growth, investor sentiment was gradually shifting towards the defensive side. At this point, it is difficult to assess whether the selloff was triggered by the nearing of Federal Reserve rate hike, or by the recent yuan devaluation by the People’s Bank of China. In addition, the Chinese government’s inability to stem losses in the equity market casts doubt on its ability to navigate through the current softness in its economy. The selling accelerated through the negative feedback loop in various markets. It is most likely an aberration, rather than the start of a bear market. It may take a few weeks for the markets to work out the kink. Investors are also eagerly anticipating what and when central banks’ next moves will be. Meanwhile, doing nothing is not the best course of action. Don’t panic, let’s discuss what to do in times of distress 1) Assessing portfolio risk Evaluate your portfolio and determine if you have too much risk exposure. If you do have too much risk, a straight-forward action is to cut positions proportionally across the board. Even if your exposure is on target, it may make sense, in times of distress, to take some chips off the table in case the selloff intensifies. Keep the powder dry and wait to add back the exposure at more attractive levels. 2) Hedging with equity index futures Even though it is often wise to hedge actively managed portfolios with correlated index options to extract alpha, it is typically not feasible in distress, simply because the elevated implied volatility makes purchasing options cost prohibitive. At one point, the implied VIX touched 50% during the session on Monday, while it traded mostly between 12.5% and 25% over the past few years. Index put spreads may be a possibility as we will discuss below. However, if you don’t have time to do a detailed portfolio analysis, and feel there is too much risk, you can immediately take some market risk out of your portfolio by shorting, say, S&P e-mini futures. Each e-mini has a notional size of close to $100,000, shorting 10 e-minis will take out close to $1,000,000 long market exposure from your portfolio. This method is extremely helpful during potential market bounce after the selloff, especially if you are not convinced of its short-term sustainability of the rebound. It would have worked perfectly during the 4% bounce this morning (Tuesday). 3) Hedging with high-beta names During the selloff of the last few days, high flyers such as Netflix (NASDAQ: NFLX ) and Tesla (NASDAQ: TSLA ) started to show cracks. What goes up a lot could come down hard in a selloff as many momentum chasers will be the first ones to liquidate their portfolios. This makes high flyers the perfect candidates for portfolio hedges. Nevertheless, shorting high flyers could expose you to unquantifiable risk. It is not for the faint of heart. However, buying put spreads on high-beta names could be an attractive way to hedge the overall exposure in the portfolio. An example today is: Buy NFLX Sept 18 $100-strike put for $7 each; Sell NFLX Sept 18 $85-strike put for $3 each. You pay $4 for this put spread, and it is the maximum you can lose; but you could make $11 if NFLX is below $85 at the option expiry on September 18. Although the implied volatility for the higher strike option is likely inflated, the implied volatility of the lower strike option should be even more elevated due to the “skewness” (email me if you want to learn more about this) of the option. If you are proficient in options, you may also sell Sept 4 $90-strike put instead and roll it forward on or near September 4 for more flexibility in assessing on-going market conditions. 4) Treating distress as a godsend in re-allocating portfolio We all have companies we follow and wish owning them at cheaper prices. You know what, now is the time! In times of distress, company stocks are often sold indiscriminately by agitated investors, creating incredible buying opportunities. Use some of your dry powder and dip your toe in the water to acquire a few quality names. Better yet, sell some losers in your portfolio and pick up a few winners on fire sale. It will certainly pay off when markets return to normal. Disclosure: I am/we are short NFLX, TSLA. (More…) 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.