Tag Archives: contests

Why These Funds Are Happy When Energy Players Are Sad

If you believe that breaking a record is always a good thing, you’re actually wrong. For instance, the price of crude has been on a record-breaking mode since mid-June last year. However, every record has been for the worse as oil prices could set only new lows. Last Wednesday, U.S. crude prices fell below the psychologically-resistant level of $40 for the first time since late August. The downward pressure intensified when last Friday the Organization of the Petroleum Exporting Countries (OPEC) – the international cartel of oil producers – decided not to cut oil production especially in the already over-supplied crude market. Obviously, this has spelled doom for investors who chose to hold on to their energy funds or stocks. For example Zacks Mutual Fund Rank #5 (Strong Sell) energy funds such as BlackRock Energy & Resources Inv A (MUTF: SSGRX ) and RS Global Natural Resources A (MUTF: RSNRX ) have nosedived 30.1% and 41.4% over the last one year, respectively. The agony is such that none of the energy funds under our coverage has a positive year-to-date or 1-year return. The least loss has come from Fidelity Select Energy Portfolio (MUTF: FSENX ), which is down 13.4% year to date and 17.7% over the last one year. However, we don’t want to sound too pessimistic as you gear up for your year-end celebrations. Losses in the energy sector can actually translate into gains for some other sectors. While auto and transportation are the direct beneficiaries, sectors such as retail, consumer discretionary and consumer staples also gain from low oil prices. So, investing in and profiting from favourably ranked mutual funds that focus on these sectors will make December merrier. The Recent Headwinds for Oil Last Wednesday, the U.S. government data revealed a 10th straight weekly increase in U.S. oil supplies. The federal government’s Energy Information Administration (EIA) report revealed that crude inventories increased by 1.2 million barrels for the week ending Nov. 27, 2015. U.S. crude inventories are now at the highest level witnessed around this time of the year for the first time in 80 years. As a result, U.S. crude oil prices settled below $40 for the first time since August, while Brent crude oil plummeted to an almost 7-year low. A curb in production from the OPEC was most wanted to lift the already-low crude price. However before the meeting, OPEC decided to raise the ceiling of daily production from the prior level of 30 million barrels to 31.5 million barrels. The cartel was considering an output cut during the 7-hour meeting last Friday, but found that lowering of output only by the OPEC members will not be enough to lift oil prices. Crude plunged to settle below the $40 per barrel mark post meeting. WTI crude slipped nearly 3% to $39.97 per barrel. Oil Price to Move Further South? The slide in the price of crude has been quite dramatic given that it was hovering above $100 around a year ago. Several factors suggest that the end of the slump is nowhere near to be seen. Oversupply has distressed the industry for a long time now. This is due to two factors – the U.S. shale boom and OPEC’s decision to keep output unchanged despite the slump in prices. Lower consumption across the world is the reason for lower demand. Europe and Japan continue to struggle even as they make vigorous efforts to boost their flagging economies. But the biggest worry on this front is China. The world’s second largest economy may never again experience the pace of growth it witnessed until recently, leading to falling demand even in the long term. Funds to Enjoy Crude’s Loss Auto & Transportation: Fuel cost accounts for a considerable portion of expenses of the trucking companies. The U.S. trucking industry is currently poised to benefit in two ways. Lower oil prices will reduce their operating expenditure, thereby boosting the bottom line. On the other hand, capacity constraint in the form of driver shortage and new government regulations will drive top-line growth. A decline in oil prices is probably even more crucial for airlines. Lower jet fuel prices have been a boon for the airline industry given the inversely proportional relation between crude prices and the value of aviation stocks. Fidelity Select Automotive Portfolio (MUTF: FSAVX ) invests a majority of its assets in companies that manufacture, market and sell automobiles, trucks, specialty vehicles, parts, tires, and related services. The non-diversified fund invests in both US and non-US companies, primarily in common stocks. This Fidelity fund currently carries a Zacks Mutual Fund Rank #2 (Buy). Year-to-date, FSAVX has gained just 1.8%, but it is showing an increasing trend since late September. The 3- and 5-year annualized returns are 18.9% and 8.2%, respectively. Consumer Funds: Another class of stocks gaining from this phenomenon is consumer staples. The Federal Reserve has expressed satisfaction over an improvement in the labor market situation. However, its inflation target of 2% still seems some way off. This is again a result of lower oil prices. Lower inflation has led to a considerable fall in input costs. This again would cushion the bottom line. Fidelity Select Consumer Discretionary Portfolio (MUTF: FSCPX ) invests a lion’s share of its assets in securities of companies mostly involved in the consumer discretionary sector. FSCPX primarily invests in common stocks of companies all over the globe. Factors including financial strength and economic condition are considered before investing in a company. FSCPX currently carries a Zacks Mutual Fund Rank #1 (Strong Buy). FSCPX has gained 7.7% and 9.3% over year-to-date and 1-year period, respectively. The 3- and 5-year annualized returns are 18.6% and 14.7%, respectively. Putnam Global Consumer A (MUTF: PGCOX ) invests in mid-to-large companies that are involved in the manufacture, sale or distribution of consumer staples and consumer discretionary products and services. PGCOX uses the “blend” strategy to invest in common stocks of companies. PGCOX currently carries a Zacks Mutual Fund Rank #1. PGCOX has gained respectively 6.3% and 5.3% in the year-to-date and 1-year period. The 3- and 5-year annualized returns are 13.9% and 11%, respectively. Original Post

Employment Triggers A Green Light For A Fed Rate Hike, But…

By Jack Rivkin It’s still a slow-growth environment. Inflation is low. Investors can expect continued performance dispersion. Employment is off the table for the Fed As mentioned in our earlier video blog , the November employment gain of 211,000 combined with the upward revisions totaling 35,000 for September and October certainly took the employment issue off the table as a showstopper for a Fed Funds target rate hike this month. There are very few categories where the actual unemployment rate is above the 5.0% rate for the overall workforce: teenagers at 15.7%, blacks at 9.4%, Hispanics at 6.4%, those with less than a high school diploma at 6.9%, those with only a high school diploma at 5.4%, and I would highlight mining at 8.5% (versus 2.8% a year ago). I would posit that these levels are not the responsibility of the Federal Reserve to deal with. And, what is going on in the mining sector, which includes oil and gas extraction, may have added to the employment roles in other categories as lower energy prices increased both consumption and most companies’ (ex-energy’s) profit margins. The November beige book and the latest JOLTS report point to a tighter labor market with increased difficulty filling jobs and quit rates high, which point toward an increase in wage rates. The Fed does have to look at a tight labor market and make some judgments regarding this ultimate impact on inflation and the pace at which its 2% target is achieved. So what about inflation? The Fed’s preferred measure of inflation is the core personal consumption expenditure (PCE) index. That index is up only 1.3% year-over-year and was actually flat month-over-month in October. The general belief is that the US inflation rate may stay lower longer given the expected slow pace of global economic growth, the strong dollar and continued technological innovation. One cannot ignore the tragic events in Paris and San Bernardino as having an impact – on the margin, of patterns of consumer spending and, possibly, levels. This is likely to keep the Fed on a very slow path of target rate increases extending the runway for slow but steady real and nominal growth. I think this path will be followed until inflation actually picks up. I have some views on the timing of this, which I have been saving for this year’s Perspectives piece “What to Expect in 2016 (and Beyond),” but will provide a preview in a separate blog as a wild card to watch for. And what about the markets? In turn, these economic and financial results will likely produce slow growth – matching nominal GDP – in the US stock market if valuations stay close to current levels. The fixed income markets, on the surface, could also appear somewhat benign with a moderate increase in overall rates. No doubt, the slower pace of growth will produce specific credit issues – certainly in energy, but likely some other entities – but credit overall, may hold up reasonably well. The credit markets, at the moment, would appear to be pricing a broader disaster, particularly in the high yield markets. I think we will see some specific disasters – credit issues, but decent credit analysis can eliminate or reduce the impact. An actively-managed portfolio in high yield could be a logical allocation to a portfolio. Odds are some of the longer term trends in currency, commodities, and relative market performance will continue for a while with some bumps along the way when markets misread central bank actions or statements (à la Draghi) or geopolitical events cause temporary disruptions. So, how should one invest? In the table below, which looks at performance of the S&P 500 over the last several years, an interesting pattern emerges: When the market has been up or down double digits, all one really had to do was either own or sell the whole market. However, when we have experienced single-digit performance for the overall market, much as we are seeing this year, there has been significantly greater dispersion among stocks. This is an environment we expect to continue for some time-slow nominal growth in the economy and the equity markets, leading to dispersion of performance tied to active company management and active investment management. Why do we expect slow nominal growth to persist for several years making active management more important? There are at least four reasons (and I am sure some others): As Eric Peters of One River Asset Management recently reminded us, when the Fed takes action, which is typically designed to reduce the magnitude of an economic decline or surge, it has an effect on future patterns of growth. Easing pulls growth forward, while tightening pushes growth out, reducing the depth of the valleys and the height of the peaks and the distortions in employment and inflation those produce. We have been through an extraordinary pulling forward of future growth and it will take time for us to return to normal. The debt burden incurred by sovereign nations has been and continues to be enormous. If nothing else this will affect fiscal policy as the tool it could be to add to growth opportunities. China’s transition from a global engine for industrial production and consumption to a more internally-focused services economy, combined with the reversal of its own extraordinary steps to offset the impact of the western world recession – just look at the production and pricing of hard commodities beginning in 2009 – will be a damper on global growth for the foreseeable future. This bears watching to see how closely the yuan continues to track the dollar, or if it’s inclusion by the IMF as a reserve currency leads to a tracking of a basket of currencies and a different interest rate regime. Without putting too much weight on it, the “Buffett Rule” – future equity growth is problematic for a number of years when the total market value of equities exceeds the value of GDP – is operative. I discussed this anecdotally in a recent post . In a slower growth environment the likely dispersion of equity returns would push one away from index-hugging strategies toward active managers both long only and long/short managers. We have been suggesting this for a while. We would include private equity allocations in the active long only category if immediate liquidity is less of a need and the attractiveness of a potential illiquidity premium in a lower growth environment is magnified. We have these more active managers in our stable of funds, but others do as well. The key message is to adjust allocations to include more of these active strategies in the portfolio as one looks at the environment ahead. In the fixed income space, while there is risk of rate volatility affecting all debt classes, as big a risk would appear to be more specific credit issues. Does that mean one should be moving up the credit curve? I think the answer is in part, “yes.” But, the preferred way to do that would be similar to the approach on equities: Look for active managers – not benchmark huggers – who are analyzing specific credits and taking advantage of the homogenization of yields that comes from index buying and selling. The high yield index is offering a fairly significant yield spread over treasuries – very tempting as a category. But, just remember that around 18% of that index is in energy and hard commodity bonds. As shown below, the rest of the index, while at lower yields, is at spreads we haven’t seen for almost three and a half years. Historically, in a different energy regime, the rest of the index used to trade at higher spreads than oil and metals. At this stage, I would rather have someone looking at individual securities making up a diversified portfolio where the detailed analyses show relatively lower credit risks in the environment we foresee. Who knows? There may even be some energy credits that are worth holding but have been tarred by association. We see that in our own portfolios. There are certainly some credits in both high yield and investment grade where the credit default swaps don’t fully reflect the degree of risk at this stage. I want managers who are running portfolios where they can tell me the precise nature of the balance sheets of their individual holdings and the risks associated with the businesses. This is different from what has been required previously. One should not ignore the uncorrelated strategies, particularly systematic trend following. There are some long-term trends in place. While there are likely to be occasional reversals – some of which could turn into more permanent moves, I would rather use these managers to recognize the patterns and determine which foreign exchange, commodity, equity and fixed income indices should be included, negatively or positively, in the portfolio at any given moment in time given the environment we are facing. Allocations need to change It is hard to determine in isolation what the allocations in a specific portfolio should be. That requires a discussion. I know the allocations to active strategies should be higher. As I have been saying, past performance may not be the best guide for the future as opposed to a realization of a different pattern of future returns and an understanding of the volatilities and risks that exist in the environment we foresee. It is a less easy environment, with lower overall returns, but possibly a broader set of opportunities to meet one’s specific goals.

Smart Beta Vs. Ben Graham

Summary “Smart Beta” and systematic investing strategies have become wildly popular in recent years. The trend has largely been driven by technological improvements and positive feedback loops. There are risks to systematic investing that must be acknowledged. Most importantly, systematic investors must acknowledge that stocks are not pieces of data, probabilities, or bets. They are legally, tangibly, and truly ownership interests in businesses. The Rise of Systematic Strategies According to Investopedia , “smart beta” was the most searched for financial term of 2015. Smart beta funds and ETFs are popping up all over the place. According to CNBC (emphasis mine) : As of June [2015], there were 444 strategic/smart beta ETFs in the market managing about $450 billion , according to Morningstar data. That’s up from 213 funds managing $132.5 billion in assets in 2009. They now account for 21 percent of all exchange-traded products and about 31 percent of all cash currently flowing into the industry . Anecdotally, fund companies like Gerstein Fisher (MUTF: GFMGX ) that have employed smart beta-like strategies for decades have suddenly seen a pouring in of assets. Before we go any further, what is smart beta? Investopedia defines it as follows: Smart beta defines a set of investment strategies that emphasize the use of alternative index construction rules to traditional market capitalization based indices. Smart beta emphasizes capturing investment factors or market inefficiencies in a rules-based and transparent way. The increased popularity of smart beta is linked to a desire for portfolio risk management and diversification along factor dimensions as well as seeking to enhance risk-adjusted returns above cap-weighted indices. It is a very general marketing term to describe (1) passive strategies (no active individual security selection) that (2) construct portfolios using weighting methods and metrics other than market capitalization weighting. Traditional indices are market weighted, and this has been observed to be detrimental to performance compared to equal weighting or fundamental-based weighting. By weighting, I mean the size of each position in the portfolio. An example of smart beta would be taking the 500 stocks in the S&P 500 (NYSEARCA: SPY ), but instead of assigning weights based on the market capitalizations (ex: Apple (NASDAQ: AAPL ) would be ~3% of the portfolio), you could weight the portfolio by LTM net income. For the purposes of this article, I’m more interested in smart beta for the general strategy and secular shift it represents – a shift toward systematic investment strategies that aren’t indexing, but aren’t individual security selection either. Outside of “smart beta” specifically, systematic strategies in general have become very popular. The success of Michael Covel’s Trend Following products and books, Tobias Carlisle’s The Acquirer’s Multiple product and books, Wesley Gray’s Alpha Architect , Joel Greenblatt’s Magic Formula and Gotham Funds (MUTF: GARIX ), etc. are evidence of this. What about the most popular investing blogs? Abnormal Returns , Pragmatic Capitalism , A Wealth of Common Sense . All these blogs have a systematic/passive bent. It seems to me that in the last year or two, systematic, rules-based strategies have become enormously popular. Maybe I didn’t have my eyes open before then, but now I can’t seem to avoid this stuff. Why? Technology. The rise is largely the result of technological improvements. Systematic strategies are fundamentally empirical. They require historical data and a backtest to answer the question “What’s worked in the past?” Technological improvements have made this possible. It’s now very easy to run a backtest on a Bloomberg terminal. More serious backtesters can use the extensive databases of Compustat and UChicago’s Center for Research in Security Prices (CRSP). And this feeds on itself, because people who do the research and backtests often publish their results, which are then used by other investors. So, more and more people have various answers to the question mentioned above and, naturally, more desire to do something with it. The other question: Is there a way we can run this strategy without human interference – fully automated? This is important because it’s difficult to manually follow a systematic strategy that involves purchasing hundreds of securities at potentially very short intervals, calculating weights, etc. It’s just not that feasible to do it manually. Technological improvements have made this feasible as well. I’m not so sure I understand the specifics of how this is done, but clearly, if hundreds of firms are doing it at much lower expense ratios than traditional actively-managed funds, there is automation involved. And this feeds on itself too. Once a fund/ETF has figured out how to do it, other investors can just buy into that ETF to participate in systematic investing. Personal Reflection This all is reflected in my recent articles and the evolution of my investment strategy. Being exposed to all of this has deeply influenced me. I also think, as I mentioned in a prior article, beginning to playing poker (a deeply probabilistic game) has had a significant impact. I’ve begun sourcing stocks using screens filtered by metrics that outperform, like EV/EBIT. I’ve begun taking small starter positions or bets, and looking at aggregate performance instead of performance by position. Put simply, I’ve begun to think of investments as bets and the future probabilistically. I’ve become empirical. Risks There is a lot of good in this transition, but I’m realizing now that it is dangerous if taken too far. Historical data is great, but there are risks to it. One is data mining, which I discussed in my article on stock screening. It’s worth googling “Butter in Bangladesh.” Then, there’s execution risk. What if your technology is flawed? What if there’s a power outage or you experience a data breach a la Target (NYSE: TGT )? What if you override the system at all? Joel Greenblatt points out that when he and his colleagues tried to source from Magic Formula without buying all the stocks on the list, the performance of the stocks they picked actually underperformed the market despite MF in aggregate outperforming, because they tended to avoid the biggest outperformers. They were the hairiest, and that’s why they performed so well. What if the markets change? The predictive power of metrics like P/B, which Fama and French articulated decades ago, has greatly diminished since. Past performance does not predict future performance. This is particularly important given the shift toward systematic strategies. The more popular these strategies get, the quicker the excess returns will be arbitraged away. Don’t assume you can stick to it either. It’s great looking at 50 years of data and seeing that over that period, the strategy has substantially outperformed the S&P, but that doesn’t mean there weren’t extended periods of substantial underperformance. In fact, most studies point out these spots of underperformance. One of my favorite quotes by Ben Carlson is this: The advice is to think and act for the long-term, which sounds great on paper, but the problem is that life isn’t lived in the long-term, it’s lived in the short-term… The problem is not the knowledge, it’s the behavior. Quitting smoking is not hard because people don’t know it’s bad for them, it’s hard because it’s habitual and it’s hard to change those bad habits. If you employ a systematic strategy, it’s because you think it will perform better than something else (most likely S&P 500) in terms of return, drawdown, etc. Naturally, you’ll be prone to comparing the performance of the strategy to that benchmark fairly frequently, and it will be difficult to see that it is performing worse over an extended period and still stick to it. To make this point more tangible, let’s use an example. You implement traditional Magic Formula (30 stocks, equal weight, annual rebalancing) with the expectation that your annual returns will substantially exceed the S&P 500. 4 years into implementation, you’ve underperformed in every single year (very possible) and cumulatively, the S&P 500 is up 15% annually and you are only up 8% annually. Unlike a fundamental research-driven active investor, you can’t explain this away with mistakes (“My current investment strategy works, I’ve just made mistakes and bad decisions along the way. My strategy is improved now and I’m more knowledgeable and experienced. I’ll do better going forward.”) The only thing you can do is question whether the selection criteria you are using still work. You only have four more years of data – data that disproves your initial hypothesis. That’s it. On top of that, clients and peers are badgering you about it. Surely, it’s difficult to stick to the strategy. Moreover, even if you want to stick to the strategy, there’s a good chance your clients don’t and they pull their money. At this point, you’ve stopped using the strategy at the worst time possible and managed to achieve underperformance with a strategy that has outperformed in the past and will likely outperform in the future. Stocks are Ownership Interests in Businesses I don’t mean to say that the empirical evidence is not compelling. It is. Some of these backtests encompass many decades and market cycles. Carlisle and Gray’s backtests in Quantitative Value are over 50 years. I also don’t mean to say that completely systematic strategies can’t work in practice. They can. The best example is probably Jim Simons’ Renaissance Technologies. The flagship Medallion fund did 72% annual returns before fees over a 20-year period from 1994 to 2014! What I am saying is that I don’t think a completely empirical approach to investing is sound, at least for me. There are too many things that can go wrong if we just leave it at this. Ultimately, stocks are ownership interests in businesses, not probabilities or bets. Maybe stocks can be thought of as probabilistic bets as a working assumption for a strategy, but that’s not what they actually are. A stock is legally, tangibly, and truly an ownership interest in a business. Ben Graham said this decades ago, and Buffett has singled it out as one of the 2-3 most important concepts to be learned from Graham. I think a much more sound approach to investing for empirically-driven, systematic investors is an upfront acknowledgement that goes something like this: Stocks are ownership interests in businesses. Stocks increase in price when the value of the underlying business increases or when there is a gap between the price of the stock and the value of the business and that gap closes. That is what is actually happening. As an investor, I have the opportunity to look at individual stocks and try to buy those whose prices do not fully reflect what the value of the underlying business is or will be. However, there is a wealth of data from historical markets that can be used to systematically identify these types of attractive situations. I feel, for various reasons, that these historical relationships are compelling and will continue to be. I also feel that I will be more successful as an investor using these systematic shortcuts than I would be if I tried to identify individual cases of undervaluation manually. The bottom line is that no matter who you are or how you invest, you need to acknowledge stocks for what they really are: ownership interests in businesses.