Tag Archives: etfs

Low-Beta Funds For Safety Amid Fears Of Downturn

In spite of registering this year’s best gains last week, the benchmarks remained deep in the red due to volatility in oil prices along with weakness in global and domestic growth. The Dow, the S&P 500 and the Nasdaq are down 5.7%, 6% and 10.1% in the year-to-date frame. In this erratic market, low-beta funds, which provide a better understanding on volatility or the systematic risk of a portfolio in comparison to the broader market, may turn out as safer investments. Meanwhile, low-beta funds from broader categories like utility, precious metals and municipal bonds that are performing well this year despite an overall negative tone, may offer healthy returns with low associated risk. Surging Volatility The CBOE Volatility Index (VIX) – considered the most popular fear gauge – has surged 15.2% in the year-to-date frame and is hovering around 20, indicating fears of a downtrend among investors. Investopedia defines VIX as “a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.” VIX also increased 11.2% and 13.1% over the past five days and in the trailing one-month period, respectively. The deep plunge in oil prices with short-lived spikes has been troubling investors since the start of 2016. Despite several indications, the major oil producers failed to take a bold step in reducing output and thus left a negative impact on oil prices and the broader markets. Moreover, the growth condition in major economic zones including the U.S., China and Eurozone appears bleak. And if these weren’t enough, the recent slump in global financial stocks added to investors’ worries. Why Low-Beta? Generally, there are five indicators of investment risks, namely alpha, beta, r-squared, standard deviation and the Sharpe ratio. Among these, beta is a popular tool to measure the level of volatility in a mutual fund in contrast to the broader markets. “Essentially, beta expresses the fundamental tradeoff between minimizing risk and maximizing return,” according to Investopedia. Therefore, when the major benchmarks are facing a high level of volatility, investors may seek low-beta funds to minimize the risk level in their investments. Now, the question is: what is the range of low beta? Beta ranging from 0 to 1 is generally considered low beta as funds falling in this range will show less volatility than the broader markets. While negative beta indicates an inverse relationship with the broader markets, beta equal to 0 signals no relationship at all. Beta with a minimum value of 1 indicates that the fund will experience the same or a higher level of volatility than the broader markets. 3 Low-Beta Funds from Winning Sectors Low-beta funds from sectors with a safe-haven appeal are favorable in an unstable market. This is why precious metals – especially gold- utilities and municipal bonds are enjoying a dream run since the start of this year. We present three mutual funds from the above-mentioned sectors that carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or #2 (Buy) and have beta within 0 to 1. We expect these funds to outperform their peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on the likely future success of the fund. These funds have steady three-month and year-to-date returns. The minimum initial investment is within $5000. Also, these funds have a low expense ratio and no sales load. Precious Metal Fund After experiencing a rough patch for three years, mutual funds having significant exposure to securities related to gold made a strong rebound this year by virtue of their safe-haven appeal. The American Century Quantitative Equity Funds Global Gold Fund Inv (MUTF: BGEIX ) seeks total return. BGEIX invests in securities of global companies whose operations are related to gold or other precious metals. The fund invests the lion’s share of its assets in companies involved in processing, mining, fabricating and distributing gold or other precious metals. BGEIX currently carries a Zacks Mutual Fund Rank #2 and a 3-year beta of 0.33 against the standard index. The fund has three-month and year-to-date returns of 30% and 30.3%, respectively. The annual expense ratio of 0.67% is lower than the category average of 1.44%. Utility Fund Utility is prospering this year thanks to the safety it offers. The broader utility sector, which has added 8.1% in the year-to-date frame, is the biggest gainer among the S&P 500 sectors. Also, dimming prospects of an immediate rate hike gave a boost to this sector, which requires a high level of debt. American Century Utilities Fund Investor (MUTF: BULIX ) invests a large portion of its assets in equities related to the utility industry. BULIX’s portfolio is constructed on qualitative and quantitative management techniques. In the quantitative process, stocks are ranked on their growth and valuation features. The fund currently carries a Zacks Mutual Fund Rank #1 and a 3-year beta of 0.36 against the standard index. The three-month and year-to-date returns of BULIX are 8.5% each. The annual expense ratio of 0.67% is lower than the category average of 1.25%. Municipal Bonds Fund Municipal bond funds are attracting healthy investments since the start of this year. According to Lipper, these funds witnessed a net inflow of $669 million in the week ended Feb 17, preceded by an inflow of $940.7 million in the prior week. Russell Tax Exempt Bond Fund (MUTF: RTBEX ) seeks tax-exempted current income. RTBEX invests the major portion of its assets in securities that are expected to provide income free from federal income tax. The fund primarily focuses on acquiring municipal debt obligations that are rated as investment grade. RTBEX currently carries a Zacks Mutual Fund Rank #2 and a 3-year beta of 0.69 against the standard index. The three-month and year-to-date returns of RTBEX are 2.4% and 1.6%, respectively. The annual expense ratio of 0.78% is lower than the category average of 0.81%. Original Post

ETF Product Development: Innovation Versus Over-Engineering

ETF Product Development: Innovation Versus Over-Engineering Source: Wiki Commons ETF Product Development: When Innovation Turns into Over Engineering This quarter’s volatility has produced some early victims, notably some high profile hedge funds and quantitative market-neutral based strategies . As a former quantitative equity portfolio manager, I lived through the infamous August 2007 Quantitative Meltdown , where highly levered strategies using a combination of value and momentum were forced to liquidate all at once causing significant losses tied to what had been historically strong performing strategies. With this quarter’s sharp underperformance of similar strategies, the concern floating out amongst trading desks is whether we’re seeing another forced unwind of such strategies, particularly ones focused on price momentum, which had been one of the better performing strategies in recent periods. In discussions with a handful of capital market desks, I don’t get the sense that there is as much leverage employed today as there was in 2007, but one never knows until the counter-trend unwind exhausts itself. In some ways, the August 2007 Quant Meltdown served as an early warning signal of the fragility of capital markets resulting in the Great Financial Crisis of 2008. Much has been written about this period (and more recently in film, such as The Big Short ), but I highly recommend reading a Demon of Our Own Design written by Richard Bookstaber, who formerly headed firm-wide risk management at Salomon Brothers. In a nutshell, Bookstaber maintains that a system designed with ‘complexity’ and ‘interdependence and tight coupling’ is prone to normal accidents, whether nuclear power plants or leveraged financial vehicles tied to the performance of subprime mortgage-backed derivatives. It’s a cautionary tale particularly for Wall Street whose lifeblood is tied to increasing innovation that can quickly mutate into over-engineering. Complexity when combined with leverage leaves the financial markets more prone to liquidity-driven accidents and contagious selling of unrelated market segments. Correlations spike to one where diversification no longer matters as long as the investment program is only invested in safe assets. ETF Innovation: Know What You’re Buying Becoming Increasingly More Difficult This quarter’s market-neutral meltdown partly inspired this blog post, but it was primarily due to an analysis of a recently-introduced multi-strategy ETF designed to provide U.S. equity market exposure but with lower volatility and greater risk-adjusted returns. First, ‘smart’ beta (factor) investing is not ‘smart’ at all but just a reformulation of the Dimensional Fund Advisors’ (DFA) strategy of investing in areas of the market which have afforded higher risk premia over the long run. ‘Small cap’ and ‘value’ factors outperform over the market because they come with higher risks which investors are compensated for over the long run – these factors are no ‘smarter’ than a traditional market-cap based approach such as the S&P 500. Corey Hoffstein from Newfound Research published a recent piece on ETF.com in which he makes this astute observation about smart beta investing: “It is important to point out that for the long-term premiums to exist in these factors, they must be volatile over time. The excess return generated by one investor is at the detriment of another. If the returns were not time-varying, they would be viewed as “free.” In that case, there would be significant money inflow into the style, driving up prices and valuations and driving down forward expected returns until the premium converged to zero. Quite simply, volatility in the premium itself causes weak hands to fold, passing the premium to the strong hands that remain . [Underline Emphasis Added by 3D]” Smart beta investing is not a free lunch but one with real risks involved, such that the largest harvests of risk premia occur when weaker investors are bailing out at just the wrong time. Now ETF product innovation is a good thing as it has afforded investors access to market segments and themes only available to institutional investors. ETF product innovation has captured the systematic elements of many actively-managed strategies and has helped expanded the list of options to DFA like-minded investors who no longer wish to be constrained to the Fama/French 3-factor world. But new entrants to ETF sponsorship along with more participation from institutional investors has resulted in a new cycle of product innovation characterized by increased complexity. ‘Dynamic’ management of market exposures represents the latest innovation. Rather than providing a static exposure to, say, currency hedging, the ETF sponsor implements a rules-based dynamic hedging scheme designed to generate superior risk-adjusted performance over a static hedged or fully unhedged equivalent. The chase for ‘dynamic’ management introduces a new layer of complexity into the underlying exposure an ETF is designed to achieve. This brings us back to an analysis of a recently-launched ETF whose objective is to generate superior risk-adjusted returns over traditional asset classes through a combination of long and short positions where the short exposure is dynamically managed. Consider the components: ‘Long’ position weightings are based on a multi-factor approach combining value and growth metrics. The long weighting is further adjusted for its volatility characteristics (lower volatility stocks receive an incrementally higher weighting). The short exposure is designed to hedge out equity market risk. It is implemented using short S&P equity futures. These same value and growth metrics are used to determine the hedge ratio where the ETF can be 0%, 50%, or 100% hedged to market risk. Some variants of this approach provided by other ETF sponsors use a separate top-down business cycle indicator to determine the hedge ratio or base the hedge ratio on momentum-driven technical analysis. Now consider the complexity embedded in this approach as well as the interlocking dependencies making it more vulnerable to the type of accidents of the kind found in Bookstaber’s narrative. The ETF investor must ask, “What exposure am I ultimately buying with this ETF?” It is not a straightforward answer because the exposure is contingent on how this ETF is positioned given the latest market conditions. In addition, multiple things have to go right in order for this ETF to achieve its objective. The choice of factors must be correct. How the factors are mixed and weighted must be correct. The hedge ratio must be correct (market timing is an historically dubious exercise). But what ultimately is this ETF trying to achieve? It’s trying to achieve that elusive equity market free lunch – high capital market returns associated with equity investing but without as much risk. But that sort of objective flies in the face of capital markets pricing theories and would be expected to achieve the opposite, namely lower risk-adjusted returns when you factor in the ETF’s complexities and underlying fees. Many aspects of this strategy would have to perform consistently well in order for the ETF to achieve its objective, whereas, the failure of just one aspect can result in underperformance or an accident (especially if it were combined with leverage). When it comes to strategic beta or complex ETFs, it is imperative to know what you’re buying and why you’re buying it. Ask yourself, “What is this ETF designed to achieve and how does it fit within your asset allocation?” If simpler solutions are available to achieve a similar objective, then opt for simple over complexity. Product innovation is welcomed to a growing marketplace, but it a balance must be struck between innovation and system complexity. That is the elegance of design. 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. Additional disclosure: The above is the opinion of the author and should not be relied upon as investment advice or a forecast of the future. It is not a recommendation, offer or solicitation to buy or sell any securities or implement any investment strategy. It is for informational purposes only. The above statistics, data, anecdotes and opinions of others are assumed to be true and accurate however 3D Asset Management does not warrant the accuracy of any of these. There is also no assurance that any of the above are all inclusive or complete. Past performance is no guarantee of future results. None of the services offered by 3D Asset Management are insured by the FDIC and the reader is reminded that all investments contain risk. The opinions offered above are as of February 22, 2016 and are subject to change as influencing factors change. More detail regarding 3D Asset Management, its products, services, personnel, fees and investment methodologies are available in the firm’s Form ADV Part 2 which is available upon request by calling (860) 291-1998, option 2 or emailing sales@3dadvisor.com or visiting 3D’s website at www.3dadvisor.com.

Financial Stress Index Is Screaming, ‘Bear Market Rally’

What if investors had a way to determine the extent of “stress” in the financial system? And what if those stress levels could tell investors whether or not riskier assets (e.g., stocks, higher-yielding debt, etc.) can succeed without definitive U.S. Federal Reserve intervention? Consider the Cleveland Financial Stress Index (CFSI). The CFSI monitors the well-being of a wide range of financial markets, including credit, equity, foreign exchange, funding, real estate and securitization. According to the Cleveland Fed, a CFSI reading greater than 1.855 represents the highest threat level to the financial system. We’re sitting at 1.91. Click to enlarge Both the Asian Currency Crisis in 1998 and the eurozone Debt Crisis in 2011 wreaked havoc on the typical U.S. stock. Small company shares, mid-sized company shares as well as shares of the average large company declined 20%-30%. On the other hand, when the popular market cap-weighted Dow and S&P 500 barometers approached the 20% bear market line in those crises, the U.S. Federal Reserve promptly stepped in. In 1998, the Fed orchestrated a bailout of the infamous hedge fund, Long-Term Capital Management, and sharply cut interest rates. In 2011, the Fed helped coordinate worldwide central bank stimulus as well as introduced “Operation Twist” — selling short-dated U.S. Treasuries to buy longer-dated U.S. Treasuries for the purpose of depressing borrowing costs. What about 2008? The U.S. Federal Reserve did slash interest rates dramatically in the first quarter. What’s more, the Fed organized the bailout of Bear Stearns in March of that year, sparking a relief rally that kept the S&P 500 well above the bear market demarcation line for three more months. But it wasn’t enough. Even cutting the Fed Funds overnight lending rate to 0% by December wasn’t enough. The Fed wasn’t able to inspire confidence again until quantitative easing (QE) began in 2009. The recent rally for riskier assets here in 2016 is similar to relief rallies in the past; that is, shorter-term gains often overshadow longer-term financial distress as well as deteriorating market internals. For instance, a rising price ratio for iShares 7-10 Year Treasury (NYSEARCA: IEF ):iShares iBoxx High Yield Corporate Bond (NYSEARCA: HYG ) is indicative of a preference for risk-off investment grade credit over speculative higher yielding credit. Is there anything in the present IEF:HYG price ratio to suggest that the longer-term trend is abating? Now step back in time to the 10/2007-3/2009 bear. The IEF:HYG price ratio steadily marched higher until March of 2008. The Fed bailout of beleaguered financial firm Bear Stearns temporarily provided relief for risk assets, but the relief rally ended three months later. Once more, the IEF:HYG price ratio ascended like a mountain climbing enthusiast. History teaches us that the Fed is unlikely to ride to the rescue unless the Dow and the S&P 500 challenge bear market territory. Even then, the rescue endeavor would require sufficient firepower. These historical precedents, then, make the current relief rally particularly troubling. For the Fed to wait until the major benchmarks buckle means that the financial system may grow increasingly unstable. And by then, cutting rates back to the zero bound or twisting shorter-term maturities to purchase longer-dated ones may be insufficient. Again, the Fed’s own assessment tool places the financial system at the highest level of instability, Grade 4 “Significant Stress.” Recall that the iShares All World Ex US Index ETF (NASDAQ: ACWX ) has already depreciated 25%-plus from the top. Small caps in the Russell 2000 (NYSEARCA: IWM )? Ditto. Transportation stocks in the iShares DJ Transportation ETF (NYSEARCA: IYT )? Nearly 30% erosion. Bear market descents have occurred in virtually every stock arena. It follows that when a wide range of stock types are fading, and when a wide range of debt types of different credit quality relative to U.S. treasuries are faltering, popular benchmarks like the Dow and S&P 500 eventually follow suit. The S&P 500 SPDR Trust (NYSEARCA: SPY ) will not be a lone exception. A hold-n-hope advocate may not wish to change any aspect of his/her portfolio holdings, regardless of financial stress levels, historical probability, technical trends or fundamental overvaluation concerns. On the flip side, an investor who wishes to reduce exposure to downside risk can use a bear market rally to his/her advantage . Jettison a lower quality junk bond ETF for a higher quality investment grade corporate bond ETF like iShares Intermediate Credit (NYSEARCA: CIU ). Trade in a lower quality stock ETF for a higher quality stock ETF like iShares MSCI USA Quality Factor (NYSEARCA: QUAL ). And disregard those who boldly declare that “cash is trash.” My moderate growth and income clients have witnessed less volatility and have experienced better risk-adjusted returns with roughly 20%-30% cash/cash equivalents since last summer. (And that’s before the levee broke .) Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.