Tag Archives: etfs

Chickens And Eggs

Are you a chicken farmer, or an egg farmer? Chicken farmers raise chickens for their meat. Egg farmers raise chickens for what they lay. Investors who plan to sell their stocks to pay for college or to buy a second home are chicken farmers. Investors who hope to use the income from their investments are egg farmers. The financial press doesn’t understand egg farmers. Every day they report market prices and how they’ve changed. But they almost never report on dividends. This bias sometimes causes income-oriented egg-farmer investors to forget who they are and believe that they are chicken farmers. If they get confused, they may have a hard time reaching their goals. Prices are volatile. If you’re a chicken farmer, when you buy, and especially, when you sell, is extremely important. A chicken farmer needs to watch the market like a hawk. But if you’re an egg farmer, the most striking aspect of dividend payments is how boring they are. They just don’t jump around very much. Both kinds of portfolios need oversight, but managing a dividend stream is different. Risk doesn’t come from market swings, but from factors that endanger a company’s ability to earn profits and pay investors. Egg farmers like bear markets, especially bear markets that don’t threaten corporate revenues. When the market falls, investors can adjust their portfolios without taking gains and paying taxes. By contrast, chicken farmers hate it when prices fall. But chicken farmers love mergers and acquisitions. The buyer almost always has to pay a premium. But for egg farmers, takeovers just complicate things. Acquirers – especially serial acquirers – usually aren’t as generous with their dividends. Both approaches are valid, but they meet fundamentally different needs. So you never have to ask which comes first.

Passive Investing – I Doth Protest Too Much

One of my favorite blogs, The Monevator blog , did a brief write-up on my new paper this weekend . If you don’t read their website you’re missing out because they consistently post some of the best financial content around. Anyhow, they had a very fair and objective view of the paper and approach to portfolio construction. However, one point that I seem to lose a lot of people on is my discussion of active and passive investing. So, I wanted to take this space to clarify a bit. Financial commentary doesn’t have a uniform definition for passive investing. Googling the term brings up the several different results: Passive management (also called passive investing) is an investing strategy that tracks a market-weighted index or portfolio. – Wikipedia Passive investing is an investment strategy involving limited ongoing buying and selling actions. – Investopedia The first definition is vague because there are limitless numbers of market cap weighted indexes these days, some of which are not well diversified and not low fee. Additionally, why should passive indexing be limited to market cap weighted index? Is it really correct to say, for instance, a fund like MORT , with 23 REIT holdings, reflects passive investing better than say, the equal weight S&P 500 ETF? An “index” is a rather arbitrary construct in a world where there are now tens of thousands of different indexes. The second definition is equally vague since an investor can hold a handful of stocks in a buy and hold strategy and limit ongoing buying and selling. Clearly, we shouldn’t call that passive investing in the sense that a low fee indexer would advocate. The new technologies such as ETFs have really muddled the discussion here as there’s now an index of anything and everything. So, as Andrew Lo notes: “Benchmark algorithms for high-performance computing blurred the line between passive and active.”¹ Along the traditional low fee indexing thinking I am tempted to define passive indexing as any low fee, diversified & systematic indexing strategy. But that could include all sorts of tactical asset allocation strategies that have systematic allocations. I don’t think it’s appropriate to call a tactical asset allocation strategy “passive”. So we’re back to a very blurry area in this discussion. In order to clarify this discussion I arrived at the following simple distinction: Active Investing – an asset allocation strategy with high relative frictions that attempts to “beat the market” return on a risk adjusted basis. Passive Investing – an asset allocation strategy with low relative frictions that attempts to take the market return on a risk adjusted basis. This definition has its own problem because we have to define “the market”. Is “the market” the USA, global stocks, global bonds, etc.? I’d argue that “the market” is the Global Financial Asset Portfolio, the one true benchmark of all outstanding financial assets. Therefore, anyone who deviates from this portfolio is making active decisions that essentially claim “the market” portfolio is wrong for them. This would mean that the only true “passive” strategy is following the GFAP. Obviously, not everyone does that and in fact, probably no one does it perfectly so that would mean we’re all basically active. Some people are active in silly ways (like day traders) and others are active in smart ways (diversified inactive indexers). Of course, I am a full blown supporter of low fee, low activity indexing. So please don’t confuse this as an attack on “passive indexing”. And yes, I am admittedly being overly precise. I certainly doth protest too much as Monevator says. But I am really just trying to establish a cohesive language here because I see too many people these days claiming they’re “passive” when they’re really being quite active. The worst offenders of this language problem are high fee asset managers who sell “passive” strategies cloaked as low fee platforms. I find that dishonest and extremely harmful. A little bit of clarity in this discussion is helpful in my opinion. ¹ – What is an Index? Lo, Andrew.

5 Costly ETF Mistakes You Can Easily Avoid

ETFs are becoming increasingly popular with investors due to their low cost, transparency, easy tradability and tax efficiency. The ETF revolution has made it possible for individual investors to get a convenient, diversified access to almost any investment strategy in virtually any corner of the investing world. Retail investors now have access to many investment opportunities that were earlier available only to sophisticated, high net worth individuals. Despite their widespread use, there are many misconceptions regarding ETFs leading to costly errors, which can be easily avoided. This article aims to help investors avoid some of those mistakes and become more successful ETF investors. Buying an ETF above Its NAV ETFs usually trade at fair prices, i.e. close to their intrinsic values or aggregate values of their holdings. But at times certain ETFs’ prices deviate from their NAVs and they can trade at a premium or discount to their NAVs. If you buy an ETF (or an ETN) when it is trading at a premium, you can incur losses if you sell after the premium crashes. The popular oil ETN, the iPath S&P Crude Oil Total Return Index ETN (NYSEARCA: OIL ), was trading at an almost 50% premium over its NAV for some time earlier this year. In fact, Barclays had issued a notification warning investors about ETN premiums. As expected, the premium plunged after some time, making investors vulnerable to unexpected losses. Investors should make sure to check the previous day’s closing indicative value on the sponsor’s website. They can also check the intraday indicative value on Yahoo Finance using the ticker for the ETF and adding “^” and “-IV” at the beginning and end. So, for OIL ETN, the ticker for intraday indicative value is ^OIL-IV. Avoiding Low Volume ETFs Many investors confuse low trading volumes with the liquidity of an ETF and some even avoid newer ETFs, which may have better strategies but low trading volumes, in favor of older, more popular products with higher trading volumes. ETFs are different from stocks in this area and their trading volume should not be interpreted like stock trading volume. The liquidity of an ETF is not determined by its trading volume but by the liquidity of underlying shares (ETFs’ holdings). At the same time, low volume does usually lead to wider bid-ask spreads, which add to the trading costs. So, these ETFs are not suitable for frequent trading. And it does make sense to use limit orders while trading in low-volume ETFs. Using Market Orders during Volatile Markets The market mayhem on Monday, August 24, last year (ETF Flash Crash) left some harsh lessons for ETF investors. Many ETFs fell 20% or more and some as much as 30%-45% that morning, even though their underlying stocks had not declined so much. Large dislocations in ETFs’ prices were seen not only in smaller ETFs but in some very large and popular ETFs such as the Guggenheim S&P Equal Weight ETF (NYSEARCA: RSP ) and the Vanguard Consumer Staples ETF (NYSEARCA: VDC ). While these discrepancies lasted only for a short period of time, none of the trades executed during that time were canceled. There were many factors that caused ETFs’ pricing problems. But the biggest mistake that ETF investors could have avoided was using “market orders” during those turbulent market conditions. Investors who had left a sell market order or a sleeping stop-loss sell order for one of the ETFs that had severe distortion in pricing probably saw their orders hit at worst possible prices, much below fair values. Ignoring the Contango Impact on Commodity ETFs While some commodity ETFs, mainly those tracking precious metals hold the physical commodity, most commodity ETFs use futures contracts to track the price of commodities due to high storage costs. These futures contracts are required to be rolled over when they are close to expiration. At times, futures price of the commodity is higher than the spot price – known as “contango” – which results in losses at the time of rolling over the contracts. Contango affects the performance of ETFs since the futures contracts’ return will be lower than spot price returns of the commodity. A recent article in WSJ highlighted this issue in the performance of ETFs that track the performance of oil using futures, including the PowerShares DB Oil ETF (NYSEARCA: DBO ), the United States Oil ETF (NYSEARCA: USO ) and OIL. While US crude futures were down about 20% through February 22 this year, oil funds fared much worse. Always Buying Currency Hedged International ETFs Currency hedged ETFs have been quite hot in the past couple years as the US dollar surged against most other currencies. By hedging out the currency exposure, through currency hedged ETFs, investors get access to pure equity returns in international markets. Investors should also remember that often stocks and currencies move in the same direction. That is, if an economy strengthens, its stock market as well as the currency will perform well. In such cases of positive correlation, hedging will actually work against investors. However in some cases, particularly in cases of export oriented economies, stocks and currencies have shown a negative correlation historically. That’s why currency hedged Japan funds performed so well in the recent past. That said currency hedging is not always a good idea. Take the example of Japan ETFs – while currency hedged products like the WisdomTree Japan Hedged ETF (NYSEARCA: DXJ ) outperformed the unhedged ones like the iShares MSCI Japan ETF (NYSEARCA: EWJ ) over the past couple years, as the yen weakened against the dollar, they have underperformed over the past 2-3 months, as the Japanese currency rebounded, thanks mainly to its safe-haven status and worse-than-expected stimulus measures announced by the BOJ. Original Post