Tag Archives: investing ideas

Dual ETF Momentum November Update

Scott’s Investments provides a free “Dual ETF Momentum” spreadsheet which was originally created in February 2013. The strategy was inspired by a paper written by Gary Antonacci and available on Optimal Momentum . Antonacci’s book ” Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk ” also details Dual Momentum as a total portfolio strategy. My Dual ETF Momentum spreadsheet is available here , and the objective is to track four pairs of ETFs and provide an “Invested” signal for the ETF in each pair with the highest relative momentum. Invested signals also require positive absolute momentum, hence the term “Dual Momentum”. Relative momentum is gauged by the 12-month total returns of each ETF. The 12-month total returns of each ETF is also compared to a short-term Treasury ETF (a “cash” filter) in the form of the iShares Barclays 1-3 Treasury Bond ETF (NYSEARCA: SHY ). In order to have an “Invested” signal, the ETF with the highest relative strength must also have 12-month total returns greater than the 12-month total returns of SHY. This is the absolute momentum filter which is detailed in-depth by Antonacci, and has historically helped increase risk-adjusted returns. An “average” return signal for each ETF is also available on the spreadsheet. The concept is the same as the 12-month relative momentum. However, the “average” return signal uses the average of the past 3-, 6-, and 12- (“3/6/12”) month total returns for each ETF. The “invested” signal is based on the ETF with the highest relative momentum for the past 3, 6 and 12 months. The ETF with the highest average relative strength must also have average 3/6/12 total returns greater than the 3/6/12 total returns of the cash ETF. Portfolio123 was used to test a similar strategy using the same portfolios and combined momentum score (“3/6/12”). The test results were posted in the 2013 Year in Review and the January 2015 Update . Below are the four portfolios along with the current signals: (click to enlarge) As an added bonus, the spreadsheet also has four additional sheets using a dual momentum strategy with broker-specific, commission-free ETFs for TD Ameritrade, Charles Schwab, Fidelity, and Vanguard. It is important to note that each broker may have additional trade restrictions, and the terms of their commission-free ETFs could change in the future. Disclosure: None.

ETFs: Before You Buy, Read The Warning Label

By Peter S. Kraus We don’t hate ETFs . In fact, we use them ourselves and are considering managing client assets in the active ETF space. When used properly, these instruments can be a useful component in a well-diversified portfolio. But ETFs aren’t perfect, and relying heavily on them without understanding their imperfections is risky. ETFs have structural limitations that need to be addressed. We worry that the vast amount of money invested in these instruments – close to $3 trillion globally – may have created risks that investors don’t appreciate. The asset management industry has an obligation to educate investors about these risks. We don’t think it has done that job well enough. ETFs were created as a tool for sophisticated institutional investors and traders to use to get short-term tactical exposure to a given market. They were well-suited for this purpose because they could be bought and sold at any time, just like individual stocks. We still think using ETFs for short-term, tactical purposes makes sense. More recently, however, ETFs have become popular with smaller, less experienced investors. In many cases, they have become the mainstay of these investors’ portfolios. This concerns us, because certain ETFs can damage investors’ portfolios – particularly when investors don’t fully understand how they work. Market liquidity has changed significantly since the 2008 financial crisis. ETFs – both active and passive – are not immune to the dangers this new liquidity environment poses. However, we worry that many investors have embraced ETFs because of their perceived liquidity – which in some cases can be an illusion. The plunge in global equity markets on August 24 was a case in point, when US exchanges halted trading in certain stocks that morning. But many ETFs continued to trade, and without good pricing information, 10 of the largest equity ETFs traded at a steep discount to their underlying value. In other words, the ETFs’ prices collapsed far more than the prices of their underlying securities. If you had tried to sell during that period, you could have experienced a significant loss. Sophisticated institutional investors would probably have known to use a “limit order” when selling in those conditions. It’s unfair to expect the average retail investor to have the same level of understanding. In fact, if a product requires limit orders, should it even be marketed to smaller investors in the first place? At the very least, we think these events should make investors question just how deep the ETF liquidity pool really is. And we’re not the only ones voicing these concerns. SEC Commissioner Luis Aguilar said the August events mean “it may be time to re-examine the entire ETF ecosystem.” Others, including Federal Reserve Vice Chairman Stanley Fischer, have raised similar issues. Liquidity Concerns In High Yield, Emerging Markets In other markets, ETFs are even less efficient – and less liquid. Yet, we worry that investors continue to pour money into them without a full understanding of the risks. Think about it this way: More and more investors are turning to ETFs in relatively less liquid markets like high-yield bonds and emerging markets. To meet that demand, these funds must hold an ever larger share of less liquid assets. If the underlying asset prices were to fall sharply, finding buyers might be a challenge, and investors who have to sell may take a sizable loss. Not Always As Cheap As They Look Then there’s the issue of cost. Passive ETFs passively track an index. This style of ETF investing should keep a lid on costs. Financial advisors who use ETFs as core holdings in their clients’ portfolios often tell us this low fee is why they do so. It’s true that some ETFs that invest in the most liquid assets, such as large-cap equities or government bonds, carry much lower management fees than mutual funds. But some other types of ETFs really aren’t that cheap. Take high-yield bonds, where ETF expense ratios can be as high as 0.5%. For emerging market stocks, they can be close to 0.7%. That’s not far from the average active mutual fund fee. Here’s what is different: performance. Since 2008, the biggest high-yield ETFs have underperformed the average active manager and the broad high yield market, not to mention their own benchmarks. Hidden Costs, Less Flexibility ETF costs can be high for many reasons that investors don’t see. For example, in less liquid markets, bid-ask spreads – the difference between the highest price buyers are willing to offer and the lowest that sellers are willing to accept – widen sharply when trading gets volatile. High-yield ETF managers can rack up high trading costs because bonds go into and out of high-yield benchmarks often – certainly more often than stocks enter and exit the S&P 500. Here’s something else to consider: the high opportunity cost of not using active management. ETF returns often suffer because these instruments passively track an inefficient index. That means they can’t pick and choose their exposures based on a security’s individual risk and return characteristics, the way active managers can. Investors learned this the hard way when oil prices plunged and took high-yield energy bonds – a large component in high-yield indices – and many emerging-market stocks and bonds down with them. Active managers who saw the warning signs of rapidly growing debt and leverage in this sector could have strategically reduced exposure and exploited these inefficiencies at the time. Look Before You Leap So what’s best for investors? Should they ditch ETFs altogether? Of course not. Certain ETFs have a place in a well-diversified portfolio – but they’re no panacea. It’s critically important that investors know what they’re signing up for when they buy them. And it’s time for asset managers to step up and explain the fine print. The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

Allianz Makes The Case For Alternative Investments

By DailyAlts Staff With interest rates at rock-bottom lows, the three-decade bull market in bonds is clearly in its last days. Meanwhile, stock markets from Asia to the Americas are undergoing various bouts of volatility, and valuations remain stretched, indicating recent bearishness may be far from over. These factors, along with the diverging policies of world central banks, are causing investors in traditional assets to rethink their allocation strategies. Allianz Global Investors makes “The Case for Alternatives” in the latest edition of the firm’s Analysis & Trends white paper series. Financial Repression Financial repression occurs when real interest rates are negative. In this way, savers can’t grow their wealth merely “risk-free,” and thus they’re forced to choose between losing ground to inflation or investing in riskier assets. Typically, financial repression has been the result of inflation outpacing the nominal interest rates on government bonds. But due to unprecedented monetary experiments, most European nations now have negative nominal yields on their sovereign debt. This isn’t something traditional “60/40” investors ever bargained for. (click to enlarge) Obviously, bond investors need to look elsewhere for income when they’re faced with negative nominal yields. According to Allianz, this has resulted in the growing popularity of “low-risk, low-return” alternative strategies to replace the role that bonds once played in investors’ portfolios. Monetary Consequences The negative yields on European bonds are a direct consequence of the European Central Bank’s policy of “quantitative easing” – i.e., buying bonds with newly minted money. When the central bank expands the money supply to buy bonds, it bids down interest rates. This not only props up the bond market, it also lowers the risk-free rate of return, thereby encouraging investors into riskier assets – like stocks. This is why Allianz says “ongoing expansionary monetary policy globally” should “support risky assets longer-term” – but in the meantime, “investors should be prepared for increasing volatility.” The Alternatives Universe Allianz GI points out that “alternatives” are not an asset class of their own, but a “universe” of investments that includes all of the following (and more): Commodities Currencies Real assets (timberland, fine wine, art) Intangible assets (patents, royalty streams) Private equity Alternative strategies The graphic below plots a variety of alternatives on two axes: The up/down axis considers liquidity from the perspective of the investor and the investment vehicle, while the left/right axis considers liquidity in terms of the underlying assets. For example, ’40 Act long/short equity funds are liquid from the perspective of the investor, and also in terms of their underlying assets. But while publicly traded REITs are just as liquid from the investor’s perspective (or nearly so), their underlying assets are far less liquid. Choosing the Right Alternatives Alternatives should be attractive to investors who realize the traditional “60/40” stock/bond diversification is unlikely to provide its traditional benefits going forward. Bonds are set to lose ground as interest rates rise, and stocks, which had been pumped up by monetary accommodation, are likely to come under increasing pressure, too. Whereas the income from bonds used to provide a cushion for “60/40” portfolios, even during bear markets, the ultra-low yields on U.S. and especially European bonds won’t have that effect in the immediate future. The question, then, is which alts should investors consider? According to Allianz, investors have two choices: Allocate broadly to alternatives via a custom advisory service; or Add single alternative strategies in order to achieve a specific investment objective. Allianz breaks down the alternative strategies pursued by hedge funds into four broad classes: Event driven, relative value, macro, and long/short equity. Given each strategy is designed to provide returns with limited correlation to the broad markets, and the broad markets have been bullish for years, the coming volatility and presumed end of long-time bull markets in stocks and bonds should result in a positive environment for many alternative strategies. For more information, download a pdf copy of the white paper .