Tag Archives: latest-articles

5 Smart Beta Predictions For 2015

January brings plenty of resolutions along with forecasts. I’ll spare you the details of my renewed commitment to kale and cardio fitness and instead focus on what the year ahead could look like for one of the most talked about investment ideas ― smart beta . Investors and advisors alike are becoming intrigued with an approach that combines elements of passive and active investing and can potentially outperform a typical index strategy. It’s a different way of thinking about investing, focusing on the true drivers of risk and return and putting them together in a way that’s designed to create better outcomes. Here are my top five predictions for smart beta as it continues to mature in 2015: Less arguing, more action At the last industry conference I attended, I counted six (six!) different panels on the topic of smart beta. That’s the great news. The bad: Almost every panel and press article gets mired in a discussion of the name—Do you like it or hate it? Is it always smart? Is it really beta? Enough already! This pedantic focus on the name distracts from the fact that smart beta might just be one of the most meaningful developments in the investment landscape of this decade. So let’s stop arguing over whether or not it’s “smart” or whether or not it’s beta and start talking about how it has the potential to improve investment outcomes. This year, I predict we’ll see more agreement on common classifications for the category that describe how different types of smart beta can serve different purposes. This will help investors compare and contrast smart beta strategies and the role they might play in their portfolios. Smart beta gets some respect Along with ceasing the name game, I’d also like to call a halt to the active/passive debate. Purists would argue that smart beta is neither active nor passive—and I’m inclined to agree. It’s simply smart beta—including elements of both active and passive investing. This year, I predict that investors will increasingly recognize smart beta as its own asset class and consider an allocation alongside their existing active and passive investments. Moving on to SB 2.0 The earliest and most widely adopted forms of smart beta have been equity index portfolios that are weighted by factors such as price to earnings or dividend yield, rather than by traditional market capitalization. While these index-driven strategies, often delivered in the form of exchange traded funds ( ETFs ), can help enhance returns or reduce risk, smart beta doesn’t end there. How can we deliver exposure to a particular asset class in a way that improves diversification and risk adjusted returns, or takes advantage of known market anomalies? This is smart beta. This year, I predict investors will continue to embrace equity index versions of smart beta, while also exploring the potential for more outcome-oriented strategies in other asset classes. Which brings me to prediction number four… Joining the hunt for yield The search for yield is perhaps the biggest challenge investors face in today’s interest rate climate. Reaching into longer dated securities to boost income is increasingly difficult to stomach, even with Federal Reserve Chair Janet Yellen promising to keep interest rates low for longer. Traditional fixed income indexes are currently biased toward longer term bonds, a bias that can hurt investors if rates rise, and have the largest exposures to companies or countries with the greatest amount of debt, potentially increasing credit default risk. Yet, simply reducing duration or credit exposure could erode the yield that investors so avidly pursue. One way to diversify traditional fixed income investments is to consider strategies that shift away from highly indebted companies and offer a balance between interest rate and credit risk… while still providing an attractive yield. This year, I predict that we’ll hear a lot more about smart beta in fixed income as an attractive alternative to traditional passive bond indexes. (I’ll discuss fixed income smart beta in more detail in my next post.) The resurgence of Min Vol Minimum volatility strategies were among the most popular forms of equity smart beta that attracted fervent attention in the wake of the credit crisis. Minimum volatility strategies seek to decrease the effects of the market’s ups and downs over time by providing equity investors lower risk alternatives to traditional equity portfolios. These funds enjoyed a rapid rise in fame, gathering an estimated $9.1 billion in net ETP flows in 2012 and 2013 ( Source: Bloomberg) . Since then, attention has waned. After three consecutive years of double-digit equity market returns ( Total gross return for S&P 500 Index from 12/31/2011 – 12/31/2014) there was less focus on the need for downside protection. However, over the last several months market volatility has returned with a vengeance—a function of changing monetary policy in the U.S. and a plethora of geopolitical risks popping up around the globe. In this environment of increased uncertainty, I predict that minimum volatility strategies will re-enter the spotlight as a way for investors to maintain equity exposure while seeking less risk. Original post

Between The U.S. Economic Recovery And Global Slowdown There Is GLD

Summary The FOMC is still likely to raise rates in the coming months, but the global economic slowdown could still keep up GLD. I reexamine the relation between GLD and the U.S. dollar. The upcoming non-farm payroll report could bring GLD further down. The FOMC’s recent meeting was concluded with no changes to policy. The statement presented modest changes to the wording. For now, the market still estimates a rate hike in the middle of year. Following this news, the price of the SPDR Gold Trust (NYSEARCA: GLD ) fell down albeit it’s still up for the year. Let’s review the latest from the FOMC, the upcoming reports to be released this week, and reexamine the relation between the U.S. dollar and gold in light of the global economic slowdown. Last week’s main event was the FOMC meeting , in which the FOMC tried not to “rock the boat” and provided little changes in the wording in the statement. Nonetheless, following the release of the FOMC statement, the price of GLD took another tumble. (click to enlarge) Source of data taken from FOMC’s site and Bloomberg The statement still suggested that FOMC remains bullish on the U.S. economy, which isn’t a good sign for keeping rates low for a long time. The recent release of the U.S. GDP , in which the GDP growth rate for the fourth quarter was only 2.6%, market expectations were at 3% and in the third quarter the GDP grew by 5% may have contributed to the rally of GLD on Friday. A closer look at this report, however, reveals a more complex picture: real personal consumption grew by 4.3%; conversely, government spending tumbled down by 7.5%; private inventories added 0.8 percentage points to the growth rate. So even though government spending dropped, the GDP grew by 2.6% – mostly due to higher personal consumption and gain in inventories. All in all, this wasn’t a bad result and could tie up the FOMC’s bullish sentiment with respect to the progress of the U.S. economy. The upcoming non-farm payroll report could provide another indication for the progress of the U.S. labor market. Current estimates are for a gain of 231,000 jobs in January. A much higher gain in number of jobs could result in another fall in the price of GLD. (click to enlarge) Source of data taken from the U.S. Bureau of Labor Statistics and Google Finance Moreover, if the labor market keeps showing signs of recovery over the coming months, then this will bring the FOMC one step closer towards hitting the rate hike button. The debate over the next rate hike is likely to pick up in the coming months as we will get closer to the June meeting. Some still suspect the FOMC could back down from its current direction of raising rates in the coming months. But the FOMC doesn’t tend to make such a deviation from its direction unless the economic climate when it comes to inflation and labor warrants such a change. On both counts, the FOMC continues to voice little concern and to change market expectations with a sudden announcement, while has been done in the past, seems less likely considering the conditions only continue -albeit slowly – to improve. Despite the recent fall in the price of GLD, gold holdings in GLD keep picking up, and as of last week, reached over 758 tonnes of gold – this is a 6.5% gain since the end of 2014. This is also the highest level of gold hoards for the ETF since October 2014. This means, the recent fall in the price of GLD didn’t hold back investors from investing in the ETF. Another point to consider is the ongoing rise in the U.S. dollar, which coincides with the rally of gold prices. The chart below shows the relation between the U.S. dollar and gold prices during 2014-2015. Source of chart taken from FRED The relation between the U.S. dollar and GLD should be, as expected, negative; i.e. when the U.S. dollar appreciates against major currencies, the price of GLD tends to come down. This wasn’t the case, however, in recent weeks, as indicated in the chart above. Since the beginning of the year, both GLD and the U.S. dollar appreciated. But this type of positive relation was also the case back in 2008. (click to enlarge) Source of chart taken from FRED Back then, the U.S. economy, as well as other leading economies, was in a recession. This time, however, the U.S. economy is performing well while other economies show a slowdown in growth. In both times, the demand for gold picked up when the economic climate was uncertain and the global economy wasn’t doing so well. In times of uncertainty, the U.S. dollar tends to rise, U.S. treasury yields fall and gold prices rise. The main difference is that the U.S. economy, this time, is doing much better, and thus the U.S. dollar is likely to keep appreciating. Therefore, the ongoing appreciation of the U.S. dollar is likely to eventually catch up with the price of GLD and curb down its rally. For now, it seems that even if the FOMC were to raise rates in June by 0.25%, it won’t bring down the ongoing fall in the U.S. treasury yields and, consequently, the recovery of GLD. After all, the concerns over the global economy continue to offset the impact of the potential rise in the Fed’s rate on gold. In times of uncertainty, the U.S. dollar and GLD rally. But it also means that the recent rally of GLD could slow down on account of a stronger U.S. dollar. For more see: 3 Questions About Gold Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

What Are The Limitations And Consequences Of ETFs?

By Niall H. O’Malley of Blue Point Investment Management Before delving into the limitations and unintended consequences of Exchange-Traded Funds (ETFs) it is important to define an ETF. Where did these investment vehicles originate? How significant are ETFs to investors? The first Exchange Traded Fund was launched in January 1993 by State Street Global Advisors under the ticker symbol (NYSEARCA: SPY ). The ETF was designed to track the value of the S&P 500 Index. It is quoted at 1/10 of the value of the S&P 500. The ETF was marketed as a “spider”, shorthand for Standard & Poor’s Depository Receipt (SPDR), traded on the New York Stock Exchange. The popularity of the S&P 500 SPDR led to a family of products. Other fund management companies, such as Barclays – creator of iShares – and Vanguard, followed suit in short order and the universe of ETFs rapidly expanded. The S&P 500 SPDR is still one of the most popular ETFs. Its average volume exceeds 110 million shares on a daily basis, and its assets under management are over $171 billion. 1 How Significant are Exchange Traded Funds and Related Exchange Traded Products? As a financial innovation that is approaching its 22nd anniversary, it is fair to say Exchange Traded Funds and the related Exchange Traded Products have been revolutionary. Investors have entrusted over $2 trillion to this financial innovation. ETFs have grown in popularity since they offer investors cost effective diversification to markets, sectors, currencies and commodities. ETFs have evolved into a family of closely related investment vehicles known as Exchange Traded Products (ETPs). ETPs include Exchange Traded Notes, Leveraged ETFs, Inverse ETFs, Exchange Traded Commodity Pools, Exchange Traded Vehicles (ETV) and Active ETFs. The success of ETFs and other Exchange Traded Products is quite striking, especially when one considers the number of companies traded on the New York Stock Exchange and the NASDAQ, 6,251 2 , compared to the number of global ETFs and ETPs, 5,463. Most ETFs and ETPs are traded in the U.S. There are 1,686 ETFs and ETPs that invest in just U.S. securities and 3,777 that invest in varying levels of international securities. Over 95% of the ETFs and ETPs are passively managed. Once the exchange traded basket is established the composition of the ETP is on autopilot, i.e. it is not actively managed. Note: Exchange Traded Products is often used as an umbrella term. In the chart above Exchange Traded Funds growth is detailed in the top line and growth in other exchange traded structures is detailed in the bottom line. What Are Some of the Benefits of ETFs? Cost Effective Diversification The primary strength of Exchange Traded Funds is the cost effective passive diversification they offer an investor. As an example, exposure to the S&P 500 Index can be gained through the purchase on one share of the S&P 500 SPDR ETF rather than purchasing 500 separate securities. The expense ratio for the S&P 500 SPDR is 0.09% which is very low. The average institutional ETF expense ratio is 0.562%. ETF holdings vary widely from less than 10 securities to over 16,000 securities. An ETF, like a mutual fund, pools the assets of multiple investors; however, ETFs tend to be significantly less expensive and offer instantaneous pricing information during the trading day rather than once daily pricing as is the case with mutual funds. Each share in an ETF represents an undivided interest in the underlying securities less the expense ratio. To understand the pricing variations, an investor has to factor in the type of ETF. An additional consideration with mutual funds is the share class and whether a sales fee is taken. When considering mutual funds, the investor also needs to factor in the fee structure. The table below provides insight into the expense ratio variations in open end funds. Both mutual funds and ETFs are considered open-end funds, i.e. there is no limitation on the number of shares that they can issue. You will notice in the table below that passive ETFs do not have mutual fund sales commissions referred to as front-end load/ No load and back-end load/ level load. Deep Liquidity for Popular ETFs The larger ETFs offer deep liquidity, e.g. the iShares MSCI Emerging Markets ETF (NYSEARCA: EEM ) – founded by Barclays and now managed by BlackRock – has an average daily volume that exceeds 60 million shares and assets under management exceed $36 billion. However, not all ETFs are highly liquid. In fact, liquidity varies widely among ETFs. Important liquidity considerations are the average trading volume, assets under management, plus the strength of the counterparties – authorized participants – that create and redeem the ETF shares. Another consideration is the complexity of the ETF in terms of the number of securities held. Each security is dependent on a functioning market for price discovery which can be interrupted by trading halts and “flash crashes”. New Investment Approaches Investors, both individual and institutional, can use ETFs to gain rapid, cost effective diversification to markets, sectors and various strategies, e.g. growth and/or value. The explosion of the ETF universe has expanded the toolset available to investors. A popular investment approach is a combination of active and passive investing. Investors may also take an active management approach incorporating individual securities or actively managed funds. This is referred to as “seeking alpha”. The investor is seeking a return above the market return represented by market indexes. Some investors prefer to pursue a purely passive approach with ETFs and ETPs which limits down side risk offering a weighted average return. What are Some Limitations and Unintended Consequences of ETFs? Short-term Trading, Taxes and Lower Realized Price Perhaps the biggest ETF limitation is behavioral. ETFs are credited with being less work. All an investor has to do is buy the basket of securities represented by an ETF and the benefits of diversification are gained. While it is true that ETF investing involves less work, it creates an unintended consequence of creating less conviction in the face of adversity – a market selloff. This increases the chance that the investor will become more reactive and short-term oriented. For taxable investors, this introduces the higher short-term capital gains rate. It is important to note that taxes are not the only cost. A potentially even greater cost is incurred when an investor sells during a market selloff and realizes a loss. Performance Limitation – The Best Return is an Average/Weighted Average Return If you had a child, would you encourage them to get Cs in school? The frequent encouragement from parents is to seek As and Bs. Why does the same rule not apply to your investments? How often does an index double? The answer is not that often. When an investor invests in an ETF, it is important to realize that they are electing to receive an average return for the invested amount. An average grade in school is a C. The return of an ETF is the weighted average of the underlying securities less the expense ratio. In short, while the ETF assets benefit from diversification there is a performance limitation. A Less Transparent Issue – Tracking Error & Counterparty Risk An ETF’s market price can trade at a premium or a discount to the value of its underlying securities. Wider bid/ask spreads occur when an ETF or security is thinly traded which creates additional investment costs. The creation and redemption of ETF units is dependent on counter parties that are referred to as authorized participants. An ETF fund manager enters into contractual relationships with one or more authorized participants. Authorized participants create ETF fund shares in large increments – typically 50,000 fund shares. The authorized participant or participants seek to minimize pricing differences between the market value of underlying ETF securities and the net asset value of the ETF. Authorized participants seek to arbitrage the pricing differences but are dependent on functioning markets and stability of their broker dealer operations. Flash crashes and other market disruptions associated with high frequency trading arbitrage can create tracking error. Structure Risk As the popularity of ETFs has grown, it has given way to an alphabet soup of Exchange Traded Products which include alternative ETFs, Exchange Traded Notes (ETNs), alternative ETFs, exchange traded vehicles (ETVs), exchange traded commodities or currencies (ETCs), and other types of structures. It is important to note that the product structures of the newer ETPs in turn create unique risks for investors. From a structure and regulatory perspective, ETFs are open-ended investment companies that offer investors an undivided interest in the underlying securities of the fund less expenses. The same is not true with Exchange Traded Notes (ETNs). An an ETN is just a credit obligation from the issuer, i.e. there is no collateral. The credit obligation is only as good as the balance sheet of the issuer. This became a painful lesson for investors in the Lehman Brothers ETN products as they did not own the underlying collateral, and therefore, became unsecured creditors in the Lehman bankruptcy. Alternative ETFs give investors the potential to invest in investment options that are leveraged and/or inversely correlated to its index benchmark. Typically, alternative ETFs are designed to generate daily returns that are a positive or negative multiple of its benchmark, e.g. stock indexes, currencies and commodities. The math of daily settlements introduces the risk of significant tracking error, and introduces a tax liability that does not exist with traditional ETFs. The primary collateral for alternative ETFs are the derivative contracts and money market instruments used to create the leveraged or inverse exposure. Local Firm Participation A Bethesda, Maryland firm, ProShares, is the world’s largest provider of leveraged and inverse ETFs. ProShares has grown from one fund in 2006 to over 145 alternative ETFs. Another Bethesda, Maryland, based firm is AdvisorShares which offers 28 actively managed ETFs. Actively managed ETFs were first approved by the Securities and Exchange Commission in 2008. The actively managed ETF adds an active management component to the ETF structure that has otherwise been passively managed. T. Rowe Price has received regulatory approval to issue actively managed ETFs. Legg Mason has also received approval from the Securities and Exchange Commission to begin issuing actively managed ETFs. Investment Considerations Before making any investment, it is important to identify your goals and understand the limitations and opportunities associated with the investment you are considering. Do you want the weighted average return? Faced with a market selloff do you have conviction about your investment? Are you familiar with the fund manager? What is the underlying collateral? Exchange Traded Funds and Products have expanded the investable universe for investors. One of the most important benefits that ETFs and ETPs offer is their ability to diversify a portfolio. This is especially true in emerging and developing markets where investment options may not otherwise be accessible. Whether investing in an ETP or a listed company, it is important to research your investment. Due diligence is a key consideration that should not be overlooked whether investing passively, actively or in a blended approach. Sources: – https://www.spdru.com/?internalR edirect=https%3A%2F%2Fwww. spdru.com%2F&_new_user=1#/ content/debunking-myths-and-common-misconceptions-of-etfs – https://www.spdru.com/?internalR edirect=https%3A%2F%2Fwww. spdru.com%2F&_new_user=1#/ content/9-questions-every-etf-investor-should-ask-before-investing – https://www.fidelity.com/learningcenter/investment-products/etf/ drawbacks-of-etfs – http://www.forbes.com/sites/ rickferri/2013/09/02/etf-fees-creephigher/ – https://www.fidelity.com/ viewpoints/active-trader/no-stopping-ETFs – http://www1.nyse.com/about/listed/ nya_characteristics.shtml – http://www.lipperweb.com/ Research/Fiduciary.aspx – http://etfdb.com/compare/marketcap/ – http://www.ici.org/pdf/per20-02.pdf – http://www.etfgi.com/index/cookie Endnotes : 1 ETF Database Top 100 ETFs by Assets 10/16/14 NYSE 3,296 and NASDAQ 2,955 as of 10/16/14 2 ETFs 3,868 and 1,595 ETPs