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Active Risk Parity Returns For The First Quarter

March was a good month for our risk parity portfolios. The Active Risk Parity Portfolio With 7% Volatility Target returned 1.5% for the month, putting its total returns at a little over 2% year to date. These returns are slightly higher than those of the S&P 500 year to date, but we also missed the massive drawdowns in January and early February. Slow and steady wins the race. Charles Sizemore is the principal of Sizemore Capita l, a wealth management firm in Dallas, Texas. Disclaimer: This article is for informational purposes only and should not be considered specific investment advice or as a solicitation to buy or sell any securities. Sizemore Capital personnel and clients will often have an interest in the securities mentioned. There is risk in any investment in traded securities, and all Sizemore Capital investment strategies have the possibility of loss. Past performance is no guarantee of future results. Original Post

Dumb Alpha: Sell In May And Go Away?

By Joachim Klement, CFA Every April, I am asked by clients and fellow investment professionals alike if the old adage, “Sell in May and go away,” still holds true? One of the key advantages of the ideas I present in the Dumb Alpha series is that they allow portfolio managers to rapidly improve their work-life balance. Since I am a naturally lazy person, I am constantly looking for ways to reduce my workload without my boss – or my clients – noticing. The sell-in-May effect, also known as the Halloween indicator , is one of the most well-known calendar effects. It holds that investors can outperform a simple buy-and-hold strategy by selling stocks at the beginning of May and buying them back at the beginning of November. If this were true, I could dramatically improve my work-life balance by going on a six-month vacation in May, just to come back in November and work for six months until the following spring. When I proposed this idea to my boss, he wasn’t very keen on it, arguing that, in largely efficient markets, this effect should not exist after transaction costs are taken into account. In other words, it should surely be arbitraged away by professional investors once widely known. I decided to dig in and look at the scientific evidence. After all, what is a weekend of extra research if one can expect to gain a half year off if proven right? It is indeed correct that many calendar effects do not survive increased scrutiny. Examples like the turn-of-the-month effect or the day-and-night effect require quite a lot of trading in a portfolio. If trading costs are reasonably high, many of these effects become unprofitable. Similarly, some other well-known calendar effects, like the January effect , disappeared once they were described in literature and exploited by professional investors. One of the first rigorous analyses of the sell-in-May effect was done by Sven Bouman and Ben Jacobsen , who looked at 37 international stock markets from January 1970 to August 1998. They found that the sell-in-May effect was present in 36 out of 37 countries and was statistically significant in 20 of them. The effect is not small, either. In the United States, Bouman and Jacobsen document a return in the November-to-April time frame that is 11 percentage points higher than in the May-to-October time frame; for the United Kingdom, the return difference is 24 percentage points – and can be traced back to the year 1694! So the sell-in-May effect has been around for a very long time, and, as it requires only two trades per year, it persists even after trading costs. Efficient market advocates were quick to reply. Edwin Maberly and Raylene Pierce pointed out that the sell-in-May effect disappears in the US stock market once the months of October 1987 and August 1998 are excluded from the data. Could it be that the effect was caused by just two months of awful performance? If the returns were that lumpy, surely it wouldn’t be possible to exploit them, because most investors would have lost their jobs or given up long before the next event materialized. In 2013, three researchers published what I consider the final verdict on the matter in the Financial Analysts Journal . Testing the sell-in-May effect with out-of-sample data from November 1998 through April 2012, they found that in the 14 years since the publication of Bouman and Jacobsen’s original analysis, the indicator did not disappear. In fact, on average, across the 37 markets studied, the out-performance in the winter months was still about 10 percentage points higher than in the summer months. They also found that the effect does not come in lumps. It exists in three out of four years and does not depend on specific industries, countries, or months. It seems clear that the effect is both real and persistent. What causes it is totally unknown, although several hypotheses have been proposed, tested, and rejected. Here we have a Dumb Alpha generator that defies logic and explanation. But, as a mentor of mine used to say, “Truth is what works” – and, even though the underlying causes of the effect are unknown, it does seem like a true investment anomaly. Now, I think I need to have a chat with my boss about my next vacation. Disclaimer: Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Why Investing In Private Equity ETFs Is Like Chewing On The Bones

Click to enlarge As strong advocates of direct private equity investing, we often get asked, “Why not invest in a private equity ETF?” The reasoning goes: ETFs are popular and low-cost, anyone can buy an ETF through a retail brokerage, and ETFs for private equity exist. The trouble is, a dramatic performance gap exists between the profits from PE and the profits from a PE ETF. Take a look: THE MEAT Click to enlarge The desirable returns that true private equity portfolios earn are most closely measured by the Private Equity Quarterly Index – PreQUIn. A comparison to the S&P shows PE has consistently been bringing home the bacon. Investors are tempted to believe that exposure to PE as an asset class is democratized by the public stock offering of private equity firms. Logical to imagine, but an investment in private equity ETFs is more like scrapping for leftover bones. The meat is already gone. To see what we mean, consider the PowerShares Globally Listed Private Equity ETF (NYSEARCA: PSP ), which reveals a dramatically different picture. PSP has lost nearly 60% of it’s value since inception (shown here vs the S&P 500): THE BONES Click to enlarge Why don’t the incredible profits from PE translate to profits in the ETF? (i.e. Where did the meat go?) If you’re considering investing in a private equity ETF, you have to understand the nature of the beast inside. ETFs consist of publicly-traded private equity management firms. Private equity firms are lions and there’s a simple, but rarely stated reality at play: Lions hunt to feed their own. The ‘pay for performance’ mentality is embedded into private equity culture. Private equity firms are set up to reward the people who work there. The most valuable assets at PE firm walk out the door everyday, so firms compensate their talent aggressively to keep them coming back. We’re not knocking it, either. The outcome-driven incentive system is a powerful driver of returns for investors. The key is understanding how incentives play into the firm business model and where they pay out. As a whole, private equity firms make their money two ways: Performance fees , called ” carried interest ” – The massive returns PE is known for generating come from buying businesses, rapidly turning them around to improve performance, and then selling them. Carried interest is the portion of profits (usually 20%) that PE firms earn from deal profits. Management fees – Usually 1-2% of total investment dollars under management are charged annually to investors who invest into deals through the firm. This is not performance-based. The talent at these firms are highly motivated by rewards linked to profits when a business is sold. This means, when a deal exits, the bulk of carried interest is distributed to the firm’s employees who drove the deal’s performance. They hunt, they deliver, they eat. Because a huge chunk of the carried interest is paid to people putting the deals together (about 40% of carried interest at KKR, for instance), publicly traded PE firms are valued on the basis of what’s left – their management fee streams. That value, in essence, is the remaining bones. An ETF, bundling a diverse group of publicly traded PE firms, is a mixed bag them. Private equity firm valuations have been almost entirely based on management fees, to the exclusion of performance fees. Dan Primack, Fortune Without direct exposure to deal profits, the stock is traded based on the PE firm’s value as an operating company. The size of the funds under management predict management fees and, in turn, nearly dictate the stock price. To check Fortune’s theory, we modeled the assets under management (AUM) for KKR (NYSE: KKR ) and Blackstone (NYSE: BX ) against their share prices over the last five years. The results were overwhelming: the correlations were 0.94 and 0.93, respectively. In other words, buying the stock of a PE company is betting on their ability to fundraise, not invest. THE INFLUENCE OF MANAGEMENT FEES Click to enlarge To get closer to deal-level profits, big investors have the privilege of investing in a fund. The old adage, “It takes a fortune to make a fortune” rings true. Minimum investments into PE funds are usually seven figures, limiting access to institutional players like pension funds, banks, and insurance companies, or family offices and ultra high net worth individuals. Only the very wealthiest can afford the big sums demanded for direct access to private equity funds run by famous names such as Blackstone, Apollo (NASDAQ: AINV ), and Carlyle (NASDAQ: CG ), which may require a minimum investment of $1m, $5m or more. Stephen Foley, Financial Times So exposure to the meat of private equity remains scarce for the individual investor. ETFs don’t offer enough exposure to the upside of PE, and buy-ins to PE funds are impractical for most. The shares and ETFs of private equity firms today may be a good or a bad trade at today’s prices, but don’t be fooled into thinking these are “private equity investments.” 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.