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Are Momentum ETFs Delivering Momentum Returns?

We consider a popular momentum ETF and illustrate that its historical performance is almost entirely attributable to passive exposures to simple non-momentum factors , such as Market and Sectors. Investors may thus be able to achieve and even surpass the performance of popular momentum ETFs with transparent, passive, and potentially lower-cost portfolios of simpler funds. Attributing the Performance of Momentum ETFs to Simpler Factors We analyzed the iShares MSCI USA Momentum Factor ETF (NYSEARCA: MTUM ) using the AlphaBetaWorks Statistical Equity Risk Model – a proven tool for forecasting portfolio risk and performance . We estimated monthly positions from regulatory filings, retrieved positions’ factor ( systematic ) exposures , and aggregated these. This produced a series of monthly portfolio exposures to simple investable risk factors such as Market, Sector, and Size. The factor exposures at the end of Month 1 and factor returns during Month 2 are used to calculate factor returns during Month 2 and any residual (security-selection, idiosyncratic , stock-specific) returns un-attributable to factors. There are only two ways for a fund to deviate from a passive portfolio: residual returns un-attributable to factors and factor timing returns due to variation in factor exposures over time. We define and measure both components below. iShares MSCI USA Momentum Factor ETF – MTUM: Performance Attribution We used the iShares MSCI USA Momentum Factor ETF as an example of a practical implementation of a theoretical momentum portfolio. MTUM is a $1.1bil ETF that seeks to track an index of U.S. large- and mid-cap stocks with high momentum. The fund’s turnover, around 100% annually, is about half that of the theoretical momentum factor. iShares MSCI USA Momentum Factor ETF – MTUM: Factor Exposures The following factors are responsible for most of the historical returns and variance of MTUM: MSCI USA Momentum Factor ETF – MTUM: Significant Historical Factor Exposures Click to enlarge Source: abwinsights.com Latest Mean Min. Max. Market 88.44 84.12 65.46 96.03 Health 23.73 30.28 23.73 34.94 Consumer 74.02 32.53 13.10 74.06 Industrial 1.69 9.71 1.13 24.51 Size -10.47 -1.04 -11.09 7.67 Oil Price -2.90 -2.45 -4.94 -0.04 Technology 17.72 16.56 1.50 32.29 Value -4.86 -2.13 -8.00 5.20 Energy 0.00 1.86 0.00 4.12 Bond Index 6.51 1.08 -22.90 23.64 iShares MSCI USA Momentum Factor : Active Return To replicate MTUM with simple non-momentum factors, one can use a passive portfolio of these simple non-momentum factors with MTUM’s mean exposures as weights. This portfolio defined the Passive Return in the following chart. Active return, or αβReturn, is the performance in excess of this passive replicating portfolio. It is the active return due to residual stock performance and factor timing: MSCI USA Momentum Factor ETF – MTUM: Cumulative Passive and Active Returns Click to enlarge Source: abwinsights.com MTUM’s performance closely tracks the passive replicating portfolio. Pearson’s correlation between Total Return and Passive Return is 0.96. Consequently, 93% of the variance of month returns is attributable to passive factor exposures, primarily to Market and Sector factors. Once passive exposures to simpler factors have been removed, MTUM’s active return is negligible. Since MTUM’s launch, the cumulative return difference from such passive replicating portfolio has been approximately 1%: 2013 2014 2015 Total Total Return 16.73 14.62 8.50 45.18 Passive Return 16.06 16.48 4.55 41.34 αβReturn 1.11 -2.46 2.54 1.12 αReturn 3.91 0.05 0.29 4.27 βReturn -2.71 -2.52 2.23 -3.05 This active return can be further decomposed into security selection (αReturn) and factor timing (βReturn). These active return components generated low volatility, around 1% annually, mostly offsetting each other as illustrated below: iShares MSCI USA Momentum Factor ETF – MTUM: Active Return from Security Selection AlphaBetaWorks’ measure of residual security selection performance is αReturn – performance relative to a factor portfolio that matches the funds’ historical factor exposures. αReturn is the return a fund would have generated if markets had been flat. MTUM has generated approximately 4% cumulative αReturn, primarily in 2013, compared to roughly 1.5% decline for the average U.S. equity ETF: MSCI USA Momentum Factor ETF – MTUM: Cumulative Active Return from Security Selection Click to enlarge Source: abwinsights.com iShares MSCI USA Momentum Factor ETF – MTUM: Active Return from Factor Timing AlphaBetaWorks’ measure of factor timing performance is βReturn – performance due to variation in factor exposures. βReturn is the fund’s outperformance relative to a portfolio with the same mean, but constant, factor exposures as the fund. MTUM generates approximately -3% cumulative βReturn, compared to a roughly 1% decline for the average U.S. equity ETF: MSCI USA Momentum Factor ETF – MTUM: Cumulative Active Return from Factor Timing Click to enlarge Source: abwinsights.com These low active returns are consistent with our earlier findings that many “smart beta” funds are merely high-beta and offer no value over portfolios of conventional dumb-beta funds. It is thus vital to test any new resident of the Factor Zoo to determine whether they are merely exotic breeds of its more boring residents. Conclusion Theoretical, or academic, momentum portfolios are not directly investable. A popular momentum ETF, MSCI USA Momentum Factor , did not deviate significantly from a passive portfolio of simpler non-momentum factors. Investors may be able to achieve and surpass the performance of the popular momentum ETFs with transparent, passive, and potentially lower-cost portfolios of simpler index funds and ETFs. The information herein is not represented or warranted to be accurate, correct, complete or timely. Past performance is no guarantee of future results. Copyright © 2012-2016, ALphaBetaWorks, a division of Alpha Beta Analytics, LLC. All rights reserved. Content may not be republished without express written consent. 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.

Explaining Blockchain To Traditional Investors Through Growth Capital

Note: This piece assumes some general familiarity with the blockchain technology space. If you would like an introduction to the technology that underpins Bitcoin and other cryptocurrencies, see this article on Re/code . Ever since launching CoinFund in July 2015, I’ve been viewing the blockchain technology space from the point of view of an engineer and a portfolio manager. I’ve been thinking, therefore, about how to explain the blockchain technology space to traditional investors in traditional terms. What makes blockchain companies unique and interesting opportunities in the investment landscape? To see the potential long-term implications of this fascinating space, one needs to take in a thirty minute primer of technical details: What is a blockchain? What’s interesting about decentralization and trustlessness? What’s the deal with smart contracts? In a semi-technical crowd, the audience is quickly lost in jargon and a technologist’s reasoning. Instead, I think the correct way to present the blockchain opportunity to traditional investors is through the lens of growth investments – yesterday, today, and tomorrow. It is a story of a technology that democratizes, opens, and optimizes a difficult investment environment. Where is the capital? For the last 15 to 20 years, startups have proliferated in the market across all verticals. You have ZocDoc (Private: ZDOC ) for doctors, UpCounsel for lawyers, Seamless for food delivery, Tinder for dating, and on and on. Just about every New York University junior one meets is trying to either be CEO to or a VC in the next “Uber (Private: UBER ) for X.” Take a look at this chart in which you can witness the staggering “unicorn density” of our time: Click to enlarge As more companies take up the startup model, there are more and more private companies and fewer and fewer public ones. Just a few metrics paint a clear picture. The number of firms on the U.S. stock market started declining in the mid-1990s from a high of about 7,300 listed companies. By 2015, after a lazy uptick, there were only 3,700 left. Startups, pumped by high valuations and VC capital and a tech entrepreneurial culture, stay private longer in a “psychological shift” which has been described as “Silicon Valley’s distaste for the IPO.” Between 1996 and 2014, the average time to IPO went up from 3.5 years to 6.9, according to the 2015 IPO report by WilmerHale . And most recently, the number of IPOs has been dropping globally, with the tech sector leading the way. A 58% drop in NYSE IPOs in 3Q15 YTD compared with the previous year was accompanied by a 77% drop in dollars raised, according to Ernst & Young . In short, there is a lot of capital moving from the public into the private markets for the world’s primary growth sector – technology. According to Rett Wallace’s assessment of the tech bubble , “27 times more primary capital has gone into U.S. technology companies privately than publicly. And if Box.com had actually gotten its IPO done on schedule last year, it would be 88 times more.” In such an environment, what does participating in the growth sector look like for investors? Growth investments, yesterday and today At the turn of this century, investing in growth would looked like this: Joe the Investor would identify tech as a growth sector. He would send some cash over to his Ameritrade account, and – this being 2004 – buy some Google (NASDAQ: GOOG ) (NASDAQ: GOOGL ) at the IPO. Then Joe would hold Google for 10 years. In the interim, Joe would know that he could dump some of his Google stock if technology took a downturn. Finally, Joe would sell Google in 2014 for a 12x return. And here is what growth investment looks like today: Spencer is a private investor. He has a top 1% salary and therefore qualifies as an accredited investor , which allows him to participate in private offerings. In 2009, Spencer would notice a company called Uber doing a funding round on AngelList. Spencer’s contacts on AngelList are investing, so he would follow suit. It’s not likely that these investors would be able to predict that Uber would take off, create a new industry, and become one of the greatest growth companies of all time. It’s not likely that Uber can predict that in 2009. Following his investment, Spencer would be stuck in Uber private equity for seven years with very limited options to take profits before a liquidity event. Perhaps next year Travis Kalanick will decide to take Uber public, but no one can be sure. If he does, Spencer will make a 12,700x return. When growth companies move into the private sector, traditional public investors are left with little access to growth and a precarious stock market. “Growth and value investing” seems now a fragment of the past. And even when startups do IPO, overvaluations often foil performance in the public markets. To cite some recent examples , Box (NYSE: BOX ) stock fell 30% shortly after trading. The beloved Etsy (NASDAQ: ETSY ) fell 70%. At the time of the IPO, it is simply too late for public investors to participate in the growth of startups. The chart below shows the returns that were left for public investors after the IPO of Etsy (source: Bloomberg). Click to enlarge It would appear that in this regime the privilege of private investments goes to affluent individuals. Yet, while accredited investors have much greater access to outsized returns, their investment landscape is far from rosy. First, there is little data, research, or transparency in the private markets. A hedge fund trader might receive an offer to buy Lyft (Private: LYFT ) stock, but how does he judge whether it is a good one? Virtually all ridesharing competitors today are in the private sector and are thus tight-lipped about basic metrics such as revenues and customer acquisition costs – basic parameters that have been traditionally used to price stocks. Once again, this kind of uncertainty contributes to overvaluation and only when the company eventually reaches the public market do valuations start to deflate back to reality. Finally, it goes without saying that the lack of liquidity for private investors is a long-standing issue. But with the advent of efficient new trading technologies and a global market, low liquidity might become a concern of the past. Blockchain companies are models for the growth investments of the future A blockchain company is a special species of technology startup, one where its business gives it a distinct advantage in its own business operations. It’s kind of meta, but consider that Apple’s (NASDAQ: AAPL ) expenditure on its internal hardware is probably much less than Google’s – Apple manufactures computers and has vast economies of scale on hardware; or consider that it costs Twilio (Private: TWILO ) much less to send a text message compared to a startup who has to use Twilio to do the same. Just like tech startups need computers, they also need funding. And blockchain technology companies happen to be in a unique position to fund themselves because their product is highly conducive to transferring currency-like and stock-like assets between investors, entrepreneurs, and even digital organizations . In practice, the prevalent method of funding blockchain companies in recent memory has been the “crowdsale” – a fundraising model where the company sells its own cryptocurrency, cryptoequity, or cryptotoken to the public before the system is built and then uses the funds as a seed investment. When the blockchain finally launches, the stake becomes tradable and liquid and early investors stand to make a good return – in effect, the blockchain company has done an IPO that lies outside the traditional financial system. The Ethereum crowdsale is today the fifth largest crowdfunding in the history of the planet, having raised $18M against a white paper written by a gifted 20-year-old college dropout. Having used the funds to build a complex organization with tens of employees and many more on distributed projects from all over the world, and working against non-trivial negative social pressure from the established cryptocurrency community, Ethereum was released as a public blockchain a year and a half later. In March of 2016, Ethereum grew in price by a factor of 10, and became the world’s second largest cryptocurrency by market capitalization at a $750M valuation . Such an “initial cryptocurrency offering,” or ICO, has a highly favorable character for investors: First, the ICO is available globally to all investors, and in most jurisdictions there are compatible regulations that allow participation. The disparity between Joe and Spencer investors that we see in private equity on the traditional markets has been reduced, if not eliminated. It is an equity crowdfunding, so the market can potentially accommodate large raises – a boon for companies. Even in traditional markets, we have begun to recognize the value of equity crowdfunding with the JOBS Act and the proliferation of platforms like Crowdfunder and CircleUp, with this high-growth market estimated to reach nearly $100 billion ten years from now . Unlike typical private companies, blockchain projects often adopt an open source or open community model, so development and performance metrics are available and transparent. Unlike in speculative cryptocurrencies like bitcoin, cryptoequity investments often lend themselves to straightforward modeling, as they are based on a well-defined business product proposals: if the platform acquires n customers, it will generate r returns. Liquidity is one of the foremost considerations in an investment. Most ICO investments become liquid at beta, and investors only have to wait out development time (compare with Uber, above). Not only is liquidity often available over the counter during this period, but the advent of smart contracts will send the wait period to zero: you will soon be able to trade cryptoequity immediately after purchasing it at crowdsale using a decentralized exchange . Blockchains facilitate the low-cost, fast and efficient transfer of equity between stakeholders. This is a vast improvement of the stagnating, expensive, and slow process of paper deals on the private markets. It’s easy to see that with these favorable properties, ICOs have the character of the kind of high-tech and low-friction applications that we’ve become accustomed to over the last 20 years. They stand as a open and efficient model of how growth investing could be in the future. Blockchain Technology Disclosure : I hold an economic interest in CoinFund, a portfolio which invests in cryptocurrency and blockchain technology companies by way of their cryptoequity and which has a long position in Bitcoin and the cryptocurrency of Ethereum. CoinFund’s portfolio is fully transparent at http://coinfund.io . I have no formal business relationship or affiliation with any blockchain technology company or project. Disclosure: I am/we are long GOOG, AMZN. 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.

5 ETFs To Watch In March

After a horrendous sell-off in the first two months of 2016, the third month started on a solid footing with Wall Street seeing the best day in a month . Losers turned leaders as the downtrodden financial and tech stocks ricocheted on cues of an improving U.S. economy. Impressive U.S. factory and construction data were behind this newfound optimism. While the S&P 500 gained about 2.4% and Dow Jones Industrial Average added over 2.1%, about a 4% spike in Apple (NASDAQ: AAPL ) shares led the Nasdaq Composite to return about 2.9%, making March 1 the best day on the bourses since August 2015. So far this year, both the S&P 500 and the Dow Jones indices are down 3.2% each while the Nasdaq Composite is off 6.4%. In any case, March is historically known for stellar returns. The average return of the S&P 500 was 1.06% in March, from 1950 to 2015. There were 42 years of a green March while returns were in the red only in 24 years. As per moneychimp.com , only December, April and November beat out March in terms of returns. Of course, deep-rooted concerns over global growth worries and oil price declines can’t be ignored. But with such a heavy sell-offs suffered year to date, chances are high that this March will finally see some relief and end in the green. Whatever be the case, investors might want to know about the ETF areas that are best suited for the month. For them, below we highlight a few ETFs – some that offer safety and others that have the potential to grow in this rocky environment. Market Vectors Preferred Securities ex Financials ETF (NYSEARCA: PFXF ) Since a flight to safety has put a lid on bond yields, investors’ thirst for yield can be satiated by investing in preferred stock ETFs. These are hybrid securities having the characteristics of both debt and equity. The preferred stocks pay stockholders a fixed, agreed-upon dividend at regular intervals, like bonds. Even if rates rise, an extremely strong yield will allow investors to beat out the benchmark Treasury yields. The preferred stock fund – PFXF – is heavy on REITs (33.5%) and Electric (22.5%) industries. The fund is up 2.2% year to date (as of March 1, 2016) while its 30-Day SEC yield is 6.26%. PowerShares Dynamic Building & Construction Portfolio ETF (NYSEARCA: PKB ) The industrial sector enjoys a seasonal benefit in March. Also, the space gained investors’ attention afresh after a reading of the U.S. manufacturing sector impressed investors to start the month. If this was not enough, U.S. construction spending expanded to the highest level since October 2007 . All these put this construction ETF in focus. The fund has considerable exposure in homebuilding, which is another surging sector. PKB is down 4.2% so far this year, but added over 6.8% in the last one month. PKB has a Zacks ETF Rank #2 (Buy). PowerShares KBW Property & Casualty Insurance ETF (NYSEARCA: KBWP ) Since upbeat U.S. data once again sparked off rate hike talks, 10-year Treasury bond yields jumped 9 bps in a single day to 1.83% on March 1. If the trend continues, financial and insurance ETFs would benefit. While the financial sector is presently facing issues with the potential default in the energy sector, we are banking on this insurance ETF. KBWP with a Zacks #2 ETF is down 2% year to date, but added 2.7% in the last one month. WisdomTree Emerging Markets Equity Income ETF (NYSEARCA: DEM ) Investors should note that the emerging markets are making a comeback. Though their fundamentals are not too sound, cheaper valuation is probably the key to their recent success. Via DEM, investors will get exposure to the emerging markets and simultaneously enjoy strong dividend income of about 5.36% annually. Even if the fund succumbs to a sell-off, this market-beating yield would make up for the capital losses to a large extent. The fund is heavy on Taiwan (24.7%) and China (14.1%). DEM is up 1.2% so far this year. The fund has a Zacks ETF Rank #3 (Hold) with a Medium risk. Victory CEMP US Small Cap High Dividend Volatility Weighted Index ETF (CSB) Risk-on sentiments, though still to be full-fledged, are back in the market. Hence, U.S. small-cap equities and ETFs are likely to gain ground. However, we would suggest investors to practice a defensive approach even in this segment. It’s better to go for an ETF like CSB, which consists of the highest 100 dividend yielding stocks of the CEMP US Small Cap 500 Volatility Weighted Index. After choosing the highest dividend yielding stocks, these are weighted on their standard deviation (volatility). Probably due to this quality exposure, this small-cap ETF has lost just 0.6% in the year-to-date frame (when small-caps are being thrashed). In the last one month, the fund added 5.4%. Original Post