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My Week At Oxford’s Said Business School

I just spent the last week at Oxford University’s Said School of Business on its popular week-long Private Equity Program for senior executives. Say the word Oxford, and it conjures up images of a city of dreamy spires and ancient college courtyards. Yet if you squint your eyes on a rare sunny day in Oxford, the Said Business School campus looks more like Stanford University’s Business School in Silicon Valley than a medieval college situated on an 800-year-old university campus. That’s because Oxford Said is a very new school in a very old university. Even the establishment of Said back in the 1990s was controversial, as the dons of Oxford questioned whether business was a worthy topic of study. Fast forward 20 years, Oxford Said today is a thriving commercial venture led by former Harvard Business School professor Peter Tufano. Its halls are literally overflowing with students and executives from around the world bathing themselves in the reflected glory of the global Oxford brand. The executive education programs are held in a building appropriately named after Margaret Thatcher – even as Thatcher’s alma mater, Somerville College, originally a women’s school at Oxford College, refused to give her an honorary degree because the Oxford dons protested her cuts to higher education. Thatcher Business Education Centre, Oxford Said School of Business Although Oxford is a newcomer on the global business school scene, it’s hard to imagine a more geographically diverse group of students among a class of 30. On my right sat an auditor from a sovereign wealth fund in Oman; on my left was a pension fund manager from Ghana; and across the classroom was a snarky app developer and private investor from Portland, Oregon, who regaled the class daily with his varied choice of iconoclastic headgear. Private Equity in Perspective Oxford’s Private Equity Program is led by Professor Tim Jenkinson, a spritely, athletic and affable sixty-something former rower, who teaches students private equity as far afield as India, China and Silicon Valley. Private equity, as Jenkinson defines it, includes venture capital, growth capital, leveraged buyouts and turnarounds. However you define it, private equity – “capitalism on steroids” – does have an image problem. In the U.K. press, private equity is often synonymous with greed. U.S. investors still recall Oliver Stone’s 1987 film Wall Street , which told the story of a hostile takeover of Bluestar, which many regard – rightly or wrongly – as a quintessential private equity transaction. Stripped to its essence, leveraged buyouts (“LBO”) – the most popular form of private equity transaction – are simply a way of financing an acquisition of a company with its own steady and predictable cash flows until the company can be restructured and sold at a large profit. As ruthless as that sounds to the uninitiated, this is a perfectly rational strategy. Through the lens of private equity, many publicly traded companies are under-leveraged, and they leave a lot of money on the table – especially in an era of low interest rates. And as it turns out, private equity investors are pretty good at showing their investors the money. That’s also why the Oxford endowment – whose deputy Chief Investment Officer, Jack Edmondson, spoke at the program – has allocated 20% of its funds to private equity, thereby closely mimicking the asset allocation strategy of the highly regarded Yale endowment. Calculating Private Equity Returns Private equity is all about the numbers. And in terms of headline returns, the asset class is impressive. Yet as it turns out, this has much to do with the dark arts of how investment returns in private equity are calculated. Private equity calculates returns (and fees) on an Internal Rate of Return (IRR) basis, rather than “time-weighted return. The latter is the method you are more likely to see in your mutual fund or exchange-traded fund (ETF). But there are good reasons for private equity to use IRR. After all, private equity involves constantly flipping deals and funds are never fully invested, as they are in, say, ETFs. Still, some rates of return can be staggering – and deceptive. That’s why the Yale University endowment caused such a stir when it recently revealed that its return on venture capital deals (a subset of private equity) had been an astonishing 92.7% over the past 20 years. Had Yale achieved that rate of return on its entire endowment of $4.86 billion starting in 1996, the endowment would be worth $2,422,537,000,000,000 – or 8x more than the $300 trillion of the entire value of financial assets across the globe today. But if you use time-weighted returns, Yale’s venture capital portfolio’s 20-year return drops rather dramatically to 32.3%. And once you exclude the dotcom boom by looking only at the last 10 years, even the IRR drops to 18%. That’s still impressive. But at least it’s believable. Trends in the World of Private Equity Here are three major insights about private equity I took away from the week. First, academic studies confirm that private equity investments do make more money for investors. While the managements of publicly traded companies are “fat and happy” and today spend the bulk of their time on compliance and investor communications, the board members of private companies not only have skin in the game, but also have the time and energy to focus on improving the business. Combine that with leverage and the returns ramp up fast. Second, private equity is still in its infancy. Average allocations among funds is 4%, while most are targeting twice that level. Sovereign wealth funds – say Norway with its $875 trillion – alone could have a major impact on the asset class. Private equity is also emerging as the favored approach in fast-growing emerging markets. Perhaps that explains why one-third of the Oxford class was made up of students from Africa, Latin America and Eastern Europe. Third, private equity is becoming a victim of its own success. As with any popular asset class, too much money is chasing too few deals. That means returns to investors – “LPs” or limited partners in private equity jargon – are falling precipitously. Finally, here’s what worried me most: Private equity is now the number one career choice for newly graduating Oxford MBAs. That trend ruffles my contrarian feathers. Playing the Private Equity Game So can you be a player in the private equity game? The short answer is: “Not really.” Investors – the LPs – in private equity are almost exclusively pension funds, endowments and some family offices. But there are a few indirect ways you can gain exposure to the private equity game – though they are unlikely to yield the same type of returns. PowerShares Listed Private Equity Portfolio ETF (NYSEARCA: PSP ) is an ETF that invests in many of the private equity management companies that back deals, including those funded by business development companies (“BDCs”), by master limited partnerships (“MLPs”) and by other vehicles. In terms of investment strategies, “activist investing” is a close cousin of private equity. In that space, there are a handful of publicly traded vehicles including Carl Icahn’s investment partnership, Icahn Enterprises (NASDAQ: IEP ) , and Bill Ackman’s Pershing Square Holdings, Ltd. ( OTCPK:PSHZF ) which also trades OTC in the United States. Finally, a new Global X Guru Activist Index ETF (NASDAQ: ACTX ) , launched on April 29, tracks the investments of 50 of the largest and most successful activist investors. Six of Icahn Enterprises’ top 10 positions are included, such as Apple (NASDAQ: AAPL ) and eBay (NASDAQ: EBAY ). More than half of Bill Ackman’s Pershing Square Capital Management’s holdings are represented and include Zoetis (NYSE: ZTS ) and Canadian Pacific Railway (NYSE: CP ).

Volatility ETFs: Buy Or Sell Now?

Volatility in the stock market is represented by the CBOE Volatility Index (VIX), also known as the fear gauge. This tends to outperform when markets are falling or when fear over the future is high. Notably, VIX has risen 9.6% over the past one-month period, reflecting that worries over the stock market have started to build up. Will the fear level continue to rise and push up the index? What is Pushing Fear Levels? After an impressive comeback, the S&P 500 and the Dow Jones dropped for the third consecutive week, representing the longest streak of weekly declines since January’s market meltdown. This slump has wiped off most of the gains from these indices, pushing the year-to-date gains down to 0.1% for the S&P 500 and 0.6% for the Dow Jones. The decline resumed after a spate of downbeat data across the globe, in particular China and the U.K., that brought global growth worries back on the table. Additionally, the growth momentum in the U.S. has slowed down and investors’ faith in central banks’ ability to boost growth across the globe has faded. Further, signs of sluggish growth in Europe and Asia, a pullback in industrial metals, the oil price drama, and Fed’s uncertain policy continue to weigh on stocks. This is especially true as Friday’s solid retail sales data for April reignited the case for two interest rates hikes this year while the weaker-than-expected April payrolls data early this month cast doubts over the health of the economy and pushed back the chances of a rate hike. The latest round of selling last week followed a slew of disappointing earnings reports from retailers that sparked off concerns over consumer spending. All these factors flared up volatility, pushing the volatility index higher. As per the ft.com , investors pulled out about $7.4 billion from global equities last week, sending the total outflow of five weeks to a five-year high of $44 billion. This reflects weakening faith in the global equity markets. Moreover, the International Monetary Fund (IMF) once again cut its global growth forecast to 3.2% from the earlier projection of 3.4%, citing that the ill effects of a persistent slowdown in China and lower oil prices have spilled over into emerging markets such as Brazil. The agency also highlighted economic weakness in developed countries like Japan, Europe and the U.S. This could lead to poor stock performance across the globe, providing further support to the volatility index. Against a woe-begotten backdrop, investors could look into volatility products that have proven themselves as short-time winners in turbulent times. They can use these products for hedging purposes to ensure safety when the stock market starts to plunge. Volatility ETFs in Focus A popular ETN option providing exposure to volatility, the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ), sees a truly impressive volume level of about 73.3 million shares a day. The note has amassed $1.6 billion in AUM and charges 89 bps in fees per year. The ETN focuses on the S&P 500 VIX Short-Term Futures Index, which reflects implied volatility of the S&P 500 Index at various points along the volatility forward curve. It provides investors with exposure to a daily rolling long position in the first and second month VIX futures contracts. VXX shed 7.4% over the past one-month period. Two more products – the ProShares VIX Short-Term Futures ETF (NYSEARCA: VIXY ) and the VelocityShares VIX Short-Term ETN (NASDAQ: VIIX ) – also track the same index. VIXY has $252.7 million in AUM and sees good average daily volume of more than 3.4 million shares while VIIX is the unpopular one of the two with just $9.1 million in its asset base and good volume of around 304,000 shares per day. While VIXY charges 85 bps in annual fee, VIIX is costlier, charging 0.89% annually from investors. Both products are down 7.3% in the same time frame. Another product – the C-Tracks ETN on CVOL (NYSEARCA: CVOL ) – linked to the Citi Volatility Index Total Return, provides investors with direct exposure to the implied volatility of the large-cap U.S. stocks. The benchmark combines a daily rolling long exposure to the third and fourth month futures contracts on the VIX with short exposure to the S&P 500 Total Return Index. The product has amassed $2.2 million in its asset base while charging 1.15% in annual fees from investors. The note trades in a relatively lower volume of about 147,000 shares per day and lost 5% over the past one month. Technical Look However, when we took a closer look to the technical charts, we found that the volatility index and the ETFs would remain range bound at least in the near term. In the chart below, we have considered the price movement of the ultra-popular VXX. The ETN touched its 52-week low of $14.64 on May 11 and its short-term moving average (9-Day EMA) is well below the mid and long terms (50- and 200-Day EMA), suggesting some pessimism for the product. Additionally, the bearish trend is confirmed by the parabolic SAR, which is currently trading above the current price of the fund. However, the Relative Strength Index (RSI) has been rising lately and currently stands at 42.97, indicating that the fund has clearly moved away from its oversold territory, reflecting some potential upside. Bottom Line Given global growth fears as well as mixed technical signals, it seems prudent for investors to wait until the stock market falls or more fear factors creep into the picture. Further, investors should note that these products are suitable only for short-term traders. This is because most of the time, the VIX futures market trades in a condition known as ‘contango’, a situation where near-term futures are cheaper than long-term futures contracts. Since the volatility ETFs and ETNs like VXX must roll from month to month in order to avoid ‘delivery’, the situation of contango can eat away returns over long periods. Original Post

When You Exit The Stock Market, Don’t Let The Door Hit You On Your Way Out

You cannot make this stuff up. The median stock in the S&P 500 has never been more overvalued on price-to-earnings growth (PEG) and price-to-sales (P/S). On a forward price-to-earnings (P/E) basis – where profitability expectations already reflect pie-in-the-sky speculation – the median company’s shares trade in the 96th percentile. That’s pretty darn pricey! Credit Goldman Sachs for the assessment. For that matter, give the financial conglomerate kudos for acknowledging the strong possibility that one might be wise to “sell in May” after all. Hedge fund legend Stanley Druckenmiller , who spoke at an investment conference in New York last week, forcibly advised exiting stocks as well. One of his reasons? The stock market in 1982 versus the stock market in 2016. He said, It is hard to avoid the comparison with 1982 when the market sold for 7-times depressed earnings with dozens of rate cuts and productivity rising going forward vs. 18-times inflated earnings, productivity declining and no further ammo on interest rates. Granted, overpriced stocks cannot and will not tell anyone the near-term direction of the market. What’s more, ultra-low borrowing costs a la zero percent interest rate policy largely drove risk assets like stocks to unbelievable extremes. On the other hand, front-loading investment returns over the past seven years has pilfered the potential gains one might have anticipated over the next seven years. The Federal Reserve’s own Richard Fisher confirmed the central bank’s front-loading endeavors back in January. Consider an analysis by Steve Sjuggerud. He analyzed data going back to 1870 with respect to what happened to annualized returns after seven incredible years like the current bull market. The anticipated gains over the next one, three, five and seven years were not particularly promising. In essence, the past’s remarkable returns confiscated the prospects for the future. In contrast, the worst decile rank for seven-year periods served up enhanced annualized gains going forward. Are these results surprising? Not really. It tells investors what they should already know; that is, the rewards for holding stocks at higher elevations are dismal, whereas the rewards for acquiring stocks at lower elevations are admirable. Virtually everyone who has ever looked at the relationship between high valuations and future returns understands that higher prices today imply lower future outcomes (and vice versa). Quantitative easing (QE), zero percent rate policy (ZIRP), negative rate policy (NIRP) did not alter the long-standing relationship; rather, central bank shenanigans pulled the gains from the future into the present, while decimating the hold-n-hope possibilities for the future. If I readily acknowledge that valuations alone do not predict the near-term and that stocks could “grind higher,” why have I been so adamant about maintaining a lower risk equity profile over the last 12 months? Weakness in the global economy, deterioration in market internals (including credit spreads) and the Fed’s directional shift since QE ended (December 18, 2014) have combined to create a toxic brew for “risk on” asset performance. Is it true that riskier stock assets have bounced back from two corrective beatings? In August-September of 2015 and again in January-February of 2016? Yes. Still, the percentages do not lie. Less risky asset types are clearly outperforming riskier ones… and that does not happen in powerful bull market uptrends. We should also be cognizant of the reason(s) for risky asset recovery. Is it because there has been widespread buyer demand from “mom-n-pop” retail investors, institutional advisers, pensions, mutual fund managers and/or hedge funds? On the contrary. Each of these groups have been “net sellers” for 16 consecutive weeks. Corporations are the only net buyers of their own shares and they remain the biggest source of stock demand. However, that dynamic may be changing. Corporations have started to slash spending due to revenue and profit weakness. Not only did the number of firms that cut dividends reach a seven-year high, but according to Bloomberg, corporate buybacks are set to fall below $600 billion for the first time in three years. Get a gander at the table below that shows the possibility of a slowdown based on announced buybacks over the first four months. Click to enlarge In earlier commentary, prior to the available buyback data from Bloomberg, I suggested that corporations would be incapable of perpetually spending 100% of free cash flow after dividends to artificially support share prices. The practice of ignoring capital expenditures has almost certainly hindered business growth for years to come. Take a look at the chart on corporate borrowing below. Corporations spent the majority of borrowed money on buying or maintaining land, buildings, and equipment in the 90s. Today? Most of the debt was spent on non-productive financial engineering. In other words, not only did corporations double their total debt levels since the Great Recession ended, but they barely spent any of that debt on anything other than stock buybacks or acquisitions. Click to enlarge Let’s review. Valuations sit at historic extremes. “Risk-off” has outperformed “risk-on” for an entire year. Buybacks have been remarkably influential in propping up the benchmarks, but may be less likely to do so for the remainder of 2016. Factor in global economic weakness that is showing little signs of turnaround as well as election uncertainty, and it is easy to see why preservation may be more critical than appreciation pursuits. I do not advocate getting out of stock assets completely. A tactical asset allocation shift that lowers one’s risk exposure is typically more beneficial than an “all-in” or “all-out” approach. That said, if you have not reduced your exposure yet, you might want to do so now. Otherwise, there’s a good chance the stock market door will hit you on the backside when you eventually scamper for cover. Click here for Gary’s latest podcast. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.