Tag Archives: macro-view

Today’s Best-Bet Wealth-Builder ETF Investment

Summary From a population of some 350 actively-traded, substantial, and growing ETFs this is a currently attractive addition to a portfolio whose principal objective is wealth accumulation by active investing. We daily evaluate future near-term price gain prospects for quality, market-seasoned ETFs, based on the expectations of market-makers [MMs], drawing on their insights from client order-flows. The analysis of our subject ETF’s price prospects is reinforced by parallel MM forecasts for each of the ETF’s ten largest holdings. Qualitative appraisals of the forecasts are derived from how well the MMs have foreseen subsequent price behaviors following prior forecasts similar to today’s. Size of prospective gains, odds of winning transactions, worst-case price drawdowns, and marketability measures are all taken into account. Today’s most attractive ETF Is the ProShares UltraPro Russell2000 ETF (NYSEARCA: URTY ). The investment seeks daily investment results that correspond to three times (3x) the daily performance of the Russell 2000® Index. The fund invests in securities and derivatives that ProShare Advisors believes, in combination, should have similar daily return characteristics as three times (3x) the daily return of the index. The index is a float-adjusted, market capitalization-weighted index containing approximately 2000 of the smallest companies in the Russell 3000® Index or approximately 8% of the total market capitalization of the Russell 3000® Index, which in turn represents approximately 98% of the investable U.S. equity market. It is non-diversified. The fund currently holds assets of $79.94 million and has had a YTD price return of +6.57%. Its average daily trading volume of 140,328 produces a complete asset turnover calculation in 5.9 days at its current price of $95.76. Behavioral analysis of market-maker hedging actions while providing market liquidity for volume block trades in the ETF by interested major investment funds has produced the recent past (6 month) daily history of implied price range forecasts pictured in Figure 1. Figure 1 (used with permission) The vertical lines of Figure 1 are a visual history of forward-looking expectations of coming prices for the subject ETF. They are NOT a backward-in-time look at actual daily price ranges, but the heavy dot in each range is the ending market quote of the day the forecast was made. What is important in the picture is the balance of upside prospects in comparison to downside concerns. That ratio is expressed in the Range Index [RI], whose number tells what percentage of the whole forecast range lies below the then current price. Today’s Range Index is used to evaluate how well prior forecasts of similar RIs for this ETF have previously worked out. The size of that historic sample is given near the right-hand end of the data line below the picture. The small blue thumbnail distribution at the bottom of Figure 1 indicates the current RI’s size in relation to all available RIs of the past 5 years. The first items in the data line are current information: The current high and low of the forecast range, and the percent change from the market quote to the top of the range, as a sell target. The Range Index is of the current forecast. Other items of data are all derived from the history of prior forecasts. They stem from applying a T ime- E fficient R isk M anagement D iscipline to hypothetical holdings initiated by the MM forecasts. That discipline requires a next-day closing price cost position be held no longer than 63 market days (3 months) unless first encountered by a market close equal to or above the sell target. The net payoffs are the cumulative average simple percent gains of all such forecast positions, including losses. Days held are average market rather than calendar days held in the sample positions. Drawdown exposure indicates the typical worst-case price experience during those holding periods. Win odds tells what percentage proportion of the sample recovered from the drawdowns to produce a gain. The cred(ibility) ratio compares the sell target prospect with the historic net payoff experiences. Figure 2 provides a longer-time perspective by drawing a once-a week look from the Figure 1 source forecasts, back over two years. Figure 2 (used with permission) What does this ETF hold, causing such price expectations? Figure 3 is a table of securities held by the subject ETF, indicating its concentration in the top ten largest holdings, and their percentage of the ETF’s total value. Figure 3 source: Yahoo Finance URTY holdings reveal how an average of assets in each of its top ten commitments, all swap contracts in either the Russell 2000 index or the ETF tracking that index, iShares Russell 2000 (NYSEARCA: IWM ) provide a 3x leverage to the price movements of that small-cap index. Please note that the top ten swap contracts equal 278% of the ETF’s total assets. To have an idea of the composition of the Russell 2000 index, Figure 4 is a table of data lines similar to that contained in Figure 3, for each of the top ten holdings of the ETF tracking the Russell 2000 index, IWM. Figure 4 source: Yahoo Finance Now note that the Russell 2000 index does indeed contain 2,000 securities of small-capitalization companies, many of which are in quite volatile circumstances. The IWM’s top ten holdings (by size of holding) quite probably are intended to be the better-performing issues. While these ten represent only 2 ½% of the fund’s total assets, they are five times the size of ten average pieces of 2,000 securities at 0.05% of the total. The IWM’s top ten holdings provide only a peek at the kinds of companies contained in the Russell 2000 index, but it is better than nothing (or of everything). In order to fill out some sense of these emphasized holdings of the fund and the index, Figure 5 gives the details of MM price range hedging-derived forecasts for each of the ten, and compares them with data from our ranked top20 securities list for the same day. Figure 5 (click to enlarge) In an index as unpredictably dynamic as this, wide variations in market experience seem to be the rule. Column (5) contains the upside price change forecasts between current market prices and the upper limit of prices regarded by MMs as being worth paying for price change protection. The average of +12.7% of the top ten IWM/index holdings is close to our list’s population average of all 2500+ equities MM forecasts of +13.1%. It is about 2 ½ times the upside forecast for SPY price change prospects. The other side of the coin is column (6), which shows what actual worst-case price drawdowns typically have been in the 3 months following each time there has been a forecast like those of the present day. Those risk exposures have averaged -6.3% in the holdings top ten, better than -8.6% experienced by list equities at large, but larger than the only -3.3% on the SPY ETF. These holdings have attractive reward tradeoffs between returns and risks, with the top ten (column 14) at a ratio of 2.0, compared to equities overall at 1.5 times. This is better than the market average of SPY at a ratio of 1.7 times risk avoidance, which has a cost of an anticipated reward (column 5) only half that of the ten best index stocks. Another qualitative consideration is the credibility of the ten IWM/index big holdings after previous forecasts like today’s. The net average price change (column 13) of the ten has been 0.8 times the size of the (column 5) upside forecast average, +10.6% (column 9) compared to +12.7%. The equity population’s actual price gain achievement, net of losses has been a pitiful +3.7% compared to promises of 13.1%. The ability of IWM/index holdings to recover from those worst-case drawdowns and achieve profits occurred in 83% of experiences (column 8). The equity population only recovered less than two thirds of the time, and while the SPY experiences were about the same as the ten IWM/index holdings, the achieved gains were much smaller. SPY has had only +3.4% gains previously from like forecasts of +5.7%. In many respects the IWM/index holdings are quite similar to the average of our daily best20 list. That should be no surprise, since URTY is one of those 20 best ranked issues on this day. Conclusion URTY provides attractive forecast price gains, supported by its equally appealing largest holdings. Both the ETF and many of its major holdings offer very attractive prospects in near-term price behaviors, demonstrated by previous experiences following prior similar forecasts by market makers. The diversity of its holdings is very broad, providing a wide opportunity to share in constantly developing discoveries across the biotechnology as well as software applications and other high-technology fields. URTY’s price now, in comparison to the forecast price expectations of market professionals, appears to be quite attractive. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Vanguard 500 Index Fund: A Mutual Fund Anyone Can Appreciate In Their 401k

Summary VFIAX is a mutual fund designed to track the S&P 500 with a lower expense ratio than SPY. The mutual fund is a great holding for investors wanting to replicate the performance of “the market” without getting devoured by fees. This is a solid option for the retirement account. The Vanguard 500 Index Fund Admiral Shares (MUTF: VFIAX ) offer investors an excellent way to handle their investments. While I’m a huge fan of using ETFs in the construction of a portfolio, Vanguard is offering some mutual funds with very compelling expense ratios. The nice thing about these mutual funds is that investors are able to buy fractional shares which are excellent for dollar cost averaging. Volatility The standard deviation of returns (monthly) shows very similar levels of volatility to the S&P 500 index as tracked by (NYSEARCA: SPY ). Correlation is also running around 99.9%. The holdings are very similar, but these shares are offering a lower expense ratio and the ability to use dollar cost averaging very effectively. Expense Ratio The mutual fund is posting .05% for an expense ratio. There is really nothing to complain about here. It beats SPY and it beats most mutual funds and ETFs in existence. Largest Holdings The diversification within the fund is good. There are not as many holdings as the whole market index funds that I often prefer, but all around this is a very solid fund. (click to enlarge) Risk Factors The biggest issue for VFIAX is the risk that the S&P 500 is getting fairly expensive on many fundamental levels. For instance, the P/E ratio on the index is fairly high (running over 20). The high P/E ratio comes at a time when corporate profits after taxes are also very high relative to GDP. My concern is about the valuation level of the market. When it comes to ways to buy the market, VFIAX is one of the best funds to use for the task. When it comes to risk assessment, I’m not sure I’d go with Vanguard’s scale, shown below: Vanguard has a tendency to mark any primarily equity investment as being fairly high risk. Relative to other equity investments, the risk level here is very reasonable. The fund still scores high on risk for Vanguard’s scale because they are comparing it to other funds stuffed with lower risk securities than equity. Compared to a very short term high credit quality bond fund, I have to agree that VFIAX has substantially more risk. Compared to the broad universe of equity investments, VFIAX is doing a solid job of holding a diversified portfolio of large capitalization companies with solid histories. Other Things to Know Minimum investments for opening a position were $10,000 according to the Vanguard website. After that additional purchases could be in increments as small as $1. This is a solid fund for dollar cost averaging. Based on my macroeconomic views, I would want to use a fund like VFIAX for equity exposure but I also believing hold some cash on hand is wise given the potential for a reduction in equity prices. When it comes to using mutual funds, I think the best way to deal with them is to dollar cost average in. I like using ETFs to adjust my portfolio exposure but the mutual funds can be set as a “set it and forget it” investment vehicle. When making a meaningful contribution to a fund month after month without checking up on it, it would be wise to make sure the fund is reasonably diversified and that the expense ratios are low. The Vanguard 500 Index Fund Admiral Shares easily sail through both of those tests. Conclusion While I am concerned that market valuations are a little on the high side, I’m still investing each month. I choose to hold more in cash than I would if the market looked cheaper, but I still see dollar cost averaging into the right funds as a viable long term strategy. The biggest challenge for investors is to resist the urge to pull back when the market falls. We should all expect that the stock market will fall within the next 30 years. When those drops happen, investors need to be able to stomach stepping into the market to buy. Since those times are often very scary, one solution is to set up automatic purchases for a fund like VFIAX. To avoid overthinking things, I keep automatic contributions running as a baseline for investing. I use my other accounts to make additional purchases. If your employer sponsored plan offers VFIAX, it is a mutual fund worthy of consideration. Figure out your own risk tolerance and determine if the equity exposure is right for you. The biggest potential mistake an investor could make with buying VFIAX would be to put 75%+ of their portfolio in the fund when they are only a couple years from retirement and will be required to sell off shares to take distributions. So long as the total level of risk is appropriate for the investors, this is a great fund to use as the core of a passive retirement portfolio. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

The Low Volatility Anomaly: Mid Caps

The Low Volatility Anomaly describes portfolios of lower volatility securities that have produced higher risk-adjusted returns than higher volatility securities historically. This article provides additional evidence for Low Volatility strategies by showing the factor’s success in mid-cap stocks. Provides historical comparison of returns between low volatility mid cap stocks versus broad mid cap indices and the benchmark large cap index. Thus far in this series, our most oft used description of the Low Volatility Anomaly in equity markets has been depicted through the use of a factor tilt on a large cap index. In the introductory article to this series on Low Volatility Investing, I plotted the cumulative total return profile (including reinvested dividends) of the S&P 500 (NYSEARCA: SPY ), the S&P 500 Low Volatility Index (NYSEARCA: SPLV ), and the S&P 500 High Beta Index (NYSEARCA: SPHB ) over the past twenty-five years. In an article last week , I showed that the Low Volatility Anomaly extends to small cap stocks as well as the S&P Smallcap 600 Low Volatility Index has also outperformed the broader S&P Smallcap 600 over the last twenty years, producing annual total returns of nearly 14% per annum. The volatility-tilted indices for both the small and large cap indices are comprised of the twenty percent of index constituents with the lowest (highest) volatility within the S&P 500 based on daily price variability over the trailing one year, rebalanced quarterly, and weighted by inverse (direct) volatility. The low volatility tilt of both the small and large cap indices produced both higher absolute returns and much lower variability of returns than the broader market gauges. This article will answer the question of whether such a factor tilt delivers alpha in the space in-between – the mid-cap stock market. Fortunately for our examination, Standard & Poor’s has also developed the S&P MidCap 400 Low Volatility Index . Similar to the S&P 500 Low Volatility Index, this benchmark tracks the twenty percent of the S&P MidCap 400 (eighty stocks) with the lowest realized volatility over the past year, weighted by an inverse of that volatility, and then rebalanced quarterly. While the index was launched in September 2012, Standard & Poor’s has back-tested data for over twenty years. Below is a graph of the cumulative total return of the S&P MidCap 400 Low Volatility Index, the S&P MidCap 400 Index, and the S&P 500. (click to enlarge) Source: Standard and Poor’s; Bloomberg As you can see above, the S&P MidCap 400 Index (white line; replicated through the ETF MDY ) readily bests the S&P 500 (yellow line). This outperformance is consistent with my article on 5 Ways to Beat the Market that demonstrated the structural alpha available through the size factor, which has been well documented in academic research (F ama & French, 1992 ). Some readers have also contended that the outperformance from Equal Weighting, which was also one of my “5 Ways ” is attributable to the size factor as well and more reminiscent of a mid-cap strategy given the lower average capitalization of equally weighting versus traditional capitalization weighting, but I contend that the contrarian re-balancing also contributes to the alpha-generative nature of that strategy. Whatever the source of the structural alpha, mid-caps have outperformed large-caps over long-time intervals. Low Volatility mid-caps have outperformed the broad mid-cap index on a risk-adjusted basis, but not on an absolute basis like the Small and Large Cap strategies. In tabular form, one can readily see that each of the small cap, mid cap, and large cap Low Volatility indices produce higher risk-adjusted returns with lower variability of returns than the broader market gauges from which they are constructed. The lower downside in the market selloff in 2008 greatly contributes to the lower variability of the Low Volatility indices. (click to enlarge) The PowerShares S&P MidCap Low Volatility Portfolio (NYSEARCA: XMLV ) seeks to replicate the performance of the S&P MidCap 400 Low Volatility Index with a 0.25% expense ratio. Like many of the Low Volatility ETFs, XMLV is a post-crisis innovation with a track record dating only back to February 2013. The ETF has only $100M of AUM, and thirty-day average volume of only 14,600 shares, similar AUM to the SmallCap Low Volatility ETF (NYSEARCA: XSLV ), but about 2/3 of the trading volume. Again similar to the Small Cap Low Volatility Index, I would be remiss if I did not mention that financials currently account for nearly half of the fund weighting (REITs 27.3%, Insurance 16.6%, Banks 3.8%). As I covered in a recent comparison between the PowerShares S&P Low Volatility ETF versus the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ), industry concentrations in the S&P indices are uncapped, unlike the MSCI versions, and this lack of constraints has historically led to risk-adjusted outperformance and more variable industry concentrations over time. A reader of my article on Small Cap Low Volatility contended that they disfavored these funds because of the potential higher sensitivity to higher rates given the financial bent. Rates are moderately higher in 2015, and XMLV has delivered market-beating returns. I would point out that if higher rates lead to higher return volatility, then these stocks will be attributed lower weights or excluded from the fund at the quarterly rebalance date. As described in now fourteen recent articles on the Low Volatility Anomaly, I am a believer in the relative risk-adjusted outperformance of low volatility strategies. While Mid-Cap Low Volatility did not deliver the absolute outperformance versus the Mid Cap Index over the historical sample period, it still strongly outpeformed on a risk-adjusted basis. Versus the S&P 500, which many use as their benchmark, MidCap Low Volatility still delivered 3% per annum of outperformance with less than three-quarters of the return volatility. I am also a believer in the long-run outperformance available through the size factor that favors smaller and mid-capitalization stocks. Resultantly, I am evaluating an entry into a modest position to XMLV to provide some additional diversification to the Low Volatility portion of my long-term portfolio and will monitor the efficacy of this ETF vehicle as it matures. Disclaimer: My articles may contain statements and projections that are forward-looking in nature, and therefore inherently subject to numerous risks, uncertainties and assumptions. While my articles focus on generating long-term risk-adjusted returns, investment decisions necessarily involve the risk of loss of principal. Individual investor circumstances vary significantly, and information gleaned from my articles should be applied to your own unique investment situation, objectives, risk tolerance, and investment horizon Disclosure: I am/we are long SPY, SPLV, XSLV. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.