Tag Archives: mutual-fund

Season Of The Glitch

When I look over my shoulder What do you think I see? Some other cat lookin’ over His shoulder at me. – Donovan, “Season of the Witch” (1966) Josh Leonard: I see why you like this video camera so much. Heather Donahue: You do? Josh Leonard: It’s not quite reality. It’s like a totally filtered reality. It’s like you can pretend everything’s not quite the way it is. – “The Blair Witch Project” (1999) Over the past two months, more than 90 Wall Street Journal articles have used the word “glitch”. A few choice selections below: Bank of New York Mellon Corp.’s chief executive warned clients that his firm wouldn’t be able to solve all pricing problems caused by a computer glitch before markets open Monday. – “BNY Mellon Races to Fix Pricing Glitches Before Markets Open Monday”, August 30, 2015 A computer glitch is preventing hundreds of mutual and exchange-traded funds from providing investors with the values of their holdings, complicating trading in some of the most widely held investments. – “A New Computer Glitch is Rocking the Mutual Fund Industry”, August 26, 2015 Bank says data loss was due to software glitch. – “Deutsche Bank Didn’t Archive Chats Used by Some Employees Tied to Libor Probe”, July 30, 2015 NYSE explanation confirms software glitch as cause, following initial fears of a cyberattack. – “NYSE Says Wednesday Outage Caused by Software Update”, July 10, 2015 Some TD Ameritrade Holding Corp. customers experienced delays in placing orders Friday morning due to a software glitch, the brokerage said.. – “TD Ameritrade Experienced Order Routing, Messaging Problems”, July 10, 2015 Thousands of investors with stop-loss orders on their ETFs saw those positions crushed in the first 30 minutes of trading last Monday, August 24th. Seeing a price blow right through your stop is perhaps the worst experience in all of investing because it seems like such a betrayal. “Hey, isn’t this what a smart investor is supposed to do? What do you mean there was no liquidity at my stop? What do you mean I got filled $5 below my stop? Wait… now the price is back above my stop! Is this for real?” Welcome to the Big Leagues of Investing Pain. What happened last Monday morning, when Apple was down 11% and the VIX couldn’t be priced and the CNBC anchors looked like they were going to vomit, was not a glitch. Yes, a flawed SunGard pricing platform was part of the proximate cause, but the structural problem here- and the reason this sort of dislocation WILL happen again, soon and more severely- is that a vast crowd of market participants- let’s call them Investors- are making a classic mistake. It’s what a statistics professor would call a “category error”, and it’s a heartbreaker. Moreover, there’s a slightly less vast crowd of market participants- let’s call them Market Makers and The Sell Side- who are only too happy to perpetuate and encourage this category error. Not for nothing, but Virtu and Volant and other HFT “liquidity providers” had their most profitable day last Monday since… well, since the Flash Crash of 2010. So if you’re a Market Maker or you’re on The Sell Side or you’re one of their media apologists, you call last week’s price dislocations a “glitch” and misdirect everyone’s attention to total red herrings like supposed forced liquidations of risk parity strategies. Wash, rinse, repeat. The category error made by most Investors today, from your retired father-in-law to the largest sovereign wealth fund, is to confuse an allocation for an investment. If you treat an allocation like an investment… if you think about buying and selling an ETF in the same way that you think about buying and selling stock in a real-life company with real-life cash flows… you’re making the same mistake that currency traders made earlier this year with the Swiss Franc (read “ Ghost in the Machine ” for more). You’re making a category error, and one day- maybe last Monday or maybe next Monday- that mistake will come back to haunt you. The simple fact is that there’s precious little investing in markets today- understood as buying a fractional ownership position in the real-life cash flows of a real-life company- a casualty of policy-driven markets where real-life fundamentals mean next to nothing for market returns. Instead, it’s all portfolio positioning, all allocation, all the time. But most Investors still maintain the pleasant illusion that what they’re doing is some form of stock-picking, some form of their traditional understanding of what it means to be an Investor. It’s the story they tell themselves and each other to get through the day, and the people who hold the media cameras and microphones are only too happy to perpetuate this particular form of filtered reality. Now there’s absolutely nothing wrong with allocating rather than investing. In fact, as my partners Lee Partridge and Rusty Guinn never tire of saying, smart allocation is going to be responsible for the vast majority of public market portfolio returns over time for almost all investors. But that’s not the mythology that exists around markets. You don’t read Barron’s profiles about Great Allocators. No, you read about Great Investors, heroically making their stock-picking way in a sea of troubles. It’s 99% stochastics and probability distributions – really, it is – but since when did that make a myth less influential? So we gladly pay outrageous fees to the Great Investors who walk among us, even if most of us will never enjoy the outsized returns that won their reputations. So we search and search for the next Great Investor, even if the number of Great Investors in the world is exactly what enough random rolls of the dice would produce with Ordinary Investors. So we all aspire to be Great Investors, even if almost all of what we do- like buying an ETF- is allocating rather than investing. The key letter in an ETF is the F. It’s a Fund, with exactly the same meaning of the word as applied to a mutual fund. It’s an allocation to a basket of securities with some sort of common attribute or factor that you want represented in your overall portfolio, not a fractional piece of an asset that you want to directly own. Yes, unlike a mutual fund you CAN buy and sell an ETF just like a single name stock, but that doesn’t mean you SHOULD. Like so many things in our modern world, the exchange traded nature of the ETF is a benefit for the few (Market Makers and The Sell Side) that has been sold falsely as a benefit for the many (Investors). It’s not a benefit for Investors. On the contrary, it’s a detriment. Investors who would never in a million years consider trading in and out of a mutual fund do it all the time with an exchange traded fund, and as a result their thoughtful ETF allocation becomes just another chip in the stock market casino. This isn’t a feature. It’s a bug. What we saw last Monday morning was a specific manifestation of the behavioral fallacy of a category error, one that cost a lot of Investors a lot of money. Investors routinely put stop-loss orders on their ETFs. Why? Because… you know, this is what Great Investors do. They let their winners run and they limit their losses. Everyone knows this. It’s part of our accepted mythology, the Common Knowledge of investing. But here’s the truth. If you’re an Investor with a capital I (as opposed to a Trader with a capital T), there’s no good reason to put a stop-loss on an ETF or any other allocation instrument. I know. Crazy. And I’m sure I’ll get 100 irate unsubscribe notices from true-believing Investors for this heresy. So be it. Think of it this way… what is the meaning of an allocation? Answer: it’s a return stream with a certain set of qualities that for whatever reason – maybe diversification, maybe sheer greed, maybe something else – you believe that your portfolio should possess. Now ask yourself this: what does price have to do with this meaning of an allocation? Answer: very little, at least in and of itself. Are those return stream qualities that you prize in your portfolio significantly altered just because the per-share price of a representation of this return stream is now just below some arbitrary price line that you set? Of course not. More generally, those return stream qualities can only be understood… should only be understood… in the context of what else is in your portfolio. I’m not saying that the price of this desired return stream means nothing. I’m saying that it means nothing in and of itself. An allocation has contingent meaning, not absolute meaning, and it should be evaluated on its relative merits, including price. There’s nothing contingent about a stop-loss order. It’s entirely specific to that security… I want it at this price and I don’t want it at that price, and that’s not the right way to think about an allocation. One of my very first Epsilon Theory notes, “ The Tao of Portfolio Management ,” was on this distinction between investing (what I called stock-picking in that note) and allocation (what I called top-down portfolio construction), and the ecological fallacy that drives category errors and a whole host of other market mistakes. It wasn’t a particularly popular note then, and this note probably won’t be, either. But I think it’s one of the most important things I’ve got to say. Why do I think it’s important? Because this category error goes way beyond whether or not you put stop-loss orders on ETFs. It enshrines myopic price considerations as the end-all and be-all for portfolio allocation decisions, and it accelerates the casino-fication of modern capital markets, both of which I think are absolute tragedies. For Investors, anyway. It’s a wash for Traders… just gives them a bigger playground. And it’s the gift that keeps on giving for Market Makers and The Sell Side. Why do I think it’s important? Because there are so many Investors making this category error and they are going to continue to be, at best, scared out of their minds and, at worst, totally run over by the Traders who are dominating these casino games. This isn’t the time or the place to dive into gamma trading or volatility skew hedges or liquidity replenishment points. But let me say this. If you don’t already understand what, say, a gamma hedge is, then you have ZERO chance of successfully trading your portfolio in reaction to the daily “news”. You’re going to be whipsawed mercilessly by these Hollow Markets , especially now that the Fed and the PBOC are playing a giant game of Chicken and are no longer working in unison to pump up global asset prices . One of the best pieces of advice I ever got as an Investor was to take what the market gives you. Right now the market isn’t giving us much, at least not the sort of stock-picking opportunities that most Investors want. Or think they want. That’s okay. This, too, shall pass. Eventually. Maybe . But what’s not okay is to confuse what the market IS giving us, which is the opportunity to make long-term portfolio allocation decisions, for the sort of active trading opportunity that fits our market mythology. It’s easy to confuse the two, particularly when there are powerful interests that profit from the confusion and the mythology. Market Makers and The Sell Side want to speed us up, both in the pace of our decision making and in the securities we use to implement those decisions, and if anything goes awry … well, it must have been a glitch. In truth, it’s time to slow down, both in our process and in the nature of the securities we buy and sell. And you might want to turn off the TV while you’re at it.

DoubleLine Debuts Dynamically Managed Strategic Commodity Fund

By DailyAlts Staff Led by the new “Bond King” Jeffrey Gundlach, DoubleLine Capital has been one of the hottest asset managers since its founding in December 2009. In addition to the firm’s institutional and sub-advisory businesses, DoubleLine also makes a number of its investment strategies available via its own line of mutual funds and closed end funds. On August 31, DoubleLine Funds added one more fund to its roster: the DoubleLine Strategic Commodity Fund (MUTF: DLCMX ), a ’40 Act mutual fund managed by DoubleLine Commodity LP. Through the fund, retail investors with as little as $500 to invest via their IRAs can gain access to DoubleLine’s Strategic Commodity strategy. The new fund’s objective is to seek long-term total return. In pursuit of this goal, the fund’s portfolio manager will employ to two distinct approaches: A long-only strategic allocation to commodities and A long/short tactical allocation to individual commodities. In practice, the fund seeks returns by means of long exposures to one or more commodity indexes, and long and short exposures to individual commodities. It achieves these exposures primarily through derivatives contracts, as well as individual securities and other instruments with returns tied to commodity indexes, baskets of commodities, individual commodities, or a combination thereof. The fund’s portfolio manager is Jeffrey Sherman. Mr. Sherman is a portfolio manager for DoubleLine LP’s derivative-based and multi-asset strategies, and he’s supported in his management of the new fund by analysts and traders in DoubleLine’s Cross Asset Team. “The rationale for investing in commodities has several components,” said Mr. Sherman, in a recent statement. “A broad mix of commodities historically has shown low correlations to stocks, bonds and cash. So commodities can diversify a portfolio invested in traditional asset classes.” Mr. Sherman, who will be holding a webcast on September 29 to discuss the fund and answer questions, also noted that commodities have inflation-hedging properties, and that “incremental returns potentially can be obtained by exploiting the term structure of prices of individual commodities.” Shares of the DoubleLine Strategic Commodity Fund are available in I (MUTF: DBCMX ) and N ( DLCMX ) classes. I shares have a $100,000 minimum initial investment and a 1.11% net-expense ratio; N shares have a $2,000 minimum initial investment and a 1.36% net-expense ratio. For IRAs, the initial minimums are $5,000 and $500, respectively. For more information, visit the fund’s web page .

Understand Your Smart Beta: A U.S. Min Vol Example

Summary Smart beta strategies are not always smart and are not just beta. USMV is a smart beta strategy that demonstrates alpha. Don’t buy USMV to reduce volatility, buy it because you believe it has alpha. Smart beta is active management and you should understand the source of outperformance for a given strategy. Smart beta strategies are not always smart and are not just beta. Smart beta ETFs can be used to take active positions relative to a given index. The goal of the smart beta ETF is to outperform the index, after adjusting for risk. This is the same goal as any other active investment strategy. There needs to be an underlying reason the active positions, in a smart beta ETF, will continue to outperform on a risk adjusted basis. The Theory: A great example is the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ). USMV purchases a portfolio of U.S. equities such that volatility is minimized, given a set of constraints. From a marketing perspective it is a great idea. Who doesn’t want to buy lower volatility stocks? However, if USMV does not offer alpha then it serves no purpose in a portfolio. Now, let’s bring in the theory. CAPM says that all returns are explained by their exposure to market beta. CAPM assumes markets are efficient & normally distributed. I am not saying that CAPM is a perfect theory, but it should be the starting point for an analysis. The Fama-French Three Factor Model was the first “smart beta” model. The three factor model says there are other factors that can explain the return and tilting to those may factors increases risk adjusted return, i.e. alpha. Market inefficiencies need to exist for CAPM not to work and for a given smart beta strategy to work. Inefficiencies can come from several places including market structure, behavioral, information availability and other factors. The Formula: Smart Beta Strategy Return = Beta*(Market Return) + Alpha. The alpha can come from factor tilts that occur in smart beta. This assumes the risk free rate is 0.0%. The Inefficiency: Please don’t say you want to buy USMV to lower your volatility! You can buy the Vanguard S&P 500 ETF ( VOO) + cash to achieve the same exact beta, it is also a lot cheaper. Buy USMV for the correct reason. USMV outperforms the market, after adjusting for risk, because it picks up a market inefficiency. USMV has been shown to have an alpha of 4.2% from October 2011 to July 2015. (click to enlarge) It is important to understand the market inefficiency that USMV relies on. The inefficiency is from U.S. mutual funds owning cash and wanting a beta of 1 or higher. For a mutual fund to have a beta of 1, while also owning cash, it must purchase higher beta stocks. Therefore higher beta stocks (high volatility stocks) receive a higher flow of dollars. This makes lower beta stocks (lower volatility stocks) are cheaper than they otherwise would be. USMV owners are effectively taking their excess return from U.S. equity mutual fund investors. Conclusion: When Investing in Smart Beta… Certain smart beta strategies outperform the index due to inherent market inefficiencies. Understand the underlying reason why a smart beta strategy will outperform an index (at least check that it shows alpha historically after adjusting for market beta). Don’t buy USMV to reduce volatility, buy it because you believe it has alpha. If you want to reduce volatility then sell risky assets and buy cash. Smart beta is active management and you should understand the source of outperformance for a given strategy. USMV has historically shown positive alpha of 4.2% and I expect the market inefficiency that it relies on to continue. 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. Share this article with a colleague