Tag Archives: nreum

Junk Bond ETFs Quench Traders’ Thirst For Liquidity

Summary High-yield bond investors are concerned about liquidity concerns in the primary markets ahead of a Federal Reserve interest rate hike. Nevertheless, junk bond traders have been turning to ETFs to meet their liquidity needs. Growing importance of ETFs in the fixed-income market. By Todd Shriber & Tom Lydon Participants in the high-yield bond market are once again fretting about liquidity as the Federal Reserve inches closer to raising interest rates. With the Fed likely on course to raise interest rates before the end of 2015, investors are once again questioning the ability of junk bond ETFs to endure a potential sequel to the taper tantrum of 2013. However, liquidity-starved junk bond traders are increasingly turning to ETFs, such as the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) and the SPDR Barclays High Yield Bond ETF (NYSEARCA: JNK ) , as it becomes harder – and pricier – to trade junk-rated debt. “The growing size of trades in the funds tells the same story: Transactions of more than $1 million are making up about a quarter of volumes in the two biggest high-yield ETFs now, up from 15 percent in early 2012, according to a July 10 Deutsche Bank report,” reports Lisa Abramowicz for Bloomberg . HYG and JNK are the two largest high-yield bond ETFs by assets. The average trailing 90-day volume for the two ETFs is nearly 7.2 million shares compared to just under three million shares per day for the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA: LQD ) , the largest investment-grade corporate bond ETF. Due to new regulations and capital requirements imposed following the financial crisis, these same banks could be forced to cut inventories as well As investors found it more difficult to price fixed-income securities, many have turned to ETFs for their greater perceived liquidity. The potential problems ahead are associated with large redemptions in the ETFs or secondary markets. If enough people exit the funds, the ETF providers will have to swap shares for bond securities in the primary market. However, if there is not enough bond securities in the underlying market to meet redemptions , ETF investors may not be getting what they bargained for. Speaking broadly of fixed income ETFs, BlackRock (NYSE: BLK ), the world’s largest asset manager and issuer of HYG, said in a recent whitepaper, “Bond ETFs offer many of the benefits bond market reformers have long urged: they improve the ability of all investors to transact efficiently, with complete price transparency, and at lower transaction costs. Because bond ETFs trade on an exchange, they show investors what’s really going on, which is especially important when markets are stressed.” “ETFs have been increasingly providing institutions with a safety valve to get out of investments quickly. These days, big bond buyers are willing to fork over cash for that,” according to Bloomberg. Year-to-date, investors have pulled $797.6 million from HYG while adding $539.4 million to JNK. LQD has added over $2.4 billion in new assets. iShares iBoxx $ High Yield Corporate Bond ETF (click to enlarge) Tom Lydon’s clients own shares of HYG, JNK and LQD. Disclosure: I am/we are long HYG, JNK, LQD. (More…) 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.

Tough Times For Broadly Diversified Portfolios

How’s your globally diversified strategy faring these days? Having a tough time? You’re not alone – the headwinds are fierce. For the first time in recent memory, the overwhelming majority of the major asset classes are in the red on a trailing one-year basis. As a result, broadly defined asset allocation strategies are suffering, at least relative to the stellar numbers in recent years. Using a set of ETF proxies for the trailing 250-day (1 year) total return, only US stocks, US REITs (real estate investment trusts), and US bonds (broadly defined) are posting gains among the major asset classes. By contrast, the other 11 asset classes are in varying states of loss over that period. Here’s another view by indexing all the ETFs to 100 as of July 16, 2014… ouch! (click to enlarge) Given the current environment, it’s no surprise that a broadly defined asset class strategy has stumbled lately. For instance, consider an ETF-based version of an unmanaged, market value weighted mix of all the major asset classes – the Global Market Index Fund, or GMI.F, which holds all the ETFs in the table above. Here’s how GMI.F stacks up for the past 250 trading days through yesterday (July 14, 2015). This investable strategy is ahead by less than 1% over that span – below the performance for US stocks (NYSEARCA: VTI ) and US bonds (NYSEARCA: BND ). (click to enlarge) Is GMI’s diminished performance surprising? Maybe, but only if you weren’t paying attention. Risk premia projections for GMI have been relatively soft for some time ( see this month’s update, for instance) – after several years of hefty gains for GMI and equivalent strategies. The lesson, of course, is that mean reversion is alive and well when it comes to market (and portfolio strategy) returns. Share this article with a colleague

Why The Law Of Large Numbers Dictates Effective Risk Management

Summary It is effective risk management that determines profitability rather than the incidence of wins to losses. The law of large numbers suggests that a larger number of trades with a positive reward to risk ratio will be more effective than a smaller number of trades. In this regard, it is possible for a trader to be “wrong” a majority of the time while continuing to remain profitable. “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.” – George Soros The entire dynamic of successful trading could probably be summed up in the above sentence. When I started out trading forex, I was overly concerned with getting the trades right. However, I have come to learn that the most successful traders are not the ones who are right all the time; rather they are the ones who know how to manage their risk most effectively . For instance, the odds that a plane will crash somewhere in the world are 1 in 11 million. Indeed, this is a very low probability. However, when one considers the vast number of flights that take off and land every day, it is sadly almost inevitable that there will be a plane crash at some point in the future. The odds of a golfer getting a hole in one are 5,000 to 1. However, across the world there are far more than 5,000 games of golf being played in a single day; it is therefore almost inevitable that a player somewhere in the world will manage to score a hole in one today. The above phenomenon is known as the law of large numbers ; where an event with a low probability of occurring on its own has a higher probability of occurring when subjected to a large number of trials. This has important implications for risk management, and moreover it demonstrates how a trader can still be wrong the majority of the time while continuing to be profitable. Let us take this as an example. Suppose that we have eight forex trades in a particular month, with a 1:3 risk-reward ratio, or a stop loss of 50 pips and a take profit of 150 pips. For each trade (discounting technical or fundamental factors), the odds are greater that we will make a loss rather than a profit. However, the profit on each trade far outweighs the potential loss. With a 1:3 risk-reward ratio, we have a 75 percent chance of the price hitting our stop loss with a 25 percent chance of it hitting our take profit ratio. However, this also means that only two of the eight trades need to be profitable for us to breakeven. Moreover, the law of large numbers dictates that at least two of our trades are indeed likely to be profitable. 1-(1-p)^number of trials where p is the probability of an event occurring In the above instance, we need at least three of our trades to hit the take profit point in order to be profitable. Given that we have a 0.25 probability of this happening, our probabilities are as follows: 1-(0.25)^1 = 0.25 1-(0.25)^2 = 0.4375 1-(0.25)^3 = 0.5781 1-(0.25)^4 = 0.6835 1-(0.25)^5 = 0.7626 1-(0.25)^6 = 0.8220 1-(0.25)^7 = 0.8665 1-(0.25)^8 = 0.8998 We see that with eight trades being placed, we have an 89 percent probability that at least one trade will hit our take profit point. Given that we need three trades to be profitable: 0.8998^3 = 72.85 percent probability of three trades being profitable In this regard, we see that the law of large numbers provides us with an attractive risk-reward set up in that it limits our downside while maximizing our upside. Moreover, we can be wrong more often than we are right and still remain profitable. One of the big reasons why most new traders fail is the inability to manage risk effectively. For instance, if we decided to set up trades with a high risk and low return, e.g. 150-pip stop loss and 50-pip profit, then even if we were right a majority of the time it would only take a couple of losing trades to wipe out our winnings. Ultimately, being a successful trader is not always about being right. It is about managing your risk effectively. As we can see, the law of large numbers plays a key role in doing so. 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.