Tag Archives: opinion

3 Must Consider Funds To Boost Your Portfolio During Crises

Summary Markets cratered this morning with the Dow dropping almost 1,000 points. The fact is the economy is the global economy is not strong and the weakness and China and Europe is taking its toll in the States. I discuss 3 funds you should consider holding short-term to quell losses in your portfolio. Panic. Fear. Dow down 1,000 points at the open. Despite a massive bull run, many professionals and analysts that I talk to still believe earnings estimates are too high for this quarter and next. Thus far, companies reporting earnings have delivered average results. We have a Fed that has done everything it can to inflate stock prices and keep the economy running. It is essentially our of tricks. Now, while the markets are rebounding off of the lows today, the worst may bot be over. Fear has skyrocketed and while some may buy quality companies at a fair price on the way down, this is likely the beginning of an overdue correction. Image source: UK telegraph The fact is the economy is not strong. The weakness and China and Europe is taking its toll in the States. These events will likely exert pressure on markets that have essentially been propped up by central bank actions. Thus, traders may want to consider taking some bearish action should market panic ensue. Those who are bearish could consider selling stock, selling covered calls on their positions, shorting stocks, buying puts or investing in a bear fund. While each of these approaches has its respective benefits and risks, in this article I want to highlight three ETFs that could provide great returns in the event of a market sell-off on fear of uncertainty, disappointing earnings or continued international news that spooks markets. Direxion Daily Small Cap Bear 3X Shares (NYSEARCA: TZA ): This is my favorite way to invest in a bear market short term. TZA seeks : Daily investment results of 300% of the inverse of the price performance of the Russell 2000 Index (also known as the small cap index). The Russell 2000 measures the performance of the small-cap segment of the United States equity universe and consists of the smallest 2,000 companies in the Russell 3000 Index, representing approximately 10% of the total market capitalization of the Russell 3000 Index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. TZA actually does not invest in equity securities or stocks. What TZA does is creates short positions by investing at least 80% of its net assets in financial instruments to provide leveraged and unleveraged exposure to the Small Cap Index and the remainder in money market instruments. TZA currently trades at $13.00 a share on average daily volume of 14.1 million shares. In the last five days TZA is up 27.1% compared with the ETF that tracks the Russell 2000 index, which is down 8.3%. TZA has a 52-week range of $8.81-$19.59. ProShares Short S&P 500 ETF (NYSEARCA: SH ): This ETF seeks : Daily investment results that correspond to the inverse of the daily performance of the S&P 500 index. The S&P 500 index is a measure of large cap United States stock performance. It is a capitalization weighted index of 500 United States operating companies and selected real estate investment trusts. SH attempts to invest: At least 80% of its net assets, including any borrowings for investment purposes, to investments that, in combination, have economic characteristics that are inverse to those of the index. It intends to invest assets not invested in financial instruments, in debt instruments and/or money market instruments. The Fund intends to concentrate its investments in a particular industry or group of industries to approximately the same extent as the index is so concentrated. SH currently trades at $22.80 on approximately 3.6 million shares exchanging hands daily. SH is up 9.0% in the last five days, while the S&P 500, as measured by the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) is down 8.8%. SH has a 52-week range of $20.58-$24.86. Direxion Daily S&P 500 Bear 3x ETF ( SPXS ): SPXS, formerly the Direxion Daily Large Cap Bear 3X fund, seeks : Daily investment results before fees and expenses of 300% of the inverse of the price performance of the S&P 500 Index. As with other funds there is no guarantee the fund will meet its stated investment objective. The fund has a 0.95% annual expense ratio. Under normal circumstances SPXS management creates short positions by investing at least 80% of its net assets in: futures contracts; options on securities, indices and futures contracts; equity caps, collars and floors; swap agreements; forward contracts; short positions; reverse repurchase agreements; ETFs; and other financial instruments that, in combination, provide leveraged and unleveraged exposure to the S&P 500. SPXS currently trades at $22.60 a share. SPXS has average daily volume of 3.8 million shares exchanging hands. In the last five days SPXS is up 29.4% while the SPY is down 8.8%. SPXS has a 52-week trading range of $16.98-$30.83. Image source: memegenerator.net Take home message: There are lots of ways to prepare for a potential short-term bear market including selling covered calls, buying puts, shorting stocks and stock indices, or just plain old selling equities to raise cash. While central bank action has bolstered markets for years, I believe earnings reports as well as turmoil in Europe and China will dictate the direction of the market. The aforementioned funds perform very well in the events of market sell-offs. Disclosure: I am/we are long TZA. (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: I have call options in TZA

An Exceptional Bond Fund For Improving Risk-Adjusted Portfolio Performance

Summary The Vanguard Short-Term Corporate Bond Index ETF is everything I would hope for in a short-term corporate debt exposure. The ETF has low volatility and low correlation with other important investments. The credit quality is respectable without being so high that it eliminates most of the yield. Using this fund as part of a diversified portfolio makes it shine. The Vanguard Short-Term Corporate Bond Index ETF (NASDAQ: VCSH ) is simply a great fund. I wish I could start more articles out with comments that are this positive. This fund is simply great. The yields are severely limited since this is short term debt with respectable credit quality, but the ETF on the whole is just exceptional when it comes to being part of an effective portfolio. Credit The following chart shows the credit quality breakdown. When it comes to a corporate bond fund there are two ways that I like to see the weightings. Either I would want a junk bond fund or I would want one with a credit breakdown similar to this. Personally, favor combining a fund like this with quite a few other bond funds to create a more complex group of bond holdings. Duration The following chart breaks down the duration of the funds. Holdings are almost all less than 5 years and usually more than 1 year. Again, this is a solid choice. If an investor wants to load up on even shorter term bonds, there are funds designed specifically for that. It is difficult to find a useful yield level on those ultra-short bonds so this is a reasonable portfolio composition. Sector The following chart breaks down the sector allocation: This sector allocation may seem absurd if an investor looks at numbers without reading the names. The names of the sectors indicate that rather than breaking down the market into all the corporate sectors, Vanguard is containing several other bond sectors that are not relevant to corporate debt. It wouldn’t make sense for this fund to have an allocation to foreign debt issues or MBS. My hypothetical portfolio, shown lower in the article, picks up those allocations through other ETFs. A Hypothetical Portfolio I put together a very simple sample portfolio using Invest Spy. Due to some of the ETFs being newer the sample period is limited to a little over two years. (click to enlarge) This hypothetical portfolio is weighted to 60% equity and 40% bonds. To break that down the weights from the equity section are 30% total market index (NYSEARCA: VTI ), 10% equity REITs (NYSEARCA: VNQ ), 5% Utilities, 5% Consumer Staples (NYSEARCA: VDC ), 10% International Equity. The bond section is holding 10% in junk bonds (NYSEARCA: JNK ), 5% in extended duration treasuries (NYSEARCA: EDV ), 5% in emerging market government bonds (NASDAQ: VWOB ), 5% short term corporate debt , 5% in short term government debt (NASDAQ: VGSH ), 5% in mortgage backed securities (NASDAQ: VMBS ), and 5% in intermediate-term corporate bonds (NYSEARCA: BIV ). This portfolio won’t be perfect for hitting the efficient frontier, but it should beat the vast majority of real portfolios investors are using on a risk adjusted basis. If long term rates were higher I would have used a higher weighting for long duration bonds due to their exceptionally correlation to major equity classes. My disclosure already states it, but I’ll reiterate that I am long VTI and VNQ. Annualized Volatility When measuring risk adjusted returns for a portfolio the most efficient method is usually to use the Sharpe ratio. For that ratio we are taking the total return annualized return and subtracting the risk free rate. Then we divide the resulting number by the annualized volatility. The problem is that this metric is only really known after the fact. Predicting the level of returns in advance is problematic but correlations and relative volatility are more reliable over time than returns. Within the chart investors can see the annualized volatility of each holding as well as the resulting annualized volatility for the portfolio. While some holdings have higher annualized volatility scores, such as EDV, the ETF makes up for that by having negative correlation to a few of the equity holdings. As a result, the ETF only contributes .6% of the total risk in the portfolio. VCSH has an annualized volatility of 1.8%, which is not bad at all. Once we adjust for correlation the risk contribution is extremely low. That means VCSH fits extremely well in this kind of hypothetical portfolio. The expected returns are not going to be very strong since this is short term corporate debt, but for an investor trying to achieve superior risk adjusted returns relative to the SPDR S&P 500 Trust ETF ( SPY), this is a great holding. It will usually underperform SPY, but it will result in material reduction in total portfolio risk. Correlation I want to dive a little deeper into the correlation statistics. The table below provides the correlation across each of those ETFs which should make it very quick to see which ones are work very well together. When a correlation is shown in the tan color it indicates a negative correlation which is very attractive for reaching the efficient frontier. You’ll notice that quite a few of the bond funds have negative correlations to VTI and the S&P 500. Since VTI and SPY have a correlation ranging between 99% and 99.9% depending on the measurement period, it should not be surprising that those two funds have very similar correlations to other holdings. Here is the correlation table: (click to enlarge) Conclusion When the ETF is placed within the context of a portfolio that is heavy on U.S. equities it looks like an intelligent way to reduce the overall risk of the portfolio. When it comes to generating alpha, I’ve often told investors that the secret to reaching alpha is to focus on reducing risk. Most other investors are already focused on trying to maximize their returns and many will take on more risk than they can handle. Focusing on risk reduction reduces the incentives for an investor to sell off after a big loss and makes it easier to generate alpha relative to the S&P 500 because it is easier to reduce risk through superior diversification. Disclosure: I am/we are long VTI, VNQ. (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.

Response To: Structured Note Read The Fine Print

Response to a biased article by AllianceBernstein on Structured Notes. Structured Notes may be helpful in introducing, reducing or modifying risk. The referenced Structured Note is not given credit in the referenced article for the downside protection it provides. Furthermore, to compare to a balanced portfolio which wins in all markets is unrealistic. I recently came upon a Seeking Alpha article by Alliance Bernstein titled Structured Notes: Read the Fine Print . The article expressed a fairly negative and, in my opinion, inaccurate view of structured investing based on an analysis of one structured note in particular. As an experienced structurer and trader prior to founding Exceed Investments, I’d like to help set the record straight. The article analyzes a 5-year 28% buffered note on the S&P 500 as an example. While they do not share a link to the terms, the note is similar to, if not exactly the same, as this note . First, let’s briefly consider what a structured note is and discuss its purpose. Structured notes are an example of what I call “defined outcome” investments, which are options-based strategies that allow investors to shape a risk/ reward exposure to fit their personal objectives. In these strategies, market participation levels are preset. Therefore, the targeted downside participation is known in advance, as is the upside potential. A defined outcome investment can be built to introduce risk, reduce risk, or modify it – in this case, the 28% buffered note offers S&P exposure with a material level of downside protection, which I will refer to as downside “insurance” in this article. Performance at maturity, assuming no default of the issuer, looks like this (X axis is Adjusted S&P 500 return; Y axis is the Note return): An investor may be interested in this product if they are risk-averse but still want to participate in equity markets (e.g., an executive who is retiring in 5 years from now and can’t take a big hit over the next 5 years). The “insurance policy” of this note will cover up to 28% of downside “damage” 5 years from now – e.g., market down 28%, investor loses 0, market down 40%, investor loses 12%. As in all insurance policies, a premium needs to be paid – in this case, the investor loses all dividends of the S&P 500. Over 5 years, those lost dividends amount to about 12% in a reasonable model scenario (2% annual dividend rate, assumed reinvestment at a compounded 8%). Is 28% of potential downside insurance worth giving up 12% of dividend upside, while still participating in the price appreciation of the S&P 500? There’s no right answer to that question as it depends on an individual’s needs and perspectives. As mentioned, I found a number of inaccuracies and misrepresentations (e.g., expense levels, liquidity) in the article but will focus on the main items which I found to be flawed. To summarize: The article directly compares the expected performance of the S&P 500 with the Note, without fairly pointing out the insurance benefit provided by the Note The article then compares the performance of a balanced portfolio with the Note, which I find two issues with – Why compare a product vs. a balanced portfolio? It’s an unfair comparison – no sane investor would invest all their funds in a single note The balanced portfolio described is somehow expected to gain during equity declines as well as fairly closely match bull returns, which is just impossible Greater detail follows: “Our analysis suggests that this structured note has an 80% chance of underperforming the S&P 500 over the next five years…” On one hand, while I can’t attest to the accuracy of their model, it seems reasonable. The note will underperform the S&P if the S&P finishes > -12% after 5 years. That’s because the cost of the insurance purchased, (i.e., 12% of lost dividends), will be greater than the insurance “payout” if the market isn’t down by more than 12%. Given historical performance, odds are the S&P does better than a cumulative -12% over the next 5 years. On the other hand, this isn’t a fair statement. If an investor buys any type of insurance, (e.g., earthquake insurance, fire insurance, theft insurance) and there is no major catastrophe in the next 5 years, which is usually the case, the investor will lag the performance of people who didn’t buy insurance. The same is true of buying 28% worth of portfolio insurance – if the market isn’t down by at least your premium spent, you will lag. That obviously doesn’t mean ipso facto that no one should buy insurance. “Projecting thousands of plausible outcomes across all types of market environments, we found that the median outcome for the structured note is more than 6% below what we’d expect from a fully diversified balanced portfolio, as the next Display ” For starters, no reasonable investor would take all their assets and purchase this single structured note vs. choosing a balanced portfolio. A more reasonable approach to this comparison may be to replace a relevant component of the balanced portfolio, for instance large cap value, with the structured note and then stress test outcomes between the two varying portfolios. Now let’s talk about the finding that a balanced portfolio over 5 years results in a median 4.5% return when the stock market finishes down, and a median 38% return when the market finishes up (which is apparently just about equal to the S&P price return). While I am sure their model is well designed, this simply doesn’t pass the smell test. How did individuals with balanced portfolios do in 2008? Hint: not very well. I am not aware of any product or portfolio design that had positive returns in 2008 and then proceeded to equal the price return of the S&P 500 over the following five years. If someone else is, please share it with me so I can invest. In conclusion, while I acknowledge that Structured Notes have issues (I cover them in detail at the end of this white paper ), which is what drove me to found Exceed Investments in the first place, this article does not treat them fairly. Ultimately, the referenced note provides a very defined risk / reward exposure to the S&P 500, providing a level of downside protection that may be deemed appropriate and/or may resonate for a subset of investors. 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. I have no business relationship with any company whose stock is mentioned in this article.