Tag Archives: portfolio-strategy

Enhancing Performance With Low Volatility ETPs

One theme that I will spend more time on in 2016 and beyond is the low volatility anomaly, which has been discussed in considerable detail in the academic world, leading to papers such as the following: In a nutshell, the research supports the claim that low volatility and low beta stocks in the United States and across the globe outperform high volatility and high beta stocks, with low volatility stocks generating substantially higher risk-adjusted returns. Not coincidentally, the groundswell of research pointing to outperformance by low volatility stocks has created a land rush for low volatility ETPs in the first generation of “smart beta” or factor-based investment products in ETP wrappers. Since I believe smart beta or factor-based ETPs is one of the key revolutionary ideas to appear in the investment world in recent memory, I will have a great deal to say about this subject and the many tangential ideas that arise from it going forward. After nine years focusing primarily on the VIX, volatility and related subjects, it is time to charge off in some new directions, starting with some that have a whiff of volatility and ETP innovation. For now, I am going to be content with updating a February 2013 post, with the title The Options and Volatility ETPs Landscape . At that time, I wanted to capture those ETPs that employed a buy-write/covered call approach, employed a put-write strategy, focused on the convertible bond space or targeted low volatility stocks. Well, a lot has changed in the past three years, notably in the low volatility space. This time around, I have some enhancements to the options and volatility ETPs graphic. As is the case with The Current VIX ETP Landscape , I have added yellow stars for those ETPs with an average daily volume of 1,000,000 or higher and pink stars for ETPs with an average daily volume between 100,000 and 1,000,000. Additionally, I have highlighted the new currency-hedged crop of low volatility ETPs by using a red font and have captured the demise of HFIN, a financials buy-write ETF that closed in March 2015 with an X-HFIN designation. (click to enlarge) (source(s): VIX and More) There are a number of other sub-categorizations I will delve into at a future date, but note that whereas FTHI is a buy-write only, FTLB adds an out-of-the-money put. Three other relatively new arrivals, CFO , CDC and CSF , are structured so that they will hold up to 75% of portfolio assets in cash in adverse market conditions. Another intriguing new entrant, SLOW , attempts to avoid sector bias by forcing greater sector diversification than most other low volatility ETPs. So if you found 2015 volatility to be daunting and are looking to dampen volatility in your portfolio in 2016 or tap into the performance benefits of the low volatility anomaly, keep the list above in mind. While comprehensive and including many ETPs with marginal liquidity, this list may not touch upon some of the many new and illiquid products that might be flying under the radar.

Deep Value Stocks Bouncing Back Strongly To Close 2015

Summary Deep value, out-of-favor stocks bounced back strongly in the holiday-shortened Christmas week. As part of my premium research service on Seeking Alpha, I am tracking an equity focused “Concentrated Best Ideas Portfolio.”. The Concentrated Best Ideas Portfolio was up 7.43% for the week, while the S&P 500 was up 2.83%. Since its inception on Dec. 7, 2015, the Concentrated Best Ideas Portfolio is up 7.51%, while the S&P 500 is down 1.30%. The three most crowded, intertwined trades could be unwinding and recent price action may foreshadow emerging 2016 trends. “To buy when others are despondently selling and to sell when others are avidly buying requires the greatest fortitude and pays the greatest ultimate rewards.” – Sir John Templeton – 1958 “Knowledge is limited. Imagination encircles the world.” – Albert Einstein Introduction On November 17th, 2015 Reuters published the latest BAML global fund manager survey. It showed that the most crowded trade , by far, among fund managers was long the U.S. Dollar, followed by the related trades of short commodity stocks and short emerging market equities. As a value investor and a keen follower of behavioral analysis, I have been attracted to the opposite side of these trades. In particular, commodity stocks have caught my eye for several years, as valuations have been historically cheap. I illustrated this in a recent article on U.S. Steel (NYSE: X ), which showed that its current price-to-book ratio and price-to-sale valuation ratio are substantially below U.S. Steel’s prior year-end 2008 comparable metrics. This is true across a wide variety of companies, particularly in the material, energy, and emerging markets space, despite the S&P 500 Index, as measured by the SPDR S&P 500 ETF (NYSEARCA: SPY ), trading within shouting distance of its all-time highs. I have highlighted the bifurcated market in several articles, including ” 2 Distinct Markets ,” and I am highlighting the undervalued firms in a series titled ” Too Cheap To Ignore .” For the last several years, historically cheap valuations have been a “value trap,” and investors wading into this deep value space have been punished severely, including your humbled author. Patience and persistence are usually rewarded in life and investing, and this is doubly true in deep value investing. Thus, I have kept researching the undervalued, out-of-favor firms, and I launched a premium service on Seeking Alpha, titled ” The Contrarian ” to try to take advantage of this unique opportunity from a research and portfolio strategy perspective. The premium research service launched on Seeking Alpha on December 7th, 2015, and so far, so good as the portfolios have significantly outperformed the broader markets, including a 90% cash portfolio, whose premise I wrote about in an article titled, ” Why A 90% Cash Portfolio Will Probably Outperform .” Within the service, there are several portfolios that have been put together. One of the equity focused portfolios is called “Concentrated Best Ideas Portfolio”, and it is primarily composed of deep value stocks. While the portfolio remains approximately 40% in cash versus its inception value, it was up strongly last week, registering a gain of 7.43% versus the SPY gain of 2.83%. Since its inception on December 7th, 2015, the Concentrated Best Ideas Portfolio is up 7.51%, while the SPY has declined 1.30%. The outperformance is the tip of the iceberg in my opinion, as I believe value stocks are set for their day in the sun after lagging their growth counterparts for a majority of the current bull market, and the performance to close 2015 may be foreshadowing what is to come in 2016. Concentrated Best Ideas Portfolio Update This portfolio screenshot is from “The Contrarian” premium research service. The portfolios in “The Contrarian” are updated whenever trades are made, and there are weekly updates with commentary. The following is this week’s update for the Concentrated Best Ideas Portfolio and commentary. (click to enlarge) It was a strong, holiday-shortened week for the market, and a very strong week for the “Concentrated Best Ideas Portfolio”. Material and energy stocks bounced back, with Peabody Energy (NYSE: BTU ), Teck Resources (NYSE: TCK ), Freeport McMoRan (NYSE: FCX ), CONSOL Energy (NYSE: CNX ), and Westmoreland Coal (NASDAQ: WLB ) all up more than 10% for the week. Overall, I am very pleased with the terrific relative and absolute outperformance, over the S&P 500 Index , by the Concentrated Best Ideas Portfolio during its first three weeks of inception. The results are even more impressive, considering that 40% of the portfolio’s starting value remains in cash. Since the portfolio’s inception, SunEdison (NYSE: SUNE ), Westmoreland Coal , and CONSOL Energy are leading the way, with respective gains of 67%, 42%, and 28%. The outsized gains coincide with the beginning of a reversal in the major three trades that have been put in place by the investing mainstream (long the U.S. Dollar, short commodities, and short emerging markets). Once these three intertwined trades reverse in earnest, the undervalued, out-of-favor, heavily short names will have more room to run, as headwinds turn into tailwinds. Mounting evidence of a reversal lies in the fact that the batting average of the Concentrated Best Ideas Portfolio is an impressive 67%, with 8 out of 12 positions showing gains. Building on this, the 8 “winners” have outsized gains, while the drawdowns of the “losers” have been more modest. Conclusion – With the Market Overvalued, Focus on Portfolio Strategy The underlying theory and thesis behind a deep value portfolio, is that a few “winners” can drive a deep value portfolio higher, offsetting the inevitable losses from companies in the deep value basket that never recover. In certain time frames, like 2008/2009 for financials, consumer discretionary names, and the broader market in general, and 2015/2016 (today) for commodity, energy, material, and emerging market stocks, the batting average can be higher for a deep value focused portfolio, as the extremely depressed valuations present an environment where a broad rebound in deep value stocks is possible, and perhaps even probable. While deep value stocks remain historically cheap, the forecast for broader market returns from today’s price levels looks dicey, as illustrated in a table that I have put together using data from GMO : (click to enlarge) The sell-off of commodity oriented stocks, which started in April of 2011, has driven the valuations of these companies to levels that are significantly below their 2008/2009 bottoms. In a recent article on U.S. Steel, I highlighted how cheap the price-to-book and price-to-sales valuation ratios have become today, even compared to year-end 2008 levels, which were extremely depressed due to the historic sell-off in the broader stock market. To close, the last month of 2015 is hinting at a reversal of the previously crowded trades that could carry over into 2016. The three trades (long the U.S. Dollar, short commodities, and short emerging markets) are intertwined, and the reversal could be a self-reinforcing cycle, the opposite images of the seemingly never ending unwind. With a rebound in out-of-favor names for the last five years looking probable due to their low absolute and relative valuations, and an overvalued broad bond and stock market, now is the time to be contrarian, or at least add a little dose of contrarian thinking to your portfolio. For more information, please click here .

Integrating Water Risk Analysis Into Portfolio Management

By Monika Freyman, CFA My previous article, ” Liquidity Risks of the H2O Variety ,” explored growing investor awareness about water risks within their portfolios and how that awareness plays into their investment decision making. Here, I will examine some of the increasingly sophisticated approaches that investors can take to integrate water risks into portfolio management. My recent survey of 35 institutional investors’ water integration practices found that while many investors think their methods, tools, and databases need to improve and evolve, they also found it worthwhile to integrate water into their research processes. And no wonder. As population pressures create competition for water, global groundwater supplies are declining and climate variability is increasing – leading to longer droughts and more intense flood events. All these factors pose risks that are hard to ignore. Water risk analysis happens at different stages of investment decision making, from the initial asset allocation strategies, to portfolio level analysis, through to the buy/sell decision. For example, one pension fund brought together portfolio managers from different asset classes to study how different markets, investment instruments, and geographic regions are exposed to the global water crisis. A few investors were also consistently analyzing their portfolio’s water risk exposure or its water footprint. Although far from a perfect approach – often missing location specific data or wastewater production metrics – portfolio water footprinting can be helpful in flagging companies and sectors with high water risk exposure relative to a benchmark and highlighting where further analysis is warranted. Various forms of portfolio analysis and attribution software allow managers to run water use metrics versus an index. For an example of water footprinting, see this South African study . At the individual security level, investors identified three critical research steps to obtain a comprehensive picture of water risk exposure: Understand Corporate Water Dependency: This varies by sector and, of course, company, with some industries relying heavily on access to abundant freshwater suppliers directly or in their supply chain. Corporate water dependency is not always easy to assess, but some companies are making the task easier by reporting their water use and wastewater trend data more consistently on their websites, in their annual reports, SEC filings or to data aggregating organizations, such as CDP Worldwide’s Water Program . Combine Water Dependency Data with an Assessment of Water Security: This gives a more comprehensive picture of corporate water risk exposure. A company may have high water needs but have their operations located in relatively water abundant regions. Another company, however, may be operating in regions of high water competition and drought. Such assessments are not simple to perform, but evolving tools, such as World Resources Institute (WRI)’s Aqueduct corporate water risks map , the World Wildlife Fund (WWF)’s Water Risk Filter , and other efforts are seeking to make the task easier. Get a Sense of Corporate Water Risk Awareness and Response: This step is essential because a company may have high water needs and poor water security, but mitigate the risks very effectively by elevating water issues to strategic decision making and putting water management and reporting systems in place. Tools such as The Ceres Aqua Gauge can be used to assess how well companies are managing their water and their exposure to water risks. For a more comprehensive list of third-party water tools and analytics, An Investor Handbook for Water Risk Integration is a helpful resource. Once water risk analysis is conducted on a corporation or security, our research found that fund managers use this information in a variety of ways, from avoiding high water risk industries or companies, to influencing internally created company environment, social, and governance (ESG) scores, to clarifying corporate engagement priorities. Several managers use their corporate water risk assessments to influence or modify financial projections or their weighted average cost of capital assumptions. For example, one fund manager studying companies in Brazil conducted scenario analysis modeling regarding how much the market cap of companies would be impacted if they had to absorb more of the costs of treating their wastewater discharges, especially as drought intensified and communities and regulators were becoming less tolerant of water use and pollution. Once impacts to market cap were assessed and shared with the management of those companies, engagement on those issues was far more pointed and productive. Other managers were trying to get a deeper understanding of the probability of large financial losses due to strategic risks related to water, such as not being able to grow revenue, access new markets, or develop new facilities. No matter what methodology one chooses to deepen water risk analysis practices, the most critical things to keep in mind are that water risks can lead to unlimited financial impact and loss. If a company loses access to water, a community kicks them out of a region due to water concerns, or permission to discharge wastewater is denied, the financial and strategic implications can be immense. For example, Newmont Mining (NYSE: NEM ) has postponed a $5 billion project in Peru due to community concerns over its water practices. In addition, it is important to look at sector specific issues, as water risks related to mining are obviously very different to those in semi-conductor manufacturing and so on. An Investor Handbook for Water Risk Integration includes a sector-specific cheat sheet on these issues. And most important of all: No matter how incomplete your water risk analysis starts off, it will likely provide a better understanding of sector or company risks (and opportunities) – which ultimately should add predictive power to your existing research processes. The goal is not to be perfect in your methods from the outset, but to begin including water risk analysis into your portfolio management practices. Disclaimer: Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.