Tag Archives: pro

All I Want In Life Is A Small Unfair Advantage

New business ventures often face the challenge of how to be truly innovative and use that in a way that gives them an advantage in the marketplace. For investors, an unfair advantage can come from a number of sources, including inside information (the legal kind, not the kind that will land you in jail). Don’t settle for the conventional wisdom when it comes to making investment choices. Hank “Ace” Greenberg, former chairman of insurance giant AIG (NYSE: AIG ), once said “All I want in life is a small unfair advantage.” As it turns out, he had one – and it was a whopper. Do you have one? Yes, you do. But you may not be aware of it. “Having the time, willingness, and ability to do original research is a true unfair advantage. Unfortunately, very few individual investors are able to pull it off.” – Jesse Livermore New business ventures often face the challenge of how to be truly innovative and use that in a way that gives them an advantage in the marketplace. In his book Running Lean, Ash Maurya offers a new take on the idea by introducing the concept of a small unfair advantage. A true unfair advantage is one that cannot easily be copied, stolen or bought. Anything that is worth copying will be copied, so how do you establish an advantage? By building something that is difficult or impossible to be copied. For investors, an unfair advantage can come from a number of sources, including inside information (the legal kind, not the kind that will land you in jail). The way to gain access to this kind of information is by networking with people who are experts in the area that you’re interested in. Here’s an example of what I mean. The last time I bought Starbucks’ (NASDAQ: SBUX ) stock was right after I heard my barista talking about how the company was going to make a special contribution to the employee retirement plan. Hmmm… Why would they do that unless they knew they were going to have a very profitable year? That was legal inside information, and my small unfair advantage was that I was able to recognize the significance of what that barista had told me. Comments like this, and other sources of objective, unbiased, and timely information are threads that weave your unfair advantage as an investor. By the time a news story hits the media, it’s too late to profit from that information. The price of the stock has already moved, thanks to the action of other investors who may not be smarter than you, but they are much quicker to act. Here’s another example. A well-connected blogger who specializes in junior gold mining shares often has access to people inside that industry who are more likely to speak the unvarnished truth, instead of repeating the talking points that were prepared for them by the Investor Relations Department. There are other skills you can learn, that are part of your unfair advantage. Take problem solving, for example. If you take the time to write down your thoughts regarding an investment idea, and list the possible solutions, you’re more likely to choose the one that advances your goal in the most cost-effective and meaningful way. A single-minded, uncompromising commitment to following through on your strategic plan is an unfair advantage in and of itself. All institutional investors, and most wealthy individual investors, have a strategic plan in place. But following through on it is another matter. If your plan is well-written, it can save you from making costly mistakes that can ruin an otherwise great year. Your Dream Team is another source of unfair advantage. This is your “inner circle,” your private network of contacts and experts who make up your Brain Trust. Highly successful investors have a small group of advisers who are all specialists in their fields. They understand the value of paying for expert advice because they recognize that they will never have enough time and energy to learn more than an expert about that one particular thing. Critical Thinking is an unfair advantage, because so few people practice it. This is the process of detaching yourself from the emotions of the moment, and examining the facts about the decision at hand. It takes patience and discipline, but it’s not rocket science. It’s simply a clearly defined and well-executed procedure. When you put all these things together, you can see that the common thread is independent thinking. Don’t settle for the conventional wisdom when it comes to making investment choices. Look for unbiased expert opinion, even if that means paying someone to advise you about a specific issue. The essence of your small unfair advantage is that nobody can copy, steal, or buy your investment ideas if you think for yourself.

The Specter Of Risk In The Derivatives Of Bond Mutual Funds

By Fabio Cortes, Economist in the IMF’s Monetary and Capital Markets Department Current regulations only require U.S. and European bond mutual funds to disclose a limited amount of information about the risks they have taken using financial instruments called derivatives. This leaves investors and policymakers in the dark on a key issue for financial stability. Our new research in the October 2015 Global Financial Stability Report looks at just how much is at stake. A number of large bond mutual funds use derivatives-contracts that permit investors to bet on the future direction of interest rates. However, unlike bonds, most derivatives only require a small deposit to make the investment, which amplifies their potential gains through leverage, or borrowed money. For this reason, leveraged investments are potentially more profitable, as the gains on invested capital can be larger. For the same reason, losses can be much larger. Derivatives offer mutual fund managers a flexible and less capital intensive alternative to bonds when managing their portfolios. When used to insure against potential changes in interest rates, they are a useful tool. When used to speculate, they can be bad news given the potential for big losses when bets go wrong. Strong growth in the assets of bond mutual funds active in derivatives The assets of large bond mutual funds that use derivatives have increased significantly since the global financial crisis. As you can see below in Chart 1, we now estimate they amount to more than $900 billion, or about 13 percent of the world’s bond mutual fund sector. While existing regulations in the United States and the European Union on mutual funds impose clear limits on cash borrowing levels, the amount of leverage that can be achieved through derivatives exposure is potentially large, often multiples of the market value of their portfolios. This may explain why mutual funds accounting for about 2/3 of the assets in our sample disclose derivatives leverage ranging from 100 percent to 1000 percent of net asset value in their annual reports. This range may be also conservative as these are the notional exposures of derivatives adjusted for hedging and netting at the fund manager’s discretion. What makes them sensitive to higher rates and volatile financial markets Although these leveraged bond mutual funds have not performed differently to benchmarks over the past three years, their relative performance has occurred in a period of both low interest rates and low volatility, which may mask the risks of leverage. This is because the market value of a number of speculative derivatives positions could have been unaffected by the relatively small changes in the price of fixed income assets. In addition, limited investor withdrawals from leveraged bond mutual funds may have also masked the risks of fund managers having to sell-off illiquid derivatives to pay for investor redemptions. In our analysis we find that a portion of leveraged bond mutual funds exhibit both relatively high leverage and sensitivity to the returns of U.S. fixed-income benchmarks, depicted in Chart 2 below. This combination raises a risk that losses from highly leveraged derivatives could accelerate in a scenario where market volatility and U.S. bond yields suddenly rise. Investors in leveraged bond mutual funds, when faced with a rapid deterioration in the value of their investments, may rush to cash in, particularly if this results in greater than expected losses relative to benchmarks (and the historical performance of their investments). This could then reinforce a vicious cycle of fire sales by mutual fund managers, further investor losses and redemptions, and more volatility. Improve disclosure: regulators need to act Making a comprehensive assessment of these risks is problematic due to insufficient data; lack of oversight by regulators compounds the risks. The latest proposals by the U.S. Securities and Exchange Commission to enhance regulations and improve disclosure on the derivatives of mutual funds is a welcome step. There is currently no requirement for disclosing leverage data in the United States (and only on a selected basis in some European Union countries). Implementing detailed and globally consistent reporting standards across the asset management industry would give regulators the data necessary to locate and measure the extent of leverage risks. Reporting standards should include enough leverage information (level of cash, assets, and derivatives) to show mutual funds’ sensitivity to large market moves-for example, bond funds should report their sensitivity to rate and credit market moves-and to facilitate meaningful analysis of risks across the financial sector.

Achieving 16.7% Returns With The Value Score

Summary What is the OSV Action Score? What is the OSV Value Score? How was the Value Score created? The Quality Score produces 16.8% CAGR in the tests that I’ve performed for the upcoming “Action Score” that I’m implementing into Old School Value. Next is the Value Score. Here is the full table of results again. stocks are bought at the beginning of the year held for one year rebalanced after 1 year commissions and fees are not included into these results If you followed this strategy, the 16.74% is the max return. After fees, it likely comes down to 13-14% range annualized. Here’s How I Created the Value Score When you create a ranking system (or even a screener) the higher the number of criteria, the worse the performance becomes. When picking individual stocks, making sure a stock passes lots of checks is a good strategy because you allocate based on your conviction. However, when you try to employ any sort of quantitative strategy, it is not a good idea to list 20 different criteria that must be passed. Of all the tests I’ve performed, a strategy with lots of checks consistently lose to the market by a wide margin. I mention this because people ask me whether I’ve tried combining several of the best performing value screeners on display. I have. And the results are pathetic. It severely handcuffs the number of stocks that pass and the screen ultimately fails. When you pick stocks individually, you have to be precise and picky. For anything quant based, it needs to be looser as you are buying a bunch. As I mentioned in the Quality Score article, instead of blindly coming up with metrics for each Q, V and G, I already had a list of metrics for each methodology based on previous research papers and proven results. Then the theory was tested and confirmed via backtesting. In its purest form, the Value Score is based on the following 3 factors: P/FCF – best range is less than P/FCF of 10 EV/EBIT – best range is less than 11 P/B ratio – preference for P/B to be less than 3 Here’s the initial backtest to confirm the theory for a 20 stock holding portfolio. Eliminating OTC stocks, financials, energy, mining or utilities and the results continue the outperformance. Great. Backtest works with the selected metrics. It now comes down to how well the same idea can be applied when creating a ranked database. To further clean up the results, additional weightings were applied to each of the above ratios. Then all the stocks are further ranked with the Piotroski score again to eliminate low quality stocks. P/FCF has the biggest impact on the results and receives the highest weighting EV/EBIT does a great job of identifying cheap stocks and receives the second highest weighting P/B acts as a “cleaning” filter to remove stocks where you overpay for assets. Also a way to remove bad stocks you wouldn’t want to own no matter how cheap it looks The Piotroski score is assigned a fairly high weighting so that the list removes “lotto” stocks and potential black swan stocks The Value Rank Results Even if I did follow this strategy, it’s not an easy one to follow. There is a LOT of volatility. If you can’t stomach big moves and have faith in the process, you are doomed. If you focus too much on beating the market each year instead of an absolute long term return, you are doomed. When buying and holding the top 20 ranked Value stocks each year for the entire universe of stocks, the scoring system achieves 16.74% CAGR. If you start with $10k, you’d end up with $138k after 16.5 years. Eliminate OTC, financials, miners, utilities and energy again and the results are shockingly great at 19.4% CAGR. $10k becomes $203.6K after 16.5 years. But what I don’t like about the Value Rank on its own is the lack of downside protection in 2008. Cheap stocks and growth stocks get hammered the most during severe bear years. But a -40% return is a huge blow and a can easily shatter your faith in the system and process. Something to think about. Top 20 Value Stocks from 2015 Here is the list of top 20 stocks that make up the Value Score portfolio starting from Jan 1, 2015 so that you get a sense of what type of stocks the Value Rating is selecting. Disclosure No positions in any stocks mentioned.