Tag Archives: russia

The Limits Of Risky Asset Diversification

Do you want to reduce the volatility of your asset portfolio? I have the solution for you. Buy bonds and hold some cash. Now once upon a time, in ancient times, prior to the Nixon Era, no one hedged, and no one looked for alternative investments. Those buying stocks stuck to well-financed “blue chip” companies. The diversification from investor behavior is largely gone (the liability side of correlation). Spread your exposures, and do it intelligently, such that the eggs are in baskets are different as they can be, without neglecting the effort to buy attractive assets. But beyond that, hold dry powder. Think of cash, which doesn’t earn much or lose much. Think of some longer high quality bonds that do well when things are bad, like long treasuries. Photo Credit: Baynham Goredema . When things are crowded, how much freedom to move do you have? Stock diversification is overrated. Alternatives are more overrated. High quality bonds are underrated. This post was triggered by a guy from the UK who sent me an infographic on reducing risk that I thought was mediocre at best. First, I don’t like infographics or video. I want to learn things quickly. Give me well-written text to read. A picture is worth maybe fifty words, not a thousand, when it comes to business writing, perhaps excluding some well-designed graphs. Here’s the problem. Do you want to reduce the volatility of your asset portfolio? I have the solution for you. Buy bonds and hold some cash. And some say to me, “Wait, I want my money to work hard. Can’t you find investments that offer a higher return that diversify my portfolio of stocks and other risky assets?” In a word the answer is “no,” though some will tell you otherwise. Now once upon a time, in ancient times, prior to the Nixon Era, no one hedged, and no one looked for alternative investments. Those buying stocks stuck to well-financed “blue chip” companies. Some clever people realized that they could take risk in other areas, and so they broadened their stock exposure to include: Growth stocks Midcap stocks (value & growth) Small cap stocks (value & growth) REITs and other income passthrough vehicles (BDCs, Royalty Trusts, MLPs, etc.) Developed International stocks (of all kinds) Emerging Market stocks Frontier Market stocks And more… And initially, it worked. There was significant diversification until… the new asset subclasses were crowded with institutional money seeking the same things as the original diversifiers. Now, was there no diversification left? Not much. The diversification from investor behavior is largely gone (the liability side of correlation). Different sectors of the global economy don’t move in perfect lockstep, so natively the return drivers of the assets are 60-90% correlated (the asset side of correlation, think of how the cost of capital moves in a correlated way across companies). Yes, there are a few nooks and crannies that are neglected, like Russia and Brazil, industries that are deeply out of favor like gold, oil E&P, coal, mining, etc., but you have to hold your nose and take reputational risk to buy them. How many institutional investors want to take a 25% chance of losing a lot of clients by failing unconventionally? Why do I hear crickets? Hmm… Well, the game wasn’t up yet, and those that pursued diversification pursued alternatives, and they bought: Timberland Real Estate Private Equity Collateralized debt obligations of many flavors Junk bonds Distressed Debt Merger Arbitrage Convertible Arbitrage Other types of arbitrage Commodities Off-the-beaten track bonds and derivatives, both long and short And more… one that stunned me during the last bubble was leverage nonprime commercial paper. Well guess what? Much the same thing happened here has happened with non-“blue chip” stocks. Initially, it worked. There was significant diversification until… the new asset subclasses were crowded with institutional money seeking the same things as the original diversifiers. Now, was there no diversification left? Some, but less. Not everyone was willing to do all of these. The diversification from investor behavior was reduced (the liability side of correlation). These don’t move in perfect lockstep, so natively the return drivers of the risky components of the assets are 60-90% correlated over the long run (the asset side of correlation, think of how the cost of capital moves in a correlated way across companies). Yes, there are some that are neglected, but you have to hold your nose and take reputational risk to buy them, or sell them short. Many of those blew up last time. How many institutional investors want to take a 25% chance of losing a lot of clients by failing unconventionally? Why do I hear crickets again? Hmm… That’s why I don’t think there is a lot to do anymore in diversifying risky assets beyond a certain point. Spread your exposures, and do it intelligently, such that the eggs are in baskets are different as they can be, without neglecting the effort to buy attractive assets. But beyond that, hold dry powder. Think of cash, which doesn’t earn much or lose much. Think of some longer high quality bonds that do well when things are bad, like long treasuries. Remember, the reward for taking business risk in general varies over time. Rewards are relatively thin now, valuations are somewhere in the 9th decile (80-90%). This isn’t a call to go nuts and sell all of your risky asset positions. That requires more knowledge than I will ever have. But it does mean having some dry powder. The amount is up to you as you evaluate your time horizon and your opportunities. Choose wisely. As for me, about 20-30% of my total assets are safe, but I have been a risk-taker most of my life. Again, choose wisely. PS – if the low volatility anomaly weren’t overfished, along with other aspects of factor investing (Smart Beta!) those might also offer some diversification. You will have to wait for those ideas to be forgotten. Wait to see a few fund closures, and a severe reduction in AUM for the leaders…

4 Country ETFs To Shun If Oil Hits $20

Now that OPEC has announced that it will continue to pump out more oil despite piling-up supplies and falling demand, traders have set a new bottom for the long-exhausted commodity oil of $20 which is way below the psychologically resistant level of $40. OPEC terminated the production limit after the December 4 meeting. Though the investing was expecting in the same line as the OPEC top brass Saudi Arabia and other Gulf countries are more concerned about market share, per CNBC , rather than falling oil prices. Goldman Sachs viewed the outcome of this meeting as a serious threat to future oil prices and commented that this ‘leaves risks to their forecast as skewed to the downside in coming months, with cash costs near $20/bbl ‘. However, all are not as bearish as Goldman since HSBC expect non-OPEC supply growth to decrease from 2.3 mbd in 2014 to 0.9 mbd in 2015, before turning negative in 2016. HSBC also projects Brent crude to average $60 per barrel in 2016, $70/bbl in 2017 and $80/bbl in 2018. While nobody knows where the bottom is, one thing for sure is that oil is due for a wilder or a rather sluggish run in the coming days. At the time of writing, oil prices are hovering around the $40 level and are giving no signs of a near-term recovery. While a WTI crude oil ETF like United States Oil Fund (NYSEARCA: USO ) lost over 9.8% in the last five trading sessions, there are other corners as well which are linked to the commodity oil and are equally at risk if black gold slips to $20 or remains stressed. Those corners are key oil producing and exporting countries which have been exhibiting a downtrend, as revenues earned from this commodity account for a major share of their GDP. We have seen this trend in a number of countries so far this year. Market Vectors Russia ETF (NYSEARCA: RSX ) The Russian economy contracted 4.1% year over year in Q3. The economy shrunk for the third successive quarter with stubbornly low oil prices being mainly responsible. Among the other reasons for the deterioration are the ban on Russia by the West on the Ukraine issue and sky-high inflation. Oil – seemingly the main commodity of the nation – posed huge risks to the nation. The plunge in oil prices forced investors to think twice before investing in Russia even at bargain prices. In fact subdued oil prices and a stronger U.S. dollar on the Fed lift-off bet put pressure on the Russian currency ruble which lost about 17.2% in the last one year against the greenback (as of December 4, 2015). RSX is the most popular and liquid option in the space with an asset base of $1.83 billion and average trading volume of more than 8 million shares a day. The energy sector accounts for about 43% of RSX, which charges 61 basis points as expenses. The Zacks ETF #4 (Sell) fund advanced 5.9% but lost 6.5% in the last five trading sessions (as of December 7, 2015). Global X FTSE Norway 30 ETF (NYSEARCA: NORW ) Norway is among the top 10 nations famous for oil exports and with its comparatively low population, oil forms the key part of the country’s GDP. As per U.S. Energy Information Administration (EIA), Norway is the biggest oil driller in Europe. The most popular way to play the country is with Global X ETF NORW. The product tracks the FTSE Norway 30 Index, a benchmark of 30 companies that focus on Norway, charging investors 50 basis points a year in fees. The ETF is heavily concentrated on energy stocks, as these make up for nearly 45% of the portfolio. In fact, Norwegian oil giant Statoil accounts for one-fifth of the portfolio alone, suggesting a heavy concentration. Thanks to a slump in oil prices, NORW has lost about 11.3% in the year-to-date frame and was down 2.9% in the last five trading sessions. iShares MSCI Canada ETF (NYSEARCA: EWC ) Canada is also among the world’s top 10 oil producers. The oil, gas and mining sector make up about over a quarter of the Canada’s economy. Its currency plummeted to an 11-year low level after the disappointing outcome of the OPEC meeting. Canadian currency lost about 15% year over year while jobless data spiked last month. The best way to invest in Canada is the iShares MSCI Canada ETF, a product that has nearly $1.89 billion in assets. The fund tracks the MSCI Canada Index, which holds just under 100 stocks in its basket. Energy makes up a huge chunk of assets accounting for one-fifth of the total. The fund was off about 19% in the last one year. The fund has lost 22.7% this year and has a Zacks ETF Rank #4. The fund lost over 4.4% in the last five trading sessions. Global X Nigeria Index ETF (NYSEARCA: NGE ) Nigeria – an OPEC member – is one of the biggest net crude exporters in the world. An option to invest in Nigeria is a Global X ETF, NGE. This new product follows the Solactive Nigeria Index, giving exposure to about 25 companies and charging investors 68 basis points a year in fees. Though financials actually take the top spot in the ETF, making up about 45% of the holdings, energy has about 10% exposure. That is why, it is important to see how the fund fared during the recent oil price downturn. NGE shed about 31.1% during the last one year and is down 30.8% so far this year. NGE retreated 1.4% in the last five trading sessions. The fund has a Zacks ETF Rank #4. Original Post

RSX Is My Top Pick For 2016

Summary The Market Vectors Russia fund is poised to have two factors pushing it up starting from next year, aside from the oil & gas recovery. It is looking increasingly likely that EU-Russia relations are set to normalize next year, given many positive signals given by EU officials. Russia’s other industries, such as defense, agriculture, IT have been growing at a strong pace, which should not be under-estimated going forward. I predicted last year that 2015 will be a good entry point to buy the Market Vectors Russia ETF (NYSEARCA: RSX ). There is a good chance that I may have been right and perhaps the bottom did occur at the end of 2014 at just under $14/share, given that it is currently at over $15/share. I myself did not buy, because I thought at the time that other investments related to energy were more attractive, such as Chevron (NYSE: CVX ), Suncor (NYSE: SU ) and Shell (NYSE: RDS.A ). I have been building up positions in those stocks, in the past few months, looking to hold for the next few years. Truth is that RSX is an investment which might more or less mirror the performance of those stocks, with the added twist of the geopolitical situation in the past few years. For instance, the bottom RSX made for this year in late August coincides with the ceasefire which took effect between the Ukrainian army and the ethnic Russian rebels in the East, starting from the first of September. This led to speculations that the EU sanctions against Russia will be lifted soon, which is what gave the fund a bit of a boost. EU sanctions. A lot does depend on those sanctions being lifted. After all, Russian companies do depend on being able to access the EU debt markets to a great extent for their financing needs. Some may have hoped that the sanctions will be lifted sooner, especially after EU president Junker made a pro-Russia reconciliation speech, where he suggested that Europe needs to start thinking about ending the confrontational relationship with its Eastern neighbor. Now it looks like the sanctions might last until next year, but more and more people are grumbling about it, therefore I think it will not be much longer before the sanctions end, unless things in Ukraine take a nasty turn back towards open conflict. Even if they do turn worse again, it may no longer be seen as Russia’s doing. Europe cannot afford this extra load of hardship given its already full plate. There is the almost decade of almost zero percent average yearly growth since 2008. There is the resulting social and economic tensions, including the continued threat of defaults in the Euro-zone, and the rise of the extremist parties due to dissatisfaction with the mainstream. Now, the migration crisis, which is the greatest challenge that the EU ever faced, is leading to an actual shutdown of one of Europe’s most important institutions, namely its Shengen agreement. Within this context, removing an important impediment from realizing increased trade and other economic exchanges with the EU’s third largest trading partner is an increasingly popular concept. Oil & gas prices. While normalizing relations with the European Union is an important factor which is likely to affect the RSX fund, there is nothing more important than achieving a higher price for Russia’s dominant export, namely oil & gas. As we can see, investor sentiment is increasingly turning bearish on oil prices for the near-term, with prices threatening to break towards $30/barrel. But we should remember that there is a very important fact which makes current prices far from viable, namely the fact that many current and future projects are not even close to reaching breakeven at current prices, in fact many projects which our future medium to long-term supplies depend on are not viable at anything short of $80-100/barrel. While we are currently seeing a surplus in supply, which is pushing prices ever lower due to heavy investment during the 2010-2014 $100/barrel price plateau period, as well as almost a decade of subdued global economic growth, which has dampened demand, we should not mistake this for something it is not. It is definitely not some sort of long-term fundamental shift. We are already seeing a drop in supplies from some of the most flexible projects, namely the U.S. shale patch, where it contributed to a 500,000/barrel production decline in the U.S. so far this year from the April production peak according to the EIA weekly report. We are also seeing it in Canada, where it seems production is in decline. (click to enlarge) Source: OPEC November report. In fact, if we compare quarterly data for the year, it seems global non-OPEC production may have peaked in the first quarter of this year and may already be down by about a million barrels per day. This means that we are clearly on a path of global production decline, even if some of the headline numbers such as the 2015 average, versus the 2014 average will not show it. Source: OPEC November report. In my personal opinion, in 2016 we will see a dramatic decline in production compared with 2015, while global demand is still increasing, even if it is at a relatively slow pace. Within this context, by this time next year, we will most likely be looking at oil prices that are significantly above current levels. Russia’s other industries. While there is no debating the fact that Russia’s oil & gas industry is by far the most important factor in determining Russia’s future, we should remember that we cannot treat Russia same way as we do Saudi Arabia. Yes, Russia’s economy is contracting this year due to the drop in oil & gas prices. But, if we look at other oil exporting countries such as Canada, it also entered recession this year, even though it is nowhere near as dependent on those exports as Russia is. Russia may be very dependent on oil & gas, but far less dependent compared with many other petro-states. Russia does in fact have a relatively diverse economy. There is the defense industry which has been doing alright in terms of exports growth for over a decade now. Russia’s defense industry employs three million people and in 2014 it exported $15 billion worth of products, which is a 50% increase compared with 2010. In agriculture, Russia has in fact been helped by its counter-sanctions against the EU and the U.S., which mainly focused on food import bans. Russia is still a major net food importer, but its situation seems to be steadily improving, with production last year growing in the double digit range. Grain exports are increasing, while domestic products are capturing a larger part of the domestic market. Even as Russia is in recession this year, the government has made it a priority to increase support for agriculture by 50 billion rubles. There are other industries which are seeing growth, such as in IT , with growth in software exports in the double digits range every year for the past half decade. Russia’s auto industry is increasingly looking at increasing exports, in part spurred by the weak ruble. In effect, we are seeing to a great extent a re-balancing of the economy which we cannot expect from other petro-states such as Saudi Arabia. In this respect, Russia is a lot closer to more economically diverse countries such as Canada or Brazil, due to its more diverse nature. It is this mis-perception in regards to Russia’s economic diversity which I think makes RSX a potentially interesting play which I am looking to potentially get into possibly early next year. In addition to my expectations of the oil market turning soon, there is also the positive trend we are seeing in a number of non-commodity related industries which could in conjunctions with the expected normalization of relations with the EU provide an extra boost to Russian assets in coming years. RSX main holdings explain why fund is doing much better compared with most energy major energy investments. If we are to look at the top holdings in the RSX fund , we see that energy is indeed the most crucial part in its current and future performance. Lukoil ( OTCPK:LUKOY ), and Gazprom ( OTCPK:OGZPY ) are of course significant holdings in the fund, with 7.93%, and 7.77% respectively. And as one might expect, these stocks are down significantly year to date. In fact, most of the energy related companies, which dominate the fund are down for the year, with only a few exceptions. At the same time, there are other stocks, which are not related to energy which are mainly up for the year, including the top holding of the fund, Sberbank ( OTCPK:SBRCY ), which is up over 50% so far this year and it makes up 9% of the fund. There is also the retail stock, X5 Retail Group, which is up almost 70% for the year, which is also contributing to the overall fund being up for the year. The reason why these non-energy related stocks are mainly doing alright is because as I pointed out already, many non-energy related sectors of the Russian economy are doing alright. Because of that, Russia’s unemployment rate did not increase significantly since it entered recession, which makes it less likely for companies such as Sberbank to suffer losses, due to a deterioration of the loans in its portfolio. In fact, the unemployment rate in Russia remains near the ten year low of 4.8% achieved a year ago. It only rose relatively modestly to 5.5% since then. Because of that, there is no significant uptick in loan defaults in Russia, which is benefiting holdings such as Sberbank. It is true that other funds such as the iShares MSCI Russia Capped ETF (NYSEARCA: ERUS ) may offer a more aggressive way to play the expected rebound in energy. It gives more weight to Gazprom, Lukoil and other energy stocks compared with RSX. At the same time however, the attractive aspect of the RSX is the fact that it is more balanced, with stocks not related to energy, which will still most likely do well when energy recovers, at the same time are not likely to suffer as much if the current depressed energy price environment will last longer than most of us expect. This concept seems to be already working as we can see, given that RSX, which is heavily tied to energy is up 5% year to date, while the S&P 500 is flat for the year. With downside risk relatively limited given that energy and the Russian economy are not likely to fall much further from here and the prospect of a Russian economic rebound, driven by a recovery in energy at some point relatively soon in my opinion, I think the RSX fund has the potential to be a very strong performer starting next year and most likely will go relatively strong for some years as energy will most likely outperform. Given the fact that the world needs to stop what is seemingly a start to oil production decline gripping the world, even if there will be an economic slowdown in coming years, RSX may in fact become a star performer as investors will pile into the few investments which will not be headed down. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.