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Up For Debate Yet Again: Active Vs. Passive But This Time It’s The Emerging Markets

Summary Emerging Market Indexes are not representative of the overall universe. The commodity boom caused a widespread increase in asset prices, hurting active management. Falling commodity prices should create differentials in Emerging Market countries and companies, benefiting active management. When the term “emerging markets” was coined in the early 1980s it was an exciting time for those investors attracted to this young, inefficient, and rapidly growing set of markets. Earlier on in its evolution, if an investor could stomach the added risk, actively managed emerging market investments offered a very attractive and outsized return profile. Over time though, as these markets matured in size, sophistication, and popularity the differentiation between the active and passive investment approach began to narrow and as this occurred investors began to question whether it was still possible to earn alpha, or outperformance, through active management. At Lynx, we continue to believe emerging market active management is a value added proposition. In terms of number of securities, the emerging market, or EM, universe is very large, yet the interaction most passive investors have with these markets is through the MSCI Emerging Markets Index, which is a poor representation of the overall market. The index includes roughly 800 individual securities, while the overall emerging market universe has over 10,000 public companies. Additionally, there is the issue of sell-side analyst coverage or lack thereof (chart 1); while the number of companies in the BRIC countries far exceeds those of the S&P 500, the average number of analysts covering these names is less than half. More so, of the 800 securities included in the index over 650 are State Owned Enterprises or “SOEs”. SOEs are companies either owned by, or greatly influenced by, their respective governments; well-known examples are Gazprom (GSPFY) ( OTCPK:OGZPY )(Russia), Petrobras (NYSE: PBR ) (Brazil), and China Mobile (NYSE: CHL ) (China). The inherent risks associated with such companies are typically very different from private enterprises, as their balance sheets and overall strategies are most likely driven by a country’s geopolitical goals rather than by financial motivation. When investors purchase an MSCI Emerging Market Index based ETF, roughly 30% of the holdings are SOEs, ultimately adding additional risks that may not be fully appreciated. Chart 1 Now let’s turn to active management and the opportunities it may provide. Within the developed markets, the increasing level of efficiency has made it very challenging for active managers to outperform. Originally, the lack of efficiency among the emerging markets as compared to the developed countries was a significant talking point for EM active managers, but the question today is, does this dichotomy still exist? Through the use of statistical tools such as cross-volatility, correlations, and sector, country and stock dispersions, many have attempted to answer this question. Through a joint review by Lazard, Duke University and Russell Indices, it was discovered that dispersion between EM securities has actually increased in recent years, while in past years it had been fairly static (chart 2). However, recent research also indicates that correlations between various countries in the emerging markets have been moving upwards as of the mid-2000s (chart 3). In 2006 through 2009, correlations between the countries increased, while sectors, already high, remained elevated. The overall increasing correlations in the asset class, in theory, should reduce the opportunity for active management, but let’s combine the above statistical findings with today’s environment. Until recently, China has been the major driver of growth for both emerging countries, as well as commodities. Today these dynamics are shifting as China’s growth is slowing and transitioning to a service based economy. Commodity prices have plummeted in the last year, a sign that the rising tide that lifted all ships in EM over the last 15 years has passed. As a result, the rising correlations between countries, likely a function of the general commodity price boom, should begin to subside. This should cause the country correlations to begin to fall again, opening the door for more active management opportunities. An example that exists now is that of China and India. As Chinese growth has fallen, causing commodities to plummet, India has seen its economy expand, as it is a net importer of energy and is far more diversified than China. This kind of dichotomy should replay itself across many of the index constituents in the coming years. To see a similar example of the relationship between a macro boom, indiscriminate asset price appreciation and the struggles of active management in such an environment, please refer to the Lynx white paper titled, “How Much is Too Much to Pay for Performance: Our Views on Active and Passive Investing,” which lays out our argument for how the U.S. QE caused reduced cross-volatility between domestic stocks. In such an environment the value that active management brings to an investment universe is bound to be masked. Chart 2 (click to enlarge) Chart 3 *Lazard, “Country and Sector Contagion in Emerging Markets” To recap, this paper has discussed the case for active management in EM, and has provided data which suggests a reduced opportunity set for the strategy. Now let’s review actual emerging market mutual fund performance. RBC conducted a study indicating that EM mutual funds have maintained 2% of outperformance over the MSCI Emerging Market Index over a 5 year rolling time period (chart 4). What is telling though is that in recent years the outperformance has narrowed from over 7% in 2000 to 3% in 2014. The tightening may reflect the increased correlations between countries discussed above. However, the argument for active management still holds as outperformance has been maintained. In addition to overall outperformance, outperformance by individual managers also proves to be persistent (chart 5). Top tercile EM Fund managers have maintained top 2 quartile performance in almost 70% of quarters over a 3 year period, indicating that it is possible to outperform the market over time. Chart 4 (click to enlarge) Chart 5 (click to enlarge) In conclusion, though we have shown issues associated with both the active and passive approach, all told we do not believe investing passively in emerging markets is the ideal option. Active management, which comes in various forms, not only better maneuvers through these markets’ associated risks, but it takes advantage of shifting market dynamics and individual opportunities that a quantitative, market cap weighted index approach is likely to overlook. It is also important to emphasize that the most successful emerging market allocations will be those made by investors who are comfortable and accepting of a long-term investment period.

9 Simple College Savings Tricks

Summary Why is saving for college so hard? How to co-opt your kid and work together to save all you need. Demand an adequate ROI and decide if it is really worth it. Why is saving for college so hard? How can I pay for my kids’ college? Like everywhere else, where the government has entered into a market as a massive, price-insensitive third-party payer, it has completely distorted the price system. If you have ever heard a politician say “_________ is not a privilege, but a right”, then it is probably a subject with significant malinvestment. Here is what has happened with some of the most distorted markets over the course of my lifetime: So that is the world we face when paying for college. Here are ten simple tricks for facing this daunting task. Long-term Goal While I want to have everything organized as efficiently and rationally as possible for my kids, my long-term goal is to nurture independent adults. I have a reminder on my Microsoft (NASDAQ: MSFT ) Outlook calendar to have the locksmith come to change the locks when the youngest kid turns eighteen. After that, I expect them to succeed under their own power. One: co-opt your kids First, co-opt your kids as active participants in the process of saving for college. Whenever they want to spend money, make sure that they denominate that expense in the length of time that it will take them to earn that money. Two of my favorite places for them to save include Toronto-Dominion Bank (NYSE: TD ) and MainStreet Bank. Each kid can make $10 per year at TD. TD offers a summer reading program in which kids can earn $10 each for reading 10 books. You can get the form here . In addition, our TD branch has a coin deposit machine. As it accepts only U.S. dollars, the rejects slot typically contains a few dollars’ worth of Canadian and other foreign coins for the kids to collect. Each kid can make $40 per year in interest from MainStreet Bank. Kids can each earn $40 per year in interest in a Junior Airsavings account . These accounts offer an annual percentage yield/APY of 4% for accounts up to $1,000 owned by depositors under eighteen years old. Each kid can make $50 per year from DFCU Financial. Deposits age 0-17 get $50 in cash per $100 account. If you have an account at DFCU or if you can open one (either via a family relationship or living in their region of Michigan), it might be worth getting your kids set up with accounts too. If you live in a state that offers refunds on beverage container deposits, kids can help collect bottles. My final step in co-opting each of my kids in this effort is to offer them $0.50 on the $1.00 for any merit or athletic scholarship (or any other kind they can find) that they earn. There is a ton of money out there and I want them to have the mentality of constantly looking for such opportunities to exploit. “Never, ever, think about something else when you should be thinking about the power of incentives.” – Charlie Munger Two: start them on credit cards Kids can make an average of $272 each year from Fidelity. The best credit card deal available is the Fidelity Investment Rewards American Express (NYSE: AXP ) Card. There is no age limit. You can co-sign the agreement, get cards in your kids’ names and start building their credit history. The average American kid’s expenses are $13,611 per year. With the 2% cash back on this card, that comes to a rebate of $272 each year. Once the kids are legitimately earning income from chores, they can start funding their IRAs with this card. Three: set up a family bank Kids can make about $109,565/ each year with a family bank. According to the IRS, the long-term adjusted Applicable Federal Rate/ AFR is currently 2.3%. In order to qualify as a loan, parents need to charge that amount of interest to each kid. However, parents can also gift the interest rate payment up to $28k . So, one can loan up to $1,217,391 from each couple to each of their kids per year without it costing them any net interest. If they can compound at 9% per year, that will come to just under $110k per year per kid. Four: Max out your 529 You can contribute $370,000 to each kid’s Nevada 529. Here is why I think Nevada’s is the best one. If you fail to max out any tax-advantaged saving and investing opportunity, you are stealing from yourself. Five: Odd Lots Throw around your (lack of) weight. With my kids, we focus on how small scale can be an edge. One tactic is to exploit odd lot opportunities. These have proved to be lucrative – a great relationship between risk and reward with a limited downside. For kids’ accounts with under a million dollars in them, they can be among the best opportunities. The question of how to make $10,000 out of $5,000 is very different than making $1 billion out of $500 million. You might as well take advantage of all of the quirky opportunities strewn around the capital markets to make money at small scales. However, due to capacity constraints, I am keeping all of my best odd lot opportunities here . Six: Dividends I do not expect much of a tailwind from the U.S. equity market over the next few decades based on the market multiples discussed here . So a substantial part of the total returns that one may expect will come from dividends. One example of a high dividend payer worth considering is Digirad (NASDAQ: DRAD ): While it has returned over 20% since it was first disclosed on Sifting the World, it remains an attractive opportunity. You can read more about their recent acquisition in M&A Daily . Seven: hire world-class asset allocators… for free There is only a small number of world-class asset allocators running publicly traded companies. Berkshire Hathaway’s ((NYSE: BRK.A )/(NYSE: BRK.B )) is the most famous. Whenever you can get them at a discount to their net asset value, it is as if you are hiring one of the greats for free. For example, from time to time, you can get the Tisch family for free by buying Loews (NYSE: L ) at a discount to NAV. Today, you can get John Malone for free when you buy Liberty Media (NASDAQ: LMCA ). Seize such opportunities. In investing, you get what you don’t pay for. Eight: demand a strong return on investment This formula doesn’t just work for your money, but works well for any constrained resource including your time, energy, and focus. Demand a strong ROI on everything that you do. “I don’t get out of bed for less than $10,000 a day.” – Linda Evangelista Well I don’t get out of bed for less than a 10% ROI. Some of the top ROI for undergraduate schools include Stanford, MIT, and Princeton. Many of the best educational ROIs are degrees in computer science, medicine, business, engineering, and law. While there are many subjects that may be intrinsically interesting, one should ask if it is worth piling up mountains of debt for them, especially if they are subjects that you can pursue on your own. Generally, hard subjects pay off. If you learn something quantitative, data-based, and difficult, you can probably pick up the qualitative, subjective, and easy stuff on your own later. However, if you slide through school working on easy subjects, then the hard stuff will torture you later in life. Nine: no one has to go to college Fayetteville State University notable alumni “Junkyard Dog” If your kid gets accepted to MIT and wants nothing more than to pursue computer programming, it is probably a worthwhile endeavor. But there are also many schools and many degrees that have substantially negative ROIs. If your best bet for college is Fayetteville State University or you want to study mime, then the annual return over the subsequent twenty years will probably be quite negative. Consider skipping college altogether. You can apply here for a $100,000 Thiel Fellowship to skip college and build new things. Some people, including some extremely wealthy people, cannot afford college. Even if they have the tuition bill in their petty cash drawer, they cannot afford college because the opportunity cost is too high for people with ideas worth acting on right away. Four years is a long time, especially if you have a great idea worth pursuing. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

New Janus Mutual Fund Uses Tail Risk Analysis

Summary JAGDX is a global allocation fund (70/30) which uses tail risk analysis to mitigate risk. The Fund inception was in June 2015, and it has gotten off to a rocky start. But it may be worthwhile to track this fund to see how they manage a full market cycle. Overall Objective and Strategy The primary objective of the Janus Adaptive Global Allocation Fund (MUTF: JAGDX ) is to provide investors total return by dynamically allocating its assets across a portfolio of global equity and fixed income investments, including the use of derivatives. The fund attempts to actively adapt to market conditions based on forward looking views on extreme market conditions (both positive or negative) with the goal of minimizing the risk of significant loss in a major downturn while still participating in the growth potential of capital markets. On average, the fund provides 70% exposure to global equities and 30% exposure to global bonds (70/30 allocation). But the fund has the flexibility to shift this allocation and may invest up to 100% of its assets in either asset class depending on market conditions. Because of this, JAGDX will likely have above average portfolio turnover compared to other funds. The portfolio managers use two complimentary processes: a “top down” macro analysis and a “bottom-up” risk reward analysis. These processes use proprietary models which seek to identify indicators of market stress or potential upside. These models include an options-implied analysis that monitors day-to-day movements in options prices for indicators of risk and reward between asset classes, sectors and regions. Top-Down Macro Analysis: Focuses on how the Fund assets will be distributed between global equity and fixed income. They use a proprietary options implied information model, among other tools, to monitor expected tail gains and losses across the equity and fixed income sectors and adjust as necessary to mitigate downside risk exposure. Bottom-Up Risk Reward Analysis: Designed to identify underlying security exposures in order to maximize exposure to securities which will realize tail gains while minimizing exposure to securities expected to provide tail losses. Within the Fund’s equity positions, the managers will adjust sector, currency and regional exposures away from market cap weightings based on their evaluation of expected tail loss and gain. Within the Fund’s fixed income positions, they will adjust the credit, duration and regional exposures using the same analysis. The fund managers measure both extreme positive and negative movements known as expected tail gain (ETG) and expected tail loss (ETL). Portfolio construction is driven by the ratio of ETG to ETL, while targeting a desired level of portfolio risk with the goal of maximizing future total return. For more information on expected tail loss, take a look at this Wikipedia page on Expected shortfall . (click to enlarge) Source: rieti.go.jp Fund Expenses The Fund offers several classes of shares. JAGDX is available without a 12b-1 charge, but only if you buy the fund directly from Janus. The expense ratios for some of the share classes are listed below: JAGDX (Class D Shares): 1.01% JVGIX (Class I Shares- Institutional): 0.82% ($1 million minimum) JVGTX (Class T Shares): 1.13% (available on brokerage platforms) JAGAX (Class A): 1.07% (front-end load 5.75%) JAVCX (Class C Shares): 1.82% (deferred load 1%) Minimum Investment JAGDX has a minimum initial investment of $2,500. Past Performance JAGDX is classified by Morningstar in the “World Allocation” or IH category. The fund had unfortunate timing when it was first issued on June 23, 2015. As of the end of the third quarter it had dropped by 9%, although it has recovered a bit since then. It is still very early, but so far the Fund is lagging its peers. 1-Month 3-Month JAGDX +1.18% -4.16% Category(IH) +1.37% -3.89% Percentile Rank 61% 66% Source: Morningstar Mutual Fund Ratings The fund is too new to have a Lipper or Morningstar rating. Fund Management The fund is managed by two individuals: Enrique Chang: Chief Investment Officer, Equities and Asset Allocation. Joined Janus in September 2013, and has previously worked for American Century and Munder Capital Management. Holds a BS in Mathematics from Fairleigh Dickinson and a master’s degree in finance/quantitative analysis and statistics and operations research from NYU. Ashwin Alankar, PhD: Global Head of Asset Allocation & Risk Management. Joined Janus in August, 2014 and has previously worked for AllianceBernstein and Platinum Grove Asset management. Holds a BS in chemical engineering and mathematics and a master of science degree in chemical engineering from MIT. He also holds a PhD in finance from the University of California at Berkley Haas School of Business. Comments Tail risk hedging is designed to enhance return potential by: Helping to mitigate losses when a market storm hits. Provide liquidity in a crisis, allowing you to buy assets at distressed prices when others are forced to sell. Allow investors to take greater risks elsewhere in their portfolios. But as with any market timing strategy, there is always the possibility of market “whipsaws,” where markets trade up and down in a sideways pattern for extended periods and tail risk hedging may become an extra expense instead of a benefit. JAGDX has gotten off to a rocky start, but they have an interesting approach to risk management, and I will be tracking the fund to see how they do over a full market cycle. So far, they have attracted about $50 million in assets, so it is still uncertain whether the fund will be a long term success.