Tag Archives: vfinx

Building A Basic 2-Fund Stocks And Bonds Portfolio With Vanguard Mutual Funds

Summary Adding bonds to a portfolio of stocks generally improves risk-adjusted returns, and in some cases also improves raw returns. Implementing a stocks and bonds portfolio using Vanguard mutual funds is a great way to minimize trading costs (low expense ratios, free trades). Here I look at properties of two-fund portfolios comprised of VFINX paired with various bond funds: VBISX, VBIIX, VBLTX, and VBMFX. I provide a graph that lets you pick a bond fund and asset allocation that maximizes your expected return for the level of volatility you can tolerate. Stocks and Bonds It is well-known that stocks generally provide greater expected returns, but also greater volatility, compared to bonds. Conventional wisdom dictates that individual investors should increase exposure to bonds as they get closer to retirement, sacrificing raw returns for less susceptibility to major drawdowns. Adding bonds to a portfolio of stocks generally improves risk-adjusted returns (i.e. Sharpe ratio). This is primarily because bond funds generate positive alpha, thanks to maturing bonds. In fact it would be senseless to knowingly add a bond fund to your portfolio that doesn’t increase risk-adjusted returns. (You would be much better off using cash to decrease risk while locking in your current Sharpe ratio.) In some cases, adding a high-alpha bond fund can actually increase a portfolio’s raw returns. We will see one such example in this article. Vanguard Funds Vanguard is a great trading platform for individual investors. They offer a wide variety of mutual funds and ETFs with extremely low expense ratios, and they have zero-commission trades for Vanguard mutual funds and ETFs. When it comes to portfolio building, simpler is often better. In particular, I think when you start considering specialty funds (e.g. sector-specific; lesser-known indexes or subsets thereof) you can transition to speculative investing pretty fast. So in this article I’ll consider only the following six mutual funds. Table 1. Vanguard mutual funds included in analysis. Fund Ticker Expense Ratio Average Effective Maturity (years) SEC Yield Vanguard 500 Index Fund Investor Shares VFINX 0.17% – 2.09% Vanguard Total Stock Market Index Fund Investor Shares VTSMX 0.17% – 1.96% Vanguard Short-Term Bond Index Fund Investor Shares VBISX 0.20% 2.8 1.01% Vanguard Intermediate-Term Bond Index Fund Investor Shares VBIIX 0.20% 7.2 2.40% Vanguard Long-Term Bond Index Fund VBLTX 0.20% 24.1 3.94% Vanguard Total Bond Market Index Fund Investor Shares VBMFX 0.20% 7.9 2.03% VFINX and VTSMX are natural choices for the “stocks” part of a stocks and bonds portfolio, and the four bond funds cover bonds of various durations, including a blend in VBMFX. To allow for direct comparisons, all analyses here are based on performance of these funds over their mutual lifetimes: March 1, 1994, to Oct. 26, 2015. Historical Performance of Each Fund Let’s take a look at historical performance metrics for the six individual funds. Table 2. Performance metrics for six Vanguard mutual funds. 1 Ticker CAGR (%) MDD (%) Mean SD Sharpe Alpha (%) Alpha p-value Beta VFINX 9.08 55.3 0.042 1.193 0.035 0.0014 0.67 0.961 VTSMX 9.03 55.4 0.042 1.198 0.035 0.0014 0.71 0.959 VBISX 4.38 2.7 0.017 0.167 0.103 0.0182

A Pioneering Approach To Earnings Season

Summary US Q2 earnings season was one of the most volatile ever. We present Pioneering Quantitative Approach focusing on prices and not on fundamental data. Our analysis provides a guide per sector and per capitalization. ABSTRACT “Qui sait le passé peut conjecturer l’avenir”, Jacques-Bénigne Bossuet As we are just about to enter in the Q3 Earnings Season in the US, Uncia AM decided to provide you some keys to understand the Q2 Earnings Season. Bloomb erg already gave some keys: US stocks got biggest earnings bang since 2012 . This empirical study emphasizes many things: 1/ It is not worthwhile to keep equity position over the earnings: earnings releases are a lottery. As difficult as it may be for our equity analyst friends to admit (note: the author is an asset manager) , all available empirical data shows that it is impossible to predict market reaction following an earnings release. We thus need to distinguish the fundamental component of the reaction which is less unpredictable (related to turnover, EBITDA and other hard data) from the “price signal” component. The latter has always been impossible to predict, even if we take into account the released fundamental data. From a statistical perspective, the specific movement linked an the earnings release is on average null, as can be seen from the highly leptokurtic distribution of the movement. For an asset manager seeking to optimize their Sharpe Ratio, it is therefore not worth maintaining a position in the equity over the release period (assuming transaction & liquidity fees to be marginal) (click to enlarge) Source: Bloomberg, Uncia AM, Alphametry. Read the entire article in order to make your own opinion : 2/ Information Technology sector behaved properly during this session, on almost all indices. 3/ The specific Russell 2000 – related stocks moved a lot on earnings: maybe more interest of investors for UScentric names, as a consequence of fear over the USD strength and the world/Chinese macro slowdown. As the article may be a bit technical, here is a brief takeaway: On average, stocks from Nasdaq Composite Index (NASDAQ: CCMP ) exhibit a null return over earnings, but with large volatility. Therefore, it justifies the strategy to cut positions over earnings. In addition to that, we can notice that signals were slightly better on large caps vs small caps, and quite good in a sector such as Information Technology. “Weekly speaking”, we experienced a sharp positive signal on CCMP, but on a “PEAD” perspective only few comonotony between Earnings Moves and Drift Returns. On average, stocks from Russell 2000 Index (RTY) exhibit a null return over earnings, but with large volatility. Therefore, it justifies the strategy to cut positions over earnings. In addition to that, we can notice that signals were slightly better on large caps vs small caps, and quite good on a sector such as Information Technology, same things as we notice on CCMP. There are a lot more “PEAD” signals on RTY than on CCMP, meaning that as there are many companies belonging to both indices, many companies belonging only to RTY exhibit large signals. This means that investor attention was largely focused on UScentric companies. “Weekly speaking”, since the beginning of the year, we had very positive signals on RTY, but the summer was very complicated as we can see a downside candle at the beginning of August. Stocks from S&P 500 (SPX) are less volatile over earnings than those of CCMP, RTY or Nasdaq 100 (NDX). It may be explained by the average size of capitalization, but this is not sufficient as NDX average capitalization is higher (58.0 vs 50.2) is higher than SPX. We make the same notification about earnings release volatility that is not rewarded, unless capitalization criteria is not worthwhile anymore, nor sector criteria (even if we can see a positive skew for Information Technology sector). In terms of “Weekly signals”, we can notice numerous negative signals, emphasizing an overreaction of investors about bad news versus good news. We have only few data, but first of all, we can notice that stocks from Nasdaq 100 (NDX) exhibits the largest average capitalization, and the largest absolute earnings moves. For more technical readers, should you be interested in the underlying philosophy, please go ahead: METHODOLOGY Our sample takes into account earnings that occurred between 2015, June 30th and 2015, August 31st. We only focus on companies whose market capitalization exceeds $1 billion, the day before the earnings release (ER)/call (NYSE: EC ). We focus on 4 main US indices: Nasdaq Composite , Nasdaq 100 (NDX), S&P 500 (SPX) and Russell 2000 (RTY). Our method to estimate the move due to earnings release/call is the following: We assume that the Management Call lasts one hour, and that ER had occurred just before, which is the standard case (hugely often- we consider it happens all the time). Therefore, thinking as of Paris time, with 6-hours delay with New-York, we can set the following table: Table of earnings category Source: Uncia AM. We use the earnings return by getting rid off the total return index to the idiosyncratic move, assuming a beta for each stock = 1. For more information, you can refer to the original paper by the author, Post Earnings Announcement Drift, a Price Signal? [1] Important: in the following development, return always refers to relative return of the stock versus its index (total-return). NASDAQ COMPOSITE – CCMP: average capitalization (

Don’t Invest With Your Convictions. They’re Wrong.

Summary Investors overestimate their knowledge of financial markets. Realized returns of individual investors substantially lag benchmark results. There is no clear evidence of persistence in mutual fund returns. Most investors have some kind of view on today’s stock and bond markets. It’s only natural. Financial media is everywhere. Investment news and opinions are delivered to our smartphones as soon as they are written. While the bandwidth of financial information has expanded dramatically, its noise to signal ratio remains stubbornly high. Buy Gold! Metals are dead! The Stock Market is too high! The Market has room to run up! The reality is that almost no one knows. And it’s virtually impossible for John Q Public to identify those few who do know. This newsletter talks about investor convictions and their impact on financial outcomes. The Big Picture One way to evaluate the success of individual investor sentiment is to take a look at aggregated performance. How is everybody doing? As a group … very poorly. DALBAR is an independent consultancy that reports annually on the success that individual investors enjoy relative to various financial benchmarks. In effect, they measure the ability of the public to time movements into and out of mutual funds over long periods of time. There is a lag between expectations and performance. For the 30 years ending 2014, average equity and bond fund investors massively underperformed their respective benchmarks – the S&P 500 and Aggregate Bond Index. Why is the Investor so Wrong? There are two basic explanations for the lag. Investors repeatedly demonstrate tendencies injurious to financial health. Collectively, they lurch from euphoria to panic – based on recent market performance. In fact, investor performance lags are largest during periods of heightened market volatility. These general conclusions deserve some anecdotes. Gallup and Wells Fargo conduct a quarterly survey on investor sentiment by interviewing over 1000 individuals with stock market exposure. They distill the responses into an index of overall market optimism. It reached its apex in January 2000 – 2 months before the dotcom bust. The sentiment index reached its nadir in February 2009 – one month before what has become the 3rd longest bull market in American history. So much for investor convictions. It has been my experience that investors overestimate their own ability to maintain rationality in the face of market turbulence. The aggregated date supports this view. According to a Wells Fargo/Gallup survey conducted in early February, 76% said they were either very or somewhat likely to take no action during market volatility. Yet investors exited the equity markets en masse in late 2008. The second problem with investment outcomes are the products themselves. The mutual funds that investors choose to implement their beleaguered strategies also fall short of the mark. Fund companies spend fortunes to convince the public that their portfolio managers can beat the market through astute security selection or tactical asset allocation. These superstars get paid well. Data compiled by Morningstar indicates that the cost structure of mutual funds has remained high in the new century. The average US equity mutual fund still charges 1.25% annually. Given the secular decline in bond yields, this resilience of high fees is especially surprising in the fixed income space. Fees in the average bond fund now exceed 25% of the yield to maturity of the ten year Treasury bond – up from 13% a decade ago. Have the expert fund managers delivered? The aggregate data tells us no. In fact, actively managed mutual funds lag the performance of a corresponding index by an amount that is not significantly different than the expenses they charge. A reasonable response to this result might be that mutual funds cannot beat the average because they are ultimately competing against themselves. It’s up to individual investors or their investment consultants to identify the “best of breed” managers in each asset class. A foundational approach in this effort is the evaluation of past performance. Again the data throws cold water on this theory. Past performance demonstrates virtually no persistence across a wide range of equity mutual fund asset classes. Top quartile performers depart the top quartile at the rate faster than predicted by random chance. If returns were completely random from year to year, there would be a 25% likelihood that a dart throwing manager could return to the top quartile. Doesn’t work that way as selected data from S&P Dow Jones indicate in the table below. Is There a Better Way? There is a corollary to the rather pessimistic findings of the previous section. If moving assets around is a destructive behavior, then keeping them in place is a better option. Long term performance of the major classes has been sufficient over the last ten or even hundred years to deliver comfortable retirement outcomes to most serious investors. Sure, it’s no guarantee that the public financial markets will continue to serve as stores of value. But stocks and bonds are about the best option the investing public has. A qualified investment advisor can play a constructive role here. Besides the technical ability to craft and implement an investment plan, a key advantage is the discipline that investors gain to stick to the plan amidst the financial noise that is sure to follow. Vanguard estimates that behavioral coaching is worth about 1.5% to investors each year. Based on a Vanguard study of actual client behavior, we found that investors who deviated from their initial retirement fund investment trailed the target-date fund benchmark by 1.5%. This suggests that the discipline and guidance that an advisor might provide through behavioral coaching could be the largest potential value-add of the tools available to advisors. Although the financial markets have suffered few reverses over the past six years, rest assured that market panics will follow at some point. Consider the wisdom of Meir Statman, Professor of Finance at Santa Clara, who wrote the following in the Wall Street Journal near the nadir of the recent financial crisis when investor sentiment was stacked against the stock market. Don’t chase last year’s investment winners. Your ability to predict next year’s investment winner is no better than your ability to predict next week’s lottery winner. A diversified portfolio of many investments might make you a loser during a year or even a decade, but a concentrated portfolio of few investments might ruin you forever. Consistency will get you there. Have the courage NOT to act on your own beliefs. It will be worth it. (click to enlarge)