Author Archives: Scalper1

10 Ways To Destroy Your Portfolio

With the increased frequency of heightened volatility, investing has never been as challenging as it is today. However, the importance of investing has never been more crucial either, due to rising life expectancies, corrosive effects of inflation, and the uncertainty surrounding the sustainability of government programs like Social Security, Medicare, and pensions. If you are not wasting enough money from our structurally flawed and loosely regulated investment industry that is inundated with conflicts of interest, here are 10 additional ways to destroy your investment portfolio: #1. Watch and React to Sensationalist News Stories: Typically, strategists and pundits do a wonderful job of parroting the consensus du jour. With the advent of the internet, and 24/7 news cycles, it is difficult to not get caught up in the daily vicissitudes. However, the accuracy of the so-called media experts is no better than weather forecasters’ accuracy in predicting the weather three Saturdays from now at 10:23 a.m. Investors would be better served by listening to and learning from successful, seasoned veterans. #2. Invest for the Short Term and Attempt Market Timing: Investing is a marathon, and not a sprint, yet countless investors have the arrogance to believe they can time the market. A few get lucky and time the proper entry point, but the same investors often fail to time the appropriate exit point. The process works similarly in reverse, which hammers home the idea that you can be 200% wrong when you are constantly switching your portfolio positions. #3. Blindly Invest Without Knowing Fees: Like a dripping faucet, fees, transaction costs, taxes, and other charges may not be noticeable in the short-run, but combined, these portfolio expenses can be devastating in the long run. Whether you or your broker/advisor knowingly or unknowingly is churning your account, the practice should be immediately halted. Passive investment products and strategies like ETFs (Exchange Traded Funds), index funds, and low turnover (long time horizon / tax-efficient) investing strategies are the way to go for investors. #4. Use Technical Analysis as a Primary Strategy: Warren Buffett openly recognizes the problem with technical analysis as evidenced by his statement, “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.” Legendary fund manager Peter Lynch adds, “Charts are great for predicting the past.” Most indicators are about as helpful as astrology, but in rare instances some facets can serve as a useful device (like a Lob Wedge in golf). #5. Panic-Sell out of Fear And Panic-Buy out of Greed: Emotions can devastate portfolio returns when investors’ trading activity follows the herd in good times and bad. As the old saying goes, “Following the herd often leads to the slaughterhouse.” Gary Helms rightly identifies the role that overconfidence plays when in investing when he states, “If you have a great thought and write it down, it will look stupid 10 hours later.” The best investment returns are earned by traveling down the less followed path. Or as Rob Arnott describes, “In investing, what is comfortable is rarely profitable.” Get a broad range of opinions and continually test your investment thesis to make sure peer pressure is not driving key investment decisions. #6. Ignore Valuation and Yield: Valuation is like good pitching in baseball…very important. Valuation may not cause all of your investments to win, but this factor should be an integral part of your investment process. Successful investors think about valuation similarly to skilled sports handicappers. Steven Crist summed it up beautifully when he said, “There are no ‘good’ or ‘bad’ horses, just correctly- or incorrectly-priced ones.” The same principle applies to investments. Dividends and yields should not be overlooked – these elements are an essential part of an investor’s long-run total return. #7. Buy and Forget: “Buy-and-hold” is good for stocks that go up in price, and bad for stocks that go flat or decline in value. Wow, how deeply profound. As I have written in the past, there are always reasons of why you should not invest for the long term and instead sell your position, such as: 1) new competition; 2) cost pressures; 3) slowing growth; 4) management change; 5) excessive valuation; 6) change in industry regulation; 7) slowing economy; 8) loss of market share; 9) product obsolescence; 10) etc, etc, etc. You get the idea. #8. Over-Concentrate Your Portfolio: If you own a top-heavy portfolio with large weightings, sleeping at night can be challenging, and also force average investors to make bad decisions at the wrong times (i.e., buy high and sell low). While over-concentration can be risky, over-diversification can eat away at performance as well – owning a 100 different mutual funds is costly and inefficient. #9. Stuff Money Under Your Mattress: With interest rates at the lowest levels in a generation, stuffing money under the mattress in the form of CDs (Certificates of Deposit), money market accounts, and low-yielding Treasuries that are earning next to nothing is counter-productive for many investors. Compounding this problem is inflation, a silent killer that will quietly disintegrate your hard earned investment portfolio. In other words, a penny saved inefficiently will lead to a penny depreciating rapidly. #10. Forget Your Mistakes: Investing is difficult enough without naively repeating the same mistakes. As Albert Einstein said, “Insanity is doing the same thing, over and over again, but expecting different results.” Mistakes will be made and it behooves investors to document them and learn from them. Brushing your mistakes under the carpet may make you temporarily feel better emotionally, but will not help your financial returns. As the year approaches a close, do yourself a favor and evaluate whether you are committing any of these damaging habits. Investing is tough enough already, without adding further ways of destroying your portfolio. Disclosure: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

To Hedge Or Not To Hedge International? Revisiting The Question

Summary Currency-hedged ETFs have become a popular vehicle for international diversification with hedged currency risk. But the U.S. dollar trade has become a “crowded” and increasingly volatile trade. Does it make sense to utilize currency-hedged products in the current market environment or is it just “return chasing”? Currency-hedged ETFs have been around since 2010, but with the US dollar so strong relative to other currencies they have been gaining in popularity with investors seeking to reduce the currency risk in their portfolios. Through July there were more than 327 currency hedged products available globally, capturing an estimated $118 billion in assets. An estimated $47 billion have landed in currency-hedged products this year, representing 40% of passive flows into international products. Below is a table with the names and tickers of the largest currency-hedged ETFs: Source: ETF.com Currency-hedged international equity products can boost returns when the local currency is weakening against the dollar, but they can also be a drag on returns if the dollar weakens. Most currency-hedged ETFs use “currency forwards” to hedge currency exposure and if the trade is executed correctly, currency exposure is neutralized. The foreign currency markets can be very volatile. Just this week, the Euro rose four cents in one day against the dollar after the European Central Bank’s stimulus measures came in well short of expectations. As another example, the Swiss franc jumped by 30% in a matter of minutes last January. And then of course there was China’s currency devaluation over the summer. And ever since the global financial crisis, foreign currency volatility has markedly increased in the era of quantitative easing (QE) and monetary policy intervention. This trend has been exacerbated over the last few years thanks to the growing economic divergence between the U.S. economy and the rest of the world’s. The U.S. has emerged since the financial crisis as one of the stronger economies on the globe. Economic and currency divergence has resulted in a substantial difference in returns between hedged and unhedged investments in several regions including Developed Markets (EAFE), Emerging Markets (EM), Europe, Japan, and Germany as depicted in the chart below. (click to enlarge) Source: Bloomberg So given the fact that it is likely the Federal Reserve will raise interest rates this December, further strengthening the position of the dollar, it seems like a “no brainer” to hedge international investments. But is it? The sharp spike in the Euro relative to the dollar recently illustrates that the dollar trade is a very “crowded” trade and as a result also subject to wide swings in volatility. Even Fed Chair Janet Yellen said much of the divergence is already priced into the dollar. So by utilizing currency-hedged ETFs, as an investor are you merely piling into an already crowded trade and chasing returns? Long-term Risk Reduction Most academics would argue that over the long-term, currency investing is a zero-sum game and currency volatility cancels out over time. But currency movement does still add risk and volatility to investor portfolios. Investors unhedged to currency have excess exposure to the U.S. dollar and a rising dollar environment can severely compromise their international returns. By eliminating a form of uncompensated risk, hedging currency exposure over the long-term can serve to reduce risk and volatility. Short-term Tactical Trade As a short-term trade, currency-hedged products can also be utilized tactically to capture opportunities created by monetary policy shifts. Investors tactically playing the EU’s monetary stimulus trade for example, have been handsomely rewarded even considering the recent rally of the Euro relative to the dollar. Investors considering currency-hedged products must also consider the cost to hedge as part of their decision making process. Currency-hedged products typically have higher expense ratios and there is also a “carry cost” associated with the forward contracts. Much of the cost of the hedge is based on the interest rate differential, which provides an advantage to U.S.-based investors. Most funds reset their forwards monthly, so that may also inhibit the effectiveness of the hedge, especially in very volatile markets. But overall, currency-hedged products are a nice tool to have in the investment arsenal to help provide international diversification while mitigating currency risk. A 100% Hedge? So should investors hedge all of their international exposure in the current market environment given that much of the divergence and “flight to quality” trade has already played out? It is very easy for investors to mistime hedging. For example, there is historical evidence that the dollar tends to sell off initially after the first Fed rate hike, experiencing a “sell on the news” phenomenon. Analyzing the change in the dollar index after the last three rate hikes, the dollar has sold off the 3 months after the initial increase. (click to enlarge) A More “Balanced” Approach So perhaps the best strategy is a more balanced approach to help minimize downside risk without over penalizing upside opportunity. One such potential implementation is to allocate half (50%) of one’s international exposure to unhedged products and the other half (50%) to hedged. Along those lines, investors can create this paired exposure quite efficiently themselves with a 50/50 allocation. Another option is to utilize a 50/50 hedge ETF such as IndexIQ’s three 50% hedge products: the IQ 50 Percent Hedged FTSE International ETF (NYSEARCA: HFXI ), the IQ 50 Percent Hedged FTSE Europe ETF (NYSEARCA: HFXE ), and the IQ 50 Percent Hedged Japan (NYSEARCA: HFXJ ). IndexIQ, which is part of New York Life’s MainStay Investments, makes a compelling case for what they call in their white paper this “hedge of least regret.” And WisdomTree (NASDAQ: WETF ) recently filed for four dynamic hedging ETFs that will adjust currency hedging ratios ranging from 0 to 100 using currency-related quantitative inputs. In conclusion, currency-hedged products do indeed make sense over the long-term, but given that much of the strong dollar trade has already been priced into the market, hedging all of one’s international exposure, at least in the short-term, may be too much of a good thing.

Connecticut Water Service – A Stable Business With A Twist

Summary The company is primarily a water utility business. While the utility business is highly profitable, the return on equity is capped at around 10%. The Services and Rentals could generate significant value in the future. Connecticut Water Service (NASDAQ: CTWS ) is a utility company that focuses on water distribution. As a water utility company, the company does not have to worry about commodity fluctuations, unlike a natural gas utility company . Unfortunately, the company was not able to escape the pessimism in the market. Despite on the way to post another year of growth, the stock barely budged in 2015, fluctuating around $36. In the chart above, we can see that over the long-term, the stock tracks the company’s top-line growth. This makes a lot of sense because the company primarily runs a regulated business, so margins will be fairly consistent from year to year. More recently, the company seems to have benefited from economy of scale, as the operating margin climbed along with the growth in revenue. For any other company, this track record would suggest an extremely well-run business with the potential to generate a lot of profit. Unfortunately for investors (and fortunately for citizens), the utility business is regulated for this exact reason. The company’s two main water subsidiaries in Connecticut and Maine have a rate cap (return on equity) of 9.75% and 9.5%, respectively As you can see, ROE has fluctuated around the 10%, reflecting this cap. What this means is that the maximum growth equity investors can expect from the company’s regulated business over the long-run is around 10%. Because the company provides a critical service, I have no doubt that the company will achieve this rate of return over the long term. Of course, the company can try to apply for rate increases, but I wouldn’t count them since there is no way to know in advance whether they will be approved. While most of the revenue comes from the regulated water utility business (~90%), the company does have some non-regulated operations. On the non-regulated side, the main segment is Services and Rentals. The segment’s operation is quite diverse, ranging from typical repairs to providing emergency drinking water. While small, the company is highly profitable. Year to date, the segment’s net profit margin was 24%. This is pretty much on par with the margin of the water business (25%)! However, it would seem that the management has trouble growing it. Quarter on quarter, revenue only increased by 5%. That being said, the segment could generate significant value if the management figures out a way to scale it. While I am not seeing any promises right now, it nevertheless has good option value, after all, the segment’s services do go hand in hand with the water business. Conclusion If you are satisfied with the rate of return (~10%) over the long-term, then I think Connecticut Water Service represents a good opportunity. Due to the nature of water utility (a critical service), the company should be able to reach the rate cap over the long-run. While the non-regulated side of the business is still small, I believe that once the management finds a way to convince more water business customers to use the company’s maintenance services, there could be significant upside. Overall, I believe that the company will continue to deliver stable profits from its water business, and the non-regulated activities are an added bonus for investors.