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Smart Beta ETFs Not So Smart?

Smart beta ETFs that were on fire for quite some time now appear to be losing some momentum. Smart beta strategy helps to exploit market anomalies by adding extra selection criteria to the market cap or rules-based indices. These include among other strategies value – stocks trading cheap but performing better than stocks trading at a higher value, momentum – based on ongoing trend, dividend – stocks paying high dividend perform better in the long run and volatility – stable stocks perform better any day (read: How to Play the Choppy Market with Cheap Smart Beta ETFs ). In fact, the popularity of smart beta has soared to such a point, where a Create-Research survey has found that smart beta ETFs make up for around 18% of the U.S. ETF market. The U.S. markets are experiencing extreme volatility and the factors responsible for it are global growth concerns, escalating geopolitical tensions, a surge in the U.S. dollar and uncertainty over the timing of the next interest rate hike. Against this backdrop, investors look for smart stock-selection strategies to alleviate market risks. But nothing works forever, not even smart strategies. This is as true for smart beta ETFs as for market anomalies. Per a report by Research Affiliates’ analysts, one of the primary reasons why smart beta strategies have been performing well is because of their growing popularity, which led to higher valuations rather than structural alpha. The latter is the quality of the strategy and its potential to beat the benchmark on a sustainable and repeatable basis. This does not mean that one should reject smart beta ETFs altogether. If any inefficiency is spotted in the market, smart beta ETFs enable investors to exploit it at a cheap cost. However, it should be noted that not all smart beta ETFs have fulfilled their promise of delivering market-beating returns (read: Smart Beta ETFs That Stood Out Amid Market Volatility ). Below we have highlighted a few ‘Smart Beta’ options that underperformed the broader U.S. market ETF SPDR S&P 500 ETF (NYSEARCA: SPY ), which has gained about 1.6% so far this year (as of March 30, 2016) First Trust Dorsey Wright Focus 5 ETF (NASDAQ: FV ) This ETF tracks the Dorsey Wright Focus Five Index, which provides targeted exposure to the five First Trust sector and industry-based ETFs that Dorsey, Wright & Associates (DWA) believes have the highest potential to outperform other ETFs in the selection universe. It is a popular ETF with AUM of $4.6 billion and trades in solid volumes of around 2.2 million shares a day on average. The fund charges a higher 89 bps in fees. The ETF has lost 8.2% in the year-to-date period (as of March 30). Guggenheim S&P SmallCap 600 Pure Growth ETF (NYSEARCA: RZG ) This fund tracks the S&P SmallCap 600 Pure Growth Index. The product has a wide exposure across 146 stocks with each holding less than 2% share while healthcare and financials are the top two sectors accounting for over 20% share each. The ETF has AUM of $192 million but trades in light volume of about 28,000 shares a day on average. It charges 35 bps in annual fees and fell 2.4% in the year-to-date period. SPDR Russell 1000 Momentum Focus ETF (NYSEARCA: ONEO ) The fund tracks the Russell 1000 Momentum Focused Factor Index and holds a broad basket of 903 securities that are widely diversified with none holding more than 0.82% of assets. ONEO has accumulated $340.2 million in its asset base. It charges a lower fee of 20 bps per year and trades in solid volume of around 137,000 shares. The ETF fell 0.5% in the year-to-date period (read: 5 Very Successful ETF Launches of 2015 ). Original Post

Dumb Alpha: Sell In May And Go Away?

By Joachim Klement, CFA Every April, I am asked by clients and fellow investment professionals alike if the old adage, “Sell in May and go away,” still holds true? One of the key advantages of the ideas I present in the Dumb Alpha series is that they allow portfolio managers to rapidly improve their work-life balance. Since I am a naturally lazy person, I am constantly looking for ways to reduce my workload without my boss – or my clients – noticing. The sell-in-May effect, also known as the Halloween indicator , is one of the most well-known calendar effects. It holds that investors can outperform a simple buy-and-hold strategy by selling stocks at the beginning of May and buying them back at the beginning of November. If this were true, I could dramatically improve my work-life balance by going on a six-month vacation in May, just to come back in November and work for six months until the following spring. When I proposed this idea to my boss, he wasn’t very keen on it, arguing that, in largely efficient markets, this effect should not exist after transaction costs are taken into account. In other words, it should surely be arbitraged away by professional investors once widely known. I decided to dig in and look at the scientific evidence. After all, what is a weekend of extra research if one can expect to gain a half year off if proven right? It is indeed correct that many calendar effects do not survive increased scrutiny. Examples like the turn-of-the-month effect or the day-and-night effect require quite a lot of trading in a portfolio. If trading costs are reasonably high, many of these effects become unprofitable. Similarly, some other well-known calendar effects, like the January effect , disappeared once they were described in literature and exploited by professional investors. One of the first rigorous analyses of the sell-in-May effect was done by Sven Bouman and Ben Jacobsen , who looked at 37 international stock markets from January 1970 to August 1998. They found that the sell-in-May effect was present in 36 out of 37 countries and was statistically significant in 20 of them. The effect is not small, either. In the United States, Bouman and Jacobsen document a return in the November-to-April time frame that is 11 percentage points higher than in the May-to-October time frame; for the United Kingdom, the return difference is 24 percentage points – and can be traced back to the year 1694! So the sell-in-May effect has been around for a very long time, and, as it requires only two trades per year, it persists even after trading costs. Efficient market advocates were quick to reply. Edwin Maberly and Raylene Pierce pointed out that the sell-in-May effect disappears in the US stock market once the months of October 1987 and August 1998 are excluded from the data. Could it be that the effect was caused by just two months of awful performance? If the returns were that lumpy, surely it wouldn’t be possible to exploit them, because most investors would have lost their jobs or given up long before the next event materialized. In 2013, three researchers published what I consider the final verdict on the matter in the Financial Analysts Journal . Testing the sell-in-May effect with out-of-sample data from November 1998 through April 2012, they found that in the 14 years since the publication of Bouman and Jacobsen’s original analysis, the indicator did not disappear. In fact, on average, across the 37 markets studied, the out-performance in the winter months was still about 10 percentage points higher than in the summer months. They also found that the effect does not come in lumps. It exists in three out of four years and does not depend on specific industries, countries, or months. It seems clear that the effect is both real and persistent. What causes it is totally unknown, although several hypotheses have been proposed, tested, and rejected. Here we have a Dumb Alpha generator that defies logic and explanation. But, as a mentor of mine used to say, “Truth is what works” – and, even though the underlying causes of the effect are unknown, it does seem like a true investment anomaly. Now, I think I need to have a chat with my boss about my next vacation. Disclaimer: Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Winning ETF Strategies For Q2

After the upheaval in the first quarter, the broader market is still far from even close to a bear market. The S&P 500 may be just 0.9% up from the year-to-date look (as of April 12, 2016), but the decline in the key U.S. index is merely 4% from the previous high . This points to a far better situation than a 10% decline from the previous high which defines a correction or a 20% fall from the previous high that makes it a bear market. However, this does not ensure a smooth road ahead. With the broader market blowing hot and cold every now and then, downside risks prevail in the ongoing second quarter. Agreed, factors driving the market now – especially oil price stabilization and the drop in the dollar – are somewhat favorable, but the near-term outlook of the broader market may turn glum given the expected downbeat earnings for Q1. After all, there are always panicky investors in the market who may just start dumping stocks following the underperformance in Q1 earnings. And if it turns out to be a herd investing pattern, it could ruin market returns despite a healing earnings trend from the second quarter itself. So, what should we do? Since it is difficult to predict whether the market will move up or go down from this point in Q2, it is better to shield yourself from all volatility. Thus, for investors, we shall detail the possible asset class movements in Q2 and the likely ETF bets. Dividend Exposure As far as global market investing is concerned, it’s better to stay diversified. However, since negative rates are prevailing in many developed economies, the drive for dividend will be higher. So, investors can tap products like First Trust Dow Jones Global Select Dividend Index ETF (NYSEARCA: FGD ), which yields about 5.16% annually or the iShares Core MSCI Total International Stock ETF (NYSEARCA: IXUS ) that offers about 2.85% in annual dividend yield. The case is similar back home. Thanks to the delay in further Fed rate hike, long-term yields are hovering at lower levels, making dividend ETFs popular at present. The WisdomTree Equity Income ETF (NYSEARCA: DHS ) and the iShares Core High Dividend ETF (NYSEARCA: HDV ) could be best suited for this play. Focus on Quality or Value in the U.S. Cautious investors may also hunt for dividends in high-quality value stocks rather than running after high-yielding products. In this vein, investors can buy the Vanguard Dividend Appreciation ETF (NYSEARCA: VIG ), which considers those companies that have a record of increasing dividends over time, or the PowerShares S&P 500 High Quality Portfolio ETF (NYSEARCA: SPHQ ), which provides exposure to the constituents of the S&P 500 index with long-term growth and stability of a company’s earnings and dividends. Yet another choice for this category is the PowerShares Dynamic Large Cap Value Portfolio ETF (NYSEARCA: PWV ). Which Capitalization to Bet on in the U.S.? The U.S. economy is making strides, with improving trends seen in the manufacturing, housing and labor markets. But the dollar is sagging on a dovish Fed. This makes a winning combination for mid-cap ETFs, as this spectrum bears the traits of both large and small caps. It has moderate international exposure, which will remain unharmed in a weaker dollar environment. However, a value quotient is desirable even in this area. Thus, we pick two mid-cap value ETFs for investors, namely the Guggenheim S&P MidCap 400 Pure Value ETF (NYSEARCA: RFV ) and the PowerShares Fundamental Pure Mid Value Portfolio ETF (NYSEARCA: PXMV ). Both carry a Zacks Rank #1 (Strong Buy). Where Will the Bond Markets Go? Bond ETFs had a stupendous run in Q1 and are likely to be loved by investors this quarter too. However, investors can tap investment-grade corporate bond ETFs this time around, rather than sticking to the safe Treasury bond ETFs. The SPDR Barclays Capital Long Term Corporate Bond ETF (NYSEARCA: LWC ), yielding about 4.05% annually, can be considered for this purpose. Should You Toss Out Currency Hedging from International Investing? Since the Fed vowed to take it easy with the policy tightening stance and hinted at just two rate hikes this year, the U.S. dollar is likely to be muted in the rest of Q2. So, currency-hedged ETF investing may not be a very popular concept this quarter. If global turmoil persists, the safe-haven currency, the Japanese yen, is likely to be stronger, and thus, the currency-hedging technique will not be that fruitful. Investors can thus take a look at the Buy-rated iShares MSCI Japan Minimum Volatility ETF (NYSEARCA: JPMV ) and the SPDR MSCI Japan Quality Mix ETF (NYSEARCA: QJPN ). These funds will help you navigate market volatility. The IQ 50 Percent Hedged FTSE Japan ETF (NYSEARCA: HFXJ ), with a Zacks Rank #3 (Hold), is another option to deal with the currency translation risk. As far as the European market is concerned, investors can ride on massive policy easing by investing in the WisdomTree Europe SmallCap Dividend ETF (NYSEARCA: DFE ). Original Post