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2 Screens To Avoid Bad Investments

Summary There’s no way to avoid all investments that end up performing poorly, but there are two screens that can avoid some of them: past price performance and hedging cost. We applied those two screens to a list of top investor picks three months ago, and the ones that passed both screens significantly outperformed the others. We elaborate on the two screens, and discuss why they work. We conclude with a suggestion to consider applying these screens to guru picks, and to consider diversifying or hedging to limit risk. A Bad Fall For Top Investor Picks In a late August article (“Best Q2 Picks From Top Investors”), Seeking Alpha premium contributor and hedge fund manager Chris DeMuth, Jr. highlighted what he felt were the best stocks top investing gurus such as Warren Buffett, Carl Icahn, and Seth Klarman (Klarman pictured below; image from DeMuth’s article) added or increased their weightings of in the second quarter. On the whole, these picks have performed poorly over the last three months. In hindsight, this is consistent with the narrowness of the current bull market, one dominated by the “FANGs”, Facebook (NASDAQ: FB ), Amazon (NASDAQ: AMZN ), Netflix (NASDAQ: NFLX ), and Google (NASDAQ: GOOG ), as John Authers noted in a recent Financial Times column. But what’s interesting is the divergence in performance between two groups of these stocks. The first group includes the guru picks that passed two screens to be included in a Portfolio Armor hedged portfolio, and the second group includes the guru picks that didn’t. One of those screens is simple enough you can run it without any specialized tools. We’ll detail both of the screens below, but first, here’s a look at how the two groups of guru picks have performed over the last three months. Guru Picks Portfolio Armor Included, 3-Month Returns: Advance Auto Parts (NYSE: AAP ), -14.43% Precision Castparts (NYSE: PCP ), +1.19% Cigna Corporation (NYSE: CI ), – 1.75% Danaher Corp (NYSE: DHR ), +10.83% Humana (NYSE: HUM ), -8.16% Perigo (NYSE: PRGO ), -16.2% Shire (NASDAQ: SHPG ), -8.5% Time Warner (NYSE: TWC ), -2% Average 3-month return: -4.88% Guru Picks Portfolio Armor Rejected, 3-Month Returns: SunEdison (NASDAQ: SEMI ), -32.06% SunEdison (NYSE: SUNE ), -71.15% Williams (NYSE: WMB ), -40.8% Baker Hughes (NYSE: BHI ), -6.83% Office Depot (NASDAQ: ODP ), -24.33% Altera (NASDAQ: ALTR ), +5.94% Icahn Enterprises (NASDAQ: IEP ), +0.54% Brookdale (NYSE: BKD ), -29.6% T-Mobile (NASDAQ: TMUS ), -6.47% Average 3-month return: -22.75% Screening Out The Worst-Performing Picks In an article published in early September (“Investing Alongside Buffett, Klarman, And Other Top Investors While Limiting Your Risk”), we entered each of the guru stock picks above into Portfolio Armor’s hedged portfolio construction tool. That tool works differently depending on whether you enter your own securities or not. If you don’t enter your own securities, the tool populates your portfolio with the securities with the highest potential returns, net of hedging costs, in its universe (its universe consists of every stock and exchange traded product with options traded on it in the U.S.). If you do enter securities, as we did with those guru picks, the tool performs two screens on the securities you enter before attempting to calculate potential returns for them. Screen #1: Most Recent 6-month Performance V. Long Term The first screen is one you can easily do yourself. The tool looks at how the ticker performed over the most recent six months and compares that to the average six month performance of the security over the long term (ten years, if a stock has been around that long; if not, it uses the long term returns of an industry competitor as a proxy; for exchange-traded products it uses since-inception returns if it hasn’t been around for ten years). The tool will reject any security with a negative return over the last six months, unless the average six month return of the security over the long term is greater than the absolute value of the most recent six months return. To illustrate this, let’s look at one of the guru picks that failed this screen, SunEdison . Below is a chart, via Yahoo, showing the performance of SUNE over the 6 months prior to when Portfolio Armor rejected it for inclusion in that September hedged portfolio: (click to enlarge) SUNE was down 48% over the six months prior to early September. The only way it would have made it past this screen is if its average 6-month performance over the last 10 years was greater than 48%, and, as you might guess, that wasn’t the case, so SUNE failed the first screen. Screen #2: Hedging Cost Since SUNE failed the first screen, it was eliminated. An example of a stock that passed the first screen, but failed the second, was Williams . WMB was down 3.25% over the most recent six month period as of early September, but its average 6 month performance over the previous 10 years was 4.81%, so it passed the first screen. But it was too expensive to hedge against a greater-than-9% decline over the next six months using an optimal static hedge, so it was rejected. We explained how to find optimal hedges in a previous article , if you’re willing to do the work manually, or you could use an automated tool such as our hedging app . Why These Two Screens Work Although these two screens don’t eliminate all poor-performers, they work to eliminate some of the worst performers. They both employ what New Yorker columnist James Surowiecki termed the wisdom of crowds : Large groups of people are “smarter” than an elite few, no matter how brilliant — better at solving problems, fostering innovation, coming to wise decisions, even predicting the future. The large group of people in screen #1 is the stock market, and the large group of people in screen #2 is the option market; the elite few are the top investors who picked the stocks. Conclusion If you’re going to buy gurus’ stock picks, consider buying ones that pass these two screens. And since these screens don’t eliminate all poor-performers, consider limiting your stock-specific risk by diversifying or hedging.

No Winter Cheer For Natural Gas ETFs?

Broad commodities have gone off the deep end on sluggish trends with the energy market rout deserving a special mention. Among the issues wrecking havoc on the energy market, rising supplies and falling demand on global growth worries are primary. In such a situation, the Saudi-led OPEC’s decision of not cutting production and even scrapping the regular production limit to save their market share sent oil and other energy-based commodities into a tailspin. In such a scenario, the only hope for the natural gas market was the Arctic Chills, which gives a fresh lease of life to this commodity every winter. The cold snap boosts electricity demand across the region putting natural gas in focus. In fact, in 2014, the Polar Vortex caused natural gas prices to jump over 50%. As almost 50% of Americans use natural gas for heating purposes, withdrawals in natural gas supplies push up the commodity’s prices. The latest weekly inventory release from the U.S. Energy Department also gives the same cues. Natural gas supplies have seen a bigger than expected decline following the season’s first withdrawal. Stockpiles fell by 53 billion cubic feet (Bcf) for the week ended Nov 27, 2015, higher than the guided range (of a 46-50 Bcf draw). The decrease was also higher than both last year’s drop of 42 Bcf and the 5-year (2010-2014) average decline of 48 Bcf. Still, broad-based energy market worries and the possibility of a warmer weather this winter (due to El Nino) did not let natural gas prices enjoy the drawdown in supplies. Oil lost about 10% since the OPEC meeting. Plus, predictions that warmer weather might go into late December – key heating period also dampened investor mood. Energy commodities have now slipped to a more than six-year low. In fact, January 2016 might not imitate the previous two comparable same months due to a protracted and stronger El Nino, which causes weather disruptions in many regions around the world. The effect of El Nino includes drought in some regions and flooding in others due to abnormal warming of the Pacific Ocean. As per Weather Services International, El Niño is expected to cause below-normal temperatures across the southern Plains and into the Southwest, while above-normal temperatures will likely prevail in the eastern and northern parts of the U.S. This weather pattern would result in lower heating demand in the northern hemisphere this winter. WSI also predicted gas-weighted heating degree days to tally about 3,600, suggesting 10% less demand than the year-ago winter. ETF Impact As a result, an ETF tracking the natural gas futures – T he United States Natural Gas ETF (NYSEARCA: UNG ) – has lost about 45% so far this year and was off 16.4% in the last one month (as of December 8, 2015). So investors can avoid these natural gas ETFs in the near term (see all Energy ETFs here). UNG in Focus Investors seeking direct exposure to natural gas, a key fuel source for power plants, may find UNG an attractive option. It is the most popular ETF, having amassed about $478 million in assets. The product looks to track the changes in percentage terms of the price of natural gas futures contracts that are traded on NYMEX. The fund takes positions in the near month futures contracts on expiry and rolls over to the next month futures contracts. As the prices of the next month futures contracts exceed that of the near month futures contracts (also called “contango”), the fund loses on rolling. Hence, UNG is vulnerable to the prolonged period of contango. At present, the fund holds two contracts namely NYMEX Natural Gas NG Jan16 and ICE Natural Gas LD1 H Jan16. The fund charges 60 bps in fees. iPath Dow Jones-UBS Natural Gas ETN (NYSEARCA: GAZ ) This is an ETN option for natural gas investors. It delivers returns through an unleveraged investment in the natural gas futures contract plus the rate of interest on specified T-Bills. The product follows the Dow Jones-UBS Natural Gas Total Return Sub-Index. The note is less popular with AUM of $4.4 million. It is a high cost choice, charging 75 bps in annual fees. GAZ is down 77% in the year-to-date frame and lost about 33% in the last one month (As of December 8, 2015). United States 12-Month Natural Gas ETF (NYSEARCA: UNL ) This product seeks to spread out exposure across the futures curve in order to mitigate contango, a huge problem in the natural gas ETF market. It is done by tracking the average of the prices of 12 contracts on natural gas traded on the NYMEX, including the near month to expire (except when the near month is within two weeks of expiration) and the contracts for the following 11 months, for a total of 12 consecutive contracts. It has amassed just $12.6 million in its asset base and charges 75 bps in fees per year from investors. UNL is down 32.4% so far this year and was off 8.7% in the last one month. Original Post

5 ETF Outperformers With 20% Plus Gains Year To Date

It was a tough year for the U.S. markets, as most of the major benchmarks are struggling to register healthy gains this year. Several concerns, including sluggish global growth, a dramatic slide in oil prices and a stronger dollar, continued to hurt the performances of the benchmarks throughout the year. Though many of the ETFs followed the overall trend of the market movement, some of them took recourse to an alternative path. Major Lingering Concerns The continuing plunge in oil prices is one of the major concerns this year. The absence of a justifiable motive to reduce oil production from the Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC countries, including Russia, and weak global demand continued to weigh on oil prices. Moreover, the fact that Iran will start exporting oil next year when international sanctions are lifted, and a lower-than-expected fall in the U.S. production raised further concerns. Separately, global growth worries, including that in the world’s second-largest economy, dampened investor sentiment throughout the year. A flurry of dismal Chinese economic data released over the period increased concerns that the economy might fail to reach its 7% target this year. Though GDP growth in the third quarter for the U.S. was revised upward in the latest estimate released by the Commerce Department, the overall economic picture remained disappointing. Another main concern that had a negative impact on markets is the strengthening dollar. A stronger dollar dragged down the earnings performance of the major companies with significant international exposure. Also, strong labor market conditions and a slow upward movement of inflation rate raised the prospects of a lift-off this month, which further had a negative impact on investor sentiment. 5 ETFs Bucking the Trend Despite these concerns, some of the ETFs performed impressively to register solid returns and gained investor attention this year. In this section, we have highlighted 5 ETFs that returned at least 20% in the year-to-date frame and are poised to end the year on a positive note. Market Vectors ChinaAMC SME-ChiNext ETF (NYSEARCA: CNXT ) This fund provides exposure across 101 securities by tracking the SME-ChiNext 100 Index. Nearly 25.5% of total assets are allocated to the top 10 holdings. Sector-wise, Information Technology takes the top spot at 32.8%, while Industrials and Consumer Discretionary take the next two positions. CNXT has amassed $56.5 million in its asset base, while it sees moderate volume of around 125,000 shares a day. The ETF has an expense ratio of 0.66%, and has a Zacks Rank #3 (Hold). It returned 42% in the year-to-date frame. WisdomTree Japan Hedged Health Care ETF (NYSEARCA: DXJH ) This fund follows the WisdomTree Japan Hedged Health Care Index, holding 57 stocks in its portfolio. The product is largely concentrated in the top 10 firms that collectively make 61.6% of the basket. The ETF has been able to manage $22.9 million in its asset base, and is lightly traded with more than 14,000 shares per day. It charges 48 bps in annual fees and expenses. DXJH has a Zacks Rank #1 (Strong Buy) and returned 37.8% in the year-to-date frame. ALPS Medical Breakthroughs ETF (NYSEARCA: SBIO ) This fund provides exposure across 81 securities by tracking the Poliwogg Medical Breakthroughs Index. Nearly 39.2% of the total assets are allocated to its top 10 holdings. Sector-wise, Biotechnology takes the top spot at 74%, with the rest of the assets invested in Pharmaceuticals. SBIO has amassed $169.5 million in its asset base, while it sees moderate volume of around 149,000 shares a day. The ETF has 0.50% in expense ratio and has a Zacks Rank #2 (Buy). It returned 26.7% in the year-to-date frame. First Trust DJ Internet Index ETF (NYSEARCA: FDN ) This fund follows the Dow Jones Internet Composite Index, holding 41 stocks in its portfolio. The product is largely concentrated in the top 10 firms that collectively make 61% of the basket. The ETF has been able to manage $4.9 billion in its asset base, and is moderately traded with more than 598,000 shares per day. It charges 54 bps in annual fees and expenses. The ETF has a Zacks Rank #2 (Buy) and returned 24.8% in the year-to-date frame. PowerShares NASDAQ Internet Portfolio ETF (NASDAQ: PNQI ) This fund provides exposure across 94 securities by tracking the Nasdaq Internet Index. Nearly 61% of the total assets are allocated to its top 10 holdings. Sector-wise, Internet Software % Services takes the top spot at 56%, while Internet & Catalog Retail takes the next position. PNQI has amassed $260.8 million in its asset base, while it sees light volume of around 24,000 shares a day. The ETF has 0.60% in expense ratio and has a Zacks Rank #2 (Buy). It returned 22.7% in the year-to-date frame. Original Post