Tag Archives: author

Buy 4 Retail Funds As A Warm Up To The Black Friday Spree

Last Friday, the markets buoyed up on earnings results from certain retail primes. The Consumer Discretionary Select Sector SPDR ETF (NYSEARCA: XLY ) jumped 1.2% and was the biggest gainer among the S&P 500 components. Apart from positive results, the retail sector also has the upcoming holiday season to draw investor focus. The positives should boost retailers, translating into gains for the sector’s mutual funds as well. So, picking favorably ranked retail mutual funds will be prudent as these promise investors rich rewards this holiday season. Earnings Numbers Including releases before the opening bell on Nov. 18, 33 of the 43 retailers in the S&P 500 index have reported results. Total earnings for these retailers gained 4.4% year on year on 5.2% higher revenues. Of these companies, 57.6% beat EPS estimates and 42.4% surpassed on revenues. However, there were some robust results that came in afterward, which gave a boost to the growth numbers. Last Friday, Abercrombie & Fitch Co.’s (NYSE: ANF ) stock soared 25% after reporting quarterly adjusted earnings of 48 cents per share, significantly ahead of the Zacks Consensus Estimate of 19 cents. Moreover, earnings increased 14.3% year over year. Ross Stores Inc. (NASDAQ: ROST ) also reported better-than-anticipated top and bottom lines for the third quarter of fiscal 2015 and retained its outlook for the fourth quarter. Its shares jumped 10%. Foot Locker, Inc.’s (NYSE: FL ) shares gained 5.7% after its adjusted earnings of $1.00 per share came ahead of the Zacks Consensus Estimate of 94 cents, and jumped 20% year over year. Separately, Nike, Inc. (NYSE: NKE ) added 5.5% following its announcement of a new share repurchase program worth $12 billion, along with a hike in its dividend and a two-for-one stock split. Nike jumped to a 52-week high. Also, its weekly gain of 8.9% was the best since the week ended Sept. 26, 2014. In fact, the positive results were not a one-day event as it followed great earnings news from behemoths like Amazon.com (NASDAQ: AMZN ), Home Depot (NYSE: HD ), McDonald’s (NYSE: MCD ), BJ’s Restaurants (NASDAQ: BJRI ) and eBay Inc. (NASDAQ: EBAY ). These retail top performers have historically performed well and their stock prices have been on the rise. Upward estimate revisions based on their positive outlook should also translate into stocks moving up as the holiday season heats up. Holiday Season to be Positive Tomorrow is Thanksgiving Day. And after the turkey and prayers, America will loosen its purse strings for the year’s busiest shopping day on Black Friday. So we are on the verge of this year’s mega shopping spree, and thanks to a rebounding economy, a falling unemployment rate and improved consumer sentiment, sales should see a rise. Several factors indicate that there will be an uptrend in holiday sales this year. According to the National Retail Federation, holiday sales, excluding gasoline, restaurants and cars, will increase 3.7% on a year-over-year basis. A yearly increase of 3.7% is substantially higher than the average increase of 2.5% recorded over the last 10 years. Data compiled by eMarketer suggests a 5.7% jump in holiday sales (November and December) to $885.7 billion against 3.2% growth projected earlier. Retail e-commerce holiday season sales are anticipated to increase 13.9%, and represent approximately 9% of total sales this season (or $79.4 billion), up from 8.3% last year. Moreover, the increase in seasonal hiring by retailers, the slump in fuel prices and record wage growth are all in favor of consumers. These factors are likely to result in a strong holiday shopping season. A significant improvement in the labor market situation and lower fuel costs have increased disposable incomes. Another major factor encouraging spending this holiday season is the continued slump in fuel prices. The ability and willingness to spend should lead to jingling cash registers this time. Separately, retailers are efficiently allocating their capital toward a multi-channel growth strategy focused on improving merchandise offerings, and developing IT infrastructure to enhance web and mobile experiences of customers among others. Retail Mutual Funds in Focus Below we present 4 mutual funds from the retail sector that should be on investors’ radar now. They carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy) . Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on the likely future success of the fund. Putnam Global Consumer Fund A (MUTF: PGCOX ) invests in mid to large companies that are involved in the manufacture, sale or distribution of consumer staples and consumer discretionary products and services. PGCOX uses the “blend” strategy to invest in common stocks of companies. PGCOX currently carries a Zacks Mutual Fund Rank #1. PGCOX has gained, respectively, 6% and 7% in the year-to-date and 1-year periods. The 3- and 5-year annualized returns are 14.9% and 11.1%, respectively. Annual expense ratio of 1.26% is, however, higher than the category average of 1.21%. Fidelity Advisor Consumer Discretionary Fund A (MUTF: FCNAX ) seeks growth of capital. The fund invests mostly in securities issued by firms that are involved in manufacture and distribution of consumer discretionary products and services. The fund uses fundamental analysis and also looks into economic and market conditions for investment decisions. FCNAX currently carries a Zacks Mutual Fund Rank #1. The fund has gained 7% and 11.3%, respectively, over year-to-date and 1-year periods. The 3- and 5-year annualized returns are 18.6% and 15.1%, respectively. Annual expense ratio of 1.14% is lower than the category average of 1.41%. Rydex Retailing Fund A (MUTF: RYRTX ) invests most of its assets in retailers that are traded in the US and also in derivatives. RYRTX invests significantly in small to mid-sized retail companies. RYRTX currently carries a Zacks Mutual Fund Rank #2. RYRTX has lost 0.1% year to date, but is up 3.5% over the last 1-year period. The 3- and 5-year annualized returns are 14.2% and 14%, respectively. Annual expense ratio of 1.58% is, however, higher than the category average of 1.41%. Fidelity Select Retailing Portfolio (MUTF: FSRPX ) seeks growth of capital. FSRPX invests a large chunk of its assets in securities of retailing companies that are traded within the domestic boundary. These firms are involved in merchandising finished goods and services to consumers. FSRPX currently carries a Zacks Mutual Fund Rank #1. FSRPX has gained, respectively, 20.3% and 26.4% in the year-to-date and 1-year periods. The 3- and 5-year annualized returns are 25.1% and 21.3%, respectively. Annual expense ratio of 0.81% is higher than the category average of 1.41%. Original Post

Modern Portfolio Theory: Introduce Allocation To ‘Alternatives’

Summary Modern Portfolio Theory (MPT) implies that total portfolio risk can be reduced by combining asset classes that have less-than-perfect positive correlation. MPT provides an explanation for historical and expected outperformance of ‘David Swensen’s portfolio’ compared to typical stock-only or stock-and-bond-only portfolio. MPT also provides us with tools to further augment ‘David Swensen’s portfolio’ by introducing alternative asset classes to improve risk-return profile of the portfolio. I recommend inclusion of commodities in your Core Portfolio. This is the second article in the series that aims to develop portfolio investment approach that ‘beats the market’, or at least ‘beats the average retail investor’. The goal is to equip readers both with knowledge about the path and confidence to stay on the path. In the first article, Efficient Market Hypothesis And Random Walk Theory: Buy ‘David Swensen’s Portfolio , the author recommended using ‘Swensen portfolio’. We did not dive into a detailed review of the performance of ‘Swensen portfolio’, as doing so is one of the topics of this second article. If you haven’t read the first article, I strongly recommend doing so. Why ‘David Swensen’s Portfolio’ beats conventional stock-only and stock-and-bond portfolios? Modern Portfolio Theory (MPT) implies that the total variance of the portfolio could be reduced by combining asset classes that have less-than-perfect positive correlation. The main premise is the use of diversification. Typically, a change in the value of various asset classes is not uniform. It follows that combining such assets will help smooth out periodic upward and downward spikes (or even short-term trends) to result in a smoother ride for investors. If you are interested in learning more about MPT, please refer to the last section where I provide the list of references. I reviewed total return of ‘David Swensen’s Portfolio’ and S&P 500 for the 1988 to 2014 period. Results are presented in the table and graph below. ‘David Swensen’s Portfolio’ has lower CAGR than S&P 500. However, you would notice that both volatility and a maximum drawdown of ‘David Swensen’s Portfolio’ is about 1.4x-1.6x lower. As a result, ‘David Swensen’s Portfolio’ achieves a higher risk-adjusted return (refer to Sharpe Ratio). What does this mean? If we leveraged up ‘David Swensen’s Portfolio’ by ~1.5x to match the risk level of S&P 500, leveraged ‘David Swensen’s Portfolio’ would have had a CAGR of close to 14% (back-of-the-envelope calculation: 9.28%*1.5x = 13.92%). Portfolio CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio David Swensen’s Portfolio 9.28% 11.57% 26.78% -26.78% -26.78% 0.55 S&P 500 Total Return 10.62% 17.99% 37.58% -37.00% -37.61% 0.49 Source: Portfolio Visualizer (click to enlarge) Source: Portfolio Visualizer Above mentioned result indicates that ‘David Swensen’s Portfolio’ beats S&P 500 on a risk-adjusted basis. At the end of the day, introducing more and more ‘less-than-perfectly correlated’ asset classes should help in diversifying away non-systematic risk and offer investor every increasing portion of ‘free lunch’. Viewed in this light, comparing the performance of better diversified ‘David Swensen’s portfolio’ to all-stock or even stock-and-bond portfolio is unfair. Better diversified portfolios, MPT implies, would perform better than a portfolio that involve a fewer number of asset classes. Does it mean that ‘David Swensen’s Portfolio’ generates alpha? And how much of alpha it generates? No, ‘David Swensen’s portfolio’ does not generate positive alpha ! Just because this portfolio has better risk-adjusted performance than S&P 500 does not mean that it generates alpha. When computing relative performance of any portfolio, we should be using the appropriate benchmark. In the case of ‘David Swensen’s portfolio’, the benchmark would include same asset classes and same allocations to each. Market practice would not subject benchmarks to management fee, trading costs (e.g. bid-ask spread, brokerage fees), and other externalities. As such, ‘David Swensen’s portfolio’ will underperform customized benchmark by a number of such externalities. In other words, alpha generated by ‘David Swensen’s portfolio’ will be negative of the sum of all fees and expenses. The same argument applies to any passive index ETF: index ETFs are expected to underperform their relevant benchmark by a number of management fees (and trading costs). However, I argue using a more appropriate yardstick… First of all, we should make it clear that benchmarks by not accounting for actual real-life expenses and costs are not actually appropriate yardsticks. Furthermore, I argue that relevant benchmark for the average retail investor should not be a well-diversified portfolio of indexes, but an actual average composite portfolio that average investors build and maintain. It’s not a secret that a number of research papers showed that average investors struggle to meet the performance of even broad market indexes (I would argue that on average active professional asset managers underperform passive indexes as well). This is partially due to various market timing efforts of the general public. The chart presented below shows that average retail investor would have achieved ~4x higher annual return by holding S&P 500 index during last decade. (click to enlarge) Source: JPMorgan In other, the average investor is better off holding S&P 500, and better yet ‘David Swensen’s Portfolio’, than utilizing market timing approaches. Is it possible to improve ‘David Swensen’s Portfolio’? Of course, it is! And I plan to take you step-by-step as I introduce various theories, research papers and practical recommendations to help you build superior portfolios. At this step, let’s just focus on the implications of MPT and suggest augmenting ‘ David Swensen’s Portfolio’ by introducing ‘alternative’ asset classes, such as commodities, MLPs (master limited partnerships), BDCs (business development companies), Hybrid (preferred stocks, convertibles), peer-to-peer loans, less liquid assets (Hedge Funds, Private Equity, and Venture Capital), and volatility. Some authors might argue that BDC stocks are not different from typical equity shares and, therefore, should not be treated as an independent asset class. I will leave this debate and discussion of other ‘alternatives’ to future articles, when we will start discussing ‘satellite portfolio’. At this stage, let’s focus on our ‘core portfolio’ and change ‘David Swensen’s Portfolio’ to include only one new asset class – commodities. (click to enlarge) Source: Portfolio Visualizer (portfolio 1 represents ‘David Swensen’s portfolio’; portfolio 2 represents portfolio that includes an allocation to commodities). As you can see from the chart above, the introduction of an even small amount of commodity exposure can make a meaningful impact. For the purposes of this exercise, I propose introducing 5% allocation to commodities, which will come at the expense of lower allocation to foreign developed equity. The return profile of commodities is comparable to equities (please, refer to a research paper by Bhardwaj, Gorton, and Rouwenhorst ); therefore, I decided to swap some of the equity exposure to commodity exposure. Asset Class David Swensen’s Portfolio Augmented Portfolio Domestic Equity 30% 30% Foreign Developed Equity 15% 10% Emerging Market Equity 5% 5% Real Estate 20% 20% Bonds 15% 15% TIPS 15% 15% Commodities 5% Source: David Swensen; augmented portfolio is based on my personal recommendation Historical return comparison portfolios is provided in the table below: Portfolio CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio David Swensen’s Portfolio 9.28% 11.57% 26.78% -26.78% -26.78% 0.55 Augmented Portfolio 9.44% 11.19% 26.33% -26.88% -26.88% 0.59 S&P 500 Total Return 10.62% 17.99% 37.58% -37.00% -37.61% 0.49 Source: Portfolio Visualizer As shown in the table above, the introduction of commodities improves Sharpe ratio. Using 1.6x leverage, augmented portfolio would have yielded closer to 15% per annum. Once again, we will discuss leveraging portfolios in the future articles. Potential criticism I will address two main groups of potential criticisms with this proposal: EMH, RWH, and MPT are flawed concepts Commodities are a poor investment choice EMH and RWH discussion is covered in the previous article and in the comments to that article. Simplifying assumptions used by MPT (refer to Appendix) are far from the real life. Some more elaborate models where created to allow for more realistic assumptions; the key takeaway from those models is in line with MPT framework: diversification remains to be ‘free lunch’. Commodities have recently been one of the asset classes that suffered. There are a number of Wall Street banks publishing research with a very bleak take on commodities, driven mainly by oversupply or decreasing demand by China. A group of investors might claim that recent historical performance and future expectations make commodities a poor investment choice. Another group might claim that it is actually a good time to buy commodities while they are on ‘sale’. I do not support the approach of either group. Price or short-term expectations should not cloud our long-term asset allocation decisions. Reminder: I’m recommending commodity exposure for ‘Core Portfolio’. I’m a strong advocate of not using market timing and any other ‘active’ approach for Core portfolio. Execution For Core Portfolio, I recommend using the following allocation to various ETFs: Asset Class ETFs David Swensen’s Portfolio Recommendation Augmented Portfolio Domestic Equity Vanguard Total Stock Market ETF ( VTI) 30% 30% Foreign Developed Equity Vanguard FTSE Developed Markets ETF ( VEA) 15% 10% Emerging Market Equity Vanguard FTSE Emerging Markets ETF ( VWO) 5% 5% Real Estate Vanguard REIT Index ETF ( VNQ) 20% 20% Bonds iShares 20+ Year Treasury Bond ETF ( TLT) 15% 15% TIPS iShares TIPS Bond ETF ( TIP) 15% 15% Commodities PowerShares DB Commodity Index Tracking ETF ( DBC) 5% Source: David Swensen; augmented portfolio is based on my personal recommendation Reminder: please note that above mentioned ‘augmented portfolio’ should be utilized for Core Portfolio. Recommendation for the Satellite Portfolio will be covered in the future articles. Disclaimer: I’m not a tax advisor, please consult your tax advisor for any tax related matters. Also, I would like to mention that this article is the second one in the series. In the next articles, we will continue exploring stock market theories and how they impact on the way I invest. Future Next stop will be Jeremy Siegel’s Noisy Market Hypothesis and proven ways of ‘beating the market’. This article will be followed by Andrew Lo’s Adaptive Market Hypothesis, which should provide a framework to bring some reconciliation between Efficient Market Hypothesis and Noisy Market Hypothesis advocate. As a reminder, the main goal of this series of articles is to introduce new stock investors to academic theories and help them develop their own approach to stock investing. The stock investing approach that they will have enough confidence in to be able to consistently executive their chosen investment strategy. As we will discuss in the next articles, consistency is one of the main friends of the stock investor. Appendix MPT suggests that diversification eliminates non-systematic risk. It argues that unsystematic risk is not associated with increased expected return, and, therefore, diversification is expected to decrease risk without compromising return. Hence, it’s not a surprise that diversification is considered one of the few “free lunches” available to investors. MPT implies that investors can invest in assets without analyzing their fundamentals as long as they keep their individual positions in line with the capitalization-weighted index. It takes very global view: as investor match market weights, they will not crease excessive demand for any one specific asset versus another, and, therefore, would not impact expected returns of the portfolio. MPT makes many explicit and implicit assumptions about markets and market participants. These assumptions do not reflect reality. Some of those assumptions are presented below: Investors are interested maximizing their return for a given level of risk, and they are rational and risk-averse . We will review this point in the future articles when discussing implications of behavioral economics. Asset returns are normally distributed random variables: in other words, price spikes, and price momentums should not exist. Correlations between assets are stable. However, as we know during times of financial crisis all assets tend to become positively correlated as they start moving down in tandem. There are no taxes or transaction costs. As you noticed, I’m paying a lot of attention of fees and taxes, that’s why I have a strong preference for low cost and tax efficient ETFs. There are many more other assumptions that are far from the real life. However, as a framework MPT offers yet another layer of knowledge that should help retail investor gain some incremental confidence in using a broader set of asset classes. References/Bibliography Efficient Market Hypothesis And Random Walk Theory: Buy ‘David Swensen’s Portfolio’ Linked previously in the text Facts and Fantasies about Commodity Guide to the Markets Yale U’s Unconventional David Swensen, Unconventional Success: A Fundamental Approach to Personal Investment, Free Press, 2005 Next article: Noisy Market Hypothesis: Tilt Your Portfolio to Achieve Superior Returns

Sensible Market Timing

By Carl Delfeld Investing advice is a big business. Every day, investors are swamped with advice and ideas from thousands of experts. But I’ve noticed that very few are willing to even try to accomplish the most important task of an advisor – to help their clients avoid the sharp downturns that devastate portfolios and wealth. I’m not talking about day trading or other short-term strategies here, but rather educating the average investor so he or she can see the more enduring swings in the market. As legendary tycoon and investor, Sir James Goldsmith put it: The job of an investment company is to decide to invest in the right thing in the right place at the right time. But the right thing is the least important. If you picked the very best share in St. Petersburg in 1917 you could be the greatest genius in the world and still go bust… You have to be able to see the swings in the market. One common mantra of gurus is that stock prices follow earnings. This adage also applies to specific companies and the market as a whole. And we all know that Sir James Goldsmith is absolutely right that a sharply down market pulls almost all companies down – even those with rising earnings. So I found it interesting that a firm I greatly respect, Encima Global, recently came out with a cautionary message on U.S. equities. Below is a brief summary of why it thinks that stocks may be facing some rough times ahead: Weak earnings. Pro-forma earnings have appeared strong, but companies are presenting “constant currency” earnings. Actual revenues have been shrinking as expected, due to the sharp decline in world dollar GDP in 2015. For example, McDonald’s Corp. (NYSE: MCD ) reported constant currency sales growth of 7% (year over year in the quarter ending September 30), whereas actual revenue growth was -5%. Weak earnings prospects. 2016 world dollar GDP, the platform for corporate earnings, will be roughly at 2013’s $75.5 trillion level, yet expectations for the S&P 500’s dollar earnings are way above 2013. Weak U.S. investment and growth prospects. Today’s GDP data found that business’s fixed investment contributed only 0.3% to Q3 growth. That’s consistent with the weakness in orders for capital goods (orders have been below shipments for seven of the last eight months, signaling a slowdown ahead). Weak global growth. Japan looks to have fallen into a recession again. The growth outlook for Latin America continues to get worse, in part due to low commodity prices and lack of structural reforms. Europe’s growth has remained stubbornly weak, as well. The geopolitical risks are high. There’s the need for new leadership in Saudi Arabia, Iran’s rhetoric, issues in Syria, Iraq, and Russia, and tension in the South China Sea, to name a few. A negative change in technical factors. Equities often take a rest after going on a tear, as the S&P 500 did in October. Market breadth has been weak. Mid-cap stocks and the Dow transports underperformed the S&P 500 since the September 29 low. Valuations and debt burdens. In the end, we think equity prices will react to declining earnings prospects (prices too high versus declining earnings, especially if earnings are adjusted for quality deterioration). This is all important information and it may be on the mark, but it begs the question – what should you do about it? You may want to raise some cash by selling some U.S. stocks. Perhaps rotate some of this capital into out-of-favor markets like commodities or emerging markets. You might also want to put in place or tighten trailing stop losses to limit downside risk. Link to the original post on Wall Street Daily .