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New Janus Mutual Fund Uses Tail Risk Analysis

Summary JAGDX is a global allocation fund (70/30) which uses tail risk analysis to mitigate risk. The Fund inception was in June 2015, and it has gotten off to a rocky start. But it may be worthwhile to track this fund to see how they manage a full market cycle. Overall Objective and Strategy The primary objective of the Janus Adaptive Global Allocation Fund (MUTF: JAGDX ) is to provide investors total return by dynamically allocating its assets across a portfolio of global equity and fixed income investments, including the use of derivatives. The fund attempts to actively adapt to market conditions based on forward looking views on extreme market conditions (both positive or negative) with the goal of minimizing the risk of significant loss in a major downturn while still participating in the growth potential of capital markets. On average, the fund provides 70% exposure to global equities and 30% exposure to global bonds (70/30 allocation). But the fund has the flexibility to shift this allocation and may invest up to 100% of its assets in either asset class depending on market conditions. Because of this, JAGDX will likely have above average portfolio turnover compared to other funds. The portfolio managers use two complimentary processes: a “top down” macro analysis and a “bottom-up” risk reward analysis. These processes use proprietary models which seek to identify indicators of market stress or potential upside. These models include an options-implied analysis that monitors day-to-day movements in options prices for indicators of risk and reward between asset classes, sectors and regions. Top-Down Macro Analysis: Focuses on how the Fund assets will be distributed between global equity and fixed income. They use a proprietary options implied information model, among other tools, to monitor expected tail gains and losses across the equity and fixed income sectors and adjust as necessary to mitigate downside risk exposure. Bottom-Up Risk Reward Analysis: Designed to identify underlying security exposures in order to maximize exposure to securities which will realize tail gains while minimizing exposure to securities expected to provide tail losses. Within the Fund’s equity positions, the managers will adjust sector, currency and regional exposures away from market cap weightings based on their evaluation of expected tail loss and gain. Within the Fund’s fixed income positions, they will adjust the credit, duration and regional exposures using the same analysis. The fund managers measure both extreme positive and negative movements known as expected tail gain (ETG) and expected tail loss (ETL). Portfolio construction is driven by the ratio of ETG to ETL, while targeting a desired level of portfolio risk with the goal of maximizing future total return. For more information on expected tail loss, take a look at this Wikipedia page on Expected shortfall . (click to enlarge) Source: rieti.go.jp Fund Expenses The Fund offers several classes of shares. JAGDX is available without a 12b-1 charge, but only if you buy the fund directly from Janus. The expense ratios for some of the share classes are listed below: JAGDX (Class D Shares): 1.01% JVGIX (Class I Shares- Institutional): 0.82% ($1 million minimum) JVGTX (Class T Shares): 1.13% (available on brokerage platforms) JAGAX (Class A): 1.07% (front-end load 5.75%) JAVCX (Class C Shares): 1.82% (deferred load 1%) Minimum Investment JAGDX has a minimum initial investment of $2,500. Past Performance JAGDX is classified by Morningstar in the “World Allocation” or IH category. The fund had unfortunate timing when it was first issued on June 23, 2015. As of the end of the third quarter it had dropped by 9%, although it has recovered a bit since then. It is still very early, but so far the Fund is lagging its peers. 1-Month 3-Month JAGDX +1.18% -4.16% Category(IH) +1.37% -3.89% Percentile Rank 61% 66% Source: Morningstar Mutual Fund Ratings The fund is too new to have a Lipper or Morningstar rating. Fund Management The fund is managed by two individuals: Enrique Chang: Chief Investment Officer, Equities and Asset Allocation. Joined Janus in September 2013, and has previously worked for American Century and Munder Capital Management. Holds a BS in Mathematics from Fairleigh Dickinson and a master’s degree in finance/quantitative analysis and statistics and operations research from NYU. Ashwin Alankar, PhD: Global Head of Asset Allocation & Risk Management. Joined Janus in August, 2014 and has previously worked for AllianceBernstein and Platinum Grove Asset management. Holds a BS in chemical engineering and mathematics and a master of science degree in chemical engineering from MIT. He also holds a PhD in finance from the University of California at Berkley Haas School of Business. Comments Tail risk hedging is designed to enhance return potential by: Helping to mitigate losses when a market storm hits. Provide liquidity in a crisis, allowing you to buy assets at distressed prices when others are forced to sell. Allow investors to take greater risks elsewhere in their portfolios. But as with any market timing strategy, there is always the possibility of market “whipsaws,” where markets trade up and down in a sideways pattern for extended periods and tail risk hedging may become an extra expense instead of a benefit. JAGDX has gotten off to a rocky start, but they have an interesting approach to risk management, and I will be tracking the fund to see how they do over a full market cycle. So far, they have attracted about $50 million in assets, so it is still uncertain whether the fund will be a long term success.

The Real Cost Of Hedging With Leveraged ETFs

Summary Scaled hedging has some advantages over usual market-timing. Leveraged ETFs are convenient hedging tools, but they suffer from a decay. This article calculates the additional cost of hedging a stock portfolio with leveraged ETFs. A timed, scalable hedging tactic has at least 3 advantages over usual market-timing consisting in going out of the market: adaptability to the risk level, lower transaction costs, and cashing all dividends. This previous article shows how to use a systemic risk indicator to scale a hedging position and protect my premium portfolio with SPXU . ETFs are not necessarily the best hedging tools, but they are available and understandable for all investors. SPXU has the advantage to allow hedging in an account where only long positions in stocks and ETFs are possible, and without margin. Like all leveraged ETFs, it has the drawback of suffering from a decay called beta-slippage. This article calculates the real additional hedging cost incurred by this decay in 2015 for SPXU, and for another leveraged inverse S&P 500 ETF: SDS . It also shows the decay of long leveraged ETFs. What is beta-slippage? If a volatile asset goes up 25% one day and down 20% the day after, a perfect double leveraged ETF goes up 50% the first day and down 40% the second day. On the close of the second day, the underlying asset is back to its initial price. At the same time, the perfect leveraged ETF has lost 10%: (1 + 0.5) x (1 – 0.4) = 0.9 This decay is called beta-slippage. It is a mathematical property of a leveraged and frequently rebalanced portfolio (leveraged ETFs may hold futures, options and/or swap contracts). In a trending market, beta-slippage can be positive. If an asset goes up 10% two days in a row, on the second day, the asset has gone up 21%. The perfect 2x leveraged ETF is up 44%: (1 + 0.2) x (1 + 0.2) = 1.44 It is 2% better than holding the underlying leveraged 2x on margin. Beta-slippage is path-dependent. If the underlying gains 50% on day 1 and loses 33.33% on day 2, it is back to its initial value, exactly like in the first example. This time, the perfect leveraged ETF loses one third of its value, which is much worse than the 10% of the first case: (1 + 1) x (1 – 0.6667) = 0.6667 Without a formal demonstration, it shows that the higher the volatility, the higher the decay. Hence the name of beta-slippage: “beta” is the best known statistical parameter of volatility. Of course, it is uncommon to have such price variations on an ETF’s underlying asset. These numbers are here to give an amplified vision of what happens with more realistic daily returns, day after day and month after month. (click to enlarge) SPXU in red, SPY in blue. Chart and data: portfolio123 Decay of S&P 500 ETFs in 2015 The next table gives the decay of leveraged ETFs on the S&P 500 index from 1/1/2015 to 10/15/2015 (9.5 months). It was a sideways and quite volatile market, with a worse than usual beta-slippage. The decay includes beta-slippage, and also tracking errors and management fees. Ticker Return Return of SPY x leveraging factor Decay (difference) Drag on portfolio SPY -0.52% SH (1xshort) -1.84% 0.52% -2.36% -1.18% SSO (2xlong) -3.92% -1.04% -2.88% -0.96% UPRO (3xlong) -8.69% -1.56% -7.13% -1.78% SDS(2xshort) -4.84% 1.04% -5.88% -1.96% SPXU(2xshort) -9.45% 1.56% -11.01% -2.75% When using SDS or SPXU for hedging, the hedging position represents 1/3 of the total portfolio (stocks + hedge) in the first case, and 1/4 in the second one. So the real drag on the portfolio was respectively 1.96% and 2.75% compared with shorting SPY. This is the additional cost of hedging the whole portfolio during the whole period (setting it in market neutral mode), which is not the best tactic proposed in my previous article (and service ). The cost of using leveraged ETFs with any of the proposed variable hedging tactics was much lower. Rebalancing the hedge weekly also lowers the decay due to beta-slippage (but not tracking errors). Finally, the cost is lower than losing all dividends when going out of the market in a classic market-timing approach, and it is likely to provide a better long-term risk-adjusted performance. SSO and UPRO also look like decent alternatives: SSO had the lowest portfolio drag. But short selling always incurs additional risks and borrowing costs. SDS and SPXU allow to hedge without borrowing cost and with less or no margin cost. These costs depend on the broker, so the best choice for hedging with an ETF may depend on your broker. If you have the skills and possibility to manage other instruments like futures, options, CFDs, they may be more cost-effective. Keep also in mind that the hedge and the stock portfolio can be in different accounts. If you like this article, you might be interested in the next ones. Click the “Follow” tab at the top if you want to stay informed of my free-access publications on Seeking Alpha. You can even choose the “real-time” option if you want to be instantly notified.

Muddling Through Works For Me

The global economy, including the United States, is muddling through with growth well below potential, but better than a year ago. The global consumer is the winner while the global producer is suffering from excess capacity, excess inventory and much lower prices. Lower prices for the producer means higher disposable income for the consumer as long as his income is at least constant and hopefully, rising. There are clear winners and losers out there due to this conundrum. It’s not so hard really to construct a long/short portfolio in this environment if you use common sense and in-depth research. It is most interesting to see how managements are reacting to this environment. If they bite the bullet and make the right strategic changes, they will come out stronger and their stock price will reflect it but if they keep their head down and maintain the status quo, their business and stock price will erode over time. The portfolio manager who uses historical analysis and doesn’t listen to or see what is happening out there won’t see the change. But the one with an analytical proclivity, an open mind and who puts in the hard work will see the change or lack thereof and construct a winning portfolio accordingly. This is an analyst’s delight. My strength! This is a worldwide phenomenon so you need a global perspective and knowledge. That’s what we at Paix et Prospérité are all about. The financial markets continued to move up last week on the “wall of worry” that we have been discussing in previous blogs. Our view was, and remains, that the Fed is out of the way until at least December, and most likely next March, and this has become the prevailing wisdom on Wall Street. You could hear the sigh of relief around the world. The global financial markets acted accordingly: stock markets for the most part rose, led by China and the emerging markets; bond yields remained ridiculously low as fears of deflation override fears of inflation; commodity prices, including oil, fell for the week; the dollar held constant after falling over the last two weeks; a huge deal was announced in the beer industry; Dell bid over $67 billion for EMC which was under attack from an activist; and corporate earnings season began. Quite a busy week! Our portfolio continues to outperform by a wide margin. I have spent a lot of time over the last year declaring that this is a market of stocks, not a stock market. Step back and think about this for a moment. Historically, investors rotated industry sectors based on where you were in the economic cycle. For instance, you would want to have the stable growers like food and drug stocks when the economy turns down and parenthetically you would want to own the economically sensitive stocks late in a cycle as capacity utilization increases to the point that prices increase accelerate and stick. Not now! What’s different today? Globalization. The lowest common denominator, for the most part, sets prices. For example, Chinese steel imports have forced tremendous pricing pressure here and in Europe. Some nations don’t have the same profit motive as we do and may be nationalized. It could all be about jobs over profits. Currencies play a major role here too. It used to be that our high-energy costs penalized our chemical industry in competing globally. Not anymore as our feedstock costs are as low as any country, including the Middle East. Products move globally and if you don’t have a competitive advantage either in price or technology, you’ll lose out over time. It’s our job to find them. We’re pretty good at that. Change can take many forms. Take a look at Amazon (NASDAQ: AMZN ), Netflix (NASDAQ: NFLX ), and Uber as three examples whose business models turned their respective industries upside down. Just ask Wal-Mart (NYSE: WMT ) and the networks. We will discuss all of this in more depth later but you can guess where I am going with this. Do the work; don’t follow the chart, as that is history; and find the future winners as your longs and the losers as your shorts. I waited over a year for Nelson Peltz to wake up the analysts and investors in GE . Be patient and let the thesis play out. Don’t forget to maintain your liquidity and control risk too. Let’s quickly take a look at the events of the week by region, see if there any changes in core beliefs and then turn to asset allocation and specific recommendations. 1. As I mentioned last week, the U.S consumer is in great shape and continues to support the economic expansion more than offsetting industrial weakness most prevalent in weak export numbers. Specifically, consumer confidence rose to 92.1 in October from 87.2 in September; consumer expectations out six months rose to 82.7 from 78.2 in September; the consumer view of their personal finances rose to 106.8 from 101.2 last month; consumer comfort index rose to 45.2 and is up 5 points in a month and retail sales rose a mere 80.1% in September from August. The surprise for the week was that the Consumer Price Index fell a seasonally adjusted 0.2% in September and was unchanged year over year. Excluding food and energy, the core CPI actually rose 0.2% in September and 1.9% year over year. Social security recipients, over 56 million strong, will not get an increase in the cost of living index in 2016. Tell them there is no inflation in the country. Relative strength by the consumer is being partially offset by continued weakness in factory output, which declined 0.1% last month. Manufacturing comprises only 12% of the economy and will remain a drag for quite some time. By the way, capacity utilization declined to a three month low of 77.5. Finally the Beige Book came out and supported only a “modest expansion” at the end of the third quarter. Many of the districts blamed the strong dollar saying it was hurting exports and tourism. Clearly the Fed is on hold for now and maybe longer than we think despite several world central bankers asking for the Fed to end the drama and to finally lift rates. Waiting has been unsettling to the global economies, as we have mentioned many times too. Since estimates of future global growth are still falling, the Fed is on HOLD. 2. The big news out of Europe is that Switzerland is set to impose 5% leverage ratios on its largest banks which include Credit Suisse and UBS up from around 3.7% as mandated by Basel III. The Swiss authorities are following the lead of U.S. regulators who set the same levels for our biggest banks. It’s quite simple: higher capital ratios means less lending. Dodd Frank and Basel III have certainly reduced financial risk in the economy at the expense of growth. While growth in Europe has clearly bottomed, it won’t reach earlier estimates due to weakness in foreign economies impacting exports. But the European consumer is clearly doing better which bodes well for 2016. 3. China reported its third quarter GNP on Monday and had the weakest quarter in 6 years. China Premier Li has been vocal, recently committing to moving forward on market oriented reforms to open up the country more to foreigners, ongoing urbanization, more transparency and increased infrastructure spending. Services and consumer spending are supporting growth while manufacturing and exports are relatively weak. A familiar story. By the way, credit growth has accelerated recently as monetary easing has spurred loans. The CPI increased 1.6% in September from a year earlier while the PPI fell 5.9%. There is more room for further monetary and regulatory initiatives to stimulate growth as has occurred elsewhere. 4. Japan’s government recently lowered its targets for growth this year as output/industrial production is weaker than anticipated due to slower growth overseas. Here again, consumer spending is holding up as employment and wages are slowly increasing and lower energy costs are boosting disposable personal income. Catch a theme here? The global consumer is holding up well while the global producer is weaker than anticipated. So why does muddling through work for me? Let’s get back to our core beliefs: the global economy, including the U.S., will continue to grow, albeit slowly, and there will be lower highs and higher lows as imbalances are contained and a conservative bias permeates at every level from government to business to the individual; interest rates will remain surprisingly low as global competition will keep a lid on inflation along with lower energy prices; the dollar will remain the currency of choice as this country’s global competitive situation continues to improve and energy independence remains a possibility down the road; earnings, excluding commodity related industries, will surprise on the upside despite relatively sluggish global growth; speculation is limited to real estate, art and private equity; the stock markets are undervalued as 10 year bonds are around 2.1%, the risk factor should be around 3 as leverage ratios keep falling; and S&P earnings are slightly higher in the aggregate and much higher in energy and commodity companies. It’s hard to imagine M & A getting any stronger. Another of our core beliefs. Finally this is all about asset allocation, stock selection and risk controls. I listened to or read the transcripts of at least a dozen companies last week starting with Alcoa (NYSE: AA ) and ending Friday with GE and Honeywell (NYSE: HON ). I really suggest that you take the time to read some of these transcripts as managements are really doing some amazing things. Alcoa is splitting into two companies; GE is selling most of its financial assets and reinvesting in its higher margin, higher return industrial businesses; Honeywell is churning out 10%+ growth and generating 110% free cash flow; Citi (NYSE: C ), Bank America (NYSE: BAC ), JP Morgan (NYSE: JPM ), PNC etc., are all making great strides not relying on a rising yield curve to make money; Intel (NASDAQ: INTC ) is upgrading its mix. I could go on and on. My portfolio is comprised of being long companies going through positive changes, short those with their heads in the ground, a few Larry Tisch value plays and there is no industry concentration. It really is stock specific. I remain around 93% net long, no bonds and no dollar currency trading position. Take the time to understand the strategic goals of the management of each company in your portfolio, step back and reflect hard and long on it, pause once again and consider all that could go wrong and also right, control your risk by maintaining ample liquidity and be patient as change doesn’t occur over night. There are clear winners and losers out there. Perfect for a hedge fund like ours. Change is a global phenomenon.