Tag Archives: etf

Seth Klarman On Value Investing In A Turbulent Market

Investors must employ an investment philosophy and process that serve as a bulwark against a turbulent sea of uncertainty and then navigate through confusing and often conflicting economic signals and market head fakes. Amidst the onslaught of gyrating securities prices, fast and furious corporate developments, and an unprecedented volume of data, it is more important than ever to maintain your bearings. Value investing continues to be the best (and perhaps only) reliable North Star for those who are able to remain patient, long-term oriented, and risk averse.” – Seth Klarman year-end 2015 letter to investors. 2015 was a bad year for Seth Klarman and his Boston-based hedge fund Baupost. The fund lost money for its investors, a rare event – it’s only happened three times since the fund’s founding in 1982. Click to enlarge Off the back of such a terrible performance, Seth Klarman devoted the majority of his year-end letter to investors explaining that value investing isn’t a precise science in his usual calm and philosophical manner. It’s unlikely that Klarman would have been aware what was in store for the markets in the first few months of 2016, but as it turns out, his words couldn’t have come at a better time for value investors seeking reassurance in a turbulent market. Seth Klarman: Take advantage of Mr. Market Value investors gain clarity by thinking about their investments not as quoted stocks whose prices whip around on a daily basis, but rather as fractional ownership of the underlying businesses.” – Seth Klarman year-end 2015 letter to investors . To be a successful investor, you must be able to take advantage of Mr. Market’s bipolarity. You must be able to step in and buy shares when Mr. Market offers them to you at a knock-down price, but you need to be able to ignore his calls to sell at lower levels. Klarman writes that the two extremes of human nature, fear and greed drive market inefficiency. Fear is primal, the effect of confronting the apparent loss of what you have. Your shares still represent the same fractional ownership in a business as when they traded higher yesterday, however, people are now en masse delivering the verdict that your shares are actually worth less. You have to find a way not to care or even to relish this eventuality. Warren Buffett has written that one should not invest in stocks at all if uncomfortable with the possibility of a 50% drawdown. The mistake some investors make is to accept the market’s immediate verdict as fact and not opinion, and become disappointed, even frustrated.” — Seth Klarman year-end 2015 letter to investors . Losses can cause people to lose their bearings. It’s natural to want to sell everything after your portfolio has been marked down sharply. Watching your net worth evaporate in front of you as the market falls isn’t a pleasant experience. However, this is the wrong way of thinking about equities. Klarman writes that for an investor to overcome the desire to sell at the bottom and take advantage of Mr. Market’s erratic movements, they must think not about what the market will pay for the securities today, (the stock price) but rather the true value of the securities you own based on such attributes of the underlying businesses as free cash flows, private market values, liquidation values, downside protection, and growth prospects. Klarman continues, saying that when the market, in the absence of adverse corporate developments, drives an undervalued security down in price to become an even better bargain, that’s not a reason for panic, or even for mild concern, but rather for excitement at the prospect of adding to an already great buy. When tempted to sell: Investors must think not only about what they would be getting (the end of pain that accompanies the certainty of cash) but also what they’re giving up (a significantly undervalued security which, emotion aside, may be a far better buy than a sell at today’s market price).” – Seth Klarman year-end 2015 letter to investors . This is why conducting your own rigorous due diligence is essential. The insights gained from due diligence give you the justifiable confidence to maintain your bearings – to hold on and consider buying more – even on the worst days in the market. Seth Klarman: Don’t be greedy Greed works alongside greed to eat away at your confidence and push you to make decisions that are hazardous to your wealth. The angst felt when others are succeeding while you are not can lead you to make poor decisions, on this topic Klarman cities J.P. Morgan, who said “Nothing so undermines your financial judgment as the sight of your neighbor getting rich,” and Gore Vidal who dryly noted, “Whenever a friend succeeds, I die a little.” What’s more, the fear of missing out can be a kill switch for risk aversion in that it tempts people into paying up and then holding on too long. Fear of missing out, of course, is not fear at all but unbridled greed. The key is to hold your emotions in check with reason, something few are able to do. The markets are often a tease, falsely reinforcing one’s confidence as prices rise, and undermining it as they fall. Pundits often speak of the psychology of markets, but in investing it is one’s own psychology that can be most dangerous and tenuous.” – Seth Klarman year-end 2015 letter to investors . To show just how dangerous (and damaging) fear and greed can be to investors’ returns, Klarman lets the figures do the talking. The data shows that over the 30-year period from 1984 to 2013, the S&P 500 Index returned an annualized 11.1%. However, according to Ashvin Chhabra, head of Euclidean Capital and author of ” The Aspirational Investor ,” the average returns earned by investors in equity mutual funds over the same period was ” a paltry 3.7% per year, about one-third of the index return .” Bond investors were dealt even more pain. While the Barclays Aggregate Bond Index returned an annualized 7.7% over the 30-year period from 1984 to 2013, bond funds produced an annualized return of 0.7%. The underperformance in both cases was a direct result of investors pulling money out of the funds at precisely the wrong times. In short, by letting fear and greed take over their emotions, retail investors have underperformed both the markets and the very funds in which they were invested since 1984. That’s a statistic that’s difficult to ignore. So to conclude: In the moment, public market investors have no ability to control investment outcomes, but they can control and improve their own processes. We never shoot for high near-term investment returns. Trying too hard to earn positive results, or assessing performance too frequently, can drive anyone into short-term thinking, herd-like behavior, and incurring higher risk…We believe that by remaining focused on following a well-conceived process, we will make good risk-adjusted, long-term investments. And we know that if we do that, we will indeed earn good returns over time.” – Seth Klarman year-end 2015 letter to investors. Disclosure: None.

The #1 Secret Behind George Soros’s Investment Success

Although now long retired, the octogenarian George Soros is widely considered the greatest speculator of all time. Other investors such as Ray Dalio may have made more money for their investors than Soros. Activists such as Carl Icahn may have briefly exceeded Soros’s net worth. But Soros will always remain the man who “broke the Bank of England” in 1992, thereby exemplifying a gunslinging style of trading that has been largely confined to the history books. Back in 1987, he wrote a book about his investment philosophy called The Alchemy of Finance , outlining his “Theory of Reflexivity.” Soros admitted he gave his theory such a grand-sounding name so that it would sound like Einstein’s “General Theory of Relativity.” He thought it was that important. Wall Street strategist Barton Biggs called it: “a seminal investment book… it should be read, thought about, underlined page by page, concept-by-idea… (Soros) is the best pure investor ever… probably the finest analyst of our world in our time.” Because of Soros’s stature, The Alchemy of Finance turned out to be one of those books that every Wall Street investor said they had read. But I doubt any of them got through it, let alone understood it. George Soros’s #1 Investment Secret: Tackling ‘The Alchemy Of Finance’ When I was managing my first investment fund over 20 years ago, I decided that I really wanted to get inside Soros’s head. So I took Barton Biggs’s advice and read The Alchemy of Finance . I read it once… I didn’t get it… I read it again… I still didn’t get it… Now, keep in mind that I had been through law school… … So I was used to stirring concrete with my eyelashes… … And getting through more poorly written, turgid prose than most humans should have to endure… But Soros’s writing style made judicial opinions seem like Ernest Hemingway’s lucid prose. Then one day, I ran across a quote from Soros’s own son. It made everything crystal clear, but not in the way that I expected. “My father will sit down and give you theories to explain why he does this or that. But I remember seeing it as a kid and thinking, Jesus Christ, at least half of this is bulls**t, I mean, you know the reason he changes his position in the market or whatever is because his back starts killing him. It has nothing to do with reason. He literally goes into a spasm, and it’s his early warning sign.” – George Soros’s son, Robert, on his father’s Theory of Reflexivity. Soros himself went on to criticize his own theory in the next edition of the book, admitting that it was essentially incomprehensible. And he was right. George Soros’s #1 Investment Secret: Correcting False Predictions So, if no one has a grand theory to explain the market – not even George Soros – what chance do you have to be a successful trader? It turns out there is a secret to George Soros’s success. But it’s not one that you will find in The Alchemy of Finance . But once you understand and apply this secret, it will make your trading life much easier – and certainly less stressful. The “secret” to Soros’s success is not the ability of his “Theory of Reflexivity” to explain or predict the market. In fact, the secret to his success is quite the opposite. I found it buried in a Soros interview in John Train’s The New Money Masters , in what was almost a throwaway comment: “My approach works not by making valid predictions but by allowing me to correct false ones.” Now, I could get into how this all has to do with Soros’s admiration for the philosopher Karl Popper and the limits of human understanding. But comments from traders who have worked with Soros are more relevant. From James Marquez, a former Soros chief investment officer (CIO): “Soros would be the first one to tell you that sometimes his actions… look like the most rookie, odd-lot, wrong-way kind of thing, selling at the lows, and buying at the highs. But it’s much easier to understand in light of his avowed mission: to be able to come and fight another day. He says: “I don’t want to wake up broke.” And then, Alan Raphael, yet another Soros CIO: “When George is wrong, he gets the hell out. He doesn’t say, ‘I’m right, they’re wrong.’ He says, ‘I’m wrong,’ and he gets out, because if you have a bad position on, it eats you away. All you do is think about it – at night, at your home. It consumes you. Your eye is off the ball completely. This is a tough business. If it were easy, meter maids would be doing it.” Now, contrast that philosophy with how most other people think of trading or investing: We develop an opinion on a stock. We take a position. We convince ourselves that we made the right decision. This is when a bad investment turns into a “long-term investment.” And the “smarter” we are, the worse it is. We “know” we’re right. We “know” our investments will eventually “come back.” Now, let’s examine how Soros would look at the same situation. Here’s my take on what Soros believes: “The secret to my success is that I know that I will be wrong. I consider it a strength to admit my mistakes. That allows me to stay in the game and fight another day.” George Soros’s #1 Investment Secret: How To Apply It In Your Own Trading So, how can you apply this approach in your own trading? Understand that successful trading in the markets has much more to do with having proper exits and position sizing (bet size) than it does the “Theory of Reflexivity” or any other explanation of the market. So the next time you come across a “can’t fail” investment idea, here’s what you should do: Listen carefully and see if it makes sense to you. If you agree with it, then consider taking a position in it. But no matter how terrific-sounding the idea, make sure that you have your exits and position sizing strategies in place. If the position goes against you – which some inevitably will – reframe in your mind the idea that taking a loss is a strength. Make sure you cut your losses. This, I believe, is the key that will keep you from “waking up broke.”

Low Volatility Funds Outperform In 2016

In July and August of 2015, I wrote an expansive series of fourteen articles on the Low Volatility Anomaly, or why lower risk investments have outperformed higher risk investments over time. This Anomaly seems paradoxical; investors should be paid through higher returns for securities with a greater risk of loss. Across different markets, geographies, and time intervals, the series shows that higher beta investments have not delivered higher realized returns and offers suggestions backed by academic research to suggest why this might be the case. We are in another period where lower volatility stocks are dramatically outperforming higher beta stocks, and this article will demonstrate the relative performance of these strategies year-to-date. I will demonstrate the relative performance across capitalization sizes (large cap, mid-cap, and small cap equity) and other geographies (international developed and emerging markets). Readers may counter that, of course, lower risk stocks are outperforming in a down market, so I will show relative performance of the indices underpinning these strategies back to the March 2009 cyclical lows. If lower volatility strategies capture less upside in bull markets, then perhaps their value in corrections is overstated. Let’s look at the evidence. Year-to-Date Performance: Large-Cap Thus far in 2016, the two most popular low volatility exchange-traded funds, the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ) and the S&P 500 Low Volatility Portfolio (NYSEARCA: SPLV ) are handily beating the S&P 500 (NYSEARCA: SPY ), the broad domestic equity market gauge. Through Friday’s close, the S&P 500 has generated a -8.46% total return while the most popular low volatility funds have lost just over three percent. Relative performance is graphed below: Click to enlarge Source: Bloomberg; Standard and Poor’s Year-to-Date Performance: Mid-Cap Mid-cap stocks have further underperformed large cap stocks thus far in 2016 with the SPDR S&P MidCap 400 ETF (NYSEARCA: MDY ) producing a -9.57% return. The low volatility subset of this index, replicated through the PowerShares S&P MidCap Low Volatility Portfolio (NYSEARCA: XMLV ) has also meaningfully outperformed in 2016, besting the mid-cap and large cap indices. For a historical examination of the risk-adjusted returns of this index, see my article on ” The Low Volatility Anomaly: Mid Caps “. Click to enlarge Source: Bloomberg; Standard and Poor’s Year-to-Date Performance: Small Cap Like both large and mid-cap stocks, the PowerShares S&P SmallCap Low Volatility Portfolio (NYSEARCA: XSLV ) has meaningfully outperformed the S&P 600 SmallCap Index ETF (NYSEARCA: IJR ). While the exchange-traded fund has a limited history (February 2013 inception date), the underlying index has data back for twenty years, demonstrating a return profile that would have bested the S&P 500 by nearly four percentage points per annum with lower variability of returns. This fund may deliver both the “size premia” and the “low volatility anomaly” in one vehicle, and has acquitted itself decently (543bp outperformance versus small caps and 307bp outperformance versus the S&P 500) in a rough market start to 2016. For a historical examination of the risk-adjusted returns of this index, see my article on ” The Low Volatility Anomaly: Small Caps “. Click to enlarge Source: Bloomberg; Standard and Poor’s Year-to-Date Performance: International Developed Negative equity market performance has obviously not been unique to the United States amidst a global sell-off. The PowerShares S&P International Developed Low Volatility Portfolio (NYSEARCA: IDLV ) has outperformed non-US developed markets, besting the Vanguard FTSE All-World ex-US ETF (NYSEARCA: VEU ) by 450bp in 2016. Click to enlarge Source: Bloomberg; Standard and Poor’s Year-to-Date Performance: Emerging Markets Pressured by the spillover from decelerating Chinese growth, commodity market sensitivity, and increased market and currency volatility, emerging markets have been a focal point for stress in 2016, but the PowerShares S&P Emerging Markets Low Volatility Portfolio (NYSEARCA: EELV ) has meaningfully outperformed the two largest emerging market exchange traded funds – the Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ) and the iShares MSCI Emerging Markets ETF (NYSEARCA: EEM ). Click to enlarge Source: Bloomberg; Standard and Poor’s In past articles, I have often demonstrated the efficacy of Low Volatility strategies by showing the relative outperformance of the S&P 500 Low Volatility Index (NYSEARCA: SPLV ) versus the S&P 500 and S&P 500 High Beta Index (NYSEARCA: SPHB ). The Low Volatility bent produces both higher absolute returns and much higher risk-adjusted returns. Click to enlarge Readers might look at these cumulative total return graphs and believe they can time the points at which high beta stocks outperform. From the close of the week at the cyclical lows in March 2009 to Friday’s close, the Low Volatility Index has also outperformed on an absolute basis. Click to enlarge In a long bull market that saw 16%+ annualized returns, you have not conceded performance when including the recent correction. In addition to less variable returns over time, low volatility strategies also afford more downside protection – an important feature that has been valuable in early 2016. Disclaimer: My articles may contain statements and projections that are forward-looking in nature, and therefore inherently subject to numerous risks, uncertainties and assumptions. While my articles focus on generating long-term risk-adjusted returns, investment decisions necessarily involve the risk of loss of principal. Individual investor circumstances vary significantly, and information gleaned from my articles should be applied to your own unique investment situation, objectives, risk tolerance, and investment horizon. Disclosure: I am/we are long SPY, SPLV, USMV, VWO, IDLV, XSLV, IJR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.