Tag Archives: etf

Momentum, Quality And Low Volatility: Continuing The Quest For Smarter Beta

Summary In November I introduced a smart beta portfolio based on MSCI’s indexes for quality, momentum and low volatility. The semi-annual rebalancing of those indexes is complete. I review the previous six-month performance and determine the components of the rebalanced MQLV portfolio. In early November I proposed the idea of using the iShares smart beta ETF portfolios as a filter for building one’s own risk-premia portfolio ( A Quest for the Smartest Beta ). I started from three ETFs, each indexed to a single factor: Low Volatility, Momentum and Quality. iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ) iShares MSCI USA Momentum Factor ETF (NYSEARCA: MTUM ) iShares MSCI USA Quality Factor ETF (NYSEARCA: QUAL ) Taken together, these three ETFs make a solid holding as seen in this table showing results of an equal weighted portfolio of the three ETFs vs. the S&P 500 since the inception of QUAL, the youngest of the three, in August 2013. (click to enlarge) Starting from the premise that each of the ETFs is selecting for a single “smart-beta” factor I wanted to look at the intersection of the three funds. I asked if there were overlapping positions in all three ETFs. I compared their full sets of holdings looking for that overlap. There were 14 funds shared by all three. I reasoned that since each of the 14 passed the MSCI filters for low-volatility, momentum and quality, it could be worth looking at a portfolio comprising all 14, in effect, a portfolio located at the intersection of Quality, Momentum and Low Volatility. June through November Results The 14 stocks from the end of May rebalance are: Arch Capital Group Ltd (NASDAQ: ACGL ) Accenture PLC (NYSE: ACN ) Axis Capital Holdings Ltd (NYSE: AXS ) Chubb Corp (NYSE: CB ) Chipotle Mexican Grill Inc. (NYSE: CMG ) Home Depot Inc. (NYSE: HD ) Eli Lilly (NYSE: LLY ) Nike Inc. Class B (NYSE: NKE ) O’Reilly Automotive Inc. (NASDAQ: ORLY ) Reynolds American Inc. (NYSE: RAI ) Starbucks Corp (NASDAQ: SBUX ) Sigma Aldrich Corp (NASDAQ: SIAL ) Visa Inc. Class A (NYSE: V ) W.R. Berkley Corp (NYSE: WRB ) Each of the ETFs is rebalanced to a revised index twice annually, on the last business days of May and November. So, when I looked at the portfolio, let’s call it MQLV , it had a five-month record from its “inception” on the last business day of May. It had performed well. For the five months from June 1 to Nov 1, it turned in a CAGR of 41.0% vs SPY’s -1.30%. Now that the full cycle is complete we can update performance at the close of the six-month holding period. It performed thusly: (click to enlarge) That is a quite impressive performance record. In a market environment where the S&P 500 index could only muster a 1.74% total return, MQLV chalked up nearly 19%. Sharpe (2.21) and Sortino (7.29) ratios are at rarely seen levels. Pretty good evidence that there may well be something to this idea. Not in any way definitive, of course; it is, after all, a single cycle. But those results are surely saying “Hey, look over here.” Rebalancing for December through May Now that MSCI has rebalanced the indexes, I let’s have a look at the changes. The current overlap for the three funds has moved from 14 to 18 stocks. Eleven remain from the previous list. There are seven new entries, and three have dropped off. The additions are: Costco Wholesale Corp (NASDAQ: COST ) Henry Schein Inc (NASDAQ: HSIC ) Lockheed Martin Corp (NYSE: LMT ) Mcdonalds Corp (NYSE: MCD ) Public Storage REIT (NYSE: PSA ) Travelers Companies Inc (NYSE: TRV ) Ulta Salon Cosmetics & Fragrance I (NASDAQ: ULTA ) And the deletions: Chipotle Mexican Grill Inc. Reynolds American Inc. Sigma Aldrich Corp CMG is no longer included in MTUM’s holdings but remains in USMV and QUAL. RAI was dropped from QUAL; it remains in USMV and MTUM. SIAL was acquired. The sector mix is dominated by Consumer Discretionary and Financials which account for 12 of the 18 positions. (click to enlarge) If we combine these 18 positions into an equal-weighted portfolio, the portfolio metrics are as follows: (click to enlarge) (from investspy.com based on one-year’s data) One-year performance for these 18 is outstanding, having beaten SPY 27.7% to 3.5% for the year. This is, of course, no indication of what the portfolio will do over the next six months between now and the next rebalance, but it does auger well for success. And, let’s not forget, 11 of these holdings were included in the previous iteration which trounced SPY handily. Here is a correlation matrix for the holdings. (click to enlarge) Running the portfolio through Portfolio Visualizer’s four-factor analysis produces the following regressions. Once again, it’s based on one-year’s data. (click to enlarge) As commenters pointed out in discussing the November article, there is little exposure here to size, all but three of the size exposures are negative. Several suggested that I should include the value factor. I argued that value was inherent in some of the selection criteria used by USMV and QUAL, so adding an ETF like the iShares MSCI USA Value Factor ETF (NYSEARCA: VLUE ) would be redundant. That point of view was confirmed to a large extent by including the VLUE and the iShares MSCI USA Size Factor ETF (NYSEARCA: SIZE ) portfolios in the analysis as a follow-up ( Expanding the Smart Beta Filter: Does It Help? ). Now, from the results of this regression analysis of the Fama-French factors, we can see that value exposure is, in fact, fairly high. This result confirms my sense that value was being addressed at least partially, even though it is not a specific factor for any of the three source ETFs. HSIC, LLY, LMT, SBUX are negative for value, but the rest are positive or neutral. Unsurprisingly, momentum exposure–the only factor specifically selected for by a source ETF–is high; only LLY is negative here. Given the extraordinary success of the June through November record I am excited to see how the rebalanced portfolio performs. At 18 positions this is a fairly large commitment for an outright investment, but it could well be worth some serious thought. To me, the concept appears sound and the track record, limited though it may be, is supportive. Is it actionable? I’d like to think so, but the hard evidence, however impressive, is sketchy. So any action taken would be largely based on an appreciation for the conceptual basis of the strategy. I’ll be keeping this updated as we move forward.

10 Questions And Answers On ETFs And Other Topics

I was asked to participate with 57 other bloggers in a post that was entitled 101 ETF Investing Tips . It’s a pretty good article, and I felt the tips numbered 2, 15, 18, 23, 29, 35, 44, 48, 53, 68, 85, 96, and 98 were particularly good, while 10, 39, 40, 45, 65, 67, 74, 77, 80, and 88 should have been omitted. The rest were okay. One consensus finding was that Abnormal Returns was a “go to” site on the internet for finance. I think so too. Below were the answers that I gave to the questions. I hope you enjoy them. 1) What is the one piece of advice you’d give to an investor just starting to build a long-term portfolio? You need to have reasonable goals. You also have to have enough investing knowledge to know whether advice that you receive is reasonable. Finally, when you have a reasonable overall plan, you need to stick with it. 2) What is one mistake you see investors make over and over? They think investment markets are magic. They don’t save/invest anywhere near enough, and they think that somehow magically the markets will bail out their woeful lack of planning. They also panic and get greedy at the wrong times. 3) In 20 years, _____. (this can be a prediction about anything – investing-related or otherwise) In 20 years, most long-term public entitlement and private employee benefit schemes that promised fixed payments/reimbursement will be scaled back dramatically, and most retirees will be very disappointed. The investment math doesn’t work here – if anything, the politicians were more prone to magical thinking than naïve investors. 4) Buy-and-hold investing is _____. Buy-and-hold investing is the second-best strategy that average people can apply to markets, if done with sufficient diversification. It is a simple strategy, available to everyone, and it generally beats the performance of average investors who buy and sell out of greed and panic. 5) One book I wish every investor would read is _____. (note that non-investing books are OK!) One book I wish every investor would read is the Bible. The Bible eliminates magical thinking, commends hard work and saving, and tells people that their treasure should be in Heaven, and not on Earth. If you are placing your future hope in a worry-free, well-off retirement, the odds are high that you will be disappointed. But if you trust in Jesus, He will never leave you nor forsake you. 6) The one site / Twitter account / newsletter that I can’t do without is _____. Abnormal Returns provides the best summary of the top writing on finance and investing every day. There is no better place to get your information each day, and it comes from a wide array of sources that you could not find on your own. Credit Tadas Viskanta for his excellent work. 7) The biggest misconception about investing via ETFs is_____. The biggest misconception about investing via ETFs is that they are all created equal. They have different expenses and structures, some of which harm their investors. Simplicity is best – read my article, ” The Good ETF ” for more. 8 ) Over a 20-year time horizon, I’m bullish on _____. (this can be an asset class, fund, technology, person – anything really!) Over 20 years, I am bullish on stocks, America, and emerging markets. Of the developed nations, America has the best combination of attributes to thrive. The emerging markets offer the best possibility of significant growth. Stocks may have a rough time in the next five years, but in an environment where demographic and technological change is favoring corporate profits, stocks will do better than other asset classes over 20 years. 9) The one site / Twitter account / newsletter that I can’t do without is _____. Since you asked twice, the Aleph Blog is one of the best investing blogs on the internet, together with its Twitter feed. It has written about most of the hard questions on investing in a relatively simple way, and is not generally marketing services to readers. For the simple stuff, go to the personal finance category at the blog. 10) Any other ETF-related investing tips or advice? For a fuller view of my ETF-related advice, go to Aleph Blog, and read here . Briefly, be careful with any ETF that is esoteric, or that you can’t draw a simple diagram to explain how it works. Also realize that traders of ETFs tend to do worse than those that buy and hold.

Stay Out Of The Junkyard: Low-Priced Stocks Are Hazardous To Your (Financial) Health

My last post generated a fair amount of negative feedback on my Yahoo Finance page and on Twitter . There’s nothing quite like waking up in the morning and being called an idiot (and worse) by all sorts of strangers on the internet. I understand that people have strong feelings about Fannie Mae and Freddie Mac, but I have to say, the vitriol of the comments took me by surprise. Setting aside whether it was fair (or legal) for the government to change the bailout terms for Fannie and Freddie, my main point in writing about the two giant GSEs seemed rather straightforward: the low-priced stocks and preferred shares of Fannie Mae and Freddie Mac are extremely risky investments. If Washington formally nationalizes these companies (or does so informally, as it seems to be doing right now), there is a good chance that their stocks will go to zero. Sure, the big hedge funds and their armadas of lawyers might prevail in court and win the return of the companies’ dividends to shareholders. But even if that happens, it will probably take years. As I wrote in the last line of the post, “There are easier ways to make money.” The broader lesson of the GSEs for both retail and professional investors can be stated in four words: What do I mean by junk stocks? There are all sorts of ways to answer that question. Usually, junk stocks are defined as companies with shrinking revenues, outsized debt loads and negative cash flows. But there’s an easy way to spot junk stocks without digging through financial disclosures: if a stock is below five bucks, it is more than likely a troubled mess not worth investing in. As I write in my book Dead Companies Walking , the vast majority of low-single digit stocks in the market are over – not under- priced. Almost all of them have been relegated to the stock market pick-n-pull for one (or more) of three reasons: a bad business, a bad management team, or a bad balance sheet. It’s not uncommon for companies with sub-$5 stock prices to suffer from all three of these maladies. Yet, many investors cannot resist the temptation to buy these jalopies, hoping for a turnaround that almost never happens. Like vintage cars, a small percentage of cast-off stocks do defy the (very long) odds and regain their former glory. But here’s the thing pick-n-pull investors fail to understand: those stocks are even better buys at $8 or $10 than they were at $2 or $4. Why? Because improving fundamentals have taken hold by then, and the wider market has taken notice. Good news spreads quickly, and healthy, wealthy, and popular companies tend to get healthier, wealthier, and more popular as cash flows fatten and more investors pile in. Consider how brutally top-heavy the markets have been this year. At the end of July, I (lightly) cautioned investors to be wary of the high-flying FANG quartet – Facebook (NASDAQ: FB ), Amazon (NASDAQ: AMZN ), Netflix (NASDAQ: NFLX ), and Google ( GOOG , GOOGL ) – saying that any correction in the tech sector could also drag these stocks down to earth again. So much for market forecasting. Shortly after I wrote that post, the market did go through a correction. The FANGs fell along with everyone else, but they’ve all charged to new highs since then. If you add the other two largest tech companies (Microsoft (NASDAQ: MSFT ) and Apple (NASDAQ: AAPL )) to the FANGs, these six behemoths now comprise 12 percent of the S&P 500’s $18.5 trillion total market capitalization, and have accounted for just about all of the index’s gains this year. If these half dozen names were flat, not up, the S&P would be down 1.5 percent year to date instead of up 1 percent. More importantly from an investment standpoint, the likelihood that any of them will go broke is exactly nil. They all have rapid revenue growth, strong balance sheets, capable Boards and highly educated employees. Those attributes are much harder to find at troubled companies with sub-$5 stock prices. The top-heaviness of the current market might be extreme, but it isn’t new. Historically, a minority of stocks have always outperformed the overall market over any lengthy time period. All the major indexes (minus the Dow) are market capitalization weighted. That means a few mega-cap winners, like Google or Amazon, can (and often do) offset the stock price declines at dozens, or even hundreds, of smaller companies. Though I usually don’t buy the stocks of large, widely analyzed businesses, my own returns as a fund manager bear this out. My best performance has occurred when most of my shorts are below $10 (and hopefully heading toward zero) and my longs are pricier. In years where junk outperforms value (like 2003 and 2009), I tend to underperform. A few years back, Blackstar Funds analyzed the returns of the Russell 3000 between 1983 and 2007. Even for a cynic like me, the bearish results were shocking. Of the 8000+ stocks that were either in the Russell 3000 originally or that entered it at some point during the study period (usually via an IPO), 39 percent produced a negative lifetime total return – with 19 percent losing over 75 percent. Only 1 in 5 stocks produced a 300 percent or greater return. And yet, over that same time period, the Russell 3000 gained over 1000 percent – all because a small handful of large winners crushed the median stock’s advance. In life and in the stock market, the rich tend to get richer. For everyone else, it’s a different story. Original Post