Tag Archives: etfs

EZR: Is This A Useful ETF Or Symptom Of Wall Street Excess?

WisdomTree just introduced a new exchange traded fund. The Europe Local Recovery Fund sounds great, but is it? My gut tells me it’s another sign of an overextended ETF industry. Exchange traded funds, or ETFs, are amazing products in many ways. In fact, used properly, ETFs can be the basis for a solid portfolio. However, if you don’t pay close enough attention or make aggressive fund choices, ETFs can be very dangerous. WisdomTree’s (NASDAQ: WETF ) new Europe Local Recovery Fund (BATS: EZR ) falls into the riskier category in my book and is another sign that ETFs are, perhaps, too hot a product. The new fund EZR, WisdomTree’s new fund , is designed to, “…maximize exposure to European companies that may benefit from Europe’s economic recovery…” It goes about this by focusing on companies that generate 50% or more of their revenues from within Europe. According to the fund’s fact sheet, the portfolio gets about 70% of its revenues from this region. So an investment in EZR really does get you focused on Europe. There’s more to it than that, though. EZR’s portfolio excludes telecom, utilities, consumer staples, and health care, which aren’t as impacted by economic recoveries. Instead, it focuses on the industrial, materials, consumer discretionary, IT, finance, and energy sectors. All of which WisdomTree expects to benefit more from a regional upturn. But wait, there’s still more… EZR’s holdings: …are weighted by their correlation to the [European Commission’s Economic Sentiment Indicator]. Those whose returns show higher correlations to monthly changes in the indicator will be tilted toward higher weights-and vice versa. So the most economically sensitive stocks have the highest weight. Is EZR good, bad, or indifferent? Here’s the thing. EZR isn’t exactly a bad ETF. But it is a risky one. If Europe is doing well economically, the fund should perform well. If Europe isn’t doing well economically, EZR is likely to be a dog. Don’t overlook this simple fact. By its basic design, EZR is leveraged to Europe’s economic performance up and down. It’s not your typical European stock fund. You need to understand that very clearly when you buy it, otherwise you could be getting something you didn’t expect. If EZR is exactly what you’re looking for, great. But I consider this a pretty esoteric investment product. It’s highly focused around just one positive outcome. WisdomTree has other European funds, so I’m not sure why this one was needed. Except, perhaps, to bring out a new product so the fund sponsor could bring in more assets. Which is the first thing I thought about when I saw the news release on this ETF. Maybe there are a few highly sophisticated investors out there for which this product would make complete sense. But for most, it’s way too targeted. While WisdomTree suggests pairing it with its more broadly diversified Europe Hedged Equity Fund (NYSEARCA: HEDJ ), EZR is really meant for a trader. Someone who thinks the European economy is going to pick up. But that same investor needs to be savvy enough to sell EZR when he or she thinks the European economy is going to head south. If you aren’t that type of investor than owning EZR is far more likely to be dangerous to your financial health than helpful. Got to make a living This isn’t to suggest that WisdomTree is doing anything bad or wrong. If there’s a market for a niche product like EZR they have every right to fill it. In fact, if they want to keep growing, they pretty much have to find unique products to bring in more and more assets under management because the ETF market is pretty saturated with product at this point. And that’s what worries me. ETFs are a huge business and a relatively new one. We’ve quickly moved past the basics, like broad-based index funds, to increasingly focused and sometimes highly unique investment options. To give you a sense of where we’ve come from and where we are going, the Investment Company Institute’s data shows that there was about $45 billion of ETF issuance in 2002. That number was over $240 billion in 2014. So nearly six times as much money went into ETFs in 2014 as went in in 2002. If you are like me, you like to see new ideas for no other reason than they are interesting. They make you think about things in a different way. And to that extent, EZR is very interesting. But it’s also a product that isn’t appropriate for most investors. It’s also a product that’s taking such a specialized focus that it makes me question if ETFs have grown too far (I’ve long felt this, so it’s really just a symptom of an issue I’ve already been concerned about). It makes me think that ETFs are increasingly more about marketing than creating low-cost, freely traded, and broadly useful investment products. Which is what the goal was when ETFs were first created. The Global X Yieldco Index ETF (NASDAQ: YLCO ) is another fund I’d throw up as questionable so you don’t think I’m picking on WisdomTree. EZR is just a new fund that highlights my concern about increasingly esoteric ETFs. The sad truth is that it wouldn’t take me long to create a substantive list of ETFs that might be more dangerous than they are helpful. (Throw in most of the 2X and 3X ETFs on that score.) If you are an ETF investor you don’t have to run for the hills. But you do need to think carefully about what you own and why. Make sure you understand the ETFs in your portfolio and all of the implications you face from owning them-good and bad. My gut says that ETFs are a product where simple is better, particularly as ETFs get more and more complicated. As for EZR, most investors should avoid it.

Fund Watch: Liberty Street, Scharf And Nuance File For New Funds

By DailyAlts Staff In this edition, new filings from: Liberty Street / Robinson Income Opportunity Fund Scharf Alpha Opportunity Fund Nuance Concentrated Value Long-Short Fund Liberty Street / Robinson Income Opportunity Fund On October 16, Liberty Street Funds filed a Form N-1A with the Securities and Exchange Commission (“SEC”) announcing its intent to launch the Robinson Opportunities Fund. The fund, which will pursue an objective of total return with an emphasis on providing current income, will be managed by Robinson Capital Management’s James Robinson. It will invest primarily in income-generating closed-end mutual funds, and its trading strategies will include: Rotation Short sales Opportunistic trading Tender offers Mergers Paired trades Tax-related rebalancing trades Shares of the Robinson Opportunities Fund will be available in A, C, and institutional classes. The fund is expected to launch on or around December 30, 2015. Scharf Alpha Opportunity Fund Also on October 16, Scharf Funds filed a Form N-1A for the launch of the Scharf Alpha Opportunity Fund, which is expected to debut later this year. The fund will aim to provide investors with long-term capital appreciation and returns in excess of inflation, while exposing them to less volatility than traditional equity investments. This objective will be pursued through the selection of securities considered to have more appreciation potential than downside risk over the long term, as assessed by Scharf Investments and portfolio manager Brian Krawez. The fund will also take short positions in broad-market indexes such as the S&P 500, the Value Line Composite, or narrower indexes like the S&P 100. Typically, the fund will be between 30-70% net long, and its long positions will not be constrained by geographic restrictions. Shares will be available in investor and institutional classes. Nuance Concentrated Value Long-Short Fund Nuance Investments filed a Form N-1A for its Nuance Concentrated Value Long-Short Fund on October 13. The fund will take long positions in 15-35 securities and short positions in up to 50 securities, with long and short positions consisting mostly of small-, mid-, and large-cap U.S. stocks. Nuance Investments and portfolio managers Scott Moore and Chad Baumler will select investments they perceive to be undervalued for the long portfolio and investments they perceive to be overvalued for the short portfolio. The fund’s objective will be long-term capital appreciation. Shares of the Nuance Concentrated Value Long-Short Fund will be available in retail and institutional classes when the fund launches. The estimated date of the fund’s debut is December 27, 2015.

The ‘Long 2s’ Of Financial Markets

Summary In honor of the closure of Grantland, an application of sports analytics to portfolio management. In basketball, a long two-point shot is inefficient with a low average return and high variance of returns. This article looks at three similar investment classes in financial markets that similarly produce lower expected returns over time. The news late Friday of ESPN’s shuttering of sports and pop culture website Grantland was disheartening. I liked the mix of long-form journalism and irreverent pop culture topics from a diverse array of skilled young writers, but particularly I loved the articles on deep, and often arcane, sports analytics. As someone with post-graduate studies in analytic finance, the combination of Big Data and some of America’s pastimes spoke to me. Growing up in basketball-crazed Indiana, the articles from Grantland’s Kirk Goldsberry and Zach Lowe allowed me to watch a game I have had a life-long passion for in new and unique ways. One of the simplest and most frequent basketball-related discussion was the inefficiency of the “Long 2”, two-point field goal attempts from just inside the three-point line. A slightly above-average 3-point shooter making 40% of his shots could more than offset a skilled big man making 55% percent of his shots close to the basket. The 1.2 points-per-shot from the 3-point specialist outscored the 1.1 points-per-shot from the post player. The 3-point shooter will score more points on average over time, but of course, sample sizes are not unlimited in a came with a clock. Borrowing from finance, the three-point shooter has higher average returns, but more variable returns from the more difficult shots. If those long shots are not going in with enough frequency, a more steady point scorer can outperform over shorter stretches of time. Now imagine a jump shooter who typically takes long two-point shots, and makes 45% of the shots on average, more than the 3-pt shooter but less than the close range scorer. That shooter scores just 0.9 points per shot. Basketball coaches have realized these shots are inefficient. For investors, these long two point shots with lower expected returns per unit of risk can be said to be below the efficient frontier. In the spirit of Grantland and the inefficiency of the Long 2, I am going to cover three equivalencies in the world of finance, investments that do not offer requisite returns for their relative riskiness. Low Rated Junk Bonds When we learn the Capital Asset Pricing Model in school, we are taught that required returns are proportional to an asset’s (non-diversifiable) risk. The limits of this model can be seen on a basketball court. As you move further away from the basket, your shooting percentage is not going to fall linearly. If you hit 80% of your free throws from 15 feet away from the basket, you are less likely to hit 40% from 30 feet from the basket (8 feet behind the NBA 3-point line) and are even less likely to hit 20% from 60-feet from the basket, or two-thirds of length of a professional court. This analogy can be applied to the debt of corporations. Imagine you are getting paid 5% returns to lend to a company with leverage (Debt/EBITDA) of 3 times. Even if yields paid to investors did rise linearly per unit of leverage (they do not), if you expected to earn 15% returns lending to companies with nine times as much debt as their earnings, you are employing a strategy akin to shooting sixty-footers every time down the court. The only exception is in this example, you can actually see points reduced from your scoreboard in the likely scenario that the 9x levered company goes bankrupt, liquidates its assets, and pays a recovery to bondholders less than the price at which you purchased the securities. Over long-time intervals, it has been shown that buyers of BB-rated bonds (the highest quality junk bonds) outperform buyers of lower rated, higher yielding single-B and CCC-rated bonds. You just aren’t getting paid enough for those more risky shots. For additional evidence of this phenomenon, see: The Low Volatility Anomaly: A High Yield Bond Example or The Winning Trade in High Yield Corporate Bonds High Dividend Stocks Research has shown that stocks paying dividend yields between three to six percent produce higher absolute returns than stocks with yields above six percent. Dividend yields above this threshold are usually a function of lower stock prices and not necessarily higher payouts as the market begins to reflect concerns about the company’s business profile. Companies that are generating enough stable cash flow to support this dividend level could also be signaling to the market that they do not have sufficient internal investments to drive the value of the firm prospectively. S&P 500 companies that have dividend yields above this 6% threshold include businesses from the secularly declining wireline telecom industry – Frontier Communication (NASDAQ: FTR ) and CenturyLink (NYSE: CTL ). Seagate Technology (NASDAQ: STX ), a make of hard drives, would also fit into this declining business model archetype. To me these types of stocks are the Kobe Bryant’s of the investing world. CenturyLink delivered 30% annual returns from 1995-1999. Frontier put up an MVP-like 77% return in 1999. Seagate averaged 20% returns from 2003-2007. These are former all-stars, but their best days may well be behind them. Investors attracted to the flashy dividend yield may see a star, but not recognize that the future is not nearly as bright as the past. For additional evidence on the relative underperformance of high dividend yielding stocks: The Dividend Sweet Spot High Beta Stocks One of my most common themes on Seeking Alpha has been the Low Volatility Anomaly, or why lower risk investments have outperformed their higher risk cohorts. An example of this phenomenon was discussed in the junk bond/sixty-footer analogy. Across markets, geographies, sectors, and time, lower volatility investments have produced higher returns per unit of risk than higher beta investments. Similarly, there have been plenty examples of all-star laden teams that failed to have sustainable success where more disciplined teams have generated surprising outperformance. In 2014-2015, Gordon Hayward (formerly of those great overachieving Butler Bulldog teams) and DeMarre Carroll, the only member of the unexpectedly excellent Atlanta Hawks not named to the All-Star team, both averaged 1.35 points-per-shot. This figure just trailed the performance of LeBron James (1.36 points-per-shot), arguably the best player on the planet. If the NBA were a market exchange, LeBron would likely be the highest priced commodity, but two players who combined last year earned less than LeBron (who is likely vastly underpaid given the salary cap construct) produced similar levels of efficient play by one measure. Low volatility stocks are mis-priced because investors prefer the spectacular alley-oop to good ball movement and an efficient corner three. For more detailed information on why Low Volatility Stocks outperform: 5 Ways to Beat the Market: Part-3 Revisited Those closely guarded pull-up long 2s can be spectacular to watch, but as Grantland showed us, they do not lead to long-run winning performance. Hopefully, this illustration of the Long 2’s of finance can help Seeking Alpha readers build more efficient portfolios.