Tag Archives: etfs

Despite Concerns, Investors Take A Risk-On Approach To Fund Investing

By Tom Roseen Banking on the recent three-week rally in equities, supported by better-than-expected first-time jobless benefit claims, a jump in home builder confidence in October, hopes that Beijing would continue to provide more stimuli to the Chinese economy, and housing starts being near eight-year highs, investors took a risk-on approach to fund investing during the fund-flows week ended October 21, 2015, injecting a net $6.3 billion into conventional funds and exchange-traded funds (ETFs). Investors turned their back on money market funds, redeeming $2.6 billion for the week, but they were net purchasers of the other three fund macro-groups, injecting some $4.4 billion into taxable bond funds, $4.3 billion into equity funds, and $0.2 billion into municipal bond funds for the week. For the third consecutive week taxable bond funds (including conventional funds and ETFs) witnessed net inflows of a little less than $4.4 billion, their largest weekly inflows since the week ended May 20, 2015. As fund investors became more risk seeking, they padded the coffers of corporate high-yield debt funds, which attracted the largest amount of net new money for the week of the major fixed income groups, taking in $3.3 billion (their second largest weekly net inflows on record and the largest since October 26, 2011). (click to enlarge) Source: Thomson Reuters Interestingly, the risk-on mentality was not equally applied to the equity side of the business. While authorized participants (APs) injected $4.5 billion into equity ETFs for the week, conventional fund investors were net redeemers of equity funds, withdrawing $0.2 billion from the group. Despite continued concerns about the Q3 earnings season and in anticipation that the Federal Reserve may delay raising interest rates until 2016, APs were net purchasers of domestic equity ETFs (+$3.2 billion), injecting money into the group for a second consecutive week. They also padded the coffers of nondomestic equity ETFs (to the tune of +$1.3 billion) for the sixth week running. In contrast, on the conventional funds side of the business, domestic equity funds-handing back $0.8 billion-witnessed their fourth consecutive week of net outflows. Meanwhile, their nondomestic equity fund counterparts witnessed $646 million of net inflows-attracting money for the first week in four.

When Picking Mutual Funds, Don’t Be The Dumb Money

For the typical retail investor, mutual fund research reveals an uncanny ability to pick the worst fund categories at the worst possible times. The reason has to do with the tendency to base these types of decisions on “gut feeling” or emotion, rather than careful analysis. Investors feel most comfortable climbing aboard overvalued sectors of the fund universe towards the tail end of bull markets, only to flee to safety when stock prices are closer to their lowest. First identified by researchers Andrea Frazzini from NYU and Owen Lamont from Harvard, the poor timing ability of fund investors has come to be referred to as the “dumb money” effect. Emotion, limited attention, misguided perceptions and inexperience lead retail investors to make questionable decisions. This tendency to invest more in funds with high positive sentiment (for example tech stocks in the 1990s), and to pull out of funds with high negative sentiment (for example liquidating stock funds in 2008 and moving to bond funds), has led retail investors to lose on average about 1.5% annually, according to a 2007 analysis by Geoffrey Friesen of the University of Nebraska and Travis Sapp of Iowa State. Understanding investor behavior provides insight into why retail investors underperform the market. It also reveals how an investor, with a modest amount of additional effort, can improve their performance by avoiding common decision mistakes. Recent performance is the force that drives dumb money losses for many retail investors. This isn’t surprising since mutual fund advertisements and fund prospectuses tend to emphasize how well the mutual fund has performed in the past. Most investors shop for mutual funds the way they would for a toaster or microwave oven. Instead of researching the quality and durability of the product, they use shortcuts – cues of quality such as brand name recognition, an appealing marketing campaign, or a recommendation from a friend or family member. Yale researcher James Choi and his co-authors David Laibson and Brigitte Madrian of Harvard investigated how an average investor uses information on a mutual fund prospectus using identical S&P 500 index funds with different fund initiation dates. In addition to the prospectus, they gave respondents in different groups a “cheat sheet” that summarized differences in fund fees, and another that spelled out how the objective of all funds was to mimic the S&P 500. Samples of both employees and Wharton MBA students (with average SAT score at the 98th percentile) consistently focused on the obviously irrelevant fund performance rather than on fund fees even when presented with information that should have helped them make better choices. Brad Barber of UC Davis and Terrance Odean of Berkeley blame return chasing on the limited attention span of individual investors. According to their investor attention hypothesis, most of us have limited time to devote to researching mutual funds. We can either invest a huge amount of time and effort into learning how to evaluate and select funds, or we can simply invest in ones that capture our attention. The fact that mutual fund investors are attracted by the shiny funds does not serve them well in a market where sentiment can drive the value of securities too high or too low. A simple way to break the cycle of mutual fund underperformance is to develop an investment policy in which the investor maintains a diversified portfolio that reallocates periodically as market values change. This naturally works against investor sentiment by increasing investment in bonds when stock prices are rising and reducing one’s bond allocation when stock prices have fallen. Azi Ben-Rephael of Indiana University and his co-authors estimate monthly shifts between bond and stock mutual funds and find that investors consistently do the opposite-they shift to bond funds when equity values drop and back toward stock funds when equities rise in value. I use the monthly calculated shift in equity funds during the two significant equity bear markets of 2001-2002 and 2007-2009. In both cases, mutual fund investors move sharply toward bonds after stock prices have fallen. Investors appear to be unwilling to follow a disciplined long-run investment strategy by maintaining their portfolio risk exposure in a down market. Since poorly timed mutual fund sales are more harmful than poorly timed purchases, these flights to safety can have a significant impact on long-run portfolio performance. Including an investment policy statement inevitably leads to a discussion of the importance of rebalancing during good times and bad, allowing a client to anticipate portfolio volatility and follow a smart money strategy. Friesen and Sapp found that sentiment-driven underperformance on load funds was twice as large (1.92% per year) as the performance gap on no-load funds (0.96%). Incubated funds are also significantly more likely to be load funds. This is consistent with other studies that suggest that the mutual fund universe can be split between funds that are sold through the broker channel and funds that are bought through a direct channel. It is far easier to sell a privately incubated fund with significant recent excess performance, than it is to sell a fund with average performance. This is so even if neither fund is actually more likely to outperform in the future. It would be tempting to conclude that bad investor timing is primarily the result of inexperienced investors making bad choices, but a recent study by Ilia Dichev of Emory University and Gwen Yu of Harvard found that dollar-weighted returns on hedge funds are between 3% and 7% lower than time weighted returns. This is more than twice the dumb money difference observed in mutual fund investments. Since hedge fund investors are primarily institutions and extremely wealthy individuals, apparently even the professionals can get caught up in the excitement of investing in hot funds. Whether novice or professional, it is easy for an investor to fall into the trap of chasing returns of attention-grabbing funds. The good news is that investors who avoid relying on their emotions are much more likely to succeed in the long run. And a skilled investment advisor can help a client tune out the noise.

How Will The Fed Impact GLD This Time?

Summary The price of GLD declined in the past few days as the U.S. dollar rallied. The FOMC meeting will convene again this week. How will the upcoming FOMC meeting impact the price of GLD? The U.S. dollar has changed course and rallied in the past few days, which also dragged back down SPDR Gold Trust ETF (NYSEARCA: GLD ). In times when central banks aim to provide more liquidity: The ECB may expand and extend its QE program and cut rates in December, People Bank of China reduced again its rates, and Bank of Japan may ramp up its QE program this week (although the chances are low for this upcoming meeting); it becomes less likely for the FOMC to raise rates. And as long as the Fed delays its rate hike to a later date, precious metals are likely to benefit from it. This week, the FOMC will convene again for its penultimate meeting for the year. This meeting won’t include an economic update or press conference. The current market expectations , as derived from the bonds market, are for only 6% chance of a hike announcement in the coming meeting. The most likely scenario is for the Fed to publish a succinct statement with little changes to the wording in order to keep the possibility of raising rates in December. If so, GLD isn’t likely to have much of a reaction. But what does it mean about the December meeting? The two mandates of the Fed relate to labor and inflation. Since the last meeting, the reports related to these two mandates aren’t making the decision any easier. From the labor market perceptive , the NFP and JOLTS weren’t impressive. And even though unemployment rate is low, wages aren’t picking up any faster with a steady growth rate of 1.9%. When it comes to inflation, the last CPI report showed the core CPI reached 1.9% – very close to the Fed’s target inflation of 2%. It still seems that the Fed may decide to err on the side of caution and maintain its rates low this year and only raise rates around Q1 2016. If the next two NFP reports show another slow growth in jobs (fewer than 150,000 jobs per months) and little change to growth of wages, these reports will make it a bit easier for the Fed to delay it decision to next year. The changes in market expectations over the timing of the Fed’s rate hike is demonstrated in the rise and fall of short-term interest rates in recent months, as you can see in the following chart. (click to enlarge) Source: U.S Department of Treasury and Google finance The latest rally of GLD isn’t only related to the depreciation of the U.S. dollar. But that’s not all. Its rally is plausibly related to the decline in interest rates. In the past few months, the changes in the market expectations of short-term interest rates are strongly correlated with the daily shifts in the price of GLD – the linear correlation is around -0.41 over the last four months. The gold market has benefited from the recent weakness of the U.S. dollar and fall in interest rates. And if the Fed issues another dovish report or even keep its statement unchanged, this could provide another short-term boost for GLD. But as other central banks aim to turn more dovish by cutting rates or increasing QE programs, the upward pressure on the U.S. dollar will intensify, which is likely to bring down GLD. Therefore, even if GLD were to rally in the near term as the Fed delays its rate hike, the actions taken by other central banks could bring back down GLD in the coming months. For more please see: ” GLD Continues to lose its appeal “.