Tag Archives: etfs

TLT: Think Long Term

Many retail investors find it easier to access and buy bond funds or bond ETFs instead of going out andowning individual pieces of paper debt. It has been a dull few years for bond investors. As equity prices have risen higher since 2007 and 2008, bond performance has struggled. For the course of the long term, we remain very bullish on U.S. treasury bonds, and we recommend TLT – think long term. By Parke Shall Bonds can sometimes be tricky for the average retail investor. They are usually priced much higher than stocks, sometimes around $1000 if you want to buy individual bonds, sometimes higher. It’s for that reason that many retail investors find it easier to access and buy bond funds or bond ETFs instead of going out and owning individual pieces of paper debt. There are a growing number of bond ETFs that you can put your money into, but the most important thing to look at is always whether or not these ETFs are levered and what the fees are going to cost you. Bond instruments for the long term should not have leverage, and should simply track the yields of the type of bonds that you want to invest in, whether it is municipal bonds, corporate bonds, or our favorite; government bonds. Here is a list of some of the more popular treasury bond ETFs, from ETF Database , (click to enlarge) Our preference is the iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ). It has been a dull few years for bond investors. As equity prices have risen higher since 2007 and 2008, bond performance has struggled. This does not discourage us, however, as our bond investment strategy is to buy long term treasury bonds where we think there is eventually going to be some pricing support and some safety. Our investing strategy is one that always has some exposure to the consistent coupon of bonds. We try to keep some cash, we definitely keep equities, but we always do try and have varying amounts of exposure to bonds as well. Treasury bond prices have fallen, and the latest bit of news from the world of treasury bonds was that China was curbing the amount of money that they were pouring into U.S. government debt. Zerohedge said : As BNP’s Mole Hau put it on Monday, “whereas the daily fix was previously used to fix the spot rate, the PBoC now seemingly fixes the spot rate to determine the daily fix, [thus] the role of the market in determining the exchange rate has, if anything, been reduced in the short term. ” And a reduced role for the market means a larger role for the PBoC and that, in turn, means burning through more FX reserves to steady the yuan. Translation and quantification (with the latter coming courtesy of SocGen): as part of China’s devaluation and subsequent attempts to contain said devaluation, China has sold a gargantuan $106 (or more) billion in U.S. paper just as a result of the change in the currency regime. Notably, that means China has sold as much in Treasurys in the past 2 weeks – over $100 billion – as it has sold in the entire first half of the year. Today, we got what looks like confirmation late in the session when Bloomberg, citing fixed income desks, reported “substantial selling pressure in long end Treasuries coming from Far East.” We believe this move, on China’s part, is due to China needing to access the cash that it has in order to stabilize its stock market. When we look out over a broader term, we believe that Bond prices treasury bond prices will eventually study. Another interesting fact directing the bond market is the fact that inflation is seemingly nonexistent. This makes bond investing even more attractive, we believe. Short-term yields may stay at levels that they are at now for a little while to come. When the Federal Reserve finally gets around to raising rates,Will expect find pricing to begin stick up once again. However, for the course of the long term, we remain very bullish on U.S. treasury bonds, and we recommend TLT – think long term.

Tactical Asset Allocation Portfolio Performance: Theory Vs. Reality

One of the biggest challenges in implementing Tactical Asset Allocation (TAA) portfolios is coming as close to the theoretical returns as possible. Theoretical returns are based on index returns, which are not available in the real world. In this post, I’ll explore the major items that keep investors from achieving published theoretical returns of TAA strategies, and discuss some ways to minimize the gap between theory and reality. This is definitely an advanced topic, but a critical one that I really never seen addressed in the financial blogosphere. First, let’s look at the three big reasons for the gap between theoretical and real returns for TAA portfolios. Poor index replication: TAA portfolio returns are based on indexes, e.g. small cap momentum, for some of which no reasonable investable ETF exists. This is becoming less and less for an issue – for e.g., the PowerShares DWA SmallCap Momentum Portfolio ETF (NYSEARCA: DWAS ) is a potential candidate for small cap momentum – but many of these new ETFs are still quite small. Even if an investable ETF exists, there will be some tracking error between its index and the ETF. Fees: There are two sources of fees – trading fees and management fees. Many of the ETFs in TAA portfolios are available as commission-free ETFs, but some are not. And of course, every ETF has a management fee, which detracts directly from the index returns. Slippage: This is the largest source of the gap between theoretical TAA returns and real TAA returns. TAA portfolios are based on monthly investment signals. Monthly investment signals are based on closing ETF prices. Actions based on those signals are done on the following trading day. Any difference between the closing ETF price and your trade price the following day constitutes slippage. For example, a sell signal was generated on August 31, 2015 when the Vanguard Small Cap Growth ETF (NYSEARCA: VBK ) closed at $124.77. On the following day, September 1, VBK traded in a range from $123.53 to $121.06. Selling VBK in that range would generate a difference from the theoretical sell price (the previous close) of 1-3%, depending on where you sold during the day. And this does not even account for the bid-ask spread. Needless to say, that would impact your returns. Usually, it is not as bad as this example, and the slippage can even go in your favor, but in general, it detracts significantly from theoretical returns. Now, let’s put these reasons into context. I ran some backtests with the AGG3 and AGG6 strategies with some different slippage numbers. Since these backtests use real ETFs, all management fees are taken into account. The results from March 2007 through mid-September 2015 are below. If you were able to trade at the theoretical closing price of the ETFs, then with AGG3, the return would have been 13.77% annualized over the period. With just 0.25% negative slippage on every trade, that return would have decreased by 2%, annualized to 11.77%. And with 0.5% negative slippage per trade, that annualized return would have been only 9.85% annualized. As I like to say, slippage kills! BTW, any portfolio strategy has the exact same issues – even “buy and hold”. The issues are exacerbated when a strategy is more active, and thus, trades more often. OK, so what can we do about this? Let’s address each reason individually. For poor index replication, we can always be on the lookout for better-constructed ETFs that more closely match the indexes, and do so at reasonable costs. As I said earlier, this is less and less of an issue today. As far as fees go, we can look for the lowest-cost commission-free ETFs that best implement the index. Sometimes, this can conflict with the first goal of good index replication. For example, is DWAS a better choice for small cap momentum at 0.6% per year in fees, versus VBK, which is really a small cap growth ETF (not momentum), but is only 0.09% per year in expenses? In other words, the better index replication may not be worth the extra fees. And then there is the big one – slippage. In theory, the solution is easy. Trade as close to the theoretical model price as possible. At the minimum, this ideally means the use of high volume, low bid/ask spread ETFs. I’ll give you my favorite example. The Vanguard Long-Term Government Bond Index ETF (NASDAQ: VGLT ) trades 50K shares per day, at an average bid/ask spread of 0.2%. The iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) trades 9M shares a day, at an average bid/ask of 0.02%. Which one would best minimize slippage? TLT by a long shot, despite the slightly higher management fee (0.15% versus 0.12%). So, to minimize slippage, we may sometimes actually end up using different ETFs. You may also want to change from end-of-month portfolio signals to some other day during the month to avoid volatile month-end periods due to options expirations, portfolio window dressing, etc. Then, at the advanced end of the spectrum, you can actually ‘trade the close”, i.e., execute your trades as near the end of trading as possible on the last day of the month (the day that generates your portfolio signals). The use of conditional orders and MOC (market on close) orders greatly simplifies this strategy. I’ve been working on this strategy most of the year, and have found it quite effective in minimizing slippage. Also, even the choice of brokerage can impact slippage. I have stopped using TAA strategies at certain brokers, due to poor execution prices. In summary, there will always be a difference in model returns versus real-world returns. The question is, how can we minimize these gaps? With attention to detail in choosing the best, liquid, low bid/ask, low-cost ETFs and some smart trading strategies, you can keep the gap down to a minimum.

Why Seeking Alpha Recommendations Outperform Mutual Funds And Brokerage Analysts

Summary Academic research indicates that, on average, Seeking Alpha recommendations outperform mutual funds and brokerage (sell-side) analysts by substantial margins. The SA coverage universe includes many small company stocks that are ignored by sell-side analysts, despite the longstanding and significant negative correlation between returns and market cap. SA contributors are far more likely than sell-side analysts to issue sell recommendations when circumstances warrant, thereby avoiding losses and exploiting opportunities to short. SA taps the “wisdom of crowds” via large numbers of highly trained contributors who are freer than brokerage analysts to develop and express individual stock ideas in great detail. Given the findings of academic studies at NYU and Purdue , there can be little doubt that Seeking Alpha (SA) recommendations, on average, actually do deliver substantial positive alpha. Nor can there be much doubt that actively managed equity mutual funds typically deliver negative alpha . With respect to sell-side analysts, a 2014 academic study of their performance found that only “about 50% of ‘buy’ recommendations issued by industry and market benchmarkers meet or beat their objective.” (Roughly as reliable, in other words, as basing one’s investment decisions on coin flips.) Fundamental Advantages of SA Research 1. Microcap and small cap stocks have a long history of outperforming large caps. As the NYU study noted, SA analysts often cover companies that are too small to attract coverage by brokerage analysts – or to be owned by mutual funds. When my Data Driven Investing co-author, Mitch Hardy, and I analyzed Compustat data for over 20,000 companies between 1951 and 2002, we found that an annually rebalanced portfolio of the 100 smallest stocks (with a minimum market cap of $10 million in 2002 dollars and assuming reinvestment of dividends at year end) would have grown from $1 to $4,418 ( 17.52% compounded annually ) during this 52-year period. This figure assumed that buys and sells were done for zero commission at year end closing prices, which is certainly an overly optimistic assumption. Nevertheless, it is a meaningful indicator of a powerful negative correlation between company size and investment returns when compared to the terminal values of $1 invested in similarly constructed portfolios with higher market cap minimums: $100 million minimum market cap – $1,293 terminal value (14.77% compounded annually) $250 million – $667 (13.32%) $500 million – $289 (11.51%) $1 billion – $303 (11.62%) S&P 500 – $254 (11.23%) 100 largest market caps – $148 (10.08%) From 1/1/03 through 10/2/15, this correlation has persisted. The Russell Mega Cap 50 has returned 139.9% (with dividends reinvested) vs. 199.9% for the Russell Microcap Index. 2. SA contributors are far more likely to issue sell recommendations when warranted than are sell-side analysts. Because brokerages have little to gain and much to lose from issuing negative reports, they make very few of them , thereby exposing their clients to avoidable losses, as well as causing clients to miss out on profitable short sale and put buying opportunities. Whereas almost all investors are potential buyers of the individual stocks that brokerage analysts recommend, relatively few are in a position to act upon sell recommendations. That is, unless an investor either owns a stock already or is inclined to short it (or buy puts), that investor will not act upon a sell recommendation. As a result, the potential commission revenue to be derived from making a negative call is relatively small. In addition, there are strong disincentives in play. Not only is the subject of a sell recommendation quite likely to look askance upon doing investment banking business with the brokerage that makes it, but it’s also possible for a single negative research piece to harm relationships with an entire industry . At the very least, going negative on a company can impede an analyst’s access to its management and the information needed to do his or her job. Moreover, these analysts have strong incentives to defend the stocks of companies that are either investment banking clients or prospects of their brokerages – even when short sellers put forth solid evidence of existential product liability problems and unsustainable business models. The next time Citron Research makes one of its “emperor has no clothes” calls, watch for one or more brokerage analysts to leap to the stock’s defense, however compelling the sell case might be. The more troubled the company, the more opportunity there may be to profitably pursue investment banking opportunities with it. Such companies may well be in the market for assistance from accommodative Wall Street firms in raising cash and/or dumping the stock owned by their managements upon unsuspecting investors. 3. SA contributors can focus far more attention than brokerage analysts on each opportunity they research. The SA posts of Citron provide us with prime examples of the thoroughness that brokerage analysts lack. (Click on the link in the preceding sentence to see what I mean.) The focus of sell-side analysts is necessarily diluted, due to the number of stocks they are assigned to cover, as well as their sales responsibilities. Academics have noted a negative correlation between analyst workload and accuracy (as well as a negative correlation between workload and research timeliness). Whereas it’s commonplace for a single sell-side analyst to have coverage responsibility for a dozen stocks or more (e.g. at Raymond James ), SA contributors have far more freedom to focus on developing one individual stock idea at a time. And when an important sell-side prospect or client needs handholding from an analyst, be it an institutional investor or investment banking-related, this may take precedence over research . 4. As the preeminent aggregator of crowdsourced investment research, SA is uniquely positioned to harness a large and growing pool of individuals with underutilized talent who are highly motivated to produce quality work. Many SA contributors (like yours truly , for instance) earn CFA designations with the hope of becoming an equity analyst or portfolio manager with an established firm. For those of us who will never realize this hope, SA provides an attractive means of pursuing our analytical passions, as well as a platform for sharing our analyses with, and receiving feedback from, thousands of viewers. Whether or not one has secured such a position, the rewards for writing insightful analyses can extend beyond the intellectual challenges, kudos from viewers, and penny per page view. There’s a reasonable chance that one’s audience will include someone impressed enough to make a suitable job offer or open a new account. The CFA charterholder population has roughly doubled during the past decade and now stands at over 123,000 – and there are more on the way, with more than 210,000 exam registrations received in 2014. Inevitably, this crop of CFA wannabees will ultimately yield a bounty of well-trained SA contributors. There are, of course, many highly competent SA contributors who do not hold CFA charters. Their numbers include underemployed MBAs, downsized financial services personnel, and those with no relevant formal training who have enough sense to know a good investment opportunity when they see one. In fact, when flooring contractors have something to say about Lumber Liquidators (NYSE: LL ), their observations carry more weight with me than whatever a desk-bound CFA/MBA type might have to offer. Whereas Wall Street firms offer no effective way for small investors to band together in challenging the assertions of their brokerage analysts, SA gives users the opportunity to publicly point out errors, unwarranted assumptions, and other shortcomings in the analyses submitted by its contributors. In addition, SA provides a convenient venue for critiquing the alleged wisdom of Wall Street. SA’s sharp-eyed editors constitute a first line of defense against the publication of factually incorrect or otherwise misleading submissions. And if significant deficiencies remain after publication, SA users’ multitude of eyeballs can generally be counted on to catch them. To the extent that the “wisdom of crowds” exists in the investment world – in contrast to the “madness of crowds” that is the Wall Street norm – it can be found at seekingalpha.com.