Tag Archives: financial

Examining An ETF Strategy For Your U.S. Equity Exposure

Summary Reviewing several ETFs with exposure primarily to the U.S. equity space to see which combination will produce the highest risk-adjusted returns. I have used a mixture of large, mid, and small cap ETFs to get broad exposure to the U.S. stock market. Using fifteen years of historical data, I believe increasing exposure to a smaller-cap ETF will produce higher long-term risk-adjusted returns. With Christmas just around the corner, many investors begin their focus on asset allocation and reviewing their portfolios. It has been a turbulent year for global equities with many different macro events affecting returns throughout the world. With the recent economic news coming out of the U.S., specifically the Friday jobs report and the imminent rate hike from the Fed later in December, I’ve turned my focus onto the U.S. equity space to ensure my exposure to this market is balanced, poised for long-term growth, and well-diversified in terms of sectors. For the purposes of this article, I have narrowed down my selection of ETFs to include those that are simply focused on different market capitalizations within the U.S. equity space. That means I have eliminated funds that may be dividend-focused, value/growth focused, sector-specific, or other specialty funds. I’ve done this to keep my analysis simple and ensure I get as broad and diversified as possible. Once I narrowed it down my list, I had three broad categories – Large Cap, Mid Cap, and Small Cap – as defined by the fund companies themselves. Next, I wanted to focus on just a few from each category to see which performed better. For the Large Cap ETFs, I chose the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) and the SPDR Dow Jones Industrial Average ETF (NYSEARCA: DIA ). For the Mid Cap space, I chose the iShares Core S&P MidCap ETF (NYSEARCA: IJH ) as well as the SPDR S&P MidCap 400 ETF (NYSEARCA: MDY ). Finally, for the Small Caps I only had one fund that had enough historical data to do the simulation, so I chose the iShares Core S&P Small-Cap ETF (NYSEARCA: IJR ). Timing When I was narrowing down my list of ETFs, I wanted to ensure they have been active long enough to see some of the more significant events of the last decade and a half. That way, the results would capture the tech bubble, the financial crisis, as well as the bull markets that accompanied them. Since most of the iShares ETFs were launched in May 2000, I chose to begin my analysis on July 1, 2000. SPY data by YCharts Assumptions All the daily share price data was pulled from Yahoo! Finance and I used the adjusted close price for all of my analysis. In addition, I used the 3-month treasury bill rates from the Federal Reserve website for each calendar year to calculate excess returns and risk-adjusted returns. Finally, I pulled the most recent MER information for each fund from Yahoo! Finance as well and reduced each year’s gross returns by that percentage before calculated the excess return information. Analysis Below is the summary of each of the five funds performance over the 15 years of data. To make my analysis easier, I used the last trading day of each year to calculate the yearly portfolio return to compare against the risk-free rate. (click to enlarge) Sources: Yahoo! Finance, Federal Reserve website As can be seen above, the small cap fund IJR offers the highest risk-adjusted return profile of the five funds I analyzed. Furthermore, you should note that as you move from the large cap funds of SPY and DIA to the mid-caps and then small, both absolute and risk-adjusted returns become stronger. I found this to be quite interesting as typically smaller cap funds comparatively have higher risk profiles. Since I wouldn’t recommend having all your U.S. equity exposure in one fund, I calculated some hypothetical portfolios with different weights for each of the three categories. From the data above, I also was able to narrow down which fund to use for each category; DIA for the Large Cap, IJH for Mid Cap and IJR for Small Cap. I also used $10,000 as a starting investment for each portfolio. Portfolio #1 – One third (1/3) invested in each of the three funds Portfolio #2 – 50% invested in the small cap, 25% in the others Portfolio #3 – 50% invested in the large cap, 25% in the others I found it quite interesting, although not surprising, just how much stronger the performance was on portfolio #2, which had 50% invested in the small cap ETF and ultimately how it also offered the strongest Sharpe Ratio. Overall, portfolio #2 outperformed the “standard” portfolio #1 by over 4.3% and the large-cap focused #3 by almost 12%. I also wanted to look at the sector breakdown of each fund to see if there was a significant difference in the three portfolios based on how the funds would be split up. As you can see below, there is some variance in the sector breakdown of each fund as you move from the large to small caps as well as with each portfolios’ hypothetical breakdown, but there is nothing overly significant to note. Most of the funds keep a relatively similar balance in the sectors with the exception of Real Estate which has zero exposure in the DIA. Conclusion I’ve always been well aware of the fact that, over longer periods of time, small cap stocks will tend to outperform large caps. For the most part, I was always of the impression that this higher return came with higher risk. However, after doing this analysis and seeing the results I would be inclined to increase my overall U.S. equity exposure to smaller cap companies as I am looking to hold onto this portfolio for an extended period of time. This sort of analysis is something I will continue to do each year to ensure if there are significant changes in the performance and risk profile of each fund that I capture them and adjust my investments accordingly.

Is The Market Fair? Yes Vs. No

Summary Yes. Mostly. But not entirely. 3 recent exploitable examples. Is the market fair and efficient? Yes. Well, almost always. The second best piece of news I have for you is that markets work quite well. Few activities allow for so much success for the people who don’t even try. If you sign up for a marathon and get to the starting line but don’t try to run, you lose to every other runner. If you don’t try to beat the market, you simply sign up for an index fund or buy a passive ETF in the S&P 500 (NYSEARCA: SPY ), you beat about three quarters of other investors. No. Not entirely. The best piece of news I have for you is that market prices fail sometimes – and do so in ways that are exploitable for profit. One of the best books to date on the subject has one of the worst titles: You Can Be A Stock Market Genius . It reveals the world of spinoffs, merger securities, bankruptcy, restructuring, recapitalizations, stubs, and warrants. It is in such investment opportunities where the price system often fails to accurately reflect underlying value. Today, there are three such investment opportunities where the price system continues to fail. These are not prices that are off a bit. They are prices that are wrong. They include share class trades such as CBS / CBS.A , parent/sub stubs such as Yahoo! (NASDAQ: YHOO ), and closed-end fund IPOs such as CCD . CBS There are two related opportunities in CBS. The first is that there are two share classes, each with the same economic value. According to the company, CBS Corporation has two classes of common stock: Class A, which is the voting stock, and Class B, which is the non-voting stock. There is no difference between the two classes except for voting rights. Shares of CBS Class A and Class B common stock generally trade within a close price range of each other. There are, however, more shares of Class B common stock outstanding, and most of the trading occurs in that class. The second is that it is unlikely that CBS remains a standalone company after a transition from its 92-year-old founder and executive chairman departs his role. (click to enlarge) So, it is reasonable to expect the price difference to converge. Given the likelihood that it will get a takeover premium, it is probable that the convergence is upward from the current market prices. What should one do with such situations? CBS Class B shares (NYSE: CBS ) are probably a bargain around $50 per share, even if it remains a standalone company. They are even better if Time Warner (NYSE: TWX ) or someone else buys CBS after Redstone’s tenure. But what is even more interesting is that the share class spread will probably go to zero in such a deal. One way to capture this spread is to buy the B shares ( CBS ) while writing calls on the Class A (NYSE: CBS.A ) shares. For example, you can write May 2016 CBS.A $50 calls, These have a $5.40 bid and a $7.50 ask. This is an attractive amount of premium to capture in addition to the share class spread. In an efficient market, this opportunity should not exist. But it is there for the taking. Yahoo! Net of cash, Yahoo Japan, and Alibaba (NYSE: BABA ), the public capital market valued Yahoo’s core business at $0.11 as of the beginning of this month. The structure can probably be resolved in a number of different tax-efficient ways according to this recent analysis. Reasonable people can differ on the value of the core business, but the stub is probably worth somewhere in the range of $4-$5 per share. $0.11 is just wrong. Net of cash and the exposure to BABA and Yahoo Japan, if the process goes badly and the company performs poorly, the stub should at least double. If the process goes well and the company performs well, the stub should at least double again. CEF IPOs The CEF IPO is an opportunity to lose 8% of your money quickly, then much the rest slowly. They are useful for investors because they are the financial world’s equivalent of a ski mask on a warm sunny day in that any broker caught with one has identified himself as a likely swindler. While I am a longtime skeptic of boom era IPOs generally, my skepticism is greatest when it comes to initial public offerings of closed-end funds. With industrial IPOs, there is some pre-existing corporate asset being supplied. With CEFs, the IPO is driven by the demand. What CEFs get IPOed? Whatever the retail mass market wants. Whatever is most in favor, priced-in, or trendy is what gets invented and then sold to the trusting public. At least industrial IPOs initially pop 16% or so on average on the first day and only later lose investors’ money. But with CEF IPOs, there is not even that initial pop. Then, average CEFs are down about 8% within three months, 13% within five months, and 19% within a year. While there is a market inefficiency in the repeated ability to sell such CEFs to the public for a 5-10% premium to NAV, the market is subsequently efficient at wrenching that premium out of the price. Over a billion dollars of value has been transferred from CEF investors to underwriters on day one. That is about 8% of the money that they invested. There is zero evidence of skill in the (typically expensive) management of the remaining 92% of their money. It is instructive that only about 4% of investors in new CEFs are institutional investors compared with the 22% of investors following similar industrial IPOs. One recent example is Calamos Dynamic Convertible and Income (NASDAQ: CCD ). This has been a smashing success… for its underwriters are brokers. These wealth transfers are useful tools for investors to identify brokers who are willing to do anything and say anything to take your money. So far, it is right on schedule. The market squeezed out massive underwriting fees, losing 11% of value in 100 days (slightly ahead of the -8% historical average) and 25% within five months, well ahead of the -13% pattern such funds have seen in the past. This was not a problem; this was the plan. These can be good opportunities to buy at deep discounts to NAV. Nobody sells shares for no good reason like an investor who bought them for no good reason. By the time they have sold off, the investors are probably in the market for a new broker while the broker is in the market for his next mark. Conclusion The market is good. It is good enough to trust in its general fairness and approximate efficiency. You can put all of your money in passive exposure to equities, debt, and cash with the confidence that – on average and over time – you will get what you pay for. But it is also imperfect. For diligent bargain hunters, some durable inefficiencies include occasional share class spreads, cheap parent-subsidiary stubs, and broken CEF IPOs. It is possible to beat the market over the long-term by judiciously selecting securities within such categories. Is the market efficient? I find much of the academic literature that indicates significant efficiency to be persuasive, yet in my direct experience, I keep finding lucrative exceptions. What do you think and what have you found? Please use the comment section below to weigh in with your findings.

10 Ways To Destroy Your Portfolio

With the increased frequency of heightened volatility, investing has never been as challenging as it is today. However, the importance of investing has never been more crucial either, due to rising life expectancies, corrosive effects of inflation, and the uncertainty surrounding the sustainability of government programs like Social Security, Medicare, and pensions. If you are not wasting enough money from our structurally flawed and loosely regulated investment industry that is inundated with conflicts of interest, here are 10 additional ways to destroy your investment portfolio: #1. Watch and React to Sensationalist News Stories: Typically, strategists and pundits do a wonderful job of parroting the consensus du jour. With the advent of the internet, and 24/7 news cycles, it is difficult to not get caught up in the daily vicissitudes. However, the accuracy of the so-called media experts is no better than weather forecasters’ accuracy in predicting the weather three Saturdays from now at 10:23 a.m. Investors would be better served by listening to and learning from successful, seasoned veterans. #2. Invest for the Short Term and Attempt Market Timing: Investing is a marathon, and not a sprint, yet countless investors have the arrogance to believe they can time the market. A few get lucky and time the proper entry point, but the same investors often fail to time the appropriate exit point. The process works similarly in reverse, which hammers home the idea that you can be 200% wrong when you are constantly switching your portfolio positions. #3. Blindly Invest Without Knowing Fees: Like a dripping faucet, fees, transaction costs, taxes, and other charges may not be noticeable in the short-run, but combined, these portfolio expenses can be devastating in the long run. Whether you or your broker/advisor knowingly or unknowingly is churning your account, the practice should be immediately halted. Passive investment products and strategies like ETFs (Exchange Traded Funds), index funds, and low turnover (long time horizon / tax-efficient) investing strategies are the way to go for investors. #4. Use Technical Analysis as a Primary Strategy: Warren Buffett openly recognizes the problem with technical analysis as evidenced by his statement, “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.” Legendary fund manager Peter Lynch adds, “Charts are great for predicting the past.” Most indicators are about as helpful as astrology, but in rare instances some facets can serve as a useful device (like a Lob Wedge in golf). #5. Panic-Sell out of Fear And Panic-Buy out of Greed: Emotions can devastate portfolio returns when investors’ trading activity follows the herd in good times and bad. As the old saying goes, “Following the herd often leads to the slaughterhouse.” Gary Helms rightly identifies the role that overconfidence plays when in investing when he states, “If you have a great thought and write it down, it will look stupid 10 hours later.” The best investment returns are earned by traveling down the less followed path. Or as Rob Arnott describes, “In investing, what is comfortable is rarely profitable.” Get a broad range of opinions and continually test your investment thesis to make sure peer pressure is not driving key investment decisions. #6. Ignore Valuation and Yield: Valuation is like good pitching in baseball…very important. Valuation may not cause all of your investments to win, but this factor should be an integral part of your investment process. Successful investors think about valuation similarly to skilled sports handicappers. Steven Crist summed it up beautifully when he said, “There are no ‘good’ or ‘bad’ horses, just correctly- or incorrectly-priced ones.” The same principle applies to investments. Dividends and yields should not be overlooked – these elements are an essential part of an investor’s long-run total return. #7. Buy and Forget: “Buy-and-hold” is good for stocks that go up in price, and bad for stocks that go flat or decline in value. Wow, how deeply profound. As I have written in the past, there are always reasons of why you should not invest for the long term and instead sell your position, such as: 1) new competition; 2) cost pressures; 3) slowing growth; 4) management change; 5) excessive valuation; 6) change in industry regulation; 7) slowing economy; 8) loss of market share; 9) product obsolescence; 10) etc, etc, etc. You get the idea. #8. Over-Concentrate Your Portfolio: If you own a top-heavy portfolio with large weightings, sleeping at night can be challenging, and also force average investors to make bad decisions at the wrong times (i.e., buy high and sell low). While over-concentration can be risky, over-diversification can eat away at performance as well – owning a 100 different mutual funds is costly and inefficient. #9. Stuff Money Under Your Mattress: With interest rates at the lowest levels in a generation, stuffing money under the mattress in the form of CDs (Certificates of Deposit), money market accounts, and low-yielding Treasuries that are earning next to nothing is counter-productive for many investors. Compounding this problem is inflation, a silent killer that will quietly disintegrate your hard earned investment portfolio. In other words, a penny saved inefficiently will lead to a penny depreciating rapidly. #10. Forget Your Mistakes: Investing is difficult enough without naively repeating the same mistakes. As Albert Einstein said, “Insanity is doing the same thing, over and over again, but expecting different results.” Mistakes will be made and it behooves investors to document them and learn from them. Brushing your mistakes under the carpet may make you temporarily feel better emotionally, but will not help your financial returns. As the year approaches a close, do yourself a favor and evaluate whether you are committing any of these damaging habits. Investing is tough enough already, without adding further ways of destroying your portfolio. Disclosure: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.