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We Don’t Think Volatility Is An Effective Hedging Signal. Here’s Why

By Jeremy Schwartz , Director of Research and James Wood-Collins, CEO of Record Currency Management In a recent blog post , we outlined why volatility is not among our preferred currency-hedging signals. To recap, by definition, volatility does not indicate a specific direction of a currency pair, and it would lead to opposite conclusions for U.S.-based investors compared to internationally based investors. But to expand on the analysis, consider the following: If there were a correlation between volatility and, say, U.S. dollar strength or weakness AND if an investor were willing to rely on this correlation persisting, then perhaps a more or less volatile environment could be taken to indicate the likeliness of U.S. dollar strength or weakness. However, although such correlations have been observed sporadically in the past, they have not proved persistent. The chart below shows the correlation between historic volatility (measured as the standard deviation of daily spot movements over a rolling 63-day window at successive month-ends) and the returns from being long U.S. dollar in a hedge against each of the euro, Japanese yen and pound sterling in the following month. Although there have been times when this correlation was positive at a statistically significant level, it has also been negative at times, and overall has proved highly sporadic and unstable over the full period shown. 36-Month Rolling Correlation: Currency Pair Spot Rate Volatility (63 days) vs 1m Passive Hedging Return (Long USD, 1m Lag) Click to enlarge Using volatility as a currency-hedging signal could therefore be a classic case of relying on a sporadic correlation that has emerged from time to time and naively assuming that it will continue into the future. It is worth asking, though, why this correlation emerged. We attribute it to the ” safe-haven ” status that the U.S. dollar acquired at times during the financial crisis of 2008-2009 (indeed, it’s noteworthy that even in this period, returns from being long U.S. dollar frequently had the lowest correlation with volatility, and hence safe-haven status, when measured against the Japanese yen, itself a regional safe haven). Should we expect this status to persist? To some degree, U.S. Treasuries will always be seen as one of the world’s safest asset classes. However, if U.S. dollar interest rates continue to increase, it’s possible the dollar becomes more of an “investment” than a “funding” currency in certain currency strategies, in which case we would expect its risk sensitivity to increase and safe-haven status to diminish. Therefore, relying on the sporadic correlation seen in the past could be even more unreliable in a rising U.S. dollar rate environment. All of this reinforces why we favor three directional signals in applying our hedge ratios . Higher U.S. interest rates, the momentum of the U.S dollar or an undervalued dollar will all signal to U.S. investors to hedge their euro exposure, while also being a signal to euro-based investors not to hedge their U.S. dollars. These three signals are thus consistent by virtue of being directional. Volatility does not share this feature and relies on a weak link between the correlation of U.S. dollar volatility and the strength of the U.S. dollar. Given the multitude of factors at play impacting currency markets, relying on this correlation of volatility to stay positive for an extended period seems a bet we would not be willing to take. Hedging can help returns when a foreign currency depreciates against the U.S. dollar, but it can hurt when the foreign currency appreciates against the U.S. dollar. No WisdomTree Fund is sponsored, endorsed, sold or promoted by Record Currency Management (“Record”). Record has licensed certain rights to WisdomTree Investments, Inc., as the index provider to the applicable WisdomTree Funds, and Record is providing no investment advice to any WisdomTree Fund or its advisors. Record makes no representation or warranty, expressed or implied, to the owners of any WisdomTree Fund regarding any associated risks or the advisability of investing in any WisdomTree Fund. Jeremy Schwartz, Director of Research As WisdomTree’s Director of Research, Jeremy Schwartz offers timely ideas and timeless wisdom on a bi-monthly basis. Prior to joining WisdomTree, Jeremy was Professor Jeremy Siegel’s head research assistant and helped with the research and writing of Stocks for the Long Run and The Future for Investors. He is also the co-author of the Financial Analysts Journal paper “What Happened to the Original Stocks in the S&P 500?” and the Wall Street Journal article “The Great American Bond Bubble.”

Advisors May Need To Make Changes To Win HNW Business

High-net worth (“HNW”) investors, which are defined as households with investable assets between $5 million and $25 million, accounted for one-quarter of the nearly $64 trillion U.S. investable asset share in 2015. Obviously, HNW investors are highly prized by most financial advisory firms, but aspiring advisors often underestimate the breadth of business changes that are required in order to properly serve these customers, according to a recent white paper published by BNY Mellon’s Pershing: What Wealth Wants: Refining Your Firm’s Approach to the High-Net-Worth Market . Some of the required business changes may include: Addition of new services Expanded set of financial planning products and solutions Higher service standards Ability to scale More staff Increased spending on operations and technology Pricing adjustments “Serving this segment successfully is not just a matter of identifying prospects and converting them,” said Katie Swain, director of financial solutions at Pershing, in a statement. “It requires a substantial evolution and transformation of a firm’s approach to service and infrastructure to ensure that HNW clients can be profitably and sufficiently served over the long term.” Wirehouses and private banks were the types of firms that traditionally served the HNW market. More recently, however, independent advisory firms have been expanding their capabilities in pursuit of HNW business — and they’ve been successful, thanks in part to their ability to generate greater customer satisfaction by providing more individualized service. “HNW clients’ expectations for customized solutions are driven by the complex and unique circumstances they experience in their lives,” said Gabriel Garcia, director of relationship management at Pershing Advisor Solutions. “They seek solutions for leveraging existing intangible assets in a way that minimizes interest costs and tax consequences, and advisors need to deliver these services in a seamless way.” For the independent advisors that succeed in winning HNW investor business, the rewards are lucrative. The average client size for an advisor serving HNW investors is more than 30 times that of an advisor serving clients with less than $1 million in assets under management. For more information, download a pdf copy of the white paper .

5 Picks From Top Equity-Focused Mutual Fund Sectors

In spite of a strong rebound in the second half of February, the U.S. benchmarks mostly ended the month in the red due to China-led global growth worries, mixed domestic economic data and rate hike uncertainty. Though the Dow ended the month in the green, the S&P 500 and the Nasdaq witnessed the third straight month of loss for the first time since September 2011. However, strong gains in the beaten down sectors and a considerable rise in oil price helped the benchmarks to pare down some of the losses. Meanwhile, U.S. equity-based mutual funds continued to witness significant outflows and the comparatively safer ones remained the drawing cards. Moreover, nearly half of the broader mutual fund categories ended the month in the negative territory. Then again, most of the equity-based mutual fund sectors registered gains during the month. Let’s dig into the drivers and dampeners of February. Major Market Impacts Concerns over weak global growth played a major role in dragging most of the benchmarks to the negative zone in February. Yet another rate cut by the People’s Bank of China on Monday intensified worries over the country’s sluggish economy. The central bank lowered the reserve requirement ratio by 0.5% to 17% in order to boost monetary inflow. This was the fifth rate cut by the bank over the past one year. On the domestic front, economic data was mixed over the month of February. Key manufacturing and servicing data for January was pretty discouraging. Though the unemployment rate declined to 4.9% in January, the number of jobs generated declined significantly to 151,000 from 262,000 in December. Moreover, waning consumer sentiment and decline in most of the home sales data had a negative impact on investors. However, increased industrial production, higher key inflation data, and an upwardly revised fourth-quarter GDP rate boosted investor sentiment. As per the “second” estimate by the Bureau of Economic Analysis, the economy expanded by an annual rate of 1% in the fourth quarter, up from the consensus estimate of 0.4% growth. Fourth-quarter GDP data was revised upward from the previously estimated 0.7% rise. Separately, the highest increase of 1.7% in core PCE (Personal Consumptions Expenditure) index – an important indicator of inflation – in January since July 2014 increased the possibility of a sooner-than-expected rate hike. This is because the figure came close to the Fed’s target of 2%. Though comments from some of the Fed officials suggested that there may not be a lift-off in March, these did not give any clear indication on whether the key interest rates will be hiked at all this year. However, WTI crude sprung a sweet surprise in February. After plunging to the 13-year low level of $26.05 on Feb. 11, WTI crude gained nearly 30% on chances of a production cut. This had a positive impact on energy shares, which in turn boosted the major benchmarks. The beaten down sectors like materials, industrials and financials gained 10.9%, 7.2% and 0.6%, respectively, last month. These sectors are down 3.1%, 1.1% and 10.5%, respectively, in the year-to-date frame. Outflows in Stock Funds Continue According to Lipper, U.S.-based stock funds saw withdrawals of $2.8 billion for the week ended Feb. 24, which was the eighth straight week of outflows. While funds focused on domestic stocks witnessed an outflow of $2.5 billion, those focused on stocks from foreign markets – including China, Europe, Japan and emerging economies – saw withdrawal of $231 million. Of the sectors that Lipper tracks, only utility posted positive flows during the week by virtue of its safe-haven appeal. It was the seventh consecutive week of inflows of this sector. In general, the safer options attracted significant amount of inflows. During the week ending Feb. 24, U.S. funds investing in precious metals attracted $2.3 billion in investments. Moreover, funds that emphasize investing in taxable bond added $5.1 billion, witnessing the first straight week of inflows. The U.S. Treasury funds registered inflows for the eleventh consecutive week by attracting $440 million. Separately, though riskier funds such as investment-grade corporate debt funds, high-yield bond funds and emerging market debt funds drew investor attention in the week under consideration, these saw significant outflows over the month. 5 Mutual Funds to Buy Despite continued outflows, equity-focused mutual funds performed better in the month of February than January. Out of the 14 equity sectors that are tracked by Morningstar, nine ended the month in the green. Hence, we have identified a fundamentally strong mutual fund from each of the five top performing mutual fund sectors of February. The funds mentioned below carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or #2 (Buy). We expect these funds to outperform their peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund rating systems, the Zacks Mutual Fund Rank is not just focused on past performance but also on the likely future success of the fund. These funds also have an encouraging one-month return and minimum initial investment of less than $5,000. Also, these funds have a low expense ratio and no sales load. First – Equity Precious Metals gained 29.9% American Century Quantitative Equity Funds Global Gold Fund (MUTF: BGEIX ) invests in securities of global companies whose operations are related to gold or other precious metals. The fund invests the lion’s share of its assets in companies involved in processing, mining, fabricating and distributing gold or other precious metals. BGEIX currently carries a Zacks Mutual Fund Rank #2 and has a one-month return of 31.78%. Annual expense ratio of 0.67% is lower than the category average of 1.44%. Second – Industrials gained 3.6% Fidelity Select Industrials Portfolio (MUTF: FCYIX ) seeks growth of capital. FCYIX invests a large chunk of its assets in common stocks of companies worldwide that are involved in operations related to industrial products. Notably, FCYIX is non-diversified. FCYIX currently carries a Zacks Mutual Fund Rank #2 and has a one-month return of 6.5%. Annual expense ratio of 0.78% is lower than the category average of 1.33%. Third – Natural Resources gained 2.1% T. Rowe Price New Era Fund (MUTF: PRNEX ) invests at least 75% of its assets in common stocks of companies from the natural resource domain. PRNEX may also invest in securities of companies having impressive growth prospects. Currently, PRNEX carries a Zacks Mutual Fund Rank #1 and has a one-month return of 7.4%. Annual expense ratio of 0.67% is lower than the category average of 1.46%. Fourth – Communications gained 1.8% Fidelity Select Telecommunications Portfolio (MUTF: FSTCX ) seeks capital growth. FSTCX invests the major portion of its assets in common stocks of companies involved in operations related to communications services or communications equipment. Securities of both U.S. and non-U.S. companies may find a place in this non-diversified fund. FSTCX currently carries a Zacks Mutual Fund Rank #1 and has a one-month return of 5.1%. Annual expense ratio of 0.82% is lower than the category average of 1.47%. Fifth – Utilities gained 1.2% American Century Utilities Fund (MUTF: BULIX ) invests the majority of its assets in equities related to the utility industry. The fund’s portfolio is based on qualitative and quantitative management techniques. In the quantitative process, stocks are ranked on their growth and valuation features. BULIX currently carries a Zacks Mutual Fund Rank #1 and has a one-month return of 7.3%. Annual expense ratio of 0.67% is lower than the category average of 1.25%. Original Post