Tag Archives: ideas

Spinoffs: Outperformance And Investment Strategies

Originally published on March 8, 2016 By Rupert Hargreaves Spinoffs Investment Strategies… Warren Buffett, Benjamin Graham, Seth Klarman and Walter Schloss are probably some of the greatest value investors of all time, and at one point or another, these investment titans have all mentioned spinoffs as a critical area for value investors to seek out bargains. And there’s plenty of cold hard data to back up this conclusion. Indeed, only last week, Goldman Sachs issued a Portfolio Strategy Research note to clients on this very topic using data from the past six months. Spinoffs Investment Strategies – Spinoffs are highly likely to outperform parents Goldman’s research note, titled Investment Strategies For Spinoffs And Carve-Outs looked at the performance of spincos relative to their parent companies and the S&P 500 in the first two years after spinoff. The bank’s research showed that since 1999, spincos have outperformed their parents and the index by a median of 9% and 6% respectively in the first two years after the spinoff. During 2015, the value of spinoffs at completion jumped 81% to $176 billion, the highest level in 15 years. Goldman expects this trend to continue throughout 2016. The prospect of modest top line growth coupled with flat margins this year is likely to push managements to pursue spinoffs as a means of generating shareholder returns. If the above forecast does play out, and a new wave of spinoffs hits the market this year, value investors will be spoilt for choice when it comes to picking undervalued, and unloved spinoffs that have been unfairly sold by the market. Unpopular spinoffs were plentiful last year. 18 of the 28 spinoffs that have taken place since June 15 had, at least, one of three alpha-generating attributes: Spinoffs Investment Strategies – Lower P/E multiple Spincos that traded at a lower forward P/E multiple than their parents outperformed their parents by 18 pp and 26 pp respectively during the one-year and two-year period after the spinoff. Goldman found the hit rate of this outperformance was 63% and 75% respectively. Lower expected EPS growth Spincos with lower twelve-month EPS growth expectations compared to the parents generated median excess returns of 21pp and 6pp respectively during the one-year and two-year period after the spinoff. The hit rate here was 81% and 56% respectively. Operated within a distinct industry versus their parents If the spinco and parent operate in different industries, the relative median return of spinco versus the parent was +3 pp for both one and two-year periods. If the two companies operated within the same industry, the performance was -7pp and +20pp. Spincos with a lower P/E multiple, lower expected EPS growth and operating in a different industry to the parent generated a median relative return of +29 pp and +47 pp versus their parents during the one-year and two-year post-spinoff periods, with hit rates of 80% and 90%, respectively. Click to enlarge And if you’re looking for ideas, 26 announced spinoffs are currently pending completion: Click to enlarge Disclosure: Rupert may hold positions in one or more of the companies mentioned in this article. You can find a full list of Rupert’s positions on his blog. This should not be interpreted as investment advice, or a recommendation to buy or sell securities. You should make your own decisions and seek independent professional advice before doing so. Past performance is not a guide to future performance.

Quant Strategies: Q1 2016 Performance

Here are the Q1 2016 total return and max drawdown numbers for the various quant strategies I track. For explanations of the various quant strategies see the portfolios page. All equity portfolios consist of 25 stocks and were formed at the end of 2015. No changes in the holdings since that time. In the table below, I list various quant strategies along with their YTD performance and drawdowns. Also, listed are various benchmark indices. Overall, the start of 2016 is working quite well for the various quant strategies. The utility strategy is leading the pack with a huge Q1. Only the microcap strategy is underperforming the relevant benchmarks. And that is after a great year in 2015. So not a big surprise. The staples value strategy continues to perform very well in almost every environment. I have been consistently surprised by this strategy. It’s probably due for a period of underperformance but not yet it seems. More aggressive versions of these strategies are also doing quite well. Ways to get more aggressive with these strategies are to run more concentrated portfolios, re-balance and check the portfolios more often, and in most portfolios the use of trailing stops enhances returns. A good stock and portfolio tool like portfolio123.com lets you do any of these quite easily. Also, for traders, the quant portfolios are fantastic idea generating lists for potential trades. I use them for this purpose every so often. In general, a great start to 2016 for quant strategies and much better than overall stock indexes and also the TAA strategies.

In Which I Answer A Question About The Volatility ETNs

The prevailing wisdom on the volatility ETNs, VelocityShares Daily Inverse VIX Short-Term ETN (NASDAQ: XIV ) and iPath S&P 500 VIX ST Futures ETN (NYSEARCA: VXX ), is that XIV will rise over time and VXX will fall as long as the term structure is in contango more often than it’s in backwardation. A recently elapsed period, slightly longer than a year, makes apparent that’s not the case. Over the period from 2-Mar-2015 to 18-Mar-2015, both XIV and VXX experienced substantial net losses. VXX declined -27.5%, while XIV declined -29.9% (Figures 1 and 2). Figure 1. XIV prices Figure 2. VXX prices This loss for both ETNs over a prolonged period occurred while the term structure was in contango 73% of the time – 2.7X more often than it was in backwardation, as Figure 3 shows below. Why is that? Click to enlarge Figure 3. Percent Contango from 2-Mar-2015 to 18-Mar-2016 One way to answer this question is by reference to variance drain. I picked the period 2-Mar-2015 to 18-Mar-2015 for illustration purposes in this article because it happens that the average of percent daily returns over this period is very close to zero for both ETNs. You can see that in Figure 4 below, which shows running totals for the percent daily returns for the indexes of both ETNs. Running totals for each end at zero, which of course means that the average percent daily return was also zero. Click to enlarge Figure 4. Running total of daily percent changes. The concept of variance drain was introduced by Tom Messmore in the context of comparing investment advisors based on average yearly percent returns. In brief, average periodic returns is a mathematically incorrect basis for comparison, since percentage gains accrue multiplicatively, not additively. This is best explained by example. Suppose you invest $100 in asset X. On Day 1, its market value falls by 25%. However, on Day 2, it rises by 25%. The average daily rate of return is (-25% + 25%)/2 = 0%. But your investment has not returned to its original value. Instead, it is now worth: $100*(1-0.25)*(1+0.25) = $93.75 A 6.25% loss. Since multiplication is commutative, order doesn’t matter. Investment Y that performs inversely to investment X, gaining 25% on Day 1, then losing 25% on Day 2 will also lose 6.25%. In general, this can be expressed as: I 0 *(1-α)*(1+α) = I 0 -α 2 , where I 0 is the initial investment. Clearly, the larger α is, the greater the net loss. Note that variance drain is not an actual loss. There’s no counterparty to variance drain. Nor is it a frictional drag in the sense that fees or leverage cost are. Rather it’s a demonstration that average periodic returns do not represent longer-term returns over multiple periods. In the case of the volatility ETNs XIV and VXX, the inverse relationship of their daily percent returns simply does not carry over to longer time periods, except by chance. What this means is that the question of why both XIV and VXX lost value, which several readers have raised in the comment sections of recently published articles on the volatility ETNs, is only a question if one starts from an incorrect assumption – namely that XIV and VXX are inversely correlated over time periods longer than one day. Since they’re not, both may lose value over time. Additionally, during time periods longer than one day when one loses as the other gains, those changes should not be expected to be equal and opposite. It’s also worth noting that excess of contango during this approximately one-year period did not result in XIV gaining value. On the contrary, it lost a substantial amount of its prior value. I’d like to encourage those who trade these ETNs to be certain the risks are well understood. Among those risks is the risk of placing too much faith in axioms and strategies that were formed during a period when the VIX was generally calm and declining. They may not apply during prolonged periods when the VIX is rising or is more frequently spiking. Disclosure: I am/we are long XIV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: I may initiate or close a long or short position in any of the volatility ETNs over the next 72 hours.