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Was Dalio Risk Parity Strategy Responsible For Recent Turmoil?

Within minutes after the opening bell on Black Monday, August 24, the Dow plummeted 1,089 points, surpassing even the flash crash of 2010. Dramatic declines caused stocks and exchange-traded funds to be automatically halted by stock exchanges more than 1,200 times. The market remained volatile in next weeks also, pulling down both the Dow and the S&P 500 indices down by more than 6 percent in August. The risk parity strategy, pioneered by Ray Dalio, the founder of world’s largest hedge fund, came under fire for this market volatility. The risk parity investment strategy was developed and first adopted as All Weather Fund in Bridgewater Associates in 1996 and has become increasingly popular in the industry. This has been one of most successful investment strategies since last two decades. But its recent performance has been poor. Of late some analysts and fund managers such as Lee Cooperman of Omega Advisors have started blaming the risk parity strategy for the market turmoil seen in recent weeks. This pushed Dalio to a defensive position, prompting his firm to come out with a report for its clients defending his risk parity approach. The Bridgewater report tries to dispel many of the concerns surrounding risk parity and the All Weather fund. Let us see what this risk parity strategy is, how it works, what blames are and what Dalio wants to say. What is All Weather risk-parity strategy and how does it work? The risk- parity strategy is Bridgewater’s flagship strategy, known as All Weather strategy. It is one of the two investing strategies consistently followed since last two decades by Bridgewater Associates, the world’s largest hedge fund with $170bn in assets under management. While the Bridgewater’s other strategy, known as Pure Alpha, is a traditional hedge fund strategy, All Weather is a risk-parity and leveraged beta strategy. It is based on the philosophy that there are four basic economic scenarios: rising or falling growth, rising or falling inflation. And different class of assets behave differently in each of these economic scenarios. The risk-parity’s objective is to reduce the volatility of investing in assets that normally move in the opposite direction in different economic environment. The All Weather strategy allocates 25% of a portfolio’s risk to each of these scenarios. It is allocation of risk and is different from allocation of assets. The portfolio makes money in any economic environment and is considered as a solid strategy in both good and bad markets. All Weather has given 8.95 percent average annual return since its inception in 1996. Its long-term success has helped the industry expand. But this August, $80bn “All-Weather” risk parity fund lost 4.2 per cent and is down nearly 5% YTD. The famous all weather strategy is facing rough weather from critics. What are blames on the risk parity strategy? First, the risk parity strategy allocates assets based on volatility. The ‘smart beta’ passive equity strategies adjust their exposures according to algorithms in response to market moves. The risk parity funds and momentum investors known as CTAs are typically computer driven. Any in volatility can trigger a rash of automated selling. Second, the risk parity strategy involves use of leverage, derivatives and borrowed money, to amplify their bets tied to the performance of bonds, stocks and commodities. Fund Managers often shift their allocations of assets to maintain an equal distribution of risk. They invest passively in a range of financial assets according to their mathematical volatility. In August as volatility increased, these funds are accused to have begun selling with increased intensity. The selling created more selling. This effect then cascaded through markets, and asset correlations increased. As a result assets like stocks and bonds, which often trade in opposite directions, began to fall at the same time. Market collapsed. The risk parity strategy too underperformed. What does Ray Dalio say in defense of risk parity strategy? The inventor of risk parity strategy, Ray Dalio, strongly defends his strategy and Bridgewater’s approach amid criticism. While the strategy might occasionally underperform other investment techniques, but it was still the best long-term strategy. Unlike other funds, Bridgewater does not tend to sell assets when prices fall and buy them when prices rise. It does the opposite to rebalance to achieve a constant strategic asset allocation mix. All Weather portfolio is well diversified so as not to be exposed to any particular economic environment. It has no such systematic bias to do better when interest rates are falling compared to that when they are rising. So it is not vulnerable to a bond sell-off. Dalio says Bridgewater is not responsible for the stock market increased volatility seen last month. Relative to the size of global asset markets, the risk parity strategy funds is too small to move market. It is like a drop in the bucket. Allocations are not adjusted due to swings in volatility, and therefore could not have created the market impact. “All Weather is a strategic asset allocation mix, not an active strategy. As such, All Weather tends to rebalance that mix which leads us to tend to buy those assets that go down in relation to those that went up so that we keep the allocations to them constant. This behavior would tend to smooth market movements rather than to exacerbate them,” fires back Dalio in the Bridgewater Report .

Following The Smart Money For Asian Stocks Beyond 13Fs

Summary Filing form 13F, the reporting of holdings for institutional investment managers with investment discretion over $100 million or more in stocks, is unique to the U.S. It is possible to utilize a piggybacking strategy for idea generation in Asia, if you know who and how to follow. I utilize a 360-degree idea generation process via screens, insider trades, 13Fs, fund manager letters, analyst reports, blogs, forums among others. Following The Smart Money In Asia In the U.S., institutional investment managers with investment discretion over $100 million or more in stocks have to file 13Fs declaring their holdings (long only) with the U.S. Securities and Exchange Commission within 45 days of every quarter. This has indirectly made the investment strategy of cloning the portfolios of well-known and successful fund managers a reality. Even for investors who do not believe in replicating the positions of their favorite investors in full, they might still generate potential investment ideas by taking a peek at the investors’ holdings. Since I invest in both Asian and U.S. stocks, I have always thought about the possibility of applying certain aspects of this piggybacking strategy in the Asian context and this is precisely the focus of this article. In the sections below, I will provide a few examples of generating Asian stock ideas by following the smart money. That being said, it is intriguing that while I generated most of my stock ideas via quantitative screens, my investments and calls were validated to a large extent by similar positions that other fund managers and investors held. I will share some of these past and current stock ideas below. Following U.S. Investors Vested In Asian Stocks An increasing number of U.S. funds are investing in Asia-listed stocks. While they do not have to file 13Fs for these non-U.S. holdings, it is possible to uncover these hidden gems by reviewing mutual funds’ shareholder reports and hedge funds’ investor letters (assuming that they are accessible). Let me illustrate this with some examples. Oriental Watch Holdings Ltd ( OTC:ORWHF ) (0398.HK) was the first Asia-listed stock which I wrote about here on Seeking Alpha. Oriental Watch simply just appeared on my net-net screens one day, and it appeared to be attractive given its long-term profitability and dividend track record and the value of its self-owned properties. I was not alone in my views on Oriental Watch. Tweedy Browne, Benjamin Graham’s former broker which subsequently made its foray into fund management as a classic Graham value manager (read “The Little Book Of Value Investing” by Christopher Browne if you are interested about understanding the firm’s investment philosophy), first disclosed its stake in the stock in its Q3 2013 commentary , and referred to it as “a luxury retailer and a classic Ben Graham net current asset microcap stock, which at purchase was trading at two-thirds of its net cash and inventories.” As of June 30, 2015, Tweedy, Browne Global Value Fund and Tweedy, Browne Global Value Fund II held 7,364,000 and 3,348,000 shares of Oriental Watch, respectively. Other Hong Kong-listed stocks currently held by Tweedy Browne include Great Eagle Holdings Ltd ( OTCPK:GEAHF ) (41 HK), Hengdeli Holdings Ltd ( OTCPK:HENGY ) (3389 HK), Miramar Hotel & Investment ( OTC:MMHTF ) (71 HK) and Tai Cheung Holdings Ltd ( OTC:TAICY ) (88 HK). Tweedy Browne also holds shares in a Japanese net-net, Shinko Shoji ( OTCPK:SKSJF ) (8141 JP), which I briefly wrote about here . Besides reading investor letters and shareholder reports of U.S. funds investing globally, one can also follow individual fund managers on their social media platforms such as blogs. Travis Wiedower, Managing Director of Wiedower Capital, a small value-oriented investment firm, writes a blog (called Egregiously Cheap) and he recently wrote an article titled “Oriental Watch: Deep Value at its Finest”. In the article, Travis refers to Oriental Watch as a “company selling for ~35% of liquidation value that has a clear route back to profitability.” This is the first Asia-listed stock that Travis has written about, and I hope he can share more such ideas in the future! Following Asian Fund Managers Directly Asian mutual funds will disclose their holdings periodically in quarterly or semi-annual shareholder reports, which are typically available on their respective websites. For Asian hedge funds, I will be on the lookout for any interviews that the fund managers have done or investor letters that they have made available. Ronald Chan will probably be a familiar name to my readers. Ronald Chan is the author of the book “The Value Investors: The Lessons From The World’s Top Fund Managers, which I have quoted a couple of times in my previous articles. Ronald is also the author of another book “Behind the Berkshire Hathaway Curtain: Lessons from Warren Buffett’s Top Business Leaders,” where he interviewed the top managers of Berkshire Hathaway’s subsidiaries. It is obvious from these two books that Ronald is a value investor; he is currently the Chief Investment Officer of Chartwell Capital based in Hong Kong, which he started in 2007. In a Barron’s interview published in November 2014, Ronald spoke about some of his holdings, including Oriental Watch (I am using the same stock as an example to illustrate that implementing a piggybacking strategy in Asia is more difficult compared with the U.S., but not impossible if one knows where to look). Ronald has this to say about Oriental Watch: Oriental Watch is a classic Benjamin Graham example where its assets are trading much higher than its market cap. Its market cap is about HKD900 million. Its retail properties are worth HKD650 million. The watch inventory, which is 70% Rolex, has a value of HKD1.8 billion. Add cash, minus debt, I think it’s worth HKD2.4 billion. I can sleep at night because I know that it has good inventory and the retail locations that are worth a fortune. This is a classic asset-driven, asset-backed idea which no one looks at! In his interview with Barron’s, Ronald also highlighted the following Asian stocks: Hyundai ( OTC:HYMPY ) (005380.KS), Kia ( OTC:KIMTF )(000270.KS), Central China Real Estate (832 HK) and Dynam Japan Holdings Co. Ltd. ( OTC:DJPHF ) (6889 HK), a Magic Formula stock which I wrote about here . Cederberg Capital is another Asian fund that I follow. On its website , Cederberg Capital outlines its investment approach as follows: “Cederberg Capital utilizes a disciplined value-oriented approach in order to protect capital during periods of market declines and to maximize returns in the long run.” In Cederberg Greater China Equity Fund’s Q2 2015 letter, Managing Director Dawid Krige also commented on the firm’s investment philosophy: We are value investors at heart. However, we aren’t looking for Ben Graham’s “net-nets” or the “cigar butts” of the early-Buffett years. In our experience “cheap” often stays cheap in China, hence we are better off buying undervalued quality, i.e. good businesses managed by trustworthy people. We love growth, if through our research we can gain confidence about the likelihood it will be realised. However, we are careful not to overpay for growth, hence we always insist on a significant margin of safety, regardless of a company’s growth potential. Past and present investments that Cederberg Capital has profiled or commented on in its letters include Kweichow Moutai (600519 CH), which owns the top Maotai liquor brand in China, and Clear Media ( OTC:CRMLY ) (100 HK). Clear Media was a past investment of mine which I successfully exited with a 80% return in 14 months in August 2014, inclusive of a special dividend. Clear Media was an outdoor media company with dominant bus-shelter advertising network; it boasted an unique mix of deep value and wide moat characteristics. At the point of my purchase, Clear Media traded at 3x EV/EBITDA, with net cash accounting for close to half of market capitalization. Its business and attractive returns on capital were protected by high barriers to entry due to local regulatory approvals required for construction and maintenance of bus shelters. However, it is unfortunate (for investors like us) that Cederberg Capital has decided to “limit discussions of existing holdings to protect our intellectual property and to mitigate any behavioral biases, though we will continue to discuss investments we’ve exited in future letters.” Nevertheless, I look forward to reading Cederberg Capital’s future letters to learn about the firm’s past “case studies.” Replicating Guru Investors’ Potential Buys In Asia Via Quantitative Screening Walter Schloss is one of the deep value investors that I admire and seek to emulate, particularly considering that he has the longest and most consistent investment track records among his peers. However, it is regrettable that Walter Schloss stopped managing money in 2001 (partly due to the fact that cheap U.S. stocks became hard to find), and he never invested in Japan or Asian stocks given concerns over differences in politics, language and regulations. Nevertheless, I thought hard about what Walter Schloss could have potentially bought in Asia if he applied his stock selection criteria for U.S. In an article titled “Walter Schloss’ Japan Shopping List For Deep-Value Stocks” published here , I did a screen based on Schloss’ 16-point “investment checklist” and found 20 Japanese stocks and 299 Asian stocks that will meet his stock selection criteria of trading near historical share price lows, being valued at a discount to net asset value and having debt-to-equity ratios below 1. Looking ahead, I plan to try to replicate other investors’ investment strategies in Asia using screens and sharing the results with my readers and subscribers. Concluding Thoughts Personally, I don’t subscribe to the view of cloning any investor’s portfolio lock, stock and barrel, even for U.S. stocks. The reason is that there are various complications involved with piggybacking such as time lag, average purchase cost and portfolio sizing. In the Asian context, a complete cloning approach is even more risky, considering that it is more difficult to track any individual fund manager’s exact holdings and buy/sell history with reasonable accuracy. Instead, I advocate that investors use fund managers’ holdings as either an idea generation tool or an alternative form of validation of one’s original investment thesis. Note: I utilize a 360-degree process to generate investment ideas, including screens, insider trades, 13Fs, fund manager letters, analyst reports, blogs, forums among others. Subscribers to my Asia/U.S. Deep-Value Wide-Moat Stocks exclusive research service get full access to the list of deep-value & wide moat investment candidates and value traps, including “Magic Formula” stocks, wide moat compounders, hidden champions, high quality businesses, net-nets, net cash stocks, low P/B stocks and sum-of-the-parts discounts.

401(k) Spotlight: Invesco Select Companies Fund

Summary With a very concentrated, long-term focused portfolio, the Select Companies Fund is the furthest from an index hugger that you are likely to fund in the mutual fund industry. The fund’s managers have carried a large cash position for several years while the broader small cap universe has been relatively overvalued and is now better positioned. The recent market selloff has presented an opportunity for 401(k) investors to take a position in the fund. Introduction I select funds on behalf of my investment advisory clients in many different defined contribution plans, namely 401(k)s and 403(b)s. I have looked at a lot of different funds over the years. 401(k) Fund Spotlight is an article series that focuses on one particular fund at a time that is widely offered to Americans in their 401(k) plans. 401(k)s are now the foundational retirement savings vehicle for many Americans. They should be maximized to the fullest extent. A detailed understanding of fund options is a worthwhile endeavor. To get the most out of this article it is helpful to understand my approach to investing in 401(k)s . I strive to write these articles for the benefit of the novice and professional. Please comment if you have a question. I always try to give substantive responses. Invesco Select Companies Fund The Select Companies Fund has the following share classes: If the fund is an option in your 401(k), it will likely come in the form of the R or R5 shares. The expense ratio for the R shares is 1.45% and for the R5 shares it is .88%. For the purposes of this article, I will assume the A shares are being discussed since that share class holds most of the fund’s assets. Some readers may own the fund outside of a company retirement plan. The expense ratio of the A shares is 1.20%. The fund is best classified as a small capitalization (“cap”) blend or core fund. The weighted median market cap of the fund’s holdings is right around $2 billion. Fund Strategy The strategy of the fund is simply “beautiful” from my perspective. Invesco states it as follows: A high-conviction, long-term investment strategy in which managers view themselves as business people buying businesses and consider the purchase of a stock the same as the purchase of an ownership interest in a business. The actions of the fund’s managers speak louder than these words. As of June 30, 2015, the fund had only 25 holdings. Also, the fund only turned over 10% of its holdings during its 2014 fiscal year. This fund strays from the index like Jonah from Nineveh. I love it. It is difficult to find a fund with such a concentrated portfolio in mutual fund land. It gets even better … As of August 31, 2015 the fund had 17% of its portfolio in cash. This was not a one time event either. 19% of the fund was in cash on June 30, 2015 and 23% was in cash on June 30, 2014. The small cap universe has been relatively overvalued for quite a while. It is good to see that the fund’s managers are not just indiscriminately throwing money into stocks. They are obviously waiting for the right opportunities. This is not surprising given that the Russell 2000 index has been trading at a forward P/E (price to earnings per share) multiple of over 20 for a few years now. As of June 30, 2015 the fund’s forward P/E was only 15.37 versus 24.91 for the Russell 2000 index. Performance Sometimes a simple chart speaks volumes. Here is one that shows the outperformance of the fund over the long-term: ATIAX Total Return Price data by YCharts Over the last ten years (as of August 31, 2015) the fund has returned 7.95% versus the index’s 7.12%. Over the last several years the fund has lagged the index, but this comes with the territory when management is not afraid to carry a sizeable cash position and make concentrated long-term bets. The following chart compares to the fund to the index over the last year: ATIAX Total Return Price data by YCharts Attractive Top Holdings The fund’s third largest holding, MicroSemi Corp. (NASDAQ: MSCC ) could benefit from a broader rebound in semiconductor stocks. It was recommended by Scott Black early this year during the Barron’s roundtable . One of the fund’s largest holdings, John Wiley & Sons (NYSE: JW.A ), was included in a recent analysis I conducted on stocks in the information solutions industry. It came up as attractively valued compared to most of its peers and sports an 8% free cash flow yield. Conclusion: Attractive Entry Point The recent pullback in the broader equity markets has presented a buying opportunity across the board for U.S. stocks. I was out of U.S. stocks for months in client 401(k)s (excluding energy funds) but recently started buying aggressively during this false panic. When a solid mutual fund has demonstrated long-term outperformance, but lagged in the near term, it often presents investors with a buying opportunity. I think this is the case now with the Select Companies Fund. The fund had a relatively low P/E multiple months before the recent selloff and is likely deep in value territory now compared to its peers. Furthermore, the fund’s sizeable cash position gives the managers the ability to add to positions in the current environment, setting them up for future outperformance. After conducting this analysis, I bought shares of the fund today for a client in her 401(k). Investors with the Select Companies Fund in their 401(k) may want to consider including it as part of a broader allocation to U.S. stocks. Investing Disclosure 401(k) Spotlight articles focus on the specific attributes of mutual funds that are widely available to American’s within employer provided defined contribution plans. Fund recommendations are general in nature and not geared towards any specific reader. Fund positioning should be considered as part of a comprehensive asset allocation strategy, based upon the financial situation, investment objectives, and particular needs of the investor. Readers are encouraged to obtain experienced, professional advice. Important Regulatory Disclosures I am a Registered Investment Advisor in the State of Pennsylvania. I screen electronic communications from prospective clients in other states to ensure that I do not communicate directly with any prospect in another state where I have not met the registration requirements or do not have an applicable exemption. Positive comments made regarding this article should not be construed by readers to be an endorsement of my abilities to act as an investment adviser.