Tag Archives: management

How To Avoid Potential Value Traps With Net-Nets And Other Deep Value Stocks

Summary Rejecting ideas fast is a key aspect of making one’s stock research and investment process more efficient and effective. I provide several categories of companies and specific stocks that I rejected as potential value traps, as I ran through my raw stock screens. My exclusive research service, Asia/U.S. Deep-Value Wide-Moat Stocks, flags potential value traps with corporate governance issues, financial statement manipulation risks and other red flags. Background On The Idea Of Rejecting Potential Value Traps I have been a keen follower of Nate Tobik’s (Oddball Stocks) writings and work on deep value investing. In October 2014, Nate participated in a value investing seminar, where the video of his presentation was posted online here. In Nate’s presentation, he spoke about the process of finding and investing in oddball stocks. What caught my attention was this first bullet point on his slide titled ‘Evaluating Ideas’ where Nate wrote “Fail fast: Want to reject ideas as quickly as possible.” In the sections below, I outline certain (non-exhaustive) categories of companies and specific stocks that I rejected as potential value traps, as I ran through my raw stock screens. Past Dealings With Minority Shareholders Wong’s Kong King International (532 HK) operates under two segments: Trading and Manufacturing. The Trading segment is engaged in the trading and distribution of chemicals, materials and equipment used in the manufacturing of printed circuit boards and electronic products; while its Manufacturing business is involved in the manufacturing of electrical and electronic products. Wong’s Kong King is a net-net trading at 0.60 times P/NCAV. Based on its share price of HK$0.65 as of September 25, 2015, Wong’s Kong King’s share price is approaching its 5-year low, while its P/B ratio of 0.34 is close to the 10-year low of 0.32. In August 2006, Wong’s Kong King announced that Chairman Mr Senta Wong proposed to privatize the Company via a Scheme of Arrangement at HK$1.38 per share. The proposed privatization did not go through because it was not approved by the majority of independent shareholders (excluding controlling shareholders/interested parties) in October 2006. In April 2007, the Company announced that it will dispose of substantially all the operating businesses and assets of the Company to Mr Senta Wong and distribute the sales proceeds of approximately HK$1.17 billion or HK$1.65 per share to shareholders (“Proposal”); the Company will become an empty shell and subsequently be delisted. At the Special General Meeting in June 2007, the resolution relating to the Proposal was not passed by independent shareholders. Only 47.22% of the votes were cast in favor of the Proposal, falling short of the 75% required. Mr David Webb, a well-known activist investor, owned more than 3.16% of Wong’s Kong King’s shares at that point the Proposal was announced, and highlighted that he “would veto it at the shareholders’ meeting on June 28.” According to a South China Morning Post article dated June 7, 2007, Mr David Webb said that “We estimate that fair value of this stock to be around eight times trailing earnings, or over HK$3 per share. We would reject an offer below HK$2.50.” According to the circular issued by the independent financial advisors, comparable companies trade at mean and median P/Es of 9.64 and 8.84 respectively, compared with a 4.68 times implied P/E based on the HK$1.65 per share disposal value. While Wong’s Kong King is enticing as a deep value net-net stock at current valuations, the Company’s past actions indicate that it is less likely that an attractive or reasonable privatization offer will be on the cards anytime soon. Sub-Optimal Capital Allocation Miko International Holdings (1247 HK) is “a mid-to-high end children’s apparel brand in China. Its “redkids” brand is ranked second among mid-to-high end children’s apparel brands in China,” according to its company profile . Miko is a net-net valued by the market at 0.54 times P/NCAV. Net cash also accounted for approximately 124% of Miko’s market capitalization, implying the investors are getting the Company’s core business operations for free at current valuations. In June 2015, the Company announced it was issuing 85 million new placement shares (10.3% of the issued share capital) at HK$1.03 per share, or 10% discount to its closing share price of HK$1.15 on June 24, 2015. In the end, the placement was terminated in July 2015, due to “continued high volatility in Hong Kong and PRC securities market and unstable political and economic conditions in Europe.” Nevertheless, the proposed placement did not make sense considering the significant amount of net cash (HK$528 million of net cash on its books as at end-June 2015 versus HK$87.6 million to be raised) it has on its balance sheet and the stock’s low valuations (even at that point in time). Good companies engage in value-accretive capital allocation practices by placing out new shares when their stock is overvalued, and repurchasing shares when their stock is undervalued; companies which are potential value traps do the reverse. Target Of Short-Sellers China Zhongwang (OTC: CHZHY ) (1333 HK) is the world’s second largest and Asia’s largest producer and developer of industrial aluminum extrusion products.” China Zhongwang is a deep value stock trading at half of its book value, which is close to its historical P/B low of 0.46. Dupre Analytics (DA), a short-seller research firm, issued a report on China Zhongwang and disclosed its short position in the Company in end-July 2015. DA claimed that the Company’s “real revenues are much lower than reported,” and “overstated CAPEX expenses” among other allegations. China Zhongwang has since made clarifications in announcements here and here , rebutting DA’s claims. In the announcements, the Company’s Board “reiterates that the allegations in the DA Report are groundless, and that the DA Report contains various misrepresentations, malicious and false allegations and obvious factual errors.” I follow a couple of short-seller research firms and their work; I tend to avoid stocks highlighted by them as I prefer not to bet against the “smart money.” I also use the Beneish M-Score as a tool to filter for potential value traps. Takeaways I always liked the quote “Losing an illusion makes you wiser than finding a truth,” and I found that this applies equally to value investing. The earlier that one loses the illusion that all deep value stocks are unjustifiably cheap, and rejects certain potential investment candidates and adds them to his or her list of value traps to be avoided, the closer he or she will get closer to finding and picking the truly undervalued stocks. (Note: I am not a English major; I might have misinterpretated the quote and applied it incorrectly.) Note: I flag potential value traps with corporate governance issues, financial statement manipulation risks and other red flags as part of my Asia/U.S. Deep-Value Wide-Moat Stocks exclusive research service. My subscribers get access to the list of value traps for both deep value & wide moat stocks, in addition to monthly top ideas, potential investment candidate profiles and potential investment candidate watchlists.

Lower Risk Versions Of A Dual Momentum Fixed Income Strategy

Summary This article presents the performance and risk of Lower Risk Versions (LRVs) of a dual momentum fixed income strategy as compared to a High Risk Version (HRV) presented previously. The difference between the LRVs and HRV is the number of assets per month; the HRV selects one asset per month, while the LRVs select multiple assets per month. The LRV-3 (3 assets per month), backtested to 1994 using mutual fund proxies, has a CAGR of 10.2%, a standard deviation of 6.3%, and a maximum drawdown of -6.1%. The minimum annual return of LRV-3 is -2.4% in 1994. All other annual returns are positive. The LRVs are more robust than the HRV, and should be used by more conservative investors, who desire reasonable growth with less volatility and drawdown. In a recent article on Seeking Alpha, I discussed a simple tactical bond ETF strategy employing relative strength momentum. This strategy is explained in detail here . I will call the original strategy the High Risk Version (HRV) of the fixed income strategy, since only one ETF is selected each month (out of a basket of five ETFs). This article presents Lower Risk Versions (LRVs) of the same momentum strategy. For LRVs, a multiple number of ETFs are selected each month in order to reduce volatility and drawdown compared to the HRV, while still maintaining a CAGR greater than an equalweight portfolio holding all five assets. My basic objectives of the LRVs are: 1. A CAGR > 10%; 2. A standard deviation (SD) that is less than the SD of an equalweight portfolio of all assets; 3. No negative years of return; and 4. A maximum drawdown based on monthly returns of less than 7%. I started out by making a slight modification to the original HRV strategy in order to turn the strategy into a dual momentum strategy. The original methodology only used relative strength (no absolute momentum) to determine what asset to select. But, in a way, the original HRV that selected only one asset each month was really a dual momentum strategy, because a short-term treasury was included in the basket of assets. In order to determine the effect of selecting multiple assets each month rather than just one asset, I needed to use a true dual momentum approach instead of a relative strength strategy. So I have switched to the dual momentum technique in this study. Dual momentum strategies have been popularized by Gary Antonacci and are well-known to many investors. Dual momentum means relative strength momentum is first used to select the top-ranked asset(s) each month, and then the top-ranked asset(s) have to pass an additional absolute momentum test (must have positive momentum) in order to be selected in any given month. I selected a basket of five fixed income assets that have relatively low correlation to each other. A major challenge in developing fixed income strategies is the short history of fixed income ETFs. This results in rather limited backtesting for the ETFs. To extend the backtesting, mutual fund proxies are used that have longer histories; this permits backtesting of the strategy to the 1990s. Shown below are the assets in the basket, both the ETF and the mutual fund proxy. Convertible Bonds: SPDR Barclays Capital Convertible Bond ETF (NYSEARCA: CWB ) – Vanguard Convertible Securities Fund (MUTF: VCVSX ) High Yield Bonds: SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ) – Fidelity Advisor High Income Advantage Fund (MUTF: FAHDX ) Long Term Treasury: iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) – Vanguard Long Term Treasury Fund (MUTF: VUSTX ) Short Term Treasury: iShares 1-3 Year Treasury Bond ETF (NYSEARCA: SHY ) – Vanguard Short Term Treasury Fund (MUTF: VFISX ) Emerging Market Bonds: PowerShares Emerging Markets Sovereign Debt Portfolio ETF (NYSEARCA: PCY ) – Fidelity New Markets Income Fund (MUTF: FNMIX ) In the original article, I used CNSAX as proxy for CWB and PREMX as proxy for PCY. But based on comments by EquityCurve in the original article, in order to get backtesting to 1994 instead of 1998, I changed to VCVSX instead of CNSAX and FNMIX instead of PREMX. So backtesting of the mutual funds now goes back to 1994. 1994 turns out to be a difficult year for bonds and I’m glad I could include it in the analysis. (All of this work was performed using the free Portfolio Visualizer software. Any investor can go online and trade the strategies in this article without any cost.) It turns out that the dual momentum strategy using this basket of assets is very robust, and good results are seen if one, two, three, four or all five ETFs are selected each month. There is the usual tradeoff between growth and drawdown depending on the number of assets selected each month. The greater the number of assets selected, the less the risk and growth. I will now present the results of the HRV that selects only one asset each month. These results are similar to the results presented in the original article, and are presented here just to be consistent with the results of the LRVs shown later in this article. The basket of mutual funds is used, and the backtesting timeframe is 1994-present. Two relative strength timing periods are employed to rank the funds: 4-months and 2-months. A 51% weighting on the 4-month ranking and a 49% weighting on the 2-month ranking is used. The 51%/49% weighting split is a good way to ensure that the 4-month timing period determines the better-ranking asset if there is a tie. The total return curves of the HRV, the equalweight portfolio (buy and hold all five assets, rebalanced annually), and the S&P 500 are shown below, together with a table of their relevant parameters and annual returns. Total Return Curve of HRV: (click to enlarge) Tabular Summary of HRV Results: (click to enlarge) Annual Returns: (click to enlarge) It can be seen that the HRV has a CAGR of 15.0%, an SD of 10.4%, and a maximum drawdown (based on monthly returns) of -13.0%. In terms of a risk-adjusted return on investment, the CAGR/SD is 1.44. This compares with holding an equalweight portfolio that has a CAGR of 7.8%, an SD of 7.0%, a maximum drawdown of -17.6%, and a CAGR/SD of 1.11. It can be seen that the HRV substantially increases growth at the expense of volatility (standard deviation). Yet the maximum drawdown is actually better for the HRV than the equalweight portfolio holding all five assets. For the LRVs, I systematically looked at various combinations of timing periods and number of assets selected each month. Overall, when two or more assets are selected each month, the strategy tends to be very robust in terms of what timing periods are used for relative strength ranking. This means the strategy works well for various sets of timing periods and results do not change dramatically when timing periods are varied slightly. With some flexibility in what timing periods to choose, I decided to use the same timing periods that I employed for the HRV in my previous article, namely 4-months and 2-months. I first show graphical results when one, two, three, four and five assets are selected each month. A logarithmic scale of total return is employed. One asset (HRV): (click to enlarge) Two assets (LRV-2): (click to enlarge) Three assets (LRV-3): (click to enlarge) Four assets (LRV-4): (click to enlarge) Five assets (LRV-5): (click to enlarge) The results of LRV-5, compared to the equalweight portfolio, identify the effect of absolute momentum. It can be seen that absolute momentum mainly plays a role in reducing drawdown, and does not significantly affect growth in the years when drawdown does not occur. The beneficial effect of absolute momentum continues to be seen as the number of assets is reduced using relative strength. When the number of assets is reduced using relative strength, higher portfolio growth is seen as expected. The highest growth, of course, comes when only one asset is selected each month corresponding to the HRV. The tabular form of the overall results is shown below: (click to enlarge) The tradeoff between performance and risk is seen in the table above. Based on the objectives stated previously, the best LRV is LRV-3 (three assets each month). LRV-3 has a CAGR of 10.2%, an SD of 6.3%, a maximum drawdown of 6.1%, and CAGR/SD of 1.62. This compares well against the equalweight portfolio that has a CAGR of 7.8%, an SD of 7.0%, a maximum drawdown of -17.6%, and a CAGR/SD of 1.11. Thus, the LRV-3 has significantly higher CAGR, lower SD, and substantially lower drawdown and higher risk-adjusted return on investment than the equalweight portfolio. The equalweight portfolio also has three negative years: 1994 (-6.4%), 1998 (-0.3%), and 2008 (-11.6%), while the LRV-3 only has one year with negative returns: 1994 (-2.4%). In comparison to the HRV, the LRV-3 has lower growth (CAGR of 10.2% versus 15.0%), but the SD (6.3% versus 10.4%) and maximum drawdown (-6.1% versus -14.5%) are greatly improved. And the risk-adjusted return on investment of LRV-3 is significantly better (CAGR/SD of 1.62 versus 1.44). And for 1994, the LRV-3 has a -2.4% return, while the HRV has a -5.4% return. One negative aspect of the LRV-3 is that more trades are required each year compared to the HRV. However, the costs will still be minimal for an account value over $100K. Based on backtest results, the average number of annual trades (buys and sells) is approximately 20 for LRV-3. In a Schwab account, this amounts to a cost of 20 x $9 = $180 per year. So, the cost is about 0.18% for a $100K account. In addition, PCY and CWB are commission-free ETFs on Schwab (and the commission-free SCHO is a good substitute for VFISX). So, the commission costs of trading LRV-3 (neglecting any other costs) are quite minimal. A final step in this study is to ensure the ETF version of the strategy gives similar results as the mutual fund version. The ETF version can only be backtested to 2010, so the 2010-present timeframe is used for comparison. The backtest results for the ETFs and the mutual funds for LRV-3 are shown below. LRV-3 Results Using ETFs (2010 – Present) (click to enlarge) LRV-3 Results Using Mutual Funds (2010 – Present) (click to enlarge) Good agreement is seen between using ETFs and mutual funds. Using ETFs, the CAGR is 7.9%, the SD is 6.2%, and the maximum drawdown is -4.5%. Using mutual funds, the CAGR is 8.3%, the SD is 5.3%, and the maximum drawdown is -4.2%. It should be noted that the performance of the mutual funds from 2010-present is less than the performance between 1994-present. This is probably caused by the Federal Reserve holding short-term rates near zero from 2009-present. When short-term rates are increased, performance should eventually increase (after, perhaps, a short time of reduced performance). Also to be noted is that LRV-3 has gone to all cash (money market) since July 2015. So, for July, August and September, the top three assets based on relative strength have not passed the absolute momentum test. In summary, the LRV-3 should be used by more conservative investors, who desire solid growth (10%) with lower risk, while HRV should be used if more growth is desired (15%) at the expense of higher risk. For those investors, who desire even lower risk than LRV-3 as well as higher risk-adjusted return on investment, LRV-5 might be a better choice. For 1994-present, LRV-5 has a CAGR of 9.0%, a maximum drawdown of only -4.4%, and a CAGR/SD of 1.80. It should be mentioned that this strategy using fixed income ETFs is best employed in non taxable retirement accounts that avoid tax issues. I would also like to thank Terry Doherty for reading over this article and making a number of excellent suggestions.

Finding The Right Volatility ETF

Summary Volatility products can provide market leading returns. Proper education and knowledge of the VIX futures market is needed to be highly successful. Risk factors should be accounted for when creating and implementing your strategy. Welcome to the Seeking Alpha ETF Guide. This article will focus on how a VIX ETF could play an active role in your portfolio. When looking for a VIX ETF you have several different options between short-term and mid-term futures products. This article will cover only the most active funds. For more options visit the Seeking Alpha ETF Hub for a list of all volatility funds. Both types of products (short and mid-term) focus on the VIX Futures which trade independent of the market and the popular and well publicized VIX Index. Short-Term There are two types of short-term volatility products. To determine which type of product is for you, you first need to determine whether you are betting on an increase or decrease in volatility. Long volatility products, such as iPath S&P 500 VIX ST Futures ETN (NYSEARCA: VXX ) and ProShares Ultra VIX Short-Term Futures (NYSEARCA: UVXY ) which offers two times the leverage, benefit from increasing volatility. During periods of low or decreasing volatility, inverse products such as VelocityShares Daily Inverse VIX ST ETN (NASDAQ: XIV ) and ProShares Short VIX Short-Term Futures (NYSEARCA: SVXY ), produce better results. All short-term VIX products focus on the front and second month’s contract in the VIX Futures. Mid-Term You also have long and inverse options available in mid-term futures products. For rising mid-term futures you have VelocityShares Daily Inverse VIX MT ETN (NASDAQ: ZIV ) and for decreasing mid-term futures there is VelocityShares Daily Inverse VIX MT ETN . All mid-term VIX products focus on the seventh through fourth month’s contracts in the VIX futures. Mid-term futures products are not as popular as the short-term products. Education Investors looking to use VIX products in their portfolios should have a very high level of education into the inner workings of the VIX Futures market. Seeking Alpha is a great resource for many articles that focus on the how and why rather than the right now. I have written many articles that are specifically geared towards investor education and are meant to serve as training tools for years to come. Since the vast majority of these products have been around less than a decade, back testing is often used to demonstrate the effectiveness of different strategies. Investors should also note there are distinct differences between short-term and mid-term volatility products. A personal pet peeve for me is when I see comments such as “this thing is rigged.” That is a good example of someone who hasn’t educated themselves on volatility and is now mad about their poor decision. Many misconceptions exist in regards to VIX Futures products. A thorough understanding of how these products are structured can prevent expensive mistakes. Trades based on hopes and dreams or borrowed money are a recipe for disaster. A proper education is the only way to prevent failure when trading volatility. Contango/Backwardation A key indicator when determining longer-term directions of volatility products are contango and backwardation. Contango will benefit inverse volatility products, like XIV, while backwardation will benefit long volatility products, such as VXX. For more information on this key metric I recommend this short video . Trading Objectives Long volatility products – Many investors use long volatility products as insurance for their primary portfolio. It is difficult to time spikes in the VIX and these products lose value over time. They are not meant to be buy and hold investments. From historical data, the longest these products have gone without losing value is less than one year. Inverse volatility products – During flat and rising markets, these products can often beat the major benchmark indices. Although I don’t advocate a long-term buy and hold strategy with any volatility products, short-term inverse funds have provided the best returns when held for periods of 2-6 months. Risks This would be the most important section of this article. I have spent countless hours promoting the education and risk factors of investing in various VIX funds. Although these products can provide returns several times greater than the market, they also come with many risks that are hidden to novice investors. I have seen many beginners with high hopes of getting rich quick. They may win the first or second hand but eventually lose all or a very significant amount of their capital by not properly assessing risks before making trades. If you do not fully understand how these products work or do not have a thorough idea of the risks of investing in volatility, my recommendation would be to avoid them while you become more comfortable and complete additional research. Practice accounts and small trades are a great way to build real knowledge on the effectiveness of your strategy. Rising markets make inverse products seem like the perfect investments. However, these products can easily lose 50-80% of their value during periods of economic turmoil. Black swan events are rare but would significantly effect volatility products. Historical examples of these events would include acts of war, terrorism, and other unforeseen events that would have profound impacts on the market. Returns VIX funds have provided some of the best returns over short to medium time frames. Take a look below at some of the best results for inverse and long volatility products: Chart created by Nathan Buehler using backtesting data from The Intelligent Investor Blog . Conclusion The best advice I can give if you are thinking about trading volatility is to learn as much as you can about how these products operate. Test your strategies, document results, confirm successes, and evaluate failures. You should feel very comfortable with using these products before making your first large trade. Seeking Alpha is a great resource to use. By interacting with contributors and other users, you can create your own virtual professional learning community. I hope you have found this introduction to volatility funds useful. Now it is time to start researching and comparing individual funds. Thank you for using the SeekingAlpha ETF Guide!