Tag Archives: real estate

Low Blow – Why Low-Volatility ETFs Could Prove Anything But When You Really Need Them To Be

By Ian Kelly Just as nobody buys a parachute primarily for its colour – well, certainly not twice – presumably the main reason investors choose to buy low-volatility exchange-traded funds (ETFs) is safety-related. If they really were looking for a smoother ride from the share prices of their underlying holdings, though, events in global markets over the last few days may well have come as a considerable shock. Low-volatility stocks have enjoyed a good run in recent years, and as is often the way with investment, the better an asset or sector performs, the more people want a piece of the action. The low-volatility ETF market is now considerable – to pick out one example, the PowerShares offering that tracks the S&P 500 Low Volatility Index (NYSEARCA: SPLV ) has attracted almost £3bn from investors since its launch in May 2011. If pushed on why low-volatility stocks have done so well, here on The Value Perspective, we would raise the possibility they were priced very cheaply at the start of their run. In a previous article, ” Lost and pounds “, for example, we reminded you how lowly valued tobacco stocks used to be as the market fretted over, among other things, huge threats of litigation. Then, as those fears largely receded, the shares re-rated. Once a group of stocks reach “fair value”, however, the only way they can continue to outperform the rest of the market is if they grow their earnings more quickly. Where we would take some convincing then is that there is any reason why a business would be able to grow its earnings faster over the longer term just because its share price happens to bounce around a little less than the wider market does. In other words, while a low-volatility strategy has worked in the past, we have our doubts as to whether it will to continue to do so. Where we have few doubts, however, is that many people will have been shocked over the last few days by just how volatile their low-volatility ETFs have proved since the global markets went into free fall over concerns about China. The following chart shows how the aforementioned S&P 500 Low Volatility ETF traded versus the whole S&P 500 on Friday, August 21. While we would not normally focus on intra-day pricing on The Value Perspective, when a low-volatility ETF at one point plummets 46% as its wider benchmark drops just 7% – while trading real volumes on those numbers – we are prepared to make an exception. (click to enlarge) (Source: Bloomberg, August 2015) (click to enlarge) (Source: Bloomberg, August 2015) A good lesson to take from this is the importance of, as it were, looking under the bonnet of any collective investment so you are comfortable with the sort of businesses you own through it. Anyone “popping the hood” of the S&P 500 Low Volatility Index, for example, would find an allocation of almost 15% to insurance companies and a further 13% to real estate investment trusts. Is there any great reason why the valuations of these stocks should not be volatile over time, or in the case of insurance, the businesses themselves should not be volatile? If you accept that the valuations of these businesses and their earnings are likely to be volatile, you might ask what are they doing making up more than a quarter of a low-volatility benchmark? The answer lies in the fact that these kinds of indices, and the funds that track them, are mechanistic in nature. Thus, the S&P 500 Low Volatility Index is set up to measure the performance of the 100 least volatile stocks of the S&P 500, with volatility defined as “the standard deviation of the security computed using the daily price returns over 252 trading days”. It may seem odd for the index to have a 15% allocation to insurance companies today, but over time, ideas such as low volatility can become self-fulfilling. There will be times when this sort of strategy works and times when it does not. But you only ever get what the market is willing to pay, and at one point on August 21, for low volatility, that was half what it was the day before. To our minds, owning a low-volatility investment that fails to provide it when it is really needed is akin to a pretty-coloured parachute which doesn’t open when you pull the cord.

Microsoft Windows 10: A Phoenix Rising from the Ashes

Microsoft Inc. ‘s MSFT Windows 8 was nothing short of a debacle. Three years later, Windows 10 was launched. According to Gartner tech analyst Brian Blau, “It can’t be overstated how important this is for Microsoft. They’ve positioned Windows

The Sky Seems To Be Falling. What Now?

Summary Understanding portfolio risk in the context of net worth. Assessing the cause of current distress. Discussing what to do in times of distress. Every successful investor should have a good idea of his asset allocation and risk tolerance in order to manage active market exposure accordingly. I consider an affluent investor with 40% net worth in real estate, 40% in an actively managed portfolio, and 20% in cash and other liquid assets to be prudent and well balanced. But in times of distress like the past few days, the actively managed portfolio becomes the center of focus. Understanding portfolio risk in the context of net worth I find volatility of a portfolio best describes its risk. Most commonly used volatility is in fact the annualized standard deviation of portfolio returns on a daily or monthly basis. I personally run an enhanced equity portfolio with roughly 30% volatility, which is about twice of the S&P 500 index volatility, and has generated about 40% annualized returns in the last six years. Assuming returns are normally distributed, an easy way to quantify 30% volatility is the following: With 68.2% probability, the annual portfolio return will be in the range of up +30% and -30%; With 13.6% probability of each, the annual portfolio return will be between +30% and +60% or between -30% and -60%; With 2.3% probability of each, the annual portfolio return will be up or down more than 60%. As you can see, with volatility of an actively managed portfolio at 30%, the chance of a significant drawdown within a year is still fairly high. However, keep in mind, you ought to view your net worth as a whole when determining risk tolerance. With the portion of an actively managed portfolio at 40% of the net worth, assuming other assets are relatively stable, the actual volatility of your net worth is only 12%, significantly lower than viewing the active portfolio as an isolated entity. We all enjoy upside volatility, but sporadic downside volatility is fair play. Most market participants are prepared to endure such risk in search of long-term profitability. Assessing the cause of the current distress I believe the current selloff has sentimental, rather than fundamental, drivers. Aside from some weakness in the Chinese economy, the global economy is tracking reasonably well with Europe finally starting to emerge from the shadow of sovereign debt crisis. However, U.S. equity markets had sustained several years of stellar performance without correction. Wary of the sustainability of global growth, investor sentiment was gradually shifting towards the defensive side. At this point, it is difficult to assess whether the selloff was triggered by the nearing of Federal Reserve rate hike, or by the recent yuan devaluation by the People’s Bank of China. In addition, the Chinese government’s inability to stem losses in the equity market casts doubt on its ability to navigate through the current softness in its economy. The selling accelerated through the negative feedback loop in various markets. It is most likely an aberration, rather than the start of a bear market. It may take a few weeks for the markets to work out the kink. Investors are also eagerly anticipating what and when central banks’ next moves will be. Meanwhile, doing nothing is not the best course of action. Don’t panic, let’s discuss what to do in times of distress 1) Assessing portfolio risk Evaluate your portfolio and determine if you have too much risk exposure. If you do have too much risk, a straight-forward action is to cut positions proportionally across the board. Even if your exposure is on target, it may make sense, in times of distress, to take some chips off the table in case the selloff intensifies. Keep the powder dry and wait to add back the exposure at more attractive levels. 2) Hedging with equity index futures Even though it is often wise to hedge actively managed portfolios with correlated index options to extract alpha, it is typically not feasible in distress, simply because the elevated implied volatility makes purchasing options cost prohibitive. At one point, the implied VIX touched 50% during the session on Monday, while it traded mostly between 12.5% and 25% over the past few years. Index put spreads may be a possibility as we will discuss below. However, if you don’t have time to do a detailed portfolio analysis, and feel there is too much risk, you can immediately take some market risk out of your portfolio by shorting, say, S&P e-mini futures. Each e-mini has a notional size of close to $100,000, shorting 10 e-minis will take out close to $1,000,000 long market exposure from your portfolio. This method is extremely helpful during potential market bounce after the selloff, especially if you are not convinced of its short-term sustainability of the rebound. It would have worked perfectly during the 4% bounce this morning (Tuesday). 3) Hedging with high-beta names During the selloff of the last few days, high flyers such as Netflix (NASDAQ: NFLX ) and Tesla (NASDAQ: TSLA ) started to show cracks. What goes up a lot could come down hard in a selloff as many momentum chasers will be the first ones to liquidate their portfolios. This makes high flyers the perfect candidates for portfolio hedges. Nevertheless, shorting high flyers could expose you to unquantifiable risk. It is not for the faint of heart. However, buying put spreads on high-beta names could be an attractive way to hedge the overall exposure in the portfolio. An example today is: Buy NFLX Sept 18 $100-strike put for $7 each; Sell NFLX Sept 18 $85-strike put for $3 each. You pay $4 for this put spread, and it is the maximum you can lose; but you could make $11 if NFLX is below $85 at the option expiry on September 18. Although the implied volatility for the higher strike option is likely inflated, the implied volatility of the lower strike option should be even more elevated due to the “skewness” (email me if you want to learn more about this) of the option. If you are proficient in options, you may also sell Sept 4 $90-strike put instead and roll it forward on or near September 4 for more flexibility in assessing on-going market conditions. 4) Treating distress as a godsend in re-allocating portfolio We all have companies we follow and wish owning them at cheaper prices. You know what, now is the time! In times of distress, company stocks are often sold indiscriminately by agitated investors, creating incredible buying opportunities. Use some of your dry powder and dip your toe in the water to acquire a few quality names. Better yet, sell some losers in your portfolio and pick up a few winners on fire sale. It will certainly pay off when markets return to normal. Disclosure: I am/we are short NFLX, TSLA. (More…) 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.