Tag Archives: seeking

What Is And Isn’t ‘Risk’

It’s a popular thing to bash on measuring the risk of an investment portfolio with standard deviation, the preferred metric of most academic studies. If you skipped stats in college (congratulations, by the way), standard deviation measures how much movement around an average return you might expect in an asset or portfolio. So higher standard deviation = bigger “swings” in, say, annual stock market returns. Of course, standard deviation is far from perfect. Most commonly cited is that no one cares about big swings to the upside – a big up year is hardly perceived as risk by any investor! A popular line from many institutional investors, especially value-oriented stock pickers, is that “the only real risk is the permanent loss of capital.” Such a nice little soundbite. You hear this all the time, including from giants like Seth Klarman and Howard Marks. And for a stock picker, I suppose avoiding the permanent loss of capital is huge. Especially if you run a concentrated portfolio of 20-30 stocks. Right now I wouldn’t want to be the guys managing the Sequoia fund, which at the end of the second quarter had a 28.7% stake in Valeant Pharmaceuticals (NYSE: VRX ). Valeant is down big ($96.65 today from $178 and change less than a week ago) this week after becoming the target of a short-seller accusing the company of massive fraud. I don’t know or particularly care how Valeant shakes out, but if you have a stock that is over 25% of your portfolio, you don’t want it to go bankrupt. There’s no coming back from that. The trouble with the “permanent loss of capital” risk definition for most investors is that it is laughably easy to avoid. Anyone who owns one single diversified index fund has done it. Sure, if you have a fund with 3,000 stocks in it, a few are bound to go bankrupt. But those fractional losses are indistinguishable from the day-to-day 1% swings in the broad market. Any diversified investor has effectively eliminated the permanent loss of capital. So we’re back to other definitions of risk. Despite its imperfections, standard deviation (or volatility, call it what you want) is a pretty decent measurement of risk. No one is shocked to learn that a 90-day T-Bill has less volatility than an emerging market stock. Or that a 30-year Treasury Bond has more volatility than that 90-day T-Bill. And sure, standard deviation measures big swings to the upside right alongside big drawdowns. But the thing is that you can’t find me an asset class that has big upside swings without the big drawdowns. Here’s everybody’s favorite chart: (click to enlarge) Emerging markets stocks were up 66.42% in 1999! Of course they were down 25% the year before that and down 30% the following year. Small-cap growth stocks crushed it in 2009-2010 up 34.47% and 29.09%, but they were down -38.54% in 2008, worse than the S&P 500. Nothing gives you high double-digit gains without the occasional double-digit loss, unless you’re Bernie Madoff. The last argument against using volatility as a measurement of risk is usually, “So what?” Many value stock managers like to act as if huge one-year drawdowns don’t matter in the long run. They don’t want to talk about risk-adjusted returns. Well, maybe they don’t interact with their investors very much, but volatility matters to investors for two very real reasons. Drawdowns are hard to deal with, emotionally. Big losses can make for skittish investors. I don’t care how “experienced” you are as an investor. It is still hard. I remember in 2008-2009 talking to very intelligent, longtime investors who were really convinced (for a myriad of reasons we’ll get into some other time) that this time was worth being scared. Each new bear market is scary. It’s different, the economy is different, your life is different, your portfolio’s behavior is different. Each and every time. Successful investors have to stick to their investment strategy throughout these periods. We are often the greatest risk to our own portfolio, and a very real risk indeed. Drawdowns can be hard to deal with, financially. Warren Buffett is famous for saying that his favorite holding period is “forever,” but you aren’t Warren Buffett. At some point in our lives, most of us will spend money regularly from our investment portfolios. If you’re taking regular distributions, volatility matters a lot. A big drawdown can put a portfolio’s longevity at risk if liquidity is insufficient, withdrawals are too large or the drawdown is too deep. Platitudes about indefinite time horizons are lovely, but real life doesn’t always work that way. Volatility as risk matters to the bottom line of any portfolio funding regular withdrawals.

Inside New Diversified Return U.S. Equity ETF By J.P. Morgan

The global economy is presently caught in a vicious cycle of volatility with the sole star U.S. (in the developed market pack) also finding itself trapped. Instead of leaning on policy tightening, the domestic economy is now backtracking on the issue. This was especially true given the slowing momentum in the labor market and muted inflation. In this backdrop, volatility has taken center stage. Still, several other economic indicators at home are sturdy enough for investors to bet on U.S. stocks. Plus, a dovish Fed eased tensions over the sudden cease or shrinkage in cheap money inflows. All in all, risky assets regained some lost ground but volatility prevailed. Probably keeping this in mind, issuers look to deploy quality factors as much as possible. After all, be it developed economies, emerging nations or commodities and currencies, shocks were felt everywhere. Thanks to this, J.P. Morgan’s new factor-based ETF targeted on the U.S. market – J.P. Morgan Diversified Return U.S. Equity (NYSEARCA: JPUS ) – deserves a detailing. JPUS in Focus The fund looks to track the performance of the Russell 1000 Diversified Factor Index and has exposure to domestic multi-cap stocks. The fund seeks to score high on basic factors like quality and momentum to mitigate risks and tack on capital appreciation. The 561-stock portfolio is equally weighted resulting in minimal company-specific concentration risk. No stock accounts for more than 0.65% of the basket at present. Xcel Energy Inc. (NYSE: XEL ), TECO Energy Inc. (NYSE: TE ) and Henry Schein Inc. (NASDAQ: HSIC ) are the top three holdings. Consumer discretionary (17%), health care (16%), utilities (13%), consumer staples (13%) and technology (12%) get double-digit exposure in the fund. Large caps rule the basket with about 60% focus followed by 35% of assets invested in the mid caps and 5% in the small caps. The fund charges 29 bps in fees. How Will it Fit in a Portfolio? Several academic researches indicated that the risk-adjusted returns from quality stocks outperform the broader market over long term. Thus, this ETF could be an intriguing pick for investors looking to invest in stocks that have high quality and are rich in momentum factors. This way the fund appears to stay afloat in a booming as well as in a volatile market. ETF Competition The craze for smart-beta or high-quality products is high of late especially given the heightened volatility in the market. Issuers are increasingly coming up with multi-factor ETFs, though the space is yet to be jam-packed. However, J.P. Morgan has been quite proactive with this technique and bet on the trend last year with the launch of a global equity ETF (NYSEARCA: JPGE ) which focuses on factors like value, size, momentum and low volatility. State Street is also ramping up its multi-factor lineup. Apart from these, a few products including PowerShares S&P 500 High Quality Portfolio (NYSEARCA: SPHQ ), MSCI USA Quality Factor ETF (NYSEARCA: QUAL ), MSCI USA Value Factor ETF (NYSEARCA: VLUE ) or Arrow QVM Equity Factor ETF (NYSEARCA: QVM ) could put pressure on this new J.P. Morgan ETF. There is also iShares MSCI USA Momentum Factor ETF (NYSEARCA: MTUM ) which is a notable momentum play. Despite these threats, we do not expect J.P. Morgan’s Russell 1000 Diversified Factor ETF to face much problem in garnering assets given a unique index, the strong brand name of the issuer and multi-factor techniques. Within just a few days of its launch, JPUS has accumulated over $10.5 million of assets which gives an idea about its forthcoming success. Original Post

Rebutting Bogle On International Investing

John Bogle recently stated that he does not invest overseas. Much of Bogle’s good fortune is luck and has to do when he was born. Some of the best companies in the world are international. John Bogle, founder of Vanguard and major proponent of index funds, recently stated that he does not invest overseas. This article will discuss why it is a bad idea to follow this particular piece of advice and lay out why an investor should hold stocks and funds based in foreign countries. There is no doubt that the Vanguard S&P 500 Index (MUTF: VFINX ) has worked well for Mr. Bogle. According to this handy little calculator that I found, the S&P has averaged 11.217%, with dividend reinvested, over the last forty years. I’ll use 40 years for two reasons: that was when Vanguard was founded and that was the year I was born. You’ll see why I added myself into this equation pretty soon. A few years ago, I heard Mr. Bogle speak to the CFA Society in Los Angeles. He stated that an attorney for Vanguard invested in the fund back then. According to my calculations, $10,000 would now be worth $212,000. With that type of return, you’d be beating your chest too. I started my career at Merrill Lynch (NYSE: BAC ) in Naples, Florida, in the summer of 1998. Since then, the S&P 500 has averaged 5.813%, with dividends reinvested. Pretty dismal. I’ve been in the business for a little over 17 years. $10,000 invested in the S&P 500 would now be worth $16,130. I wonder if anyone would have done business with me had I told them that I thought they get a little over 5% a year? Back then, the famous Merrill Lynch Cash Management Account (CMA) was paying 5% in its money market. So why would I be bold enough to interject my own experiences with the great John Bogle? To prove a point. Much luck in life depends upon when you were born. Mr. Bogle was born on May 8, 1929. Mr. Bogle’s life went something like this: he was born during the stock market crash of ’29 and was brought up during the Great Depression, was a teenager during World War II, attended college in the late 1940s and early 1950s, and then went to work when the U.S. was booming. In John Bogle’s investing life, he hasn’t really experienced a bad market. Sure, he lived through the 1973/1974 crash but it quickly recovered in 1975. Sure, he lived through the 2008/2009 crash but it too recovered. For the last 30 years, interest rates have been falling, Baby Boomers have been driving the economy, and the stock market has exploded. I’d put all of my money into an S&P 500 fund too. In the interview with CNBC mentioned above, Mr. Bogle stated that he did not like investing in international funds. Why would he? If you can make 11% returns investing domestically, why do anything else. However, the world has changed and it would be foolish to eschew foreign stocks. What company is the number one beer manufacturer in the world? Anheuser-Busch InBev (NYSE: BUD ), which is based in Belgium and denominated in the euro. What is arguably the number one food manufacturer in the world? Nestle ( OTCPK:NSRGY , OTCPK:NSRGF ), which is based in Switzerland and denominated in the franc. How about automotive? Toyota ( TM or Volkswagen ( OTCQX:VLKAY , OTCQX:VLKAF , OTCQX:VLKPY ). Or tractors? CNH Industrial (NYSE: CNHI ). Distilled spirits? Diageo (NYSE: DEO ) or Pernod Ricard ( OTCPK:PDRDF , OTCPK:PDRDY ) are the undisputed leaders in liquor. Mining? There are too many miners to mention and the U.S. has none of them. The U.S. is number one in only a few categories: technology, finance, oil and gas, entertainment, and maybe real estate. Sounds like a pretty lopsided portfolio. Many of the industries above like beer and liquor have long track records of dividends and high profit margins. Tech companies on the other hand come and go. Name a tech company that has been around since the 1960s other than IBM (NYSE: IBM ) and Hewlett-Packard Co. (NYSE: HPQ ). I will give Bogle one thing. At this point when comparing international funds to domestic, domestic funds win. Of course, we are measuring at a high point. The American markets are close to an all-time high and the US dollar has been very strong. Go back a few years and it’s a different story. Go forward a few years and it may be different too. There are many text book reasons to invest internationally. One is to reduce volatility. When your US funds are zigging, your foreign funds will be zagging. John Bogle has had a storied investing career but has had substantial tail winds. Folks born in my generation have witnessed nothing but mediocre returns and view the financial markets with a jaundiced eye. I love the stock market and truly feel that there are better years ahead (just not for the next 10 or 15). I feel that the Millennials will be buying my stocks as I am getting into retirement. If you are an index fund person, consider the Vanguard Global Equity (MUTF: VHGEX ) or add an international fund like Vanguard International Explorer (MUTF: VINEX ).