Tag Archives: stocks

Passive Investing – I Doth Protest Too Much

One of my favorite blogs, The Monevator blog , did a brief write-up on my new paper this weekend . If you don’t read their website you’re missing out because they consistently post some of the best financial content around. Anyhow, they had a very fair and objective view of the paper and approach to portfolio construction. However, one point that I seem to lose a lot of people on is my discussion of active and passive investing. So, I wanted to take this space to clarify a bit. Financial commentary doesn’t have a uniform definition for passive investing. Googling the term brings up the several different results: Passive management (also called passive investing) is an investing strategy that tracks a market-weighted index or portfolio. – Wikipedia Passive investing is an investment strategy involving limited ongoing buying and selling actions. – Investopedia The first definition is vague because there are limitless numbers of market cap weighted indexes these days, some of which are not well diversified and not low fee. Additionally, why should passive indexing be limited to market cap weighted index? Is it really correct to say, for instance, a fund like MORT , with 23 REIT holdings, reflects passive investing better than say, the equal weight S&P 500 ETF? An “index” is a rather arbitrary construct in a world where there are now tens of thousands of different indexes. The second definition is equally vague since an investor can hold a handful of stocks in a buy and hold strategy and limit ongoing buying and selling. Clearly, we shouldn’t call that passive investing in the sense that a low fee indexer would advocate. The new technologies such as ETFs have really muddled the discussion here as there’s now an index of anything and everything. So, as Andrew Lo notes: “Benchmark algorithms for high-performance computing blurred the line between passive and active.”¹ Along the traditional low fee indexing thinking I am tempted to define passive indexing as any low fee, diversified & systematic indexing strategy. But that could include all sorts of tactical asset allocation strategies that have systematic allocations. I don’t think it’s appropriate to call a tactical asset allocation strategy “passive”. So we’re back to a very blurry area in this discussion. In order to clarify this discussion I arrived at the following simple distinction: Active Investing – an asset allocation strategy with high relative frictions that attempts to “beat the market” return on a risk adjusted basis. Passive Investing – an asset allocation strategy with low relative frictions that attempts to take the market return on a risk adjusted basis. This definition has its own problem because we have to define “the market”. Is “the market” the USA, global stocks, global bonds, etc.? I’d argue that “the market” is the Global Financial Asset Portfolio, the one true benchmark of all outstanding financial assets. Therefore, anyone who deviates from this portfolio is making active decisions that essentially claim “the market” portfolio is wrong for them. This would mean that the only true “passive” strategy is following the GFAP. Obviously, not everyone does that and in fact, probably no one does it perfectly so that would mean we’re all basically active. Some people are active in silly ways (like day traders) and others are active in smart ways (diversified inactive indexers). Of course, I am a full blown supporter of low fee, low activity indexing. So please don’t confuse this as an attack on “passive indexing”. And yes, I am admittedly being overly precise. I certainly doth protest too much as Monevator says. But I am really just trying to establish a cohesive language here because I see too many people these days claiming they’re “passive” when they’re really being quite active. The worst offenders of this language problem are high fee asset managers who sell “passive” strategies cloaked as low fee platforms. I find that dishonest and extremely harmful. A little bit of clarity in this discussion is helpful in my opinion. ¹ – What is an Index? Lo, Andrew.

5 Costly ETF Mistakes You Can Easily Avoid

ETFs are becoming increasingly popular with investors due to their low cost, transparency, easy tradability and tax efficiency. The ETF revolution has made it possible for individual investors to get a convenient, diversified access to almost any investment strategy in virtually any corner of the investing world. Retail investors now have access to many investment opportunities that were earlier available only to sophisticated, high net worth individuals. Despite their widespread use, there are many misconceptions regarding ETFs leading to costly errors, which can be easily avoided. This article aims to help investors avoid some of those mistakes and become more successful ETF investors. Buying an ETF above Its NAV ETFs usually trade at fair prices, i.e. close to their intrinsic values or aggregate values of their holdings. But at times certain ETFs’ prices deviate from their NAVs and they can trade at a premium or discount to their NAVs. If you buy an ETF (or an ETN) when it is trading at a premium, you can incur losses if you sell after the premium crashes. The popular oil ETN, the iPath S&P Crude Oil Total Return Index ETN (NYSEARCA: OIL ), was trading at an almost 50% premium over its NAV for some time earlier this year. In fact, Barclays had issued a notification warning investors about ETN premiums. As expected, the premium plunged after some time, making investors vulnerable to unexpected losses. Investors should make sure to check the previous day’s closing indicative value on the sponsor’s website. They can also check the intraday indicative value on Yahoo Finance using the ticker for the ETF and adding “^” and “-IV” at the beginning and end. So, for OIL ETN, the ticker for intraday indicative value is ^OIL-IV. Avoiding Low Volume ETFs Many investors confuse low trading volumes with the liquidity of an ETF and some even avoid newer ETFs, which may have better strategies but low trading volumes, in favor of older, more popular products with higher trading volumes. ETFs are different from stocks in this area and their trading volume should not be interpreted like stock trading volume. The liquidity of an ETF is not determined by its trading volume but by the liquidity of underlying shares (ETFs’ holdings). At the same time, low volume does usually lead to wider bid-ask spreads, which add to the trading costs. So, these ETFs are not suitable for frequent trading. And it does make sense to use limit orders while trading in low-volume ETFs. Using Market Orders during Volatile Markets The market mayhem on Monday, August 24, last year (ETF Flash Crash) left some harsh lessons for ETF investors. Many ETFs fell 20% or more and some as much as 30%-45% that morning, even though their underlying stocks had not declined so much. Large dislocations in ETFs’ prices were seen not only in smaller ETFs but in some very large and popular ETFs such as the Guggenheim S&P Equal Weight ETF (NYSEARCA: RSP ) and the Vanguard Consumer Staples ETF (NYSEARCA: VDC ). While these discrepancies lasted only for a short period of time, none of the trades executed during that time were canceled. There were many factors that caused ETFs’ pricing problems. But the biggest mistake that ETF investors could have avoided was using “market orders” during those turbulent market conditions. Investors who had left a sell market order or a sleeping stop-loss sell order for one of the ETFs that had severe distortion in pricing probably saw their orders hit at worst possible prices, much below fair values. Ignoring the Contango Impact on Commodity ETFs While some commodity ETFs, mainly those tracking precious metals hold the physical commodity, most commodity ETFs use futures contracts to track the price of commodities due to high storage costs. These futures contracts are required to be rolled over when they are close to expiration. At times, futures price of the commodity is higher than the spot price – known as “contango” – which results in losses at the time of rolling over the contracts. Contango affects the performance of ETFs since the futures contracts’ return will be lower than spot price returns of the commodity. A recent article in WSJ highlighted this issue in the performance of ETFs that track the performance of oil using futures, including the PowerShares DB Oil ETF (NYSEARCA: DBO ), the United States Oil ETF (NYSEARCA: USO ) and OIL. While US crude futures were down about 20% through February 22 this year, oil funds fared much worse. Always Buying Currency Hedged International ETFs Currency hedged ETFs have been quite hot in the past couple years as the US dollar surged against most other currencies. By hedging out the currency exposure, through currency hedged ETFs, investors get access to pure equity returns in international markets. Investors should also remember that often stocks and currencies move in the same direction. That is, if an economy strengthens, its stock market as well as the currency will perform well. In such cases of positive correlation, hedging will actually work against investors. However in some cases, particularly in cases of export oriented economies, stocks and currencies have shown a negative correlation historically. That’s why currency hedged Japan funds performed so well in the recent past. That said currency hedging is not always a good idea. Take the example of Japan ETFs – while currency hedged products like the WisdomTree Japan Hedged ETF (NYSEARCA: DXJ ) outperformed the unhedged ones like the iShares MSCI Japan ETF (NYSEARCA: EWJ ) over the past couple years, as the yen weakened against the dollar, they have underperformed over the past 2-3 months, as the Japanese currency rebounded, thanks mainly to its safe-haven status and worse-than-expected stimulus measures announced by the BOJ. Original Post

Will Gold Continue Its Dominance Over Silver ETFs?

The weakness in the global financial markets has helped precious metals, like gold and silver, to recover their sheen in 2016. Sluggish growth in China since the beginning of the year and the global oil market turbulence has lifted safe-haven demand. The jump in gold and silver prices was also supported by plunging interest rates on a global scale. With the Fed not expected to raise interest rates in the near term, the rally is expected to continue. While gold has gained 18% and 11% year to date and in the past one month, respectively, silver has risen 10% so far this year and just 4.4% in February. Will the Trend Continue? Gold and silver prices have exhibited a strong correlation in the past 10 years. In fact, some investors regard silver as a leveraged play on gold. Per a regression analysis based on FactSet data, silver prices move 1.4 times the increase in gold prices on an average. In other words, if gold rises by 1% in a particular session, silver is expected to gain 1.45%. However, this year prices have gone the other way round as evident from the year-to-date and monthly figures. The outperformance of gold can be due to the fact that silver is widely used for industrial purposes. Weak manufacturing activities across the globe, particularly in China, have hurt the demand for the white metal, affecting its price. How to Play? But history they say repeats itself and the appreciation of gold prices over silver is not likely to be sustainable over the long run. This is because conditions in the U.S. market are slowly improving and industrial demand for silver is expected to get a boost from stepped-up domestic economic activity. Additionally, silver supply could contract given the dearth in deposits faced by the silver miners , forcing producers to look for fresh projects. Meanwhile, investors returned to risk-on trade sentiment in the recent week, which could affect the demand for gold bullion. Investors could play the market by going long on silver and short on gold. Below, we have highlighted some of the silver and inverse gold ETFs. Investors should note that since these inverse products when combined with leverage are very volatile, these are suitable only for traders and those with a high-risk tolerance and short-term outlook. Additionally, the daily rebalancing – when combined with leverage – may force these products to deviate significantly from the expected long-term performance figures. Still, for ETF investors who expect the outperformance of gold over silver to be short-lived, the products discussed below could make for interesting choices. Long on Silver iShares Silver Trust ETF (NYSEARCA: SLV ) The fund tracks the price of silver bullion measured in U.S. dollars. It is the ultra-popular silver ETF with AUM of over $5 billion and heavy volume of nearly 6 million shares a day. It charges 50 bps in fees per year from investors. The fund holds a Zacks ETF Rank #3 (Hold) with a High risk outlook and has returned 10.2% so far this year. ETFS Physical Silver Trust ETF (NYSEARCA: SIVR ) This fund has amassed $227.8 million in its asset base while trades in moderate volume of more than 82,000 shares per day on average. It tracks the performance of the price of silver less the Trust expenses and is backed by physical silver. Expense ratio is 0.30%. The fund also holds a Zacks ETF Rank #3 (Hold) with a High risk outlook and has returned 10.4% so far this year. PowerShares DB Silver ETF (NYSEARCA: DBS ) This product provides exposure to the silver futures market rather than spot market and tracks the DBIQ Optimum Yield Silver Index Excess Return index. It is has AUM of $19.5 million and average daily volume of less than 3,000 shares, increasing the total cost for the fund in the form of a wide bid/ask spread. DBS is the high cost choice in the silver bullion space, charging 79 bps in fees per year from investors. Like other silver ETFs, the fund holds a Zacks ETF Rank #3 (Hold) with a High risk outlook. In the year-to-date period, it has gained 10.4%. Short on Gold ProShares Ultra Short Gold ETF (NYSEARCA: GLL ) This fund seeks to deliver twice (2x or 200%) the inverse return of the daily performance of gold bullion in U.S. dollars; the gold price is fixed for delivery in London. GLL gains when the gold market falls and is appropriate for hedging purposes against the decline in gold prices. With an expense ratio of 0.95%, the product has AUM of $47 million and average daily volume of 21,000 shares. DB Gold Double Short ETN (NYSEARCA: DZZ ) This ETN seeks to deliver twice (2x or 200%) the inverse return of the daily performance of the Deutsche Bank Liquid Commodity Index-Optimum Yield Gold. DZZ initiates a short position in the gold futures market but charges a relatively lesser price of 75 bps a year. The product has amassed over $49.6 million in AUM. The ETN has volume of 432,000 shares a day. VelocityShares 3x Inverse Gold ETN (NASDAQ: DGLD ) This product provides three times (300%) short exposure to the daily performance of the S&P GSCI Gold Index Excess Return plus returns from U.S. T-bills net of fees and expenses. This $9.9 million ETN charges 135 bps in fees per year from investors and has average daily volume of 24,000 shares. Original Post