Tag Archives: stocks

Shield Fund Earns Its Name

Summary Hedged Exposure to S&P 500 currently protecting investors’ capital. Delta approaches zero as market drops. New investors in with a -8.33% floor and a 18.95% cap. The recent volatility in the equity markets was a fun test for an investment I introduced upon its launch last April, which is the Exceed Structured Shield Fund (MUTF: SHIEX ). The fund has indeed shielded investor capital as the market plummeted. A detailed description of the mechanics of this fund can be found in my previous article , but as a refresher of the highlights: Passive, synthetic exposure to the S&P 500 via OCC cleared options 1:1 up and down, i.e. no leverage Protection level of -12.5%, or better if market execution allows Ceiling of approximately +15% The fund opened for business on 16 April 2015 and marked at $10 on close of market that day. For several months we were in a relatively sideways market, with SHIEX closely tracking the SPDR S&P 500 ETF Trust ETF (NYSEARCA: SPY ), so there were not any real opportunities to begin to highlight the performance success of an options-based hedge. We were able to observe the success of the 1-to-1 tracking, as SHIEX paralleled SPY. The following chart is the first four months of SHIEX, which is right before the market started cratering. (click to enlarge) At the lowest point, SPY was only down -2.79%. You can see that SHIEX was preserving capital at that point, since it was only down -1.89%. As measured from inception to that low-point, SHIEX had a 0.68 downside capture ratio. That means that for every $1 that SPY lost, SHIEX lost only $0.68. You can also see that SHIEX lagged slightly when SPY turned positive. I wanted to show you the mundane first, in order to set the stage for a stressed, falling market. Let us extend our view to include the most recent market activity. (click to enlarge) As the S&P 500 heads further south, we can see more clearly the impact of the hedge I call a “floor.” Recall that Exceed achieves this by being long (owning) a Put that is out of the money (OTM) by -12.5% or better. For small losses one can hardly notice the effect of this Put. But as the underlying security approaches being at the money (ATM), the delta decreases, approaching 0, and you can see that reflected in the pricing of the fund. The following table will help demonstrate that. The “change” column for both SHIEX and SPY relates to the launch date of 16 April 2015. The second row demonstrates that slight lag I mentioned earlier. The third row, 8/24/2015, is demonstrating the effect of the hedge starting to come into play. While the market has -9.92%, SHIEX has only captured 72.6% of that drop, with a -7.2% drop. But, as the market tanks for a second day, pushing SHIEX closer to its floor, the downside capture ratio shrinks to 66.5%. You can see that clearly in the bottom row. Imagine it like the “ground effect” in aviation. As one gets closer to the ground, the ground (floor) starts “pushing” back. SPY lost -1.18% in the next day of the sell-off, but SHIEX only shed -0.11%. In other words, as the floor was approached, the downside capture ratio sank to 9.3%. That means SHIEX only lost less than a dime for every dollar SPY dropped. Indeed, if SPY continues to drop, you will see the downside capture ratio also continue to drop. The chart for SHIEX will likely look like an invisible Atlas is supporting the fund price. There is nothing mythical about the mechanics, though. This is merely a hedge doing exactly what it is supposed to do: saving investor capital. If the markets continue to correct down, will we see a point where SHIEX will absolutely stop and drop no further? I can’t answer that forward statement, because there are too many variables at play. Recall that there are four, consecutive, 1-year collars being employed at every moment in the fund. Each one expires within a different quarter of the year. The 12.5% floor is set on each collar at a different strike point. The collar that initiated when the S&P 500 was at its lowest will also have the lowest floor, so that will be the critical path to reaching the bottom. But options do not price merely on Delta. Other factors such as volatility, time to expiration, and interest rates also weigh on the value of this synthetic exposure. Also remember that there is a large fixed-income portfolio of investment grade bonds collateralizing the fund, which will have a small impact on the pricing. But, as we have seen demonstrated, the downside capture ratio will continue to shrink towards zero (i.e. an absolute floor)as the long Put approaches being at-the-money. All the historical test data, and mathematical proofs, support this: NASDAQ Exceed Structured Protection Index (EXPROT). Further, they indicate that as the lowest Put goes in-the-money, the hedge will hold solid. (click to enlarge) For every one of the four collars that expires while the market is below the -12.5% or worse, the floor is absolute. The reason is Delta is at 0 (zero). Where is the Fund at this time? Exceed sent out an update on the current state of their collars as of 8/24/2015. This is an average of all four collars currently at-work in the fund: Floor: -8.33% Cap: 18.95% These are the levels that an investor would realize if they invested at the close yesterday. I noted in my introduction piece that the -12.5% floor was a minimum requirement. As you can see, they have exceeded the minimum requirement, and are executing a superior hedge. Further, for those concerned about missing a runaway bull-market, the cap has increased to +18.95%. That is the defined-outcome range of SHIEX as of the most recent, quarterly collar-roll. In this market, by most subjective projections, that is a highly desirable range of outcomes. Unfortunately, the fund has only managed to raise around $7MM assets, which I find disappointing. Disappointing, that is, for all the investors that are losing billions of dollars in this down market with their unhedged, long, domestic, passive and active, large cap investments. I attribute this to a few factors: Lack of awareness of this solution, which I hope to address with articles like this. Misinformation about bundled option strategies propagated by for-profit competitors. Reticence to trust a theoretical strategy; instead preferring to see if it really does work. The numbers are in, and the strategy is working as engineered. Only Schwab and Pershing clients have been able to take advantage of this fund’s strategy. The fund is not yet approved on the TD Ameritrade and Fidelity platforms, but it is my understanding that TD and Fidelity clients will have access within a month. I see little reason to have unhedged exposure to the S&P 500 when this solution is available. The Exceed Structured Shield Index Strategy Fund was just put the test, and it scored. Disclosure: I am/we are long SHIEX. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

5 IBD 50 Stocks Are Holding Above This Key Level

There was a lot of turbulence in the market the last two sessions, with many stocks taking big hits and falling below their moving averages. As stocks start to recover, here’s a look at five IBD 50 stocks that are holding above their 50-day lines: Google (GOOGL), Paycom Software (PAYC), Foot Locker (FL), Chipotle Mexican Grill (CMG) and Constellation Brands (STZ). Google gapped up 3.3% in big volume Wednesday, retaking its 50-day moving average.

Messy Fund Managers Create An Illusion Of Skill

Mutual fund rating services divide mutual funds into categories based on their investment style. This helps investors compare the performance of one style to another and helps them compare the performance of individual funds in a particular style. While useful in many ways, this methodology can also create the illusion of superior performance when none exists. Among the most familiar investment style tools is the Morningstar Style Box, a nine-square grid that provides a graphical representation of a fund’s investment style. For stock funds, it classifies funds according to primary market capitalization (large, mid and small) and investment style (growth, core and value). Morningstar (NASDAQ: MORN ) tracks the performance of securities in the nine style boxes, creates style indices, and then compares fund performance to these indices. According to Morningstar magazine , the average actively managed US equity fund performance has fallen short of its comparable style box index in all nine categories over the past five years ending in June 2015. However, there are times when a majority of active managers appear to perform better than a style box index. Over the past three years, surviving large-cap value managers have fallen into this category by outperforming their benchmark index 62.7% of the time. See Figure 1 below. Outperformance by a majority of managers in a particular style is often followed by calls from the fund community to use active management in that style. There are those who begin to argue that the market is inefficient in certain areas. They say indexing doesn’t work in these styles and that active management works better. Don’t take these periods of active manager outperformance at face value. It is an illusion that is expected to fade over time. What’s actually occurring is the difference between pure style index returns and messy active manager returns. Style indices represent a pure selection of securities driven strictly by empirical measurements, while fund managers are often messy in their portfolio constructions. For example, the only securities you’ll find in a small-cap value index are small-cap value stocks. In a small-cap value fund , a manager may choose to extend into other style boxes by drifting outside of the pure style. (The fine print in the fund prospectus typically allows for this.) A fund with messy style drift often compares favorably to the style it is benchmarked against when the benchmark is lagging other styles. When enough fund managers in a category are messy in their stock selection, and the benchmark style performs poorly relative to adjacent styles, it creates a period when active style-drifting managers appear to be a better option for investors. This is a temporary illusion of superiority that is not expected to persist. Figure 1 compares the three-year performance of Morningstar Style Box returns to the percentage of managers outperforming their style index benchmark. The X-axis represents the three-year annualized Morningstar style index return and the Y-axis represents the percentage of managed funds that outperformed each style. Figure 1: Morningstar Style Box Performance and Percentage of Managers that Outperformed. Three years ending June 30, 2015. (click to enlarge) Source: Morningstar magazine, August/September 2015, chart and regression by R. Ferri Figure 1 graphically illustrates the relationship between style performance and the ability of active fund managers to outperform the style. Mid-cap Value ( MV ) earned 20.7% annually and outperformed all other styles; MV managers had a very difficult time outperforming this index and succeeded only about 9% of the time. In contrast, Large-cap Value (LV) earned 14.1% annually and was the worst-performing style index; LV managers had an easier time outperforming, winning about 63% of the time. The regression is close to 85%. This means the percentage of managers who outperformed in each style is highly correlated with the relative performance of the style index. The greater a style index outperforms adjacent styles, the fewer managers outperformed in that style and vice versa. This observation isn’t new in mutual fund analysis. William Bernstein wrote about the phenomenon in 2001 article, Dunn’s Law Review : The Life and Times of “Core and Explore,” in which he noted, “[T]he fortunes of indexing a particular asset class depend on its performance relative to other asset classes.” The concept was expanded by William Thatcher in a 2009 article, When Indexing Works and When It Doesn’t in U.S. Equities: The Purity Hypothesis . Both articles indicate an inverse relationship between a style’s relative performance to other styles and active management’s ability to outperform in style. This brings us to a couple of important questions. First, when do a majority of active managers outperform a poor-performing style? Second, can managers time styles and position their portfolios accordingly and make it worth investing in messy active funds? Tables 1, 2 and 3 help answer the first question: When do a majority of active managers outperform a poor performing style? The yellow box with the red numbers in each table represents the percentage of managers that outperformed that style over a three-year period ending in June 2015. The red box represents the performance of the Morningstar style index for that category. The green box represents the performance of surrounding Morningstar style indices. (click to enlarge) Table 1 indicates Large Cap Value (LV) managers had a great run over the three-year period ending June 2015. Almost 63% of active manager beat the Morningstar Large Value Index return of 14.1%. It’s easy to see why. The green areas in Table 1 represent the performance of adjacent styles indices: Large Core (18.3%), Mid Core (19.9%), and Mid Value (20.7%). All three had notably superior performance to Large Value. Any messy LV managers who invested outside of, but near the LV style index constituents would have added performance to their portfolio. Table 2 shows the opposite story for Mid Cap Value ( MV ) managers. Only 9.0% outperformed their style index. MV was the highest-performing style of the nine style boxes, so any messiness on the part of MV managers would have hurt their performance relative to the style index – and it did. Table 3 represents Small Cap Value (SV) managers, 33.6% of whom outperformed the Small Cap style index. Although the index performed satisfactorily at 17.0%, it underperformed the adjacent style indices, but not by as wide a margin as LV in Table 1. Accordingly, there was some benefit to active SV manages, but not enough to increase their win rate over 33.6%. This latest evidence substantiates what Bernstein and Thatcher have indicated in the past: It appears there is no truth to the cliché that the market is inefficient in one style and not another. It’s about style performance relative to adjacent styles, and how messy managers are about remaining within a style in their equity selection. Active fund managers look superior when their benchmark style performs poorly relative to adjacent styles, and they look bad when their benchmark style outperforms adjacent styles by a meaningful amount. Eventually, this all comes out in the wash. Active managers in every style have underperformed by about the same percentage. Please see The Power of Passive Investing for more analysis on this topic. The second question is easier to answer: Can active managers time styles and position their portfolios accordingly? They cannot. If they could, today’s Morningstar active versus passive results would show improvement since the time Bernstein wrote about it. But it has not. Managers do not appear to have persistent skill in timing investment styles. Mutual fund rating services help investors compare the performance of one style to another by creating style indices, and they help investors compare the performance of funds within a particular style. But raw data can create the illusion of superior performance when none exists. You’ll need to dig deeper into a manager’s performance to determine if he or she truly has ongoing skill or if it’s just an illusion. Disclosure: Author’s positions can be viewed here .