We bring up the precious metals companies because they have become a very popular area of investment interest, for obvious reasons. Since the evolution of the ETF, gold has been able to play a role in portfolios as a hedge that was far more difficult in the pre-ETF days. It’s important to understand how the investment objectives or expectations behind those reasons are satisfied or, perhaps, obstructed by the indexation vortex. Bizarre stock price movements illustrates the premise that the efficient market is not at work in the gold miners ETFs. The high participation of leveraged ETFs in the gold miners’ group is influencing prices. Between the leveraged and the unleveraged index, the gold market has become a series of interlocking reflecting mirrors.Read More >
Under the Hood Index Series
For the first time since the late 1940s, stock and bond yields have essentially converged. Once upon a time – say for the prior 80 years – investors demanded higher yields from stocks since the risk was greater. So what does this mean? If nothing else, caution is in order, and investors should be very thoughtful, perhaps more than at any other time in their careers, about where capital is being put at risk and why.
Which brings us to cash and public companies. Cash earns effectively no income, and can lower various valuation metrics, which are surely also important to executive compensation and performance benchmarking. As a result, many investors wish for the cash on the balance sheet to be deployed — a nice word for “spent” – through share repurchases, dividends, or acquisitions. But this is only a productive use of cash if the transactions are done at attractive valuations, and without taking on more leverage than appropriate. As is usually the case, well, take a look.
We’ve heard a lot about the historically low interest rates. But what does this mean? First, by historic, we mean in recorded history, so we’re already, in a sense, footnotes in a future economics textbook. Second, we really don’t want to be footnotes in a future financial markets textbook, as casualties of the greatest interest rate risk in history. But it appears that the potential impact from rising rates is underappreciated. The search for yield in all the ordinary places – long-term bond funds, REIT and utility funds, the ‘dividend aristocrats’ – is not diversification and it’s not safe. They’re at historic high valuations and it all hinges on interest rates. One must escape them, which means to step outside the indexation/ETF vortex.Read More >
Keep hearing the phrase “historically low interest rates”? What do you think that means, exactly? Since World War II? Since the Great Depression? World War I? The Civil War? The War of 1812? What it means is “in the recorded history of mankind.” Meaning in the last 5,000 years. Near-zero and negative long-term interest rates, which are now a near-worldwide phenomenon, have never happened before. That should arouse at least a moment’s reflection, should it not?Read More >
If a company has had declining revenue and declining earnings, and if those are unlikely to return to their prior lofty levels, then its share price should be lower, too. Right? In the world of passive indexation, as it turns out, that would be wrong.Read More >
As investors continue to search for yield in a persistent low interest rate environment, many are turning to “bond-like” securities, which offer high dividends and are perceived to be “safe.” These include utilities companies, which currently yield 3-4%, well above the yield offered by US 10-year Treasury Bonds. But the perceived safety rests on a precarious foundation. Simultaneous with their historic high valuations, they face serious risks that we do not believe are appreciated by most investors. These include: loss of marginal demand due to the rapid incursions of solar power, shrinking earnings as a result, and rising interest rates. Investors in utilities companies are urged to proceed with caution.Read More >
Over the past several years, the emergence of indexation as the dominant mode of investing has been to the detriment of the stock prices of those companies not included in the major indexes. However, as is usually the case when an idea is pushed to the extreme, this dynamic has now led to new investment opportunities.Read More >
A growing share of retail investment is made via automated asset allocation programs – robo-advisers. But how do these programs assess client needs and assemble recommended portfolios? Do potential fees earned by the provider factor into the proposal?Read More >
The trading volume for the largest index ETFs is truly astonishing, and is an order of magnitude greater than the turnover of the companies that comprise the underlying index. Why does this occur? One small part of the answer may lie in the emergence of robo-advisors.Read More >
The Beta Game Part I described one of the most important ETF statistical measures: beta. Beta is important, even though all it does is measure the historical day-to-day price variance of a stock or index fund versus the S&P 500, because ETFs are generally sold on the basis of both high performance AND low volatility. In fact, all the high-beta labeled funds we could find had, in aggregate, less than ½ of 1% of the assets of funds labeled low-volatility.
In Part II, we give some explanation–since it doesn’t otherwise really make sense–as to how, by the measure of beta, India or Peru has lower risk than the S&P 500, and as to how horribly wrong past reliance on historical correlations has gone. (It was Mark Twain who popularized the following phrase–attributed to Benjamin Disraeli but without definitive authorship: There are three kinds of lies: lies, damned lies, and statistics.)
We also offer a proof that some of the best investors of the past 30 years cannot survive in a beta-driven world. And as a bonus, we’re even giving away a classically good investment idea, because having the best kind of high beta (yes, there is good high beta) we know it would fail to even be considered as an ETF or fund product.Read More >
In yet another example of the ever widening gulf between fundamentals and valuation in the world of indexation – year-to-date, the S&P 500 was up 2.9% as of November 30, 2015; excluding just the 10 top contributing stocks, it was down 0.6% – momentum investing has become accepted practice. Momentum investing simply means buying stocks that have gone up (or, conversely, selling those that have not). Momentum indexes, and of course the ETFs that track them, create continued demand for those stocks that have risen recently, pushing them yet higher, while at the same time further pressuring the prices of stocks with recent underperformance. The momentum process is starkly different from the asset allocation process, and by design, seems likely to result in an unpleasant experience for those who are invested in (or perhaps anywhere near) momentum ETFs or the stocks that comprise them if/when the tide turns.Read More >
We have frequently observed that data without context is, at best, meaningless, and at worst, misleading. For many investors, beta (a statistical measure of the historical price risk of a stock or ETF relative to the broader market) has become among the most important factors in selecting an ETF. The implications for ETF providers can’t be ignored: demand for high beta ETFs is simply not there, so new ideas for high beta products are not likely to make it to market, while low beta products, no matter how irrational the beta may appear (e.g., does the Peru ETF really have the same beta as the S&P 500? Yes, it really does.), continue to gather assets. But if, as proposed in past commentaries, index constituent prices are driven by demand for ETFs rather than by the intrinsic value of the constituent companies themselves, what is the low beta of your ETF telling you?Read More >
Following the $1 trillion+ flow of post-2008 funds into index products such as ETFs, the valuations of the securities widely held in ETFs are driven more by demand for those ETFs than by the merits of the companies themselves. What would happen if that demand reversed – do the ETFs have sufficient liquidity to handle it? On August 24th, some of the most liquid ETFs experienced temporary, dramatic price drops though their constituent securities did not – the safety of indexation doesn’t feel so safe anymore.Read More >
Just as investing in high yield bond ETFs provides, paradoxically, little exposure to high yield bonds, investing in emerging markets ETFs does not really provide all that much emerging market exposure. The Indian market, for example, is exceptionally broad, with thousands of securities that participate in the economy’s robust growth. However, the ETFs that purport to provide exposure to the Indian market turn out to hold the same roughly 50 large-cap companies, companies that are either truly global in nature (minimal Indian exposure) or in great demand and quite expensive . If one seeks exposure to the local Indian economy, the current generation of ETFs are not the way to achieve it.Read More >
For those dubious that indexation and the indiscriminate buying it has cultivated have massively distorted equity prices, the reality is startlingly clear viewed through the impartial valuation prism of bond prices. Attached is a brief excursion through an emerging markets high yield bond ETF. Care to guess the yield of a 10-year Republic of Lebanon bond? How about Russian Federation 7.5% of 2030? The terminal experience for investors may be quite different than they originally anticipated.Read More >
In 2005, the S&P 500 Index methodology was changed to reflect float adjusted market capitalization. In this commentary, we consider the impact of this change on Index returns.Read More >
In this first “Under the Hood: What’s in Your Index?” series, we test a widely held assumption in many (if not most) investors’ allocation decisions. Most investors have some portion of their equity portfolio assigned to international stocks to diversify their exposure to U.S. stocks. But what if, through a major index like the S&P 500, you’re already allocated (or over-allocated) to non-U.S. economies?Read More >