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Wednesday, June 10, 2015

More on Robo Advisors..How Well Do They Get to Know You Before Investing Your Money ?

I have written 2 previous posts on the shortcoming of robo advisors. Probably the most important is that they know virtually nothing about you before they determine your portfolio, They are not set up to take account of your tax situation which is crucially important as well as many other factors related to personal circumstances. For instane what if a  family plans to have additional children or an investor plans to make a radical career change such as leaving a job with a steady salary to start their own business ? It doesn't take much thought to imagine the many,many other factors that could be added to the list.

A comparison table of robo advisors below.lists the following as inputs uesed to determine a portfolio allocation:

Future Advisor: 2 factors: age and risk tolerance

Wealthfront 10 question financial questionaire

Wisebanyan questionaire risk score

You REALLY Don't Know What is Inside Your Mutual Fund

The biggest advantage to ETFa other than their low cost is their transparency, For those indices using publicly available indices one can know exactly what the portfolio owns at any time. Even if the fund falls into the category of those "smart beta" funds such as Powershares PRF and PRFZ the fund still has a selection process that doesn;t change a clear definition of where in the market it invests.

This is not the case for actively managed mutual fund. This is very often the case even if he fund is to target a particular sector of the market such as small cap stocks. If one looks at the prospectus the manager often has discretion to invest outside the category (in this case small caps) for a percentage or even at times all of the portfolio. The article notes

The WSJ has an excellent article pointing how hard it is both to know what an actively managed mutual fund is even more difficult to "get under the hood" to know more about the strategy the manager is pursuing.

What a Fund’s Top 10 Holdings Don’t Tell You

Top 10 lists are fun, easily digested and make people feel they are in the know. But a mutual fund’s list of top 10 holdings isn’t as satisfying.
That is because the listed holdings aren’t necessarily still the fund’s favorites.A mutual fund is permitted to delay reporting portfolio holdings for as long as 60 days following the end of its fiscal quarter. In practice, many funds publish a complete list of their holdings on their websites 30 days after the quarter ends. Top 10 holdings and their percentage weightings in the portfolio frequently are made available online monthly with a 10- or 15-day lag.s are frequently out of date, and don’t say much about overall strategy....

 top 10 holdings are just a starting point to evaluate a fund.“It’s only one piece of a broader puzzle as to how that fund is managed,” says Mr. Rotblut.
Fitting the pieces together requires digging into a mutual fund’s inner workings: long-term results, manager tenure and expenses. Investors also should be aware of the four P’s that investment advisers tend to consider when selecting funds for clients—investment process, the people managing the fund, their performance record and the reputation of the fund’s parent company....
The article also notes:
Research shows that for stock funds, factors including sector allocation and style consistency influence returns more than the selection of individual stocks. In other words, in evaluating a fund, where and how a manager invests is more telling than what’s being bought and sold. 
The style consistency problem is eliminated with most ETFs. Sector allocation is of course eliminated in the case of style specific ETFs or in the case of bonds bond ETFs designed to invest based on a particular index either broad bond market or specific maturity or type of bond.

Other factors mentioned are more or even fully transparent with ETFs
 Fitting the pieces together requires digging into a mutual fund’s inner workings: long-term results, manager tenure and expenses. Investors also should be aware of the four P’s that investment advisers tend to consider when selecting funds for clients—investment process, the people managing the fund, their performance record and the reputation of the fund’s parent company.

For ETFs long term results are far more useful because the methodology for the ETF is consistent for an actively managed fund past results say virtually nothing about future results especially since in many cases the manager changes over the period reported. Fees are transparent for ETFs and actively traded mutual funds...although there are ETFs available with fees far lower than active funds many below .10%.


 Portfolio turnover—a measure of trading activity—is also telling. If a fund’s turnover is greater than 50% annually, top holdings might shift even more rapidly. This is especially the case with small-cap and midcap stock funds, which tend to see more trading.Turnover below 50% indicates that management is being more patient and holding on to stocks longer. 
Portfolio turnover in an ETF is limited to portfolio rebalances and in virtually no cases does it come close to 50%.

Tuesday, June 9, 2015

MSCI On Including A Shares...Not Yet

MSCI announced that it was holding off on including A shares in it's emerging markets index.

MSCI Inc. held off from adding China’s mainland stocks to its benchmark indexes, opting to work with the nation’s securities regulator to overcome remaining obstacles to inclusion. Shares dropped in Shanghai.
The index provider expects to put yuan-denominated equities, also called A shares, in its global benchmarks after settling investor concerns about accessibility and share ownership through collaboration with the China Securities Regulatory Commission, according to a statement issued Tuesday. MSCI said a decision on inclusion may come at any time.
Chinese authorities have been pushing for an MSCI endorsement as they seek to elevate the status of mainland markets on the world stage and make the yuan a more international currency. Efforts to open up local shares to foreign investors, including an exchange link with Hong Kong, have already helped propel a $6.5 trillion surge in the value of Chinese equities over the past year.
“Some might regard it as disappointing that it didn’t happen immediately,” Shane Oliver, the head of investment strategy at AMP Capital Investors Ltd. in Sydney, which manages about $124 billion, said by phone. “By the same token, it looks like it’s going to happen anyway at some point. It’s just a question of when. They’ve just got some remaining issues to resolve.”
The Shanghai Composite Index retreated as much as 2.2 percent, before paring declines to 0.5 percent at the noon-time break.
The possible addition of mainland equities to MSCI’s global indexes has been a divisive issue among fund managers. Even as China’s stocks more than doubled over the past year, foreigners have been cautious about entering a market where retail investors account for 80 percent of trading.

Boring stocks

WSJ  in a recent  article noted  the outperformance of "boring stocks"based on theri definition of boring industriesc the data but

 I am not surprised . As noted in the article this is really  subset of value stocks. And it is well know that over long term what are considered value stocks (low measures such as price/earnings or price/book outperform

The article notes:

We find that our predictions are supported by the data: Boring industries are better investments than exciting industries,”

The converse of this finding has been observed for long data periods. High valuation small cap stocks value stocks (low measures such as price/earnings or price/book outperform. It has long been known that categories of stocks that get bid up to high valuations are poor performers long term. These are referred to by observers as "lottery tickets",glamour stocks or shooting stars and usually have high valuations. Within this group the absolute worst performing stocks are those that were recent ipos which can be considered the ultimate lottery ticket since they often have no earnings and certainly no long term track record of financial performance. In fact many of these stocks can be said to have a price/earnings ratio of infinity since they have no earnings.

This a well known outdcme of the many findings of behavioral finance. Investors are attracted to stocks in the news and those that have the potential for quick large gains. There are certainly ipos and small cap growth stocks that generate eye popping returns in the short term although they generally return to reality, but the likelihood of picking one, and particularly picking a successful portfolio of them is low on a statistical basis. But nobody talks about their losers in this category at the cocktail party or barbeque and there are seldom articles about these in the media. So the prospects of “finding another google” seem more likely than they are.

The key is to take advantage of behavioral flaws in the market, .., many investors gravitate toward exciting industries in search of standout returns. That creates opportunities for investors to find undervalued stocks in sectors with less sizzle, Mr. Rudderow says nt.
Not surprisingly the a above quotation comes from "the investment officer of Mount Lucas Management, a firm in Newtown, Pa., that has $1.7 billion in assets under management and offers value funds including the large-cap Mount Lucas U.S. Focused Equityfund.
“It’s hard to be smarter than other people in something like Tesla,” where the potential for big gains is obvious, Mr. Rudderow says, “and it’s easier to be smarter than other people in boring stocks.”
I am particularly skeptical about the long term success of active managers vs. their benchmark in this case active value managers vs value indices or passive investments (not called “smar beta” active manager.
But I would say all the great long term investors have had a value oriented approach particularly when they are likely to have investors willing to view their investments as long term. The classic of this group is Warren Buffett. But many parts of his strategy such as buying non public companies and more recently buying spinoffs of public companies and taking them private indicates he may feel that the days of easy pickings in stocks are gone. Interestingly enough he has stated publicly that whatever money of his left to his wife will be passively invested in the S+P 500 not even it seems in Berkshire Hathaway stock managed by his hand picked successors.
Here is a chart comparing value vs growth indices and the S+P 500 (which is tilted towards large growth stocks).

Small cap value (yellow) Large cap value (green) S+P 500 (blue)
 Large cap growth (blue), small cap growth (red)

"Bond Market Massacre"

It is not hard to find headlines like this one all through the financial media highlighting the major selloff in "the bond market" over the past 2 weeks. As one article notes(June 4)

Yields on Global bond hit 2015 highs today, extending a selloff in government bond after a wave of upbeat economic data highlighted the valuation concerns that have nagged investors for months. Global major bond yields rose by 25 to 50 bps in last one month. Investors will be tempted to sell safe assets such as bonds and buy riskier assets as the economy recovers.

But it is a misnomer to indiscriminately write about a selloff in the bond market. Like most short term moves regardless if they are the beginning of a long term trend they reflect which positions are most vulnerable to particular risk factors. Or as the saying goes "when the tide goes out you see who is naked). In this particular case it is interest rates rising. And the most vulnearble parts of the bond market are intermediate and long term US bonds and developed and emerging market international bonds.

Here is a graph of a set of those type of bond ETFs for the last 3 months

But it is also to see which sectors of the bond market are less vulnerable: short term bonds in the US: corporate investment grade , government and high yield.

Here are some ETFs in that part of the bond market.

Thursday, June 4, 2015

Israeli Global Companies vs. "Local" Israeli Companies

I wrote about the Israeli stock market in 2 previous posts here and here  about the distinction between Israeli multinationals mostly in high tech and pharmaceuticals and "local" Israeli companies tied mostly to the local market. Since those global companies are either dual listed between the US and Israel with most of the volume on the US exchange or only listed on the US exchange.

For that reason I wrote there is not a compelling reason to invest in specifically Israeli stocks.The global Israeli companies move based on global economic and industry trends not anything specfic to the Israeli companies. And the purely local Israeli companies are not particularly compelling evidence...and represent only .34% of the world's stock market capitalization.

An excellent way to illustrate this is to compare the performance of the TA 25 index the tel aviv stock exchange large cap index dominated by multinational corporations and the TA 75 index which includes almost exclusively "local" Israeli companies.

The TA 75 Index which is dominated by local companies and as seen by the chart above has significantly underperformed the TA 25. Also noteworthy is the very large outperformance of the TA 25 vs the TA 75. That is because of the strength of the US $ against the Israeli Shekel (NIS). Simply put these are dollar priced stocks, the price on the Tel Aviv stock exchange is simply the dollar price translated into NIS. Not only are the stocks in the TA 25 not linked to the Israeli economy their value moves inversely to the NIS a weak NIS means a higher price . 

TA 25 Index (gold) TA 75 Index (blue)

Here are the components and weightings of the TA 25 Index:
5 global companies Perrigo, Teva, Nice Sytems,Opko and Elbit make up just over 37% of the index

TA 75 Components:
Here is a chart of the NIS/$ exchange rate. Note the stronger dollar here and how it coincides with the current period of large outperformance of the TA 25 vs the TA 75

Friday, May 29, 2015

Market Timing ...The Crowd Makes It Impossible for The "Experts",,,Or Anyone Else

At the Research Affiliates blog they posted a great article entitled

Calling the Turns: Why Market Timing Is So Hard

My takeaway. "Expert " analysts have so little success in timing markets because market prices are controlled by investors (certainly not confined to individual investors( who make decisions based on factors other than financial analysis. What an expert would call an overvalued market is simply not a determinant of how most investors make decisions, and those "uninformed" investors make their decisions based on other factors. And the most important factor not surprisingly is recent market performance.

Academic research and simple market observation shows that such behavior creates a momentum factor. We know it exists but it is very difficult to profit from (by knowing when to buy or sell) in excess of buy and hold. Most technical analysis is based on momentum. And much to the chagrin of academic economists a simple 200 day moving average has a fairly good record for giving market buy/sell signals.

From the article

The Market in Theory
The standard model of investment management equips portfolio managers and traders reasonably well to determine if an individual stock is fairly valued. Most investment professionals use discounted cash flow (DCF) analysis to estimate a stock’s inherent worth,3 and so to judge whether it is mispriced. With a handle on a stock’s true value, an investment professional can also observe the extent to which the market may have mispriced it. Similarly, by comparing the market’s current cap-weighted price/earnings to the long-term average, analysts can judge whether, and by how much, the market as a whole is misvalued. 

But DCF analysis, P/E multiples, and other theoretically sound valuation measures cannot tell us how much more misvalued the market will get nor can they explain the wild swings we’ve experienced in the two equity market cycles in the last 15 years.4 As Figure 1 illustrates, the stock market seems to go too far in both directions—up and down—and the amplitude of these movements cannot be satisfactorily explained within the cool analytical framework of the standard model. 

Empirical research has established that sooner or later stock prices revert toward their long-term averages. There is also strong evidence that the value premium is mean reverting (Hsu, 2014). If the market rises or falls to an extreme level despite a natural tendency to self-correct, then countervailing forces must be at work. .....

What are those countervailing forces ? Some insights from two Nobel Prize Winners in economics Daniel Kahneman and Vernon Smith neither of them believers in the efficient market theory which would argue markets are always rational:

One hypothesis is that many market participants view mental effort as an avoidable transaction cost. Disinclined to gather and analyze solid information about the stocks that interest them, they are carried along by the crowd, trading on momentum and noise. 

In addition to this kind of indolence or inertia, Daniel Kahneman and others have described a number of cognitive biases and patterns of emotionally charged behavior that affect individuals’ choices under uncertainty—the selling and buying of securities being an excellent example of such an activity. They include overconfidence and the illusion of control,5 mental accounts, availability cascades, loss aversion, overreacting to news, and herding, among others
Smith, the experimental economist who shared the 2002 Nobel Prize in Economic Science with Kahneman, distinguishes between constructivist and ecological rationality. The former involves the intentional use of reason to analyze the given and to advocate a course of action. (The standard model of investment management is a sterling product of constructivist rationality.) Ecological rationality, in contrast, emerges in institutions, such as markets, through human interaction rather than by human design. 

“Predominantly,” Smith  writes, “both economists and psychologists are reluctant to allow that na├»ve and unsophisticated agents can achieve socially optimal ends without a comprehensive understanding of the whole, as well as their individual parts, implemented by deliberate action.” But in Smith’s account, personal exchanges gave rise to impersonal markets which serve to facilitate the specialization that creates wealth. Smith demonstrates that in a diverse set of circumstances, such as the airlines’ response to deregulation, FCC spectrum auctions, and a variety of trust games, the interaction

Is all lost for the rational knowledgeable investor ? The author indicates that some use of tilting towards owning low valuation stocks has potential for outperformance or at least better risk/return. And the evidence of long term outperformance of low valuation to high valuation stocks is strong. But it should be noted that the folk at Research Affiliates have developed such strategies for several mutual funds and ETFs,:

At this juncture, we must acknowledge that financial theory does not provide clear and timely trading signals. Calling the turns is hard because we don’t have a mechanics of mean reversion. Our best theories—including behavioral finance, neuroeconomics, experimental economics, and evolutionary psychology—do not enable us to foresee the sudden exogenous shock that will trigger a reversal, or to sense when a gradual change in investors’ attitudes will reach the tipping point. Not even the most skilled and experienced asset allocators can pinpoint in advance the onset of a reversal. Most of us are well advised not to attempt market timing. The soundest plan is to choose a strategy that suits our investment objectives and risk tolerance—potentially including a disciplined smart beta strategy that systematically rebalances over time—and to stick with that choice for the long term.