Update on Hedge Fund Index

Aug 07, 2012 in Hedge Funds

Bloomberg Hedge Fund Index through July 31, 2012.    While there may be room until most managers get back above their high-water marks -- eventually you run into the same core problem --  2+20% of profits will be taken away from investors and go to the fund managers.   Upside is therefore quite limited.  Downside is limited as well but so is the case with a good, risk-managed allocation.

 

Follow us on Follow etfreplay on Twitter

Tags:

How 'long-term' are we talking about?

Aug 02, 2012

How long-term is long-term?  Everyone says they are long-term -- but the question of time horizon is a tricky one.

Certainly a good deal of your portfolio can be very long-term buy and hold oriented.  But what if your portfolio is structured poorly?  You can rationalize almost anything saying 'yes but it's long-term so I don't care about that' and if you are long-term, then you don't actually admit to mistakes until its been many years -- and that can be catastrophic if you portfolio strategy is flawed.  

The bond market is good for understanding return and risk because its so structured.   10-year bonds are clearly a lot more volatile than 5-year bonds.  20-30 year bonds move around a lot as they are quite volatile (often more volatile than stocks).

So let's back up to November 2011.  Is the time from November 2011 to today long-term?   Most would probably say no.   However, an awful lot has happened in terms of movement since then.   So we have two very different ideas.   One is acting in a useful and realistic timeframe.   The other is essentailly ignoring 8-9 months of movement and claiming nothing can be done about such a short timeframe. A core-tactical portfolio structure acknowledges there is some validity in both ideas. Multi-faceted portfolios may not lead the world in performance -- but they will help you reach your goals.

On November 30, 2011 --- the stated Yield-To-Maturity of one of iShares main intermediate investment-grade bond funds (LQD) was listed at 4.3%.   A treasury bond fund with similar duration (IEF) was listed at 1.8%.

Since that date, LQD has achieved a total return of 12.5%.   IEF is up 6.2%.    So each has achieved a return that is 3x its stated yield --- and its only been 8 months.

Looking at an extreme case,  a long-term treasury bond fund (EDV) is up +65% over the last 12 months.   A year ago it yielded 4%.   So the actual achieved return in that case was 15x the stated yield to maturity.

For the amount of times we hear about how low yields are -- very little is said about the uselessness of YTM as a predictor of INTERMEDIATE-term return.   I guess its just not 'long-term' enough.   It is the sensitivity to changes in interest rates (duration) that dominates the return.   The best way to both grow (and protect) a portfolio is to blend stocks and bonds together in a way with both the long AND intermediate term in mind.

  
We are involved in stocks in the first place because over the long-run, stocks are a good way to grow capital.   So we are long-term just like everyone else.   However, the long-run orientation is frankly a 'given' --- what we are really talking about is the intermediate-term tactical moves and in this regard, the returns and volatilities of intermediate moves are substantial.    Saying TLT has a yield to maturity of 3.0% is an interesting piece of information --- it is just not in any way a reliable indicator of the 6-18 month total return.  

Below is a quick snapshot of various bond funds stated YTM's from November 30, 2011 and their ACTUAL total return since that date.   If back then you thought YTM was an accurate predictor -- you're 'only' off by 3x in 8 months.

Summary:   It helps to understand the basic mechanics of portfolio management.    Indeed, portfolio structure and PM techniques are just as important as anything in investing.   Bonds are a useful way to understand different ideas like volatility.   We want to be in equities long-term and for the core long-term portfolio, it is perfectly reasonable to do that.   But there is clearly more opportunity than that in the intermediate-term timeframe. 

 

 

Follow us on Follow etfreplay on Twitter

Tags:

Sector ETF Investing: Black Diamond, Beware

Jul 30, 2012 in Sectors

 

At ski resorts in the U.S. each ski run is denoted with a symbol.  A green circle is for 'Easiest' runs, a Blue Square is for 'Moderate' and the more difficult runs are marked with a 'Black Diamond'.  A Double black diamond would be for experts only.   Perhaps ETFs should adopt this system?  

 

The most volatile are black diamonds and any short-duration bond funds would be marked Green.   Of course, there is no enjoyment in going 'down' green runs, you spend all your time and effort just planning how you are going to maintain some speed so that you don't come to a complete stop. 

 

If you look at virtually any institutional money managers quarterly or semi-annual review,  there is usually something that has a few lines similar to this:  'we are overweight energy for reason X [and insert reason why] and underweight financials for reason Y [and insert reason why]' etc...   Then there is usually a data table comparing the fund to its benchmark across each sector.

 

Let's take a look at some recent trends in Sector ETF investing.  For this, we pair up 2 sectors:  [Financials + Energy] vs [Staples + Utilities].    We link these together because these are classic 'High-Beta' vs 'Low-Vol' types of analysis (in recent years the popular terminology has been: 'risk-on' / 'risk-off') -- but it's all the same idea.   

 

Below is the second half of 2011.  

 

Put yourself in the spot of a fund manager trying to explain their sector positioning at each point in time.   Note that Staples + Utilities had a sharp but very short-lived corrective move beginning in July, 2011 and then promptly retraced the entire amount back up in September and then actually went back above the July/Aug highs soon thereafter.  Meanwhile, Financials and Energy continued to correct hard into very beginning of October and then go into a vertical short-squeeze type of move up that lasts about a month and then entering a volatile trading range through the end of the year.

By the time the year ends, many managers not watching such things in this format are wondering how in the world the S&P 500 ended up +2.0% (total return) for the year.    Hedge funds got whipped around badly as this action is indeed very tricky if you are spending your time trying to figure out how it all makes sense fundamentally.  But the fact is that the market doesn't sit around and wait for you to figure out how it all makes sense before it does its next thing.    Managers coming up with reasons for their quarterly positioning often have a tough go of figuring out how to make it look like they know what they are talking about.

Ok, so now say you got it right during the second half of 2011 and were overweight low-vol segments (think high dividend stocks).  Great.  Now the first quarter of 2012 begins and the exact opposite occurs.

 

As the new year got underway, the market begins with a large rally in 'high-beta' assets while classic low-vol sectors like Staples & Utilities actually go down.   High-beta had a big first quarter with low-vol lagging.   The manager who was (rightly) defensive in 2011 now has a tough time justifying why they are off to such a rough start to 2012.   Some managers likely then took their high-beta exposure up to reduce the pain.     And what has happened since then?  

 

Naturally, there was another large internal rotation with the overall market going nowhere while low-vol segments outperforming strongly with high-beta trading down.

So that is where we stand now --- these sets of ETFs are now essentially up about the same amount YTD -- but with very different paths to get here.    Given the large outperformance during the second half of 2011, the 12-month chart of course looks quite different --- with low-vol segments like Staples and Utilities back at all-time highs.

A lot of members who begin at ETFreplay set up a 'sector portfolio' --- ie, the Sector SPDRs or Vanguard Sectors.  It might be natural -- that is how a lot of people think about investing -- overweight this sector and underweight that sector.     But once you start backtesting such strategies, you may start to realize --- wow, this doesn't work very well.  

Well, look on the bright side, it's a good thing you tested it before thinking you had something.   Indeed, sector investing can be treacherous and that isn't a new thing.   We have done many examples on this blog and within the demos on the site and we've never done a sector example (it wasn't for a lack of trying various ideas).  The reason is that we just think there is a lot of lower hanging fruit than that.   We don't care to ski double black-diamonds when there are nice blue square runs out there.  

That all said, if you do indeed want to test sector strategies -- then we suggest a particular module called  'Ratio Moving Average backtest' -- our work shows some potential in this area.   However, we would stay away from things like XLE vs SPY.  There are 1400 ETFs after all, it's ok to have some imagination beyond the over-researched and over-analyzed sector approach.

Thinking from a return-risk perspective,  we do have one idea for sectors -- it involves just buying and holding lower-vol sectors and then barbelling that by tactically adjusting higher-beta exposures using the 'Ratio Moving Average' module.   If you do it like that, then you will generally create risk in the end that is similar to the overall market -- and you will greatly reduce getting caught in buying back into high-beta AFTER its had a run.

The 'Ratio MA' module compares 2 ETFs and attaches rules to trade the ratio between two market segments.   We prefer using uncorrelated ETFs in this analysis --- ie,  XLF vs IEF  --- rather than one equity ETF vs another equity ETF.  But we certainly look forward to seeing other possible techniques by watching members ideas develop on the Allocations Board

Summary:  In our opinion, sector ETF timing is something that we think is probably over-researched (and the charts above indicate its 'black-diamond' nature).

Backtesting is inherently evidence-based.   When you learn something in backtesting, then use that knowledge.   Don't try to force-fit a generic sector list into a strategy --  be flexible and don't stop the learning process.  Financial relationships can be dynamic --- that is, they can change in sometimes tricky ways.   If you have trouble making something deliver good reward/risk -- then take heed -- it probably has no edge and is therefore just a random walk.  Like the signs in the picture above --- there are various levels of difficulty.   If you go down the steepest run,  you may 'expect' to get to your destination more quickly -- but that doesn't mean you actually will -- the chance of crashing and burning is the other possible outcome.   The last 20 years are filled with managers who ski'd recklessly and won the short-term race  --- and then eventually ended up in the Ski Patrol sled.

Focus on reward-risk as a relationship.   Not just return and not just risk.

 

 

 

Follow us on Follow etfreplay on Twitter

Tags:

Allocation Example Making 'New Equity High'

Jul 16, 2012

It's still less than 7 months old but this allocation demonstrates what has been working lately.    This 'new equity high' has been driven by REITs, preferred stocks and EM Bond positions.   It's not clear what the benchmark should be on this one --- it's beating 60-40 but it actually holds 'liquid alternative' ETFs -- not equities.     Benchmarks are less important than making new all-time equity highs and generating return at reasonable risk.

 

 

New equity high has been driven by some very solid performances in areas like REITs and E.M. Bonds:

 

Follow us on Follow etfreplay on Twitter

Tags:

YTD 2012 Update: Generic Stock-Bond Index Fund vs Hedge Fund Index

Jul 03, 2012 in Hedge Funds

We updated this chart for YTD 2012 Performance:

Link to the 2011 Chart as well as the 7-Year Chart Ended March

 

2 Other Generic 'Endowment-Style' Allocations For Reference  (note: including the above stock-bond chart, all of these YTD returns are clustered in the +5 to +7% range)

 

 

Follow us on Follow etfreplay on Twitter

Tags:

Some Summary Index Charts At June 30, 2012

Jun 30, 2012

 

 

Follow us on Follow etfreplay on Twitter

Tags:

'Bernanke Is Killing Savers' -- Reality Check Part 2

Jun 24, 2012

We wrote some blog posts in  2011 about the top 25 bond ETFs in terms of assets.    This is by definition what fixed-income ETF investors actually own.    We don't have to guess -- or say comments like 'Bernanke has killed savers returns with its 0% interest rate policy'  ---  we can just observe the assets in each fund and calculate the actual achieved returns.

Using the exact same list from a May 2011 blog as a proxy, over the past 13 months fixed-income ETF investors are up in the range of +7.0%.   Over exactly 12 months, its +6.3%.

 

 

It's not spectacular -- but it certainly hasn't been 'near 0%'  as some commentators seemed to be predicting based on their views of U.S. Federal Reserve policies.   If you are just watching the stated yield-to-maturity of 10-year Treasuries relative to history and think that is all there is to it,  well then --- good luck.

Two ETFs we like to watch closely are IEF and LQD.   They aren't the only ones to watch of course, but these are 2 key intermediate index segments (Treasuries and Investment Grade Corporates).  Neither has much in terms of yield now....  NOR DID THEY 12-13 months ago.  For LQD, the total return path neatly factors in all of the following:   1) the interest earned along the way   2) the change in interest rates since the start date (for the index)  3) the change in the credit spread vs treasuries  and 4) all the bond trades the ETF manager has done to maintain the characteristics of the underlying index.    As CFA charterholders, we had to learn bond mechanics like how to calculate convexity/duration and Option Adjusted Spreads (OAS).  But in the end, a portfolio manager just wants to analyze portfolio management strategies that make money --- the mechanics of individual security analysis are important to a bond fund manager in competition with an index  -- but such mechanics are really not very meaningful when put in the context of managing an overall asset-allocation.

Below is a chart of IEF & LQD  -- and then we include XLE and DBC (the Deutsche Bank commodity index) since May 2011.  The point here is simply to re-iterate the point made 1 and 2 and 3 years ago -- you can't simplify something as vast and nuanced as the bond market into 'avoid bonds' just because the YTM of 10-year Treasuries is low.

 

Follow us on Follow etfreplay on Twitter

Tags:

Learning Through Portfolio Backtesting - The Short-Term Isn't That Meaningful

Jun 10, 2012 in Backtest

In this post, we will check back in on the 'Sample Portfolio' -- which was a portfolio we set up over 2 years ago and included as the starter example portfolio for new members.   The idea behind it was to show one type of simple mix of ETFs that can serve as good complements to each other in terms of a rotation strategy.

As seen below,  this rotation portfolio has performed pretty well over the past 2 years.   

But the more specific point we wanted to make here was in the statistical profile that accompanies the report (marked with an arrow at the bottom).  

In the last 'out of sample' 18 monthly results (2011 & 2012), while this strategy is well ahead of the major indexes -- it has actually underperformed the S&P 500 in 10 out of 18 of those months.   Yes, that is right --  it has handily beat the S&P 500 on a cumulative basis while still underperforming more times than not in terms of months.  That seems counter-intuitive -- but this actually isn't that unusual in investing.  

Many times you run a backtest and it shows good results --- make sure to scan down to that number in the table below and take a look at how often is outperforms your inputted benchmark.  If you do this a lot, you will start to understand some of the common pitfalls of bahavioral finance issues.

This is the important part --- if you didn't know this, imagine how your psychology might affect your investing process.  The start to 2012 is a good example.  Our allocations board portfolio fell behind the S&P 500 return on a Year-To-Date basis in March (relative basis only).   Was this underperformance meaningful?  No.  Not if we believe that our strategy is solid and that we don't care about the short-run --- we only care about the equity curve over time.  Through backtesting, we are armed with the knowledge that good strategies might indeed underperform in 40% or more of the months and this does nothing to change the validity of the strategy.

Summary:   We all want to outperform the indexes in every single period --- but if you obsess about this kind of thing --- chasing a benchmark around in every short-term timeframe -- it will ultimately be your un-doing.   The behavioral/mental side of investing is hugely underrated.   The specific numbers in this one example are not the point.   The point here is to use the portfolio backtesting process as a way to battle against the behavioral biases that keep you from doing well in investing.   In our view, backtesting ideas can greatly help because if you are like us, you have to SEE it and imprint it on your brain to actually believe it.  Only through a good and never-ending research process will we ever truly believe in these kinds of things.

 

Follow us on Follow etfreplay on Twitter

Tags:

ETF Bond Market Performance Since QE Began

Jun 07, 2012 in Bonds

The Federal Reserve has made a lot of money on its Treasury Bond purchases.  However, that is dwarfed by what high-yield bond investors have received over the last few years:

Follow us on Follow etfreplay on Twitter

Tags:

Corporate Bonds vs MLPs

Jun 02, 2012

 

Treasury Bonds Are Going Parabolic.   But its not well reported that high-grade US corporate bonds are also in a strong rally.  It's not just treasuries.   Meanwhile,  Oil & Gas MLPs are having very poor run and should be a reminder of the difference between fixed-income securities and riskier assets.

 

Follow us on Follow etfreplay on Twitter

Tags:

Follow ETFreplay

Archives