Friday, June 26, 2015

8 Funds That Investors Are Fleeing in Droves

 PIMCO Total Return (PTTRX), Negative $125 Billion
Why the big outflows? The Bill Gross kerfuffle. We just reaffirmed our Bronze Morningstar Analyst Rating on the fund, as things have actually gone pretty well since Gross' departure. The outflows are the biggest negative, but they have had little to no impact on returns, and performance has been solid. The new three-person team seems to be functioning well so far, though we'll want to see more evidence of that before considering an upgrade. Outflows have finally started to slow down, though there's no telling when they'll actually end. I haven't touched my PIMCO Total Return investment (other than rebalancing) since Gross left, and I think that's the wise course for most people.

 PIMCO Unconstrained Bond (PUBDX), Negative $14 Billion
Why? Even before Gross left, investors were bailing on the fund because of disappointing performance and manager turnover. I see no reason to rush into this one given those issues but also because I really want to see how new manager Marc Seidner uses the fund's very broad mandate. He's the third manager in 14 months, so let's take our time seeing what territory he marks out. When this fund was launched in 2008, the excitement was huge as investors streamed in. They hoped the fund would be a winner whether rates rose or dropped, but instead it had pedestrian returns and stumbled a few times. It has a Morningstar Analyst Rating of Neutral. We'll see how it behaves under its new management.

 Thornburg International Value (TGVAX), Negative $11 Billion
Why? Poor returns have spurred big redemptions, though the trailing 12-month return is decent. The outflows represent more than half the fund's asset base a year ago, and that's a problem for an equity fund. The fund was a poor performer from 2011–14. It will need to sustain the recent rally to staunch the outflows. Once they do stop, this Bronze-rated fund could be a decent bet. A bias toward emerging markets and energy stocks has hurt, but the market can rotate back at any time.

 PIMCO Low Duration (PLDDX), Negative $10 Billion
Why? Gross was formerly the manager at this fund. It, too, had a couple of years of weak performance that no doubt spurred the redemptions. Now, Scott Mather and Jerome Schneider are at the helm. Schneider heads PIMCO's short-term desk, so he was a logical addition. We rate the fund Bronze because of the talented pair heading it and because of PIMCO's depth in this area. It's worth holding on, though I'd caution against using it as a money market substitute given that it dips into lower-quality debt.

 Fidelity Contrafund (FCNTX), Negative $8 Billion
Why? Some of the outflows are due to some retirement plans' conversion to Collective Investment Trusts. (Fidelity hasn't said how much.) The rest is hard to explain given that performance has remained solid if unexceptional. I would certainly stick with Will Danoff as long as he's at Fidelity Contrafund. His record is remarkable. To be sure, the fund's massive asset base is a handicap, but he's had great success with a big fund for many years. We rate it Silver.

 American Funds Growth Fund of America (AGTHX), Negative $8 BillionWhy? Although the trailing three-year returns are strong, the fund endured a five-year stretch of pedestrian returns from 2007 through 2011. This is one case where redemptions are a plus. The fund needed to go on a diet, and it has. Now, this Bronze-rated fund looks more appealing. It still has good management and low costs going for it. I'd stick with it.

 PIMCO All Asset All Authority (PAUDX), Negative $8 Billion
Why? Lousy recent performance has spurred an exodus. Rob Arnott thinks emerging markets have far more appeal than the United States, but the former lagged far behind the latter in 2013 and 2014 before outperforming thus far in 2015. Thus, the fund's once-strong record has taken a hit, particularly in recent years. However, a little market rotation can fix that. We rate the fund Silver, so of course I'd stay with it.

 Columbia Acorn (ACRNX), Negative $8 Billion
Why? Performance has slumped badly. We rate this fund Neutral not just because of the slump but also because outflows are a much bigger problem for a fund that holds a lot of small caps, as this one does. Small caps don't have as much liquidity as larger names, so it can get ugly when a manager is forced to sell. They can end up driving down prices on themselves, and that can spur more redemptions. So, when a small/mid-cap fund like this has such huge outflows, there's a real danger that it will hurt returns. On May 1, Columbia Acorn announced lead manager Rob Mohn plans to retire later this year. That's another reason to stay away.

NYT: The Loneliness of the Short-Seller

For some, they are the scourge of Wall Street. Yet short-sellers — investors who stake bets against stocks — are often the first to sound the alarm on a market’s froth or a company’s fraud.
Now, six years into a bull market run, with stocks in the United States smashing one record after another, these naysayers have all but lost their voice.
William A. Ackman, who has yet to prevail in a billion-dollar bet against Herbalife, said he would “think very hard” before making another short bet. James S. Chanos, the short-seller who helped expose Enron, and who has long been seen as the fiercest of the short-selling bears, is now adding a fund that will instead focus on buying stocks.
“Short-selling is an incredibly lonely proposition,” Mr. Ackman said in an interview.
Critics accuse short-sellers of being unpatriotic and say their strategy of taking public aim at certain companies — and then profiting from the fallout — is akin to market manipulation. But proponents argue that they play a critical role in tempering market exuberance.
“People often don’t recognize the importance of short-selling in identifying fraud, deflating bubbles and being the buyers of last resort when stocks fall,” said Mr. Ackman, who for more than two years has publicly argued that the vitamin supplements company Herbalife is a pyramid scheme. (Herbalife rejects that characterization.)
As stocks continue to climb higher, some worry that absent a healthy dose of skepticism in the market, investors rushing to participate in the rally are laying the foundation for the next crisis.
Being a short-seller is no longer worth the trouble for many hedge fund managers. Investors don’t want to miss out on a rally that lifted the Standard & Poor’s 500-stock index to a record high in May. Catering to that demand, hedge funds have abandoned, or pared back, their short positions. Overall exposure to long positions by hedge funds has reached a high not seen since 2007, a year before the financial crisis. Short positions, meanwhile, are much lower than they were at that time, according to research by Bank of America Merrill Lynch.
Betting against the market is not worth the expense, either. To take a short position, traders sell borrowed stock in a company they think is overvalued with the hope of buying it back at a lower price. If the stock price goes up instead, short-sellers have to buy more stock in order to “cover” the position, which in turn pushes prices higher. Over the last several years, traders have hemorrhaged money on such bets, reporting percentage losses that are sometimes in the double digits, according to data compiled by HFR, a research firm.
In 2014, more than $1.3 billion flowed out of short-biased funds, a result of losses and investors withdrawing their money, according to HFR estimates. Within the universe of 8,431 hedge funds, there are only 17 that are short-biased, according to HFR data. (The Financial Times earlier reported on the HFR data.)
Hedge funds that shorted certain high-flying stocks have been pulverized. Take Tesla, the maker of luxury electric cars. For years, it was a favorite among short-sellers, who questioned everything from its business model to its forecasts for revenues. Despite the pessimism, the stock suddenly gained more than 600 percent from early 2013 until September of last year. The share price has since come down slightly, but at around $260 a share it is still much higher than the roughly $30 a share it traded before the run-up.
“It’s been an extremely difficult period for many short-biased managers, as negative performance during this prolonged bull market has led to capital outflows, forcing some to throw in the towel as others struggle to keep the lights on,” said Joseph Larucci, a co-founder of the hedge fund advisory firm Aksia.
It wasn’t always this way. In the turmoil of the financial crisis, short-sellers were king. Those who bet on the collapse of Lehman Brothers and Bear Stearns made a mint. As the market spiraled violently downward in 2008, the Wall Street banks that were still standing pointed the blame at short-sellers. In September of that year, the Securities and Exchange Commission issued a temporary ban on short-sellers.
Nevertheless, by the end of 2008, short-biased hedge funds had made an average return of 28 percent, compared with a decline of 38 percent across the S.&P. 500, according to HFR.
Stepping in to pick up the pieces in the aftermath of the crisis, the United States Federal Reserve pumped trillions of dollars into the financial system, pushing up the price of assets. The government also tamped down interest rates to all-time lows, prompting individual investors with retirement and pension funds to look for investments that would yield bigger returns than Treasury securities.
“Every market has its own characteristics, they all have a story and narrative, and this one really is all about the central bank,” said Mr. Chanos, founder of the hedge fund Kynikos Associates. The narrative, he added, is that “the central bank has your back and that’s embedded in everybody’s psyche and portfolio.”
This confidence, in turn, fueled a boom in mergers and acquisitions and spurred companies to buy back record numbers of shares from shareholders — two of the worst nightmares for any short-seller. To mitigate the risk, many moved to diversify the number of companies they were shorting.
Investors, for their part, have sought to place their money with hedge funds that offer long-only funds, according to a Deutsche Bank survey of 435 global hedge fund investors holding half the industry’s $3 trillion in assets under management. Nearly half of those surveyed were already allocated to long-only hedge funds, while 38 percent said that they planned to increase their allocation to such funds.
With this tidal shift in demand, short-sellers have looked to raise money by adjusting their pitch to investors. Mr. Chanos’s Kynikos Associates, for example, is pitching a new fund to investors that will take a portfolio of long positions and overlay the firm’s traditional short portfolio, according to marketing documents reviewed by The New York Times. The amount of money that Kynikos manages has more than halved in the last five years, to $2.5 billion today from $6 billion, according to regulatory filings.
Even as investors embrace the market rally, there are signs that not everyone believes it is sustainable.
“I do think it is an incredibly unloved bull market,” said Eric Peters of Peters Capital Group. “It is certainly unlike any major bull market that I have seen in that new highs have occurred in the absence of euphoria.”
Pointing to options trading, Mr. Peters said the cost for investors to insure against a 10 percent decline in the S.&P. 500 relative to the cost of insuring against a 10 percent rally in the S.&P. 500 is three times higher than its historical average.
“It’s telling you that people are willing to pay a lot more for protection on the downside in a really big way,” he said.
And some investors are starting to look around for short-sellers to help them find the exits. Jim Carruthers, a former manager at Daniel S. Loeb’s Third Point, raised more than $200 million from investors — including Yale’s endowment fund — last year to start a short-biased fund.
The other short-sellers who remain, meanwhile, have also been proved right on occasion. Whitney Tilson reaped a windfall this year when Lumber Liquidators, a flooring company he attacked for more than a year, accusing it of selling an unsafe product, came under pressure after a report by “60 Minutes” in March. Shares of Lumber Liquidators tumbled 25 percent the day after the broadcast, which accused it of selling a type of Chinese laminate flooring that contained dangerous levels of formaldehyde.
Other short-sellers are waiting patiently in the wings, among them Bill Fleckenstein. He planned to start a short fund last year, but later decided it was not possible to do successfully while the central bank continued to pump money into the financial system.
“You can keep the party going, but there is going to be a hangover,” Mr. Fleckenstein said.
Mr. Chanos used a similar analogy to describe the market today.
“As one famous banker once said,” Mr. Chanos recalled, referring to a now famous 2007 comment from Charles O. Prince, then the executive of Citigroup, “it’s hard to stop dancing while the music is playing.”

Ellis: In Defense of Active Investing

By Charles D. Ellis, CFA

Investment management is at once both a profession and a business, so it cannot be surprising that these two disciplines can come into conflict, particularly when gradual trends of change have conspired to bring such conflict forward slowly and quietly. Ironically, the driving force has been the increasing excellence of the skilled professional practitioners who have done so much so well in the exceedingly hard work of price discovery. Their collective success has made it increasingly difficult for any one manager or firm to be so consistently superior to the consensus of the other experts that it can repeatedly outperform that market pricing system — particularly in large diversified portfolios after costs.
Some will say that the crossing of the Rubicon, beyond which most active managers (after fees) fall short of the market, happened years ago. Others will say the crossing was more recent. And a few will believe it has not yet happened or, at least, has not yet happened to them.
During a long transoceanic flight, I found myself dozing while quietly reflecting on this question and the more than 50 years I’ve enjoyed the privileges of having a wide circle of friends in the profession and my full share of the economic benefits of being in the right place at the right time. As best I can recall, these were the thoughts that came to mind during my high-altitude reverie.
A Response to Critics
Something should be said. Active investing has been subjected to increasing abuse, particularly by those whose opinions are driven by the persistent accumulation of hard data and logical arguments. As we all know, active investing is on the defensive — even, some skeptics claim, “on the ropes” — having suffered a series of setbacks and increasingly virulent attacks. Especially scornful personal abuse has been aimed at active investing’s few remaining advocates.

The time has come to mount a defense, not by the usual citing of occasional exceptions or by dismissing the challengers with colorful pejoratives but, rather, by looking at the broader picture and pointing out the many indirect benefits that skeptics — with their narrow focus on just “beating the market” for clients — apparently continue to miss.
The recent past has been a particularly mean-spirited time for active managers owing to a rare market phenomenon: Small-cap stocks have performed poorly. For the 12 months ended 30 September 2014, the Russell 1000 Index (large-cap stocks) rose more than 19% while the Russell 2000 Index (small-cap stocks) rose less than 4%. This unusual differentiation in performance has recently penalized active managers, who often invest 10%–30% of their portfolios in small-cap stocks, and this factoid is being overexploited by the usual active-investing deniers. The “active attackers” are in full throat now as they gloat over such seemingly decisive data. Although sensitive defenders of active investing can retort that “it’s always darkest before the dawn” and cite the long history of how consensus conviction has almost always been wrong, the best defense is more robust. Before I present the case for the defense of active investing, however, let’s briefly review the so-called case for the prosecution.
Witnesses for the Prosecution
First came the academics, armed with their arcane null hypotheses, statistical inferences, and long equations littered with Greek letters. Most practitioners could safely ignore them, confident that nobody with a seat at the high table was all that interested in “ivory tower” mumbo jumbo. Active managers were certain that no practical men of affairs knew about — much less read — the obscure academic journals in which those in the cloister read, publish, and reference each other’s articles. Meanwhile, active managers could, if pressed, dismiss these attacks as a modern version of Bishop Berkeley’s quaint question, “If a tree fell in the forest with nobody there to listen, would it make any noise?”
Next came performance reporting and all sorts of odious comparisons. Fortunately, as Nate Silver continues to explain, the numbers we see combine both the signal and the noise in a never-ending cloud of mystery that invites manipulation: Change the base year, change the benchmark or standard of comparison, or report gross of fees rather than net. Or, in especially awkward situations, explain that certain disappointing people have been replaced, so all will now be better. If necessary, show again that most managers with superior long-term results have had three long years of underperformance, or explain that Morningstar’s ubiquitous star ratings, like all records of past performance, really have no proven predictive power and that staying the course is often wiser than switching horses in midstream.
More recently, the world of active investing has been under attack in reports that a majority of funds fall short of their benchmarks and that the trend is toward larger proportions of actively managed funds falling short andthat the magnitude of underperformance substantially exceeds the magnitude of outperformance. Even worse, investment consultants are being accused of enhancing their favorable records by such standard manipulations as backdating to delete failed managers no longer covered and including the histories of strong managers they have recently added to their recommended-manager lists. Outside observers repeatedly refer to these two concerns — both blithely banished from the banter of those paid to advise on the selection of active managers.
A particularly painful attack on active managers purports to show that most are masquerading as true actives when most of their portfolios — 60%, even 80% — replicate index funds and only 20%–40% of the whole portfolio is “active share.” Thus, the active minority of their portfolios must earn back the fees charged on the whole. If active share was 25%, then that share’s burden, based on the total 1% fee, would be nearly 4% a year. If market returns were, say, 8%, the active share would have to achieve 50% more than market returns just to cover costs and break even. Yes, it could be done by some managers sometimes but not regularly by any managers.
To active investors, it must be painful to see “index huggers” bite the hand that feeds them and nurtures their ability to index. After all, the indirect benefits of active investing all swing on the hinge of one great reality: Active investors are so numerous, skillful, independent, and superbly well informed — so well provided with information, analyses, opinions, and judgments by an extraordinary array of experienced experts, so well armed with advanced information-processing devices, and so eminently capable and highly motivated economically — that they have succeeded at “price discovery” beyond our poor powers to add or detract.
All is fair in love and war and marketing. So, active investors can take great pride in their PR masterstroke of hanging on index funds the dreaded albatross “passive.” Would any among us ever want to be called passive? (Try it. “This is my husband. He’s passive.” Or: “Our team captain is passive.”) Of course not! Throughout our society, passive has a major negative connotation while active has a major positive connotation.
In addition, some overzealous fund companies dedicated to active investing have made matters worse by their extensive advertising of those few funds that have recently had great results. Although all professionals know it takes many years of superior performance to prove that skill, not luck, is causal, the vast investing public is unwilling to wait. And most are so unsophisticated when it comes to statistics that they don’t realize how dangerous selective sampling can be. So, performance envy runs rampant and investors mutter, “I’ll have whatshe’s having!”
Thus, defenders of active investing will have to concede one part of the prosecution’s case. Owing to the unfortunate practices of a few “bad apple” managers, investors’ attention is inevitably concentrated by industry advertising on those few funds that have had the best results in recent years. Of course, firms that manage 100 or more funds — most of which underperform — will wisely focus their ads on the few that happen to perform well. As industry insiders know, this practice leads almost invariably to money pouring into “five-star” funds after their best years and then pouring out after the nearly inevitable poor years, a process that destroys up to a third of what investors would have had if they had just left their investments alone. That five-star ratings are of virtually no use in estimating future returns is naturally not acknowledged by active managers, who have a responsibility to their employers and coworkers to “stay on message.”
More recently, the attacks on active investing have focused on fees. Attackers maliciously call upon our mystic chords of memory with such clever and evocative imitations as, “Never in the course of human history have so many paid so much to so few for so little.” The usual definition of fees — “only 1%” — is being reexamined. And fees are increasingly being reframed, not as a percentage of the assets investors already have or even as a percentage of returns — which would result in 1% of assets ballooning to about 15% of returns — but, rather (and correctly), as incremental fees relative to incremental returns, compared with the indexers who persistently deliver the “commodity” market rate of return at the market level of risk. In this particularly odious comparison, the average active manager is shown to be charging incremental fees that amount to more than 100% of the incremental returns — before taxes. (Fortunately for active managers, this unfortunate reality — a specter stalking the world of active investing — has not yet caught the attention of most investors.)
The Rebuttal
Although the cost and fees part of the attack against active investing may appear compelling, this narrow focus on benefits (or lack thereof) to investors — and only to investors — is obviously unfair to active investing. It leaves out all the many important social and economic indirect benefits enjoyed every day by everyone in the broader community. As an example of only one of the numerous benefits to millions — really, billions — of people, the costs of active investing (including investors’ persistent losses relative to indexing) are, seen properly, quite small. That active investing has not worked out especially well for investors is not a sufficient reason to declare active investing a failure. To see why, let’s look at the record of indirect benefits. They are both many and mighty.
Nobody doubts that efficient markets are a major social good in many ways. By enabling “outsiders” to participate with confidence, knowing that security prices are fair for both buyers and sellers and that transaction costs are low, efficient markets encourage millions of investors to trust the capital markets with their savings. Efficient markets thus enable growing companies — particularly new companies with great promise — to raise substantial amounts of capital at low cost. They also enable stronger companies to acquire weaker companies and to redeploy assets in ways that are more socially productive. A more dynamic corporate sector has been of great benefit to the economies and societies of the world.
As active investors have searched for, found, and arbitraged away market inefficiencies, the many local and national markets of the world have been increasingly combined into one global megamarket. Local companies are obliged by international investors to rise to the global standards of corporate discipline in law, accounting, governance, and many aspects of operating management as petty corruption declines, transaction costs shrink, and access to important information expands.
Aided by computers and theories of value, active investing has been integrating the world’s stock and bond markets and incorporating the markets for commodities, currencies, real estate, auto and credit card debt, and even several sorts of insurance. The increasingly unified global market has produced faster growth, more and better jobs, more democracy, and better prospects for world peace. Massive market integration has increased access to capital, lowered the cost of capital, distributed risk, reduced uncertainty, and raised confidence in saving and investing. The best long-term benefit of active investing — and of all its many benefits — is not just economic but also spiritual. With the release of the energies and talents of millions of people created by the shift from closed to open societies, we see greater access to education and interesting careers; better food, shelter, and health care; and more free choice in the overall “pursuit of happiness.” Although active investing has not been the only reason for all this great success — lifting over 1 billion people out of poverty in just one generation — these changes could not have occurred without the impact of active investing at the macro level.
At the micro level, the benefits of active investing’s success in making markets efficient have been comparably impressive. Malicious “active attackers” narrowly focus their vision and their analysis on the inability of active managers to achieve consistently superior returns — because the markets are so efficient, made so by active investors — but the reciprocal is also true. Not only is it hard to win; it’s also hard to lose.
Not losing — or at least not losing decisively — means that many investors, both individual and institutional, can continue to hope that they too will eventually be among the winners. This hope keeps them — and their active managers — in the game, which, of course, is crucial to the breadth and depth of our megamarkets. If it costs investors a little in lower returns, isn’t it clearly for the betterment of society at large? Since active investing is exciting and fun, investors who are losing a bit in purely economic terms surely enjoy a significant social good by being part of the action. (We all know that the players at the world’s famous casinos are, on average, “losers” if calibrated in purely financial terms, but since they keep coming back, those nonfinancial benefits must surely enhance the players’ overall experience.)
Some who attack active investors and their self-rewarding business practices seem uncomfortable with practitioners’ ample compensation. Unrelenting attackers — apparently driven by the “green grievance” of jealousy — curiously ignore the enormous benefits to everyone in our society that come directly from active investors’ generous philanthropy. We should be more appreciative of active investors’ services to society as leading patrons of the performing arts and as core benefactors of colleges, universities, museums, hospitals, and orchestras — and as major donors to political campaigns, which are so important to our democracy.
Although it may be temptingly easy for casual observers to fault active managers by focusing all too narrowly on the disappointing results and high fees experienced by naive but ever-hopeful investors, the splendid benefits rendered directly and indirectly by active managers clearly deserve much more of our collective recognition, respect, admiration, and even adulation.
Thinking about the benefits flowing into so many parts of the world’s economies and societies gave me a warm, contented feeling until I was roused by a flight attendant’s instruction to sit up and tighten my seat belt. I had enjoyed contemplating the satisfaction that professional investors could take in doing good, however indirect it might be, in the world as we see it.
Although my reverie could be easily dismissed as mere fantasy, my observations over many years — of the worldwide explosion in IT and communications and the proliferation of research on companies, industries, economies, currencies, commodities, and every aspect of the investment process, as seen through my work on a dozen distinguished investment committees at leading institutions — have convinced me that very few investment managers are able to match or beat the market, particularly after adjusting for risk and after deducting costs and fees. Fortunately, all investors have access, through low-cost indexing, to funds that match the market returns at no more than the market level of risk. And this access enables investors to concentrate on the winners’ game of defining their own unique objectives and designing long-term investment portfolios that are most likely to meet those objectives. To the extent investment experts continue to do the important work of advising clients on investment policies to achieve their true objectives and values and sustain their commitments through various markets, our profession will be appropriately admired and well rewarded.

Tuesday, June 23, 2015


“We Are All Doing The Same Thing”
I recently listened to a podcast with some all-star [there are awards for everything now] “Black Box” equity trader. It was quite a “telling” interview & I thank him for his insights but I’d heard it all before. His confidence was staggering considering the general unpredictability of the future and, of course, the equity markets. He explained how he had completely converted from a generally unsuccessful, discretionary technical trading style to a purely quantitative and scientific trading mode. He seemed to be so excited that his models, according to him, were pretty much “bullet proof”. Having had more than just some tangential experience with black box modeling and trading myself I thought…you know…some people will just never learn.
You see some years ago I was particularly focused on quantitative investing. Basically, “screw” the fundamentals and exclusively concentrate on price trends/charts and cross security/asset correlations [aka “Black Box” trading]. I was fascinated with the process and my results were initially stellar [high absolute returns with Sharpe Ratios > 2.0]. And, after looking at the regression data many others agreed. I was in high demand. So I “made the rounds” in Manhattan and Greenwich to a group of high profile hedge funds. It was a very exciting time for me as the interest level was significant.
As it turned out I had the good fortune of working with one of the world’s largest and best performing hedge funds. Their black box modeling team had been at it for years…back-testing every conceivable variable from every perceived angle…twisted/contorted in every conceivable/measurable manner…truly dedicated to the idea that regression tested, quantitative trading models were the incremental/necessary “edge” to consistently generate alpha while maximizing risk-adjusted, absolutely positive returns. We worked together for some time and I became intimately involved with their quantitative modeling/trading team…truly populated with some of the best minds in the business.
While in Greenwich Ct. one afternoon I will never forget a conversation I had with a leading quantitative portfolio manager. He said to me that despite its obvious attributes “Black Box” trading was very tricky. The algorithms may work for a while [even a very long while] and then, inexplicably, they’ll just completely “BLOW-UP”. To him the most important component to quantitative trading was not the creation of a good model. To him, amazingly, that was a challenge but not especially difficult. The real challenge, for him, was to “sniff out” the degrading model prior to its inevitable “BLOW-UP”. And I quote his humble, resolute observation because, you know, eventually they ALL blow-up…as most did in August 2007.
It was a “who’s who” of legendary hedge fund firms that had assembled “crack” teams of “Black Box” modelers: Citadel, Renaissance, DE Shaw, Tudor, Atticus, Harbinger and so many Tiger “cubs” including Tontine [not all strictly quantitative but, at least, dedicated to the intellectual dogma]…all preceded by Amaranth in 2006 and the legendary Long Term Capital Management’s [picking up pennies in front of a steam-roller] demise one decade earlier. 
Years of monthly returns with exceedingly low volatility were turned “inside out” in just 4-6 weeks as many funds suffered monthly losses > 20% which was previously considered highly improbable and almost technically impossible…and, voila…effectively, a sword was violently thrust through the heart of EVERY “Black Box” model. VaR and every other risk management tool fell victim to legitimate liquidity issues, margin calls and sheer human panic. 
Many of these firms somehow survived but only by heavily gating their, previously lightly-gated, quarterly liquidity provisions. Basically, as an investor, you could not “get out” if you wanted to. These funds changed the liquidity rules to suit their own needs…to survive…though many did fail.
Anyway…to follow up on my dialogue with the esteemed portfolio manager…I asked why do they all “BLOW-UP”? What are those common traits that seem to effect just about every quantitative model despite the intellectual and capital fire-power behind them? And if they all eventually “BLOW-UP” then why are we even doing this?”
He answered the second part of the question first…and I paraphrase…“We are all doing this because we can all make a lot of money BEFORE they “BLOW-UP”. And after they do “BLOW-UP” nobody can take the money back from us.” He then informed me why all these models actually “BLOW-UP”. “Because despite what we all want to believe about our own intellectual unique-ness, at its core, we are all doing the same thing. And when that occurs a lot of trades get too crowded…and when we all want to liquidate [these similar trades] at the same time…that’s when it gets very ugly.“. I was so naive. He was so right.
Exactly What Were We All Doing?
We all knew what the leaders wanted and, of course, we wanted to please them. Essentially they wanted to see a model able to generate 4-6% annual returns [seems low, I know, but I’ll address that later]…with exceptionally low volatility, slim draw-down profiles and winning months outweighing the losing months by about 2:1. They also wanted to see a model trading exceptionally liquid securities [usually equities].
Plus the model, itself, had to be completely scientific with programmable filtering and execution [initiation and liquidation] features so that it could be efficiently applied and, more importantly, stringently back-tested and stress-tested . Long or short did not really matter. Just make money within the parameters. Plus, the model had to be able to accommodate at least $100M [fully invested most of the time as cash was not an option] and, hopefully, much more capital. This is much easier said than done but, given the brainpower and financial resources, was certainly achievable.
This is what all the “brainpower” learned…eventually. 
First of all, a large number of variables in the stock selection filter meaningfully narrowed the opportunity set…meaning, usually, not enough tickers were regularly generated [through the filter] to absorb enough capital to tilt the performance meter at most large hedge funds…as position size was very limited [1-2% maximum]. The leaders wanted the model to be the hero not just a handful of stocks. So the variables had to be reduced and optimized. Seemingly redundant indicators [for the filter] were re-tested and “tossed” and, as expected, the reduced variables increased the population set of tickers…but it also ramped the incremental volatility…which was considered very bad. In order to re-dampen the volatility capital limits on portfolio slant and sector concentration, were initiated. Sometimes market neutral but usually never more than net 30% exposure in one direction and most sectors could never comprise more than 5% of the entire portfolio. We used to joke that these portfolios were so neutered that it might be impossible for them to actually generate any meaningfully positive returns. At the time of “production” they actually did seem, at least as a model, “UN-BLOW-UP-ABLE” considering all the capital controls, counter correlations and redundancies.
Another common trait of these models that was that, in order to minimize volatility, the holding periods had to be much shorter than a lot of us had anticipated. So execution [both initiation and liquidation] became a critical factor. Back then a 2-3 day holding period was considered acceptable, but brief, although there were plenty of intra-day strategies…just not at my firm…at least not yet. With these seemingly high velocity trading models [at the time], price slippage and execution costs, became supreme enemies of forecasted returns. To this day the toughest element to back-testing is accessing tick data and accurately pinpointing execution prices. Given this unpredictability, liberal price slippage was built into every model…and the model’s returns continued to compress…not to mention the computer time charges assessed by the leadership [which always pissed me off].
So, given all of this, what types of annual returns could these portfolios actually generate? A very good model would generate a net 5-7%…but 3.5-5% was acceptable too. So how then could anybody make any real money especially after considering the labor costs to construct/manage/monitor these models…which…BTW…was substantial?
Of course there was only one real way…although it would incrementally cut into performance even more, in the near term, but ultimately pay off if the “live” model performed as tested. The answer = LEVERAGE…and I mean a lot of it…as long as the volatility was low enough. 
Back-tested volatility was one thing and live model volatility was another thing so leverage was only, ever so slowly, applied…but as time passed and the model performed, the leverage applied would definitely increase. Before you knew it those 5% returns were suddenly 20-25% returns as the positive beauty of leverage [in this case 4-5x] was unleashed. 
Fast forward 10 years and the objectives of hedge funds are still the same. Generate positive absolute returns with low volatility…seeking the asymmetrical trade…sometimes discretionary but in many cases these “Black Box” models still proliferate. And BTW…they are all “doing the same thing“…as always…current iteration = levered “long” funds. 
What has changed though is the increased dollars managed by these funds [now > $3.5T] and the concentration, of these dollars, at the twenty largest funds [top heavy for sure]. What has also considerably changed is the cost of money…aka leverage. It is just so much cheaper…and, of course, is still being liberally applied but, to reiterate, in fewer hands. 
Are these “hands” any steadier than they were ten years ago? I suppose that is debate-able but my bet is that they are not. They are still relying on regression-ed and stress tested data from the past [albeit with faster computers & more data]. They may even argue that their models are stronger due to the high volatility markets of ’08/’09 that they were able to survive and subsequently measure, test and integrate into their current “Black Boxes”…further strengthening their convictions…which is the most dangerous aspect of all. 
1. Strong Conviction…aka Over Confidence +
2. Low Volatility +
3. High Levels/Low Costs of Leverage [irrespective of Dodd-Frank] +
4. More Absolute Capital at Risk +
5. Increased Concentration of “At Risk” Capital +
6. “Doing the Same Thing”
…Adds up to a Combustible Market Cocktail
Still a catalyst is needed and, as always, the initial catalyst is liquidity [which typically results in a breakdown of historic correlations as the models begin to “knee-bend”…and the perceived safety of hedges is cast in doubt] followed by margin calls [the ugly side of leverage…not to mention a whole recent slew of ETF’s that are plainly levered to begin with that, with the use of borrowed money, morph into “super-levered” financial instruments] and concluding with the ever ugly human panic element [in this case the complete disregard for the “black box” models even after doubling/trebling capital applied on the way down because the “black box” instructed you to]. When the “box” eventually gets “kicked to the curb”…that is when the selling ends…but not after some REAL financial pain. 
So can, and will, this really occur once again? It can absolutely occur but it is just impossible to know exactly when…although there are plenty of warning signs suggesting its likelihood…as there have been for some time. 
However, I am quite confident of the following:
1.  The Fed Is Clueless On All Of This
[just too many moving parts for them…they cannot even coordinate a simple “cover-up” of leaked monetary policy…so no way the academics can grasp any of this…just liked they missed LTCM. Nor it seems…do they have any interest in it as it is too tactical for a strategically inclined central banker].
More Importantly Though
2. “Eventually They ALL Blow-Up
3.  The Only Real Question Left To Answer =
I think…if the pieces simultaneously shudder…then pretty BIG.

Coming Soon to Your LDI Plan: Equities

Pension funds are beginning to incorporate equities into their liability-driven investing (LDI) strategies in an effort to protect funding ratios when interest rates start to rise.

A survey of institutional investors, consultants, and fund managers by forecasting centre CREATE-Research showed a more “dynamic” approach to de-risking glide paths was emerging, including re-allocating to equities.
Private sector plans have begun creating dynamic LDI glide paths that favor rebalancing towards equities when bond allocations exceed their pre-set levels, the survey’s author and CREATE-Research founder, Professor Amin Rajan, wrote. “Some plans are wary of sticking to their original risk immunisation strategies, which never anticipated that yields would drop so low as to undermine bond investing.”
Rajan added that low rates and higher aging demographics “have sparked a downward spiral of rising liabilities, rising deficits, rising insolvency risk, and rising negative cash flow”. Extra contributions from plan sponsors “have eased the spiral, not reversed it,” meaning some pensions would have to take on more equity risk to improve their funding ratios.
One global consultant cited anonymously in the report said many pension funds adopted traditional LDI strategies when discount rates were between 5% and 8%. “As rates declined, more and more plans found LDI an unattractive option,” the consultant said. “When short-term rates rise, the long-term ones may follow suit, undermining the worth of LDI.”
Investors were “willing to give equities the benefit of the doubt”—despite some indexes hitting record valuations—because they believed recoveries underway in Japan and Europe would lead to improvements in company earnings that can support the high valuations.
The consultant said pension funds in Germany had increased equity allocations from 22% in 2008 to 26% in 2013. Public sector plans in Japan are dramatically expanding their traditionally low exposures to equity in the wake of a similar move by the country’s Government Pension Investment Fund.
CREATE-Research’s report—“Pragmatism Presides, Equities and Opportunism Rise”—covered 705 institutions from 29 countries overseeing $26.8 trillion in assets, and is available from the group’s website or from Principal Global Investors, which commissioned the report.
Separate research conducted by the CFA Society of the UK revealed a record proportion of its members believed developed market equities to be overvalued. Some 61% of respondents to CFA UK’s survey said developed equity markets were either “very overvalued” or “somewhat overvalued”—the highest level since the survey was launched three years ago.
Will Goodhart, chief executive of CFA UK, said quantitative easing and other market stimulus programs from central banks have driven valuations “well ahead of fair value”.
“The fact that a significant majority of respondents now regard developed market equities as overvalued means that there may be limited support for both equity and debt valuations in the face of potential increases in interest rates,” Goodhart added.

Hedge Funds for Masses Lose Shine as Goldman, Pimco See Outflows

One of the hottest areas for U.S. money managers is quickly cooling off.

Flows into hedge fund-like mutual funds, a category that attracted almost a third of the money going into actively managed funds in the past six years, have slowed this year to the weakest pace since 2008. The strategies, which include non-traditional bond funds and alternative stock funds, attracted just $1.2 billion from investors in the first five months of 2015, according to Chicago-based Morningstar Inc., down from $39 billion last year and a record $96 billion in 2013.
The funds, whose rapid growth has prompted scrutiny from regulators, trailed last year as stocks and bonds rallied. The rapid drop in investor interest is a setback for firms such as Goldman Sachs Group Inc. and Pacific Investment Management Co., which had counted on the fashionable strategies to win back clients into higher-fee products amid a general flight to cheaper, passive vehicles.

“Stocks and bonds did so well last year that a lot of people asked themselves: ‘Why do I need to own alternatives?’” said Lawrence Glazer, managing partner at Mayflower Advisors in Boston, where he helps oversee $2 billion.

The prospect for such funds could improve if the stock market slumps or if interest rates go up rapidly.
The initial appeal of the new funds was simple, especially for investors who lost money in traditional funds during the 2008 financial crisis. If wealthy individuals and institutions could put their money into vehicles with the flexibility to make money in all kinds of markets, why not ordinary investors?

Winning Deposits
That helped long-short equity funds and absolute-return funds win deposits after 2008. Non-traditional bond funds got a boost in 2013 when interest rates shot up after the Federal Reserve hinted in May of that year that the central bank might cut back its bond-buying program. In total, these strategies attracted about $253 billion in the six years through 2014, about 29 percent of all money that flowed into active U.S. mutual funds.
“The concept was sexy to a lot of people who had read about hedge fund managers making billions of dollars,” said Burton Greenwald, a mutual fund consultant based in Philadelphia.
With the client cash came attention from regulators, who questioned whether individuals understood the risks of investing in such vehicles, known as liquid alternative funds. Examiners at the U.S. Securities and Exchange Commission began looking into alternative funds last year for how they comply with leverage and liquidity rules, and whether their boards are appropriately overseeing their activities.
SEC Commissioner Kara Stein said last week that new regulations may be needed to rein in funds that are evading the limits on their holdings of riskier investments such as derivatives and other hard-to-sell assets.

Trailing Markets

The funds use such instruments in part to juice returns in adverse markets. They didn’t do well last year, when the Standard & Poor’s 500 Index returned 14 percent, including reinvested dividends. Intermediate bond funds, the most popular fixed-income investments, gained 5.2 percent, compared with 1.2 percent for their non-traditional competitors, Morningstar data show.
“Alternative strategies are bound to lag when markets are going up as much as they have,” said Josh Charney, a Morningstar analyst.
Investors responded by pulling money out. Three of the four largest unconstrained bond funds, the $22 billion Goldman Sachs Strategic Income Fund, the $20 billion JPMorgan Strategic Income Opportunities Fund, and the $9 billion Pimco Unconstrained Bond Fund, suffered redemptions in 2015, according to data compiled by Bloomberg.

Mainstay’s Withdrawals

On the alternatives side, the $5.5 billion Mainstay Marketfield Fund has been the poster child for shifting sentiment. Investors poured money into the long-short fund in 2013 after manager Michael Aronstein consistently beat peers from 2008 to 2012. They headed for the exits after he lost 12 percent in 2014, hurt by wrong-way bets on commodity stocks. In the 12 months ended May 31, the fund experienced more than $13 billion in withdrawals, Morningstar data show.
Glazer and others say individuals, known for chasing performance and timing decisions poorly, may be getting it wrong again. With interest rates finally set to increase and stocks moving sideways, investments that aren’t correlated with traditional assets might be more attractive.

“People should be looking for investments that have the possibility of doing well in market environments where the expected returns are more anemic,” said David Kabiller co-founder of AQR Capital Management, which manages $140 billion and runs the industry’s largest alternative mutual fund.

Bucking the Trend

Some funds have bucked the trend. Rick Rieder’s $30.7 billion BlackRock Strategic Income Opportunities Portfolio beat 80 percent of non-traditional bond rivals over the past year and pulled in $14 billion in deposits.
The $7.5 billion John Hancock Global Absolute Return Strategies Fund attracted $1.9 billion over the same period after producing gains every year since 2012. The fund is designed to provide positive returns with less volatility than the stock market, said Andrew Arnott, president of John Hancock Investments in Boston, where he oversees $125 billion.

“If all goes well, this fund should give people a boring ride,” he said.

So far, 2015 has been favorable for alternative strategies amid global market volatility and slower stock-market gains. Through May, hedge fund returns, as measured by the Bloomberg Global Aggregate Hedge Fund Index, topped the gains in the S&P 500. On the bond side, non-traditional funds are doing better than their conventional counterparts, Morningstar data show.
This sort of market might help get investors back in, said Kevin Quirk, one of the founding partners of Casey, Quirk & Associates LLC, a consulting firm that specializes in asset management.

“Alternatives will have greater appeal in a more difficult market,” Quirk said.

Monday, June 22, 2015

Can Kopernik Global Investors’ Top Energy Stock Picks Help It Bag Profits?

David Iben’s Kopernik Global Investors has a public equity portfolio valued at $399.18 million as per its recent 13F filing with the U.S. Securities and Exchange Commission. Iben is a former employee of Jeffery Vinik’s Vinik Asset Management and the investment manager has employed several other employees of Vinik Asset Management at his own fund. The fund manager has a concentrated portfolio, with his primary investments being in the basic materials and energy sectors, while his top ten stock holdings account for 84.14% of his public portfolio. Iben has his largest bets on Cameco Corporation (USA) (NYSE:CCJ), Barrick Gold Corporation (USA) (NYSE:ABX), and Peabody Energy Corporation (NYSE:BTU), while his top three energy investments are in Cameco Corporation (USA) (NYSE:CCJ), Peabody Energy Corporation (NYSE:BTU),  and Tsakos Energy Navigation Ltd. (NYSE:TNP). It’s these stocks we’ll look at in this article.
Why are we interested in the 13F filings of a select group of hedge funds? We use these filings to determine the top 15 small-cap stocks held by these elite funds based on 16 years of research that showed their top small-cap picks are much more profitable than both their large-cap stocks and the broader market as a whole. These small-cap stocks beat the S&P 500 Total Return Index by an average of nearly one percentage point per month in our backtests, which were conducted over the period of 1999 to 2012. Moreover, since the beginning of forward testing from August 2012, the strategy worked just as our research predicted, outperforming the market every year and returning 142% over the last 32 months, which is more than 83 percentage points higher than the returns of the S&P 500 ETF (SPY) (see more details).

Cameco Corporation (USA) (NYSE:CCJ) comes in at number one in the list of the top energy sector investments of David Iben. The investment manager has 4.91 million shares of the Canadian power firm, which have a market value of $68.39 million, which includes additional purchases of 1.79 million shares in the quarter ending on March 31. The primary work area of the power corporation involves the mining, refining, fabrication, and sale of Uranium for nuclear power reactors. It has been a rough year for all energy companies including Cameco Corporation (USA) (NYSE:CCJ), whose shares have dropped by 8.05% year-to-date. However, market experts are expecting all the companies dealing Uranium to profit from the upcoming increase in its demand, especially in emerging markets like China and India. Cameco Corporation (USA) (NYSE:CCJ) reported a 35% increase in its quarterly revenue year-over-year to $566 million and a 19% increase in gross profit to $129 million. The Uranium manufacturer has attracted investments from the likes of George Soros’ Soros Fund Management and Israel Englander’s Millennium Management.
Peabody Energy Corporation (NYSE:BTU) is the second-largest energy investment of Kopernik Global Investors, with the fund holding 9.28 million shares valued at $45.67 million. The investment manager boosted his position in the energy company by 101% during the first quarter. However, the investment hasn’t paid off very well thus far, as the shares of Peabody Energy Corporation (NYSE:BTU) have dropped 68.23% year-to-date. It is among one of the biggest private-sector coal producers in the world, but the company is struggling to keep up with the competition. In a recent announcement, Peabody Energy Corporation (NYSE:BTU) announced the immediate shutdown of its Evansville office, which has 70 employees. The company is following a company-wide cost-cutting program under which it is likely to save up to $45 million per year. The layoffs would include 250 corporate and regional office job cuts along with the closure of two offices. The other office to shut down under this plan is in Gillette, Wyoming, and this program will be complete by the end of this month. Dimitry Balyasny’s Balyasny Asset Management and Ken Griffin‘s Citadel Investment Group are among the other major investment firms holding stakes in Peabody Energy Corporation (NYSE:BTU).
Tsakos Energy Navigation Ltd. (NYSE:TNP) is another energy stock bet of Iben, who owns 1.46 million shares of the company valued at $11.93 million. The transportation service provider for crude and petroleum products has had an excellent year, with 42.24% growth in its share price in 2015. Tsakos Energy Navigation Ltd. (NYSE:TNP) operates a fleet of 47 crude oil and petroleum product tankers. The oil transporter reported an increase of 156% in its net income to $37.3 million in the first quarter of 2015 as compared to the prior year period. Its shares have an average rating of “Buy” from 14 different analysts, with a 12-month price target of $11.04, which represents an upside of 12% from its current trading price. Brian Taylor of Pine River Capital Management, and Centerbridge Partners are among the primary stockholders of the company.

Sunday, June 21, 2015

TAs Lag As Most Hedge Funds Stumble On Asian Market Dip

Hedge fund performance hit a speed bump last week, led by CTAs, who struggled with a shifting equity market environment and continued stagnation in certain commodity and foreign and exchange markets, according to a Lyxor Managed Account Platform report dated June 12.

As equity and bond market “experienced renewed tensions,” Hedge Funds with sizable long exposure to European equities were hit, as the Lyxor Hedge Fund index was down 1.2 percent on the week. While this may seem like a significant drop – and it is – the stock market benchmarks during this period took a more sustained hit. The Eurostoxx 50 was down 3 percent during the period as the U.S. broad-based benchmark, the S&P 500 was down 1.4 percent.

Lyxor6 15 CTAs all down Hedge funds
It was managed futures CTAs who took the most significant losses on the week, losing ground to the tune of 2.2 percent, bringing the month to date loss to 3.9 percent and the year to date loss for the strategy to 2.6 percent basis the Lyxor CTA Broad Index, which is heavily weighted towards trend following.
The move lower in CTA performance was “in line with the strategy’s negative momentum” as powerful trends in not only stocks, but oil, the U.S. dollar and even agricultural exposure all found a muddled market environment that lacked any meaningful price persistence. And it wasn’t just longer term funds that were hard hit, shorter systems have particularly taken a hit since April.
“Short Term systems in particular, shifted towards long energy exposure and were hurt by falling oil prices,” over the past week, the report noted. “Heavy shorts on agriculturals also proved detrimental. FX slightly added to the losses as short exposure towards the Euro proved detrimental,” while a trend lower in the Austrailian dollar and Japanese yen cushioned some of the losses.
Lyxor6 15 L S CTAs Hedge Funds

Long / short hedge fund managers, higher on the year, stumble in Asia

Long / short equity strategies also found difficulty, down -1.1 percent last week alone as many of the Asian managers stumbled. This performance adjustment comes on the back of strong strategy performance at the start of the year. The long / short strategy is up 4.3 percent on the year, beating out the second place event driven strategy, which is up 3.4 percent on the year, as well as topping the equity benchmarks as well. While many long short managers found difficulty last week, the report did note that market neutral long / short hedge funds “were fairly resilient” in what has been a volatile stock market environment, particularly in Europe.
Lyxor6 15 credit spreads CTAs Hedge Funds

Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.