Appetite for smart beta rising?

on Mar 30, 2014 in Home, Portfolio ad hoc | 2,192 comments

An increasing number of investors are moving away from traditional market capitalisation-based indices to alternative strategies, known as smart beta, in search of better returns. Alpha generation, within hedge fund investing has now been shown to be no more than having an exposure to common risk factors. The difficult part is identifying where you get paid as an investor. A paradigm shift is taking place in fund management. For years we have all been indoctrinated in the idea that fund management could either be passive and track an index, or be active and try to beat that index. There is now, however, a greater willingness to steer a middle path that is often described as alternative or smart beta. There is a spectrum of approaches that can be considered alternative beta. Some will be familiar to many investors, including style returns such as value, quality and momentum. Other strategies will be some of the alternative index approaches that have become popular over the past two years. These would include minimum variance strategies that try to achieve the lowest possible volatility, maximum diversification and so-called fundamental indices that weight stocks by accounting measures rather than market cap. State Street Global Advisors has seen a sharp rise in assets under management, in what it describes as smart beta, to more innovative, alternative methods of index construction. More than 40 per cent of investors have already adopted alternative weighting schemes. In fact, the reason behind the new indices for the vast majority of investors is probably the superiority of their performance compared with traditional cap-weighted indices. Everyone agrees that while cap-weighted indices are the best representation of the market, they do not necessarily constitute an efficient benchmark that can be used as a reference for an informed investor’s strategic allocation. However, by moving away from the consensus, investors will be questioned on the relevance of the new model chosen and the evaluation of the robustness of the past performance. Index providers are also experiencing rising demand for alternative or fundamental approaches in which stocks are weighted by metrics such as book value, dividends and sales, or minimum variance where portfolios are designed to reduce volatility. The MSCI smart beta indices turnover varies between 20 per cent, for minimum volatility and value-weighted, to 25 per cent for equally weighted and risk-weighted. MSCI cap-weighted indices average turnover of about 5 per cent. The modest turnovers achieved by MSCI, however, are achieved because it rebalances both cap-weighted and strategy indices only every six months. The appetite for customized or bespoke indices is clearly on the rise. For investors who have decided to move away from market cap, there is still much to...

Is the mint ratio relevant?

on Jun 27, 2013 in Commodity, Home, Precious metals | 2,070 comments

The mint ratio simply defined as the gold/silver ratio, is an indication of how many ounces of silver are equal in price value to one ounce of gold. In other words, how many ounces of silver would it take to buy one ounce of gold. Throughout history, governments have artificially set the gold/silver ratio for purposes of stabilizing the value of their gold and silver currency. In essence the mint ratio has been a government-established rate of exchange between gold and silver. Only when a nation establishes an official exchange rate, the market ratio is normally very close to the mint ratio in that nation because of the potential for arbitrage. For example, if Switzerland uses a 17:1 mint ratio and the UK has a 14:1 mint ratio, an investor can trade her gold for silver coins in the UK and trade her silver for gold coins in Switzerland, although he has to take the risk of transporting the precious metals safely. This bimetallist monetary system has been for instance practiced by the US government roughly from 1790 to 1870, which set by law the value of a unit of currency at a specific weight of a specific purity of metal. Of course, in doing so government is interfering with the workings of the free market and I do not expect that governments will revert to this outdated system anytime soon. I personally wouldn’t use the relationship between silver and gold prices to determine whether the price for one of these metals is likely to increase or not. But knowing its definition could be useful for your financial...

Cov-Lite – Yield hunting shifts power from lenders to borrowers

on Jun 26, 2013 in Fixed Income, Home | 2,062 comments

In their pursuit of yield, investors appear to have materially increased their appetite for risk by accepting increasingly looser covenant packages. During the last credit bubble, we saw a large increase in cov-lite loans and this phenomenon is now reemerging again. The question is, what if cov-lite features are given to less worthy borrowers? I personally have some reserves for cov-lite loans being extended to companies in dubious financial health, which could be adversely affected by higher interest rates. As far as literacy is concerned, a single borrower, rather than borrowing from a single bank, would borrow from a consortium of banks, also known as syndicated loan. Since no borrowers can maintain relationship with dozens of different banks at the same time, covenants – promises the borrower would make to its lenders – replaced the trust relationship previously established between a borrower and its prevailing bank. Essentially, loans were becoming more like bonds: they were becoming debt instruments to be traded between various investors, rather than loans which a single bank would hold to maturity and beyond. Coming back to our topic, cov-lite loans are more appealing to issuers because they entail less-restrictive covenants that enable lenders to take action if a company’s financial ratios breach specific limits. If any of those ratios were violated, that would count as an event of default on the loan, and the borrower would be forced to renegotiate with the consortium. A recent Moody’s report says, “a cov-lite capital structure allows for increased financial flexibility at a time when a company needs it most, potentially allowing it to forestall default while getting through a choppy patch in its business”. But does that flexibility only serve to increase the severity of default further down the road? If banks can’t interfere early, does that mean they are going to end up taking bigger losses later? As Moody’s puts it, there’s an assumption “that cov-lite issuers are less likely to default, but once they do, value may have deteriorated to a greater degree than it would have if lenders had been able to step in earlier to address a breached covenant”. Is the recent surge in cov-lite a source of concern for...

Regaining trust in a broken industry

on Jun 26, 2013 in Home | 2,118 comments

Today’s markets are experiencing unprecedented swings, and the investment management industry has also become far tougher than ever before: revenues have plummeted, costs have remained sticky, and the playing field has been leveraged. The global economic crisis ripped through the financial sector, one of the first casualties was client trust. Investors began to question whether the sector was acting in their clients’ best interest or their own. At the same time, the majority of investment managers have underperformed market index, meaning many individual and institutional investors are paying fees for disappointing performance. Capital requirements are now increasing, the profits are becoming more volatile and both investment risk and reputation risk are rising. Attempts to cut operating costs failed to achieve the necessary savings and the result has been a significant deterioration in the industry fundamentals. As a result, these companies are questioning the strategic fit of their non-core business activities within their portfolio; and some are logically divesting them. Indeed, there is a clear consensus that alignment of interests between the company and client will be at the center of the winning business model. But the industry desperately needs to rebuild trust and confidence, which means giving customers what they really want: unbiased advice, transparency, accountability and service...

High dividend strategy

on Mar 10, 2013 in Equity, Home | 2,143 comments

A High Dividend Strategy is structured to provide for the higher cash flow needs of the income oriented investor. The strategy seeks to provide both a stable and growing income stream while also giving clients less volatile participation in market movements, while providing principal protection during periods of rising interest rates. However, with all investment stories, there are caveats and these are the most significant ones for High Dividend Strategies: Dividends are not legally binding: Unlike coupons on bonds, where failure to pay leads to default, companies can cut dividends without legal consequence. Liquidating dividends: When companies are in decline, they may pay large liquidating dividends, where assets are sold to fund the dividends. Dividend yield for a share shoots up mainly due to price drops, not because the dividend is increased. Sometimes price drops occur because there is trouble looming on the horizon. Higher tax liability: At least in Switzerland, dividends have been taxed at a higher tax rate than capital gains. Sector concentration: If you pick the highest dividend yield shares, you may find yourself holding shares in one or two sectors. In early 2008, for instance, you may have ended up with five banks in your portfolio. Considering the shock to that sector end 2008, your portfolio literally collapsed! By screening  tax-advantaged, dividend paying shares, for suitable candidates with a market-cap greater than CHF 5 billion, above average dividend growth, investment grade debt rating, and candidates that have not have been forced to cut their dividend over the past 5 years, should provide confidence that the dividend payout is sustainable. Once a candidate has been identified, a thorough fundamental analysis of the company focusing on valuation and key balance sheet and income statement information should be conducted. With such an approach, you can construct a reasonably diversified portfolio by owning 30-40 securities spread across sectors, although higher dividend sectors such as for instance utilities will have larger...

How to determine the return on your portfolio?

on Jan 27, 2013 in Home, Portfolio ad hoc | 2,200 comments

  In an ideal world, you would be updated semi-annually or annually with your portfolio’s performance, enabling you to compare it to the appropriate benchmarks. In reality, some asset managers may not provide you with the accurate figure! As a matter of fact, deciding on which return measurements should be used is a key element to evaluate the true performance of your portfolio. Below are two of the most commonly calculated return methodologies, which will be discussed in detail. If you want to measure your asset manager success as a decision-maker, meaning how well did his selection of assets perform relative to a benchmark portfolio, use the time-weighted return methodology. On the other hand, if you want to determine how well your invested assets performed, meaning how much your money earned for you during the year, I would suggest you to use the money-weighted return methodology. An investment fund for instance uses the money-weighted return methodology. Mainly because the timing of cash flows into and out of the fund will have an impact on fund performance. Asset managers, on the other hand, are required to use time-weighted return when reporting their performance. Simply because a prospective client or yourself need a measure of the decision-making ability of the manager that excludes the effect of cash inflows and outflows that are beyond the manager’s control. The money-weighted return can differ substantially from the time-weighted return largely on a combination of the following three variables: The timing of the cash flows, the size of the cash flows and the volatility of the portfolio’s market value. The main difference between the two is that time-weighted return ignores the effect of cash inflows and outflows, whereas money-weighted return incorporates the size and timing of cash flows. The money-weighted return internalizes both the timing and size of external cash flows (such as deposits and withdrawals), whereas time-weighted return allows different sub-periods to have different returns. In most cases at portfolio level the time-weighted return methodology is the most appropriate to measure portfolio performance. Primarily to allow comparison between asset managers with different cash flow history. Ask yourself the question, would the investment decisions, asset allocation and investment selections been different, had a different amount of money been available. Almost certainly...