Low Volatility ETFs

A recent trend is the development of low volatility funds, including both ETFs and mutual. These funds invest in a subset of a specified index, selecting only those stocks with low price volatility (which may be identified by a low beta). There is not sufficient history to gauge the performance of such funds, but two issues are worth noting. First, given the impact of volatility on compounded returns (i.e., geometric averages are lower than arithmetic averages), low volatility funds should have an advantage, particularly in otherwise volatile markets. Second, value funds may outperform over long periods (albeit not every period), and since value stocks are more likely to be low volatility, this may play a role in the performance. (See article here, Schwab.)

Insider Trading

Insider trading (i.e., trading on material nonpublic information) is illegal. However, corporate executives are allowed to trade stock in the firms they manage. This is difficult to reconcile since these executives, in all likelihood, have such information. A recent study by the Wall Street Journal found that executives trading ahead of corporate earnings announcements earned substantially higher returns (or avoided substantially lower losses). See article here.

Student Loan Debt

Obviously real estate was the focus of the recent credit (or subprime) crisis. However, many investors believe that student loan debt, which is also bundled and sold (i.e., collateralized), is the next "crisis" area. Student debt has risen substantially, as has the percentage of borrowers in delinquency. See these two articles: Wall Street Journal and New York Times.

Fiscal Cliff

There has been much discussion surrounding the impending "fiscal cliff." So, what exactly is this? Well, it is a combination of items that effectively equate to about $600 billion in potential spending cuts and tax increases. This represents about 4% of US GDP. So, failing to address these issues would likely result in a deep, prolonged recession.  Read a good summary here, American Action Forum.

Index ETFs -- Not Created Equal

You might expect that all "Large Cap" ETFs are the same, as they would likely track the S&P500 index. However, in an effort to reduce costs, many ETF providers (such as Vanguard) are replacing the standard index with others that charge lower licensing fees. This allows the providers to either reduce the expenses they charge or increase operating margins. As providers make this switch, it could also impact the underlying holdings to the extent that differences occur across the indexes. See article here, Wall Street Journal.

"Alternative" Alternative Investments

Typical Alternative Investments include such categories as commodities and real estate. However, some investors have branched out into more esoteric assets such as cars and collectibles. As such, there is a growing category of managers offering such funds. See the article here, Wall Street Journal.

Apple: Head and Shoulders

In technical analysis, traders look for patterns in stock prices, which they then use to determine buy/sell decisions. One such pattern is the "head and shoulders," which, as the name suggests, is two small peaks, with a larger one in the middle. Such a pattern is often considered bearish, particularly if the price breaks through the "neckline." Unfortunately (or not, depending on your view of technical analysis), Apple's share price recently exhibited this pattern. See the article here, Yahoo.

Rogue Trader

On June 30, 2009, the price of oil jumped $1.50 per barrel during the night. This was curious since no major political event had taken place. Well, the Financial Services Authority just released a report that a drunk trader purchased futures contracts on 7 million barrels, which pushed the price up. Even more ironic, the trader was so drunk he didn't even remember doing it. See article here, CNBC.

Futures Exchanges

Most people are familiar with the primary futures exchanges, such as the CBOT, CME, and the NYMEX (all part of the CME Group). However, there are some more specialized (and interesting) exchanges. For example, check out Intrade, which is a futures market based on political outcomes. Also, you can invest based on Hollywood movies (Hollywood Stock Exchange).

High Yield Debt

High Yield Debt is a nice way of saying "junk" debt, i.e., debt that is considered speculative grade. As you would expect, the yield on such debt, due to higher default risk, is higher than standard investment grade debt. However, with historically low interest rates, even the yields on "high yield" debt don't look so high any more. See article here, International Financing Review.

Short Squeeze

Short interest may be considered an indicator of overall market sentiment regarding a stock, with high short interest being bearish. However, if short sellers rush to cover their positions, a so-called "short squeeze," the price of the stock may increase substantially. This is what recently happened with Pandora stock. See the article here, Pandora.

Media = Contrarian Indicator

The media often focuses on financial stories; however, they tend to be late to the game. Meaning, once they report on an event, the market has likely already digested it. Recently, Bespoke Investment Group found that the number of financial stories posted on the Drudge Report was negatively correlated to the subsequent market performance. See the article here, Yahoo.

Weather Derivatives

Most people are aware of stock options or futures contracts on commodities such as gold and oil. However, the derivatives market is very diverse, including such things as weather derivatives. With hurricane season upon us, you may want to do some research on hurricane futures and options (http://www.cmegroup.com/trading/weather/hurricanes/hurricane.html). Essentially, these contracts allow insurers to transfer risk to other parties, such as hedge funds. See the article here, CME Group.

Plan Now

Almost half of all retirees have $10,000 or less in savings when they die. While social security or pensions may provide adequate income, it illustrates the dependence on these outside sources. Going forward, there will be fewer pension plans (switching to defined contribution plans), and social security is no guarantee. So, plan now. See article here, Market Watch.

Investor's Pain = Government's Gain

In the wake of the Crash of 2008, the government stepped in to bail out multiple institutions, including AIG. Following the economic recovery (albeit a moderate one), the government was able to exit its position, netting a $17.7 billion gain. So, while many people opposed the bailout, it actually served as a transfer from investors (generally considered the wealthy) to the government. See article here, LA Times.

Short Sale Trading Glitch

Following the Crash of 2008, the SEC reinstated the uptick rule, albeit a modified version. The uptick rule kicks in if a stock's price drops 10% in one day. This prevents short selling except on an uptick. However, a trading glitch (which are increasingly common) effectively overlooked the rule. See article here, WSJ.

Facebook IPO Lockup Expiration

When a firm undertakes an IPO, insiders (owners and venture capitalists, among others) agree to retain their shares (i.e., lockup) for a period of time, typically six months. When the lockup period expires, it is customary to see a large block of shares flood the market, having an adverse effect on the stock's price. Facebook just hit its lockup expiration. See article here, NY Times.

High Frequency Trading

With recent events such as the Flash Crash and the trading glitch at Knight Capital, high frequency trading has come under increased scrutiny. So, what exactly is high frequency trading and flash orders? Essentially, these traders attempt to exploit differences in bid/ask prices and capture any spread that exists. Check out this video for an illustrated discussion.

Will Lightening Strike Twice?

Just before the real estate crisis really hit, the Fed said that the issue was "contained." As we know, this was not correct. Recently, Bernanke said that the $1 Trillion in asset backed student loans won't cause a crisis. Hopefully he is right this time. See article here, Kansas City Star.

Target Date Funds

Target date funds (or lifecycle funds) have simplified the investment process for many people. However, they are not without their own potential problems and differences. This article (CNN Money) gives a good overview of the main issues.

ETFs vs. ETNs

While ETFs are essentially market-traded products that are similar to mutual funds, ETNs are actually more like a variable rate fixed income product that is "guaranteed" by the issuer. This difference adds a significant element of counterparty risk. Further, most ETNs are treated like partnerships, which means that taxes on gains (and losses) are treated differently, with recognition required each year (Statement K-1) rather than simply at sale. See a brief article here, USA Today.

Selling Fear = Making Money

Buying put options is commonly understood to provide a measure of insurance against price declines. As such, the cost of options is strongly correlated to the amount of fear in the market. It might be prudent in these cases to make the opposite trade -- selling put options. The seller (or writer) collects the premium, which during times of fear is very large. The risk is a significant decline in prices. See the article here, Forbes.

Control Yourself!

Sometimes we are our own worst enemies. Research shows that our brains are wired to trade stocks actively, and this often works against us. Even professional managers (such as mutual funds) have a hard time generating consistent outperformance. So, the best managers may be those that understand the psychology of investing and are able to control themselves. See the article here, Wall Street Journal. A good book on the topic is Psychology of Investing, by John Nofsinger.

Negative Bond Yields

During the Crash of 2008, a "flight to quality" drove yields to unprecedented low levels. In fact, many Treasuries were being issued with negative yields, meaning investors were paying the government to safely hold their money. Recently, with the crisis in Europe, German bonds have exhibited similar negative yields.See link here, CNN Money.

Contrarian Indicator - Short Sales?

Short positions spiked recently, eclipsing the recent peak in 2011. After the previous peak, stock prices stages a five-month rally. Hopefully it will be the same this time. See article here, Bloomberg.

Don Quixote -- Investment Guru??

Don Quixote is a well-known literary figure, most commonly remembered for seeing the world through his own lens. He fights windmills thinking they are giants and slaughters a flock of sheep because they look like a mighty army. As investors do we make similar mistakes--seeing an asset the way we want to instead of the way it actually is? See article here, CFA Magazine.

Improving Alpha

Alpha is a measure of risk-adjusted performance. Positive alpha means an investment manager has generated returns in excess of what should have been earned given the level of risk taken. However, what if two funds have the same alpha--are they equally good? Well, tracking error helps to distinguish which fund might be better, as a lower tracking error might mean less risk and a more significant alpha. (See article here, Wall Street Journal.) The Information Ratio divides alpha by tracking error to provide a more comparable performance metric.

Even the Best Investors Can't Time the Market

Warren Buffett is considered to be one of the greatest investors ever; however, even he is not perfect. In fact, his company (Berkshire Hathaway) is named after one of his failed investments. More recently, his timing on the purchase of GM stock has not worked so well. Fortunately, his holding period is generally very long, thus it could turn out to be a favorable investment over the long-term. See article here, Bloomberg.

Municipal Bond Risk

While municipals generally carry lower yields due to their tax benefits, beware that they are more risky than comparable Treasury securities. Municipals can default since, unlike the federal government, they do not have the ability to print money. The most recent (and largest ever) city to declare bankruptcy is Stockton, CA. See the article here, Fox News.

Mutual Fund Oversight

Like corporations, mutual funds have board of directors. However, they often exhibit much less oversight and control. Thus, there is debate whether they actually provide any value or simply serve as figureheads. See article here, Smart Money.

Actively Managed ETFs

ETFs were originally designed as alternatives to index funds, but ones that could be actively traded like stocks -- meaning continuous trading and the ability to short and margin. As ETFs have developed, however, they are now moving into active (as opposed) to passive management. This may increase costs, but it provides another avenue for potential investors. See the article here, Index Universe.

Reputational Capital

Ratings agencies are supposed to provide an independent view on a firm's (or country's) financial outlook. However, their involvement in the subprime crisis (i.e., their AAA rating on defunct MBS securities) revealed that the rating agencies are often more reactive than proactive. Thus, they seem to have lost much of their respect and influence. See article here, Breakout.

It Pays to Be Young

The model is changing, as wealth management firms may need to increasingly hire younger advisors. See article here, Reuters.

Step on the Gas

With the economy hitting a "speed bump," market participants increasingly believe the Fed will "step on the gas" to get it going again. Similar thoughts seem to exist in regards to potential action by the Chinese central bank. As a result, markets around the world were up. See the articles here (xinhuanet) and here (MarketWatch).

Is Diversification Dead?

Diversification (primarily based on asset correlation) is a key component of Modern Portfolio Theory (MPT). However, the recent financial crisis illustrated an increase in correlation across asset categories. Thus, many debate whether diversification still helps. Even with increasing correlations, diversification still provides benefit (possibly just not as much). However, the more relevant issue is that increasing correlation across the typical asset categories suggests that diversification is now more critical across "non-typical" categories -- such as commodities, hedge funds, and private equity funds. See the article here, Journal of Financial Planning.

"Dumb Money" Pushing Treasuries

Demand for Treasury bonds pushes prices up and yields lower. Given that Treasury yields are at all-time lows, the implication is that demand for these securities has increased. Many attribute this to buying by the Fed, but this demand is really being driven by retail investors. For contrarian investors, this would be an indicator to sell Treasuries, as retail investors are often referred to as "dumb money." See the article here, CNBC.

Health or Money?

When asked whether they would have health or money, most people would probably choose money. However, a recent study shows that investors actually trust their investment advisors more than their doctors. So, does this imply they care more about their money than their health?????? See the article here, Investment News.

Leading or Lagging

Economists and investors often look to the index of leading indicators to predict the economic future. One measure included in this index is unemployment. However, some debate whether this is more of a lagging indicator since high unemployment hinders spending. In either case, recent news related to initial jobless claims has been positive. See the article here, Reuters.

The ECB Is NOT the Fed

Although both the ECB and Federal Reserve are central banks, they are much different in their approach to managing their respective economies. The Fed's mandate includes both promoting growth and controlling inflation, while the ECB is really only designed to mitigate inflation. Thus, the ECB is not equipped to act in a speedy fashion as the Fed did in response to our financial crisis. (See the article here, Wall Street Journal.)

Alternative Investments for the Masses

Historically, hedge funds and private equity funds have only been available to qualified (i.e., rich) investors. However, new ETFs offer the opportunity for smaller investors to join the party. Check out the new AlphaClone ETF, which will be offered on the International Securities Exchange.

Manipulating Earnings

To cover recent losses associated with CDS trading (see earlier post), JP Morgan sold securities in which they had an unrecognized gain. While this move will make their earnings look less negative, the trades will actually hurt firm value as they will trigger taxable gains and reduce future earning power. Thus, for long-term investors, metrics such as cash flow may be better measures then earnings, which tend to be more short-term in nature, as well as more easy to manipulate. (See article here, Reuters.)

Expect Low Interest Rates to Continue

As the "flight to quality" continues, interest rates will likely remain low for the nations considered to be the most stable (such as the U.S. and Germany). This is a simple supply and demand relationship, as interest rates represent the price of money. (See the article here, the Wall Street Journal.)

CDS Trades Continue

JP Morgan recently announced a $2 billion loss, which renewed criticisms that originally surfaced during the credit crisis. While final details are still to come, initial reports suggest that much of the loss is attributable to the sale of Credit Default Swap (CDS) contracts. Similar exposures helped lead to the downfall of Lehman Bros., Bear Sterns, and AIG following the Crash of 2008. (See the article here, Fox Business.)

Popularity of Alternative Investments Rises

Alternative investments were once thought to be the domain of sophisticated, wealthy investors. However, they are gaining popularity among financial advisors (and their clients) as they realize the potential diversification benefits they provide. In particular, hedge funds and private equity funds are becoming increasingly common additions to even mid-market investors. (See article here, Reuters.)

Germany Sells 0% YTM Bond

With the problems in Greece (and other Euro countries), investors are seeking out safe havens. Similar to Treasuries during the Crash of 2008, investors are willing to accept no return, simply for the assurance that funds will be kept safe. (See article here, Reuters)

Refinancing and MBS

With mortgage interest rates at record lows, refinancings continue to rise. This creates prepayment risk for holders of mortgage backed securities. (See article here, at CNBC.)

HP Cuts Jobs, Stock Price Rises

HP announced on May 23 that it will cut 27,000 jobs (see article). In class I asked students what they thought happened to the stock price. Most thought the price would drop since this is a negative indicator. However, the stock price actually rose 2.2% from its prior day close, while the market was flat. The issue is efficiency (and margin). If HP can sell the same amount with fewer employees, earnings will be higher--which translates to higher growth (and therefore market value).

Shorting Via Options (Facebook)

Following Facebook's IPO, investors were looking to short the stock. However, there was little (to no) available supply of shares to borrow. So, are we unable to create this position? Well, investors can resort to options.

Recall the Put-call parity equation:
S + P = C + K/(1+r)^t

If we rearrange the formula, we can create a synthetic (or replicated) position. So, if we wanted the equivalent of a short position in a stock:

-S = -C - K/(1+r)^t + P

Thus, to create a synthetic short, we would sell a call, short a t-bill (or borrow present value of exercise price) and buy a put.

For more on this, see the article here (Seeking Alpha).

Facebook Trips Circuit Breaker

The fallout of the Facebook IPO keeps getting worse. On the second day of trading, Facebook shares tripped their circuit breaker as prices dropped more than 10% in the opening minutes of trading. This is very unusual for an IPO, particularly one as highly anticipated as Facebook. Recall, these individual stock circuit breakers were implemented following the flash crash (which occurred on May 6, 2010). See the article here (Wall Street Journal).

Facebook IPO

Facebook went public on Friday, May 18. Although the trading was flawed (as Nasdaq admitted), the initial price action was quite typical of an IPO. Shares were offered at $38, but spiked to almost $42 shortly after hitting the secondary market. Shares closed just above the offering price. For about the last 15 years, the average level of underpricing (or first day return) has been 15%. So, in these terms, the Facebook IPO was not that successful.