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Wednesday, August 24, 2016

Why You Shouldn't Pay Attention to Short Term Market Movements and News..A Great Case Study...

I'm back after a bit of a summer hiatus

Exactly two months ago the British voted to "Brexit" leave the European Union. This was almost universally regarded as a worst case outcome with disastrous long term consequences for European stocks. European stocks fell a mouth dropping 10% the day after the vote....and where are we a mere two months later ? As can be seen in the graphs below European stocks (etf VGK) and German stocks (ETF EWG)  and even the UK (etf ewu) have recovered entirely from the drop on August 25 in response to the Brexit vote. The Euro is virtually unchanged against the dollar ...only the British pound shows a sharp fall since the Brexit vote.

The lessons from this. Certainly it shows the perils of attempting to time short term market movements or pay too much attention ot headlines. In fact for some disciplined long term investors that pursue rebalancing the sharp drop in European stocks could have presented an opportunity to actually add to an allocation in European stocks that might have become underweighted vs. target due to market movements.
VGK European Stock ETF
EWG German Stock ETF


British Pound/$ Exchange Rate

Euro/$ Exchange Rate

Sunday, May 29, 2016

How Is Your Diversification Doing ? Here's How to Find Out..and Why One can Never Get a Good Answer to that Question with Actively Managed Funds

The American Association of Individual Investors (AAII) has published an excellent article on the importance of portfolio diversification and ways to check it in your portfolio.

Since AAII is a group of  "do it yourselfers" who tend to devote significant time to their investments the article is geared to making use of available tools on the web and doing the analysis oneself.

Most investors haven't taken the time to become "investment nerds" and would prefer to have the analysis done by an investment professional and even those that have may want a "second opinion".

Advisors (like myself) have access to tools more sophisticated than the ones mentioned in the article and can generate an analysis not only giving an evaluation of your current portfolio..but also with specific recommendations for a more diversified..and often lower cost alternative.

Note that with a portfolio of actively management funds one can never know how diversified a portfolio is. Managers change their holdings and often report them only quarterly A true diversification analysis would have to be constantly updated to keep up with changes...and if one makes changes to make the portfolio of active funds more diversified it is like chasing shadows you never can know the real consequences of your changes

Contact me at if you are interested in such an analysis either in Southern California or Israel in person or via email/skype from anywhere else.

From the AAII (in italics my bolds) full content is here

Why is Diversification important ?

The best argument for mutual funds is that they offer safety and diversification. But they don't necessarily offer safety and diversification.—Ron Chernow

Mutual funds—and more recently, exchange-traded funds (ETFs)—have offered safety and diversification by allowing individual investors to buy shares in many companies in order to spread risk. It is important for investors to understand what role they play and what role the fund managers’ play in ensuring proper diversification of their portfolio. Additionally, investors need to understand when fund companies fail on proper diversification, how that results in improper diversification and what impact that could have on their portfolios. We highlight what diversification is and why it is important, then discuss why an appearance of being diversified may not mean that your portfolio is truly diversified. Finally, we identify ways that fund managers and investors can damage their portfolio diversification.

The Importance of Diversification

Diversification reduces risk by allocating investments among various financial instruments, industries and other categories. The theory is that some assets will outperform in certain scenarios while underperforming in other scenarios. The benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated. Correlation is a statistical measure of how two securities move in relation to each other.

Research supports this contention, as is illustrated by the paper by William Goetzmann and Alok Kumar, “Equity Portfolio Diversification,” from the National Bureau of Economic Research. The authors found that investors who held the least-diversified portfolios in a pool of investors earned far less than the most-diversified group of investors....

The study determined that the least-diversified (lowest decile) group of investors earned 2.4% lower return annually than the most-diversified group (highest decile) of investors on a risk-adjusted basis. The economic cost of under-diversification was higher for the group of older investors, where the risk-adjusted performance differential between the least-diversified and the most-diversified investors was 3.1%

What Can a Portfolio Analysis Do For You ?

Checking Your Diversification: An Example

For example, with a four-ETF portfolio that includes iShares Russell 2000 ETF (IWM), SPDR S&P 500 ETF (SPY), Vanguard FTSE All-World ex-US ETF (VEU) and Vanguard REIT ETF (VNQ), I have assembled what, on its face, appears to be a reasonably well-diversified portfolio.
For the purposes of this illustration, the holdings are equally weighted in terms of the number of

ETFNumber of SharesPrice per ShareTotal Investment ($)Percentage of PortfolioBeta

Analyzing Portfolio Diversification In-Depth A Case Study

Using analytical tools which examine not just the actual holdings of the ETFs and funds in a portfolio not simply the categories given to the funds by the management firm gives a true picture of the portfolios diversification. Such an analysis can also take into account any individual stock holdings as well 

International diversification. A well diversified portfolio should be allocated around the world. The US makes up around half of the worlds market capitalization. While some would argue for a geographical allocation there is no one answer. Many experts see 20-30% as the optimal % of non US stocks to hold in a portfolio. Few would recommend a portfolio with no non US stocks. And within the non US stocks most if not all experts advise a mix of developed and emerging market stocks.

While an all ETF portfolio will generally be transparent  with  regards to geographic allocation ( a US stock ETF will not hold non US stocks) that is not the case with actively managed funds which are often if not usually allowed under the terms of their prospectus to invest with a different geographic mix than the ostensible fund category (a US stock funds investing in emerging market stocks for example)

For portfolios with bonds the same would be the case. A "go anywhere" actively managed bond fund or ETF may invest in bonds anywhere in the world while a bond index fund or ETF must match the specified index.

Here is what an analysis of the above portfolio would look like

The analysis  shows us that 89% of our sample ETF portfolio is U.S. stocks (Figure 1). This may or may not be a geographic diversification issue, depending on your risk tolerance.

Stock Diversification by Sector

An indepth analysis can also look inside the porfolio and check for other types of diversification

The analysis ..

indicates the sector percentage for the companies held by the ETFs. For example, it indicates that 47% of the companies represented in the portfolio are in a cyclical type of sector such as basic materials or financial services (Figure 2). Again, as an individual investor it is important to understand what your risk tolerance is compared to what the tool is showing you. Cyclical sectors can perform quite well when the economy is expanding, but can perform quite badly when the economy is weak. The holdings for a benchmark, typically the S&P 500, are also provided for some perspective....
What you are likely to see is significant differences between weights by sector for the broad index compared to your holdings. It is important to understand how those differences can affect your portfolio. For example, as we mentioned above, our self-constructed portfolio has 47% of its holdings in cyclical companies. The S&;P 500 index maintains only 31% in cyclicals. That is a very significant difference and will affect returns and volatility

In the example here the portfolio is comprised solely of ETFs but many portfolios include actively managed mutual funds and individual stocks making this type of "xray' analysis more important in understanding a portfolio's diversification.

In some cases an advisor might advocate changes in the portfolios's holdings to reduce a high allocation to a particular industry because of holdings in company stock or options. Because of taxes or other restrictions it might not be practical to sell the company stock so other adjustments can be made with a portfolio of transparent ETFs.

Figure 2. Sample ETF Portfolio Sector Breakdown
Source: X-Ray.

In the case of our presumed “well-diversified” portfolio from above, we can see immediately on the X-Ray report that a critical error was made during construction of the portfolio. By equal-weighting the ETF shares in our portfolio, the report shows that we have 10 times the weighting in real estate that the S&P 500 has (Figure 2). In addition, we were apparently not aware that broad ETFs like SPY and others hold real estate. While REITs have, since 1971, returned 11.9% per year on average according to Ibbotson Associates (second only to small-cap stocks) and allowed investors a liquid way to gain exposure to real estate, this is more allocation to REITs than we thought. Being heavily overweight in real estate makes the portfolio vulnerable to the vagaries of that asset class. Is that what we thought we were getting? No? Surprise!

The above example shows the "surprise' high weighting of real estate in the ETF portfolio. Doing a similar analysis on a portfolio with actively managed funds is likely to lead to even more"surprises"

Style and Market Capitalization:

Although not included in this article a portfolio analysis will also show the breakdown of the portfolio by size market capitalization and valuation measures. A diversified portfolio should include large and small cap stocks but an analysis of a portfolio may show a very low representation of small and mid cap stocks.

I have written about the perils of market capitalization portfolios that are top heavy with large cap growth stocks. A portfolio analysis can give an excellent idea of the actual holdings of the portfolio broken out by categories such as large small and mid cap and value vs growth stocks. It can also give specific etrics such as market capitalization, price earnings ratio and price to book.

There is a significant body of research showing that over the long term value stocks especially small cap value stocks outperform the market capitalization weighted indices. This analysis can show if a portfolio is positioned to take advantage of this potential outperformance.

Don't Forget the Bonds

A diversification analysis can also breakdown the bond holdings in a portfolio in terms of geographical diversification, maturity/duration , types of bonds and credit quality. Without performing an analysis of an entire portfolio it is impossible to know the potential impact of changes in exchange rates, economic conditions,and interest rates on a bond portfolio.

This analysis is particularly important if a portfolio includes an actively managed mutual fund where even a fund labelled a US Investment grade corporate bond fund might hold non US corporate bonds. In the case of "go anywhere' bond funds getting a handle on the actual portfolio allocation is even more important.

The Added Perils of Using Actively Managed Mutual Funds in Both Stocks and Bonds.

Actively managed mutual funds frequently have "style drift" in which their holdings differ from the category label of the fund for example a small cap value stock fund with a significant allocation to large cap growth stocks.

The same holds true for bond funds which may drift out of their style category. "Go anywhere" bond make understanding a portfolios bond diversification difficult if not impossible since they can drastically and frequently make major changes in the portfolio for instance going from a zero weighting in non US dollar denominated emerging market bonds to a significant weighting.

 Additionally since the fund is "actively managed" an analysis such as the one may be instantly out of date . In fact since actively managed funds report their holdings with a lag the portfolio analysis likely wont even reflect the actual portfolio at the time of the analysis (which of course can only be based on reproted data). In other words even with this great analystical tool creating a properly diversified portfolio of actively managed funds is like a game of "whack a mole" everytime you correct a lack of one type of diversification another cause of poor diversification emerges.

Analysis Must Be Combined with Action

The in depth analysis here is not a mere academic exercise it is a tool to show where changes need to be made to create a properly diversified portfolio.

A complete diversification analysis such as the one I perform for clients presents a before and after portfolio. That means an analysis of the diversification of the existing portfolio and recommended adjustments to make the portfolio more diversified..and another report similar to the one descirbed here analyzing the proposed portfolio after changes are made.

Rebalancing: Wash Rinse Repeat

The movement of the various holdings in a portfolio can drive a portfolio away from the target allocationa and level of diversification. An annual diversification analysis can keep the portfolio in line with the proper level of diversification by showing where rebalancing needs to be done.

The AAII article concludes:


We have learned that while portfolios can be constructed that appear to be diversified, digging deeper can show that the diversification is not appropriate for the investor’s needs. It is incumbent upon the investor to educate themselves not only on how to construct a well-diversified portfolio, but also on how to keep it well-diversified over time. While a fund manager may take actions that can result in improper diversification for the fund’s investors, there are things that investors can do to minimize the chances of improper diversification. Actions such as monitoring correlations and automatically reinvesting dividends, while not huge actions, can pay off in spades by keeping the portfolio appropriately diversified. The key is to be an educated investor.

Update on the "Sure Thing" Long Gold Trade

Down a bit less than 8% in May and approaching what technicials call a "major support level" at $1200 according to technical analysis which imo is not mumbo jumbo espectially in commodites, a close below that would be deemed very negative. You can also see the spike in volume in late May. large scale selling just as the market turns is often as a sign some of those late to the party" taking losses.

Friday, May 20, 2016

More Pain for the "Smart Money" a Turnaround in Gold

In my March 16 entry I noted that two major "smart money" trades:

short US $ betting on a dollar fall
Short oil betting on lower oil

and that subsequent market moves turned those smart money trades into losers.

I noted the latest "smart money " trade was's what we have seen very recently :


Gold is heading for the longest run of weekly losses this year because of the Federal Reserve

While the metal was little changed on Friday, it was set for a third weekly drop. Traders have boosted bets that U.S. policy makers will raise interest rates in the next few months, spurred by comments from Fed officials, minutes of the last policy meeting and quickening inflation.
“The hawkish minutes from the Fed meeting and economic data shows an increasing chance of a rate hike in June or July,” Jens Naervig Pedersen, a senior analyst at Danske Bank A/S in Copenhagen, said by phone. “That wasn’t priced in a few months ago and implies further upside for the dollar and quite a beating for gold.”
Gold rallied to a 15-month high earlier this month on expectations that the Fed would keep rates lower for longer amid risks to the global economy, adding to the appeal of owning non-interest-bearing assets. As the likelihood of a rate move increased, the dollar strengthened, cutting demand for gold as an alternative asset.

The chart below shows more bad news for the smart money trade betting on a weaker US dollar as well as recent pain for smart money holders of long gold positions

The chart  is entitled "different paths" but in fact the path is the same..a reversal of positions held by a large number of smart money" traders and a reversal as the Federal Reserve indicates a higher likelihood of interest rate changes.

Thursday, May 19, 2016

Update on Israelis Shekel(NIS) and US $ Exchange Rate and the Israeli Stock Market

NIS/US $ Exchange Rate

The NIS/US$ rate as reversed sharply of late with the US $ rising to over 3.8700 in trading on May 20 a 2 month high (chart reflects trading through May 19)

The reasons for the rise are related to two developments:

A weak GDP report for 2Q 2016 for with growth of only .8% (vs.2% the previous quarter) with a 4% fall in exports wasreleased  eralier in the week. That would indicate no likelihood of rate hikes and also an interest to keep the NIS weak to help exports. Looking at technical analysis the break on the US $ downside accelerated after the rate fell below 3.8500 and accelerated in the other direction when it crossed 3.8500 indicating strong support/resistance at that level.

The second factor is the release of the minutes from the US Federal Reserve yesterday that increased the likelihood of US interest rate hikes in June. That would be a positive factor for the US $ as interest rate differentials would widen both vs the NIS and the Euro. As can see below Euro weakness has accelerated since the report and the sharp move likely indicating a reversal of many short $ long Euro positions.

Israeli Stock Market : Capitalization Woes

I have written before about the domination of the major Israeli stock index the TA 25 by the drug sector approaching 25% of the index. Not only does this mean the index is not diversified it also means that investing in the TA 25 doesnt reflect the economy and despite Israel's reputation as a high tech leader most top tech successes from Israel either go public on the US stock exchange --recent examples would be WIX and Mobileye or are sold to large global players such as WAZE being sold to Google.Investing in the index also doesnt give exposure to a broad range of Israeli domestically oriented coutntries and among those it has a high exposure to the large banks which make up another quarter of the index ..and have had poor results as of late. 

Israel’s main stock index has drugmakers to blame for dragging the gauge to within 1.1 percent of a bear market.
Pharmaceutical companies Perrigo Co., Teva Pharmaceutical Industries Ltd., Mylan NV and OPKO Health Inc., which make up about a quarter of the TA-25 Index, have tumbled this year, wiping $27 billion off values and sending the gauge down 19 percent from a peak in August. The measure is near a bear market even though 76 percent of its members traded above their 100-day moving average this week.
Until the stock exchange limits a company’s weighting on the index, drug companies will continue to drive the stock measure lower, according to Ayalon Group Ltd.
“The weighting of pharma companies in the main index has been a problem as it’s not a reflection of the Israeli economy with most of them not even based in the country,” Yaniv Pagot, the head of strategy at Ayalon Group, an institutional investor in Ramat Gan, Israel, said by phone. “The bourse’s reform is clearly essential but coming a bit late. The bottom line is investors won’t be able to recover losses and as a result they may need to sell positions at an increased loss.”

Wednesday, May 18, 2016

401k Fees are Falling...Are Yours ? Some Tips on Your 401k in a Lower Cost Environment

The WSJ reports some good news for 401k investors:

401(k) Fees, Already Low, Are Heading Lower

Employers, advisers shave retirement-plan costs as they face pressure to monitor expenses

On average, the fees 401(k) participants pay for funds that invest in stocks fell from 0.77% of assets in 2000 to 0.74% in 2009, before dropping sharply to 0.54% in 2014, according to ICI, a mutual-fund-industry trade group. Fee reductions have also accelerated on bond funds and a hybrid category that includes popular all-in-one target-date funds.

Companies are lowering fees through various channels. More than 60% of 144 large employers said they were very or somewhat likely to move money this year into less-expensive share classes of the mutual funds on their plan menus, according to a survey Callan published in January. One-third of the respondents said they planned to renegotiate administrative fees. And 14% said they would switch some or all of their investment options from actively managed funds to index funds, which generally cost less.

These are positive developments of course and if your 401k plan still has high fees you should consider contacting those responsible within your corporation. Int the current environment of more regulatory scrutiny --and large class action suits against corporations with high fee 401ks-- your complaints may well elicit changes.

 You should make every effort to understand all the fees in your 401k plan both administrative charges and the management fees of the funds available.

But even if the fees have come down and there are index fund options there are still other issues to consider to make the best use of your 401k particularly when you have assets in other accounts such as IRAs and taxable accounts.

  • Just because it is an index fund doesn't mean it is low cost: The growth of index funds and ETFs has meant a race tot he bottom in management fees..with funds and ETFs in many stock and bond categories reaching below .10%. For example the Vanguard Total Stock Market Index Fund carries a management fee of just .05%.
          But it is not at all uncommon to find 401k plans with index funds carrying management fees
         that are far higher. There is no justification for a plan to include a total stock market index or S+P 500 index fund with a fee of .50% but that is not uncommon.  Including ad S+P 500 index fund and justifying a .50% fee because it is significantly less than the actively managed funds in the plan is likely to raise issues in terms of the fiduciary standard .

  • In what asset classes are index funds available ? It is quite common for a broad capitalization weighted US stock market index fund based on the total stock market index or an S+P 500 index fund  to be available.
  • But a diversified portfolio should include small cap stocks. Yet small cap stocks have a very low weighting in total stock market index and no representation in a S+P 500 index.
  • A diversified portfolio should also include international stocks so a 401k plan should offer choices in international equities as well.
  • And a broad range of choices among bond index funds should allow a mix of short and long term bonds, government and corporate rather than just a single bond index fund.
Beware the target date funds: Many 401k plans now offer target date funds and some may even have the target date fund as the default option. But target funds may not be a good choice. The funds set a balance between stocks and bonds based on age/expected date of retirement and then adjusts the mix of stocks and bonds reducing the stock allocation and moving assets to bonds as retirement approaches--the glide path"

It is important that the investor understand the glide path and whether it fits with their plans. A spouse's age or retirement plans and what other assets are available for retirement are just two examples of factors that may mean the "glide path' of the target date fund is appropriate.

What is in the target date fund ?. There is an asset allocation within the target date fund it is important to know what is used for the stock and bond allocation: are they index funds or actively managed funds? international and domestic stock funds? what are the bond allocations.

All of the above would argue that many investors would be better off constructing their own allocation for their 401k rather than setting it on auto pilot with a target date fund/

Putting your portfolio together: Your 401k + your other investment accounts

The emergence of lower fees in 401k plans is definitely a positive environment.

Creating a comprehensive asset allocation involving your 401k and that of your spouse as well as other assets such as IRAs and taxable accounts is the best approach to meeting your investment goals.

Here are some tips:

Bonds go into tax deferred accounts: Because income in IRAs and 401ks are not taxed currently and interest income is taxed at ordinary income rates it makes sense for most investors to put their bond allocation in tax deferred accounts.

Optimize  the use of index funds in your 401k . No 401k plan will include as wide a variety of index funds as are available in the index fund and ETF marketplace which you can access with your taxable or IRA accounts.

That means that you should use the index funds available in your 401k to implement parts of your asset allocation and your outside account when necessary to fully implement the asset allocation.

Create an Overall Asset Allocation not just an Allocation for the 401k

For example your overall allocation might call for a traditional capitalization weighted index as well as allocations to value or small capitalization stocks , developed international and emerging markets. But your 401k plan might not offer index funds in all those categories.

To implement  the allocation  401k funds would be used to fill the capitalization weighted US stock index part of the allocation and the accounts outside of the 401k would be used to purchase ETFs in the other categories of the asset allocation.

It is also not uncommon for a couple to find that the 401k plans of each employer have different choices. One plan may include a small capitalization index fund which could be used to fill that part of the allocation while the other plan may only include an S+P 500 fund,

Rebalance:  Investors tend to chase performance buying high and selling low..the opposite of what is done when one rebalances back to a target allocation. Many 401k plans offer autormatic rebalancing. But that rebalancing isnt done at the portfolio level taking into considerations all the investment accounts.

Consider Getting  Assistance form An Outside Professional

The lower fee environment for 401ks and the changes in regulations on advice for rollovers from 401k plans to IRAs are a very positive development. But as can be seen above implementing the proper asset allocation strategy is still far from simple. There are various ways a professional advisor can help

Periodic consulting: If the vast majority of your assets are in your 401k all you may need is a consultation with a professional to personally review your situation and recommend an asset allocation . An annual review would likely be optimal as well. Investment professionals should be able to offer that service as well.

Comprehensive asset management: Some 401k plans allow investors to have an advisor manage their 401k plan. For investors that have a portfolio consisting of significant assets outside of the 401k plan it might be optimal for the investor to have an advisor manage all the assets therefore taking care of the asset allocation and rebalancing .

Asset Management + Consulting: In the cases where the investor cannot or does not want to have an advisor directly manage their 401k assets a hybrid approach may be best. The advisor would have direct management of the non 401k assets and then work with the investor on a consulting basis with regard to the 401k assets making sure there is an integrated asset allocation and rebalancing.

I work with clients in all these services with clients in person in the Southern California area and by skype/email throughout the US.

Monday, May 16, 2016

Emperors New Clothes' Time for Hedge Funds

The recently conclued SALT conference of hedge fund managers in Las Vegas this year has generated much press. It seems this year it was like a meeting at the Versailles Palace on the eve of the French Revolution It was a sharp contrast to the Berkshire Hathaway annual meeting where 1000s of individual investors gathered to hear common sense on investing from Warren Buffett and Charles Munger..including some sharp criticism  of hedge funds and strong recommendations for investors to choose low cost index funds for their stock investing.

From the WSJ

Hedge Fund Star: We Are ‘Under Assault’

Leon Cooperman of Omega Advisors sums up the mood at the annual SALT conference in Las Vegas

LAS VEGAS—Some of the most famous minds in investing convened here this week for an annual celebration of the hedge-fund industry. But, feeling the weight of years of underperformance and an uptick in client defections, the mood was anything but festive.
Longtime hedge-fund manager Leon Cooperman openly questioned whether it made sense to continue on after redemptions from his firm, Omega Advisors.
Major hedge-fund clients, including China’s sovereign-wealth fund, aired doubts, positing that 90% of hedge-fund managers probably weren’t skilled enough to navigate the markets.
And it had been hard enough to get some of the attendees to even show up. The slump in the industry—highlighted by the largest exodus of investors since the financial crisis—damped interest in the SkyBridge Alternatives Conference, commonly known as SALT, according to Anthony Scaramucci, the event’s organizer and founder of SkyBridge Capital, which puts $13 billion into hedge funds.
“There is a decided pessimism in the hedge-fund community,” he said, while predicting the industry would survive. “A lot of guys opted out of coming, frankly, because of performance issues.”...The mood was a far cry from previous years.  since the start of the bull-market run in early 2009, a more traditional mix of stocks and bonds bested a broad hedge-fund index in 22 of 28 quarters, according to a Wall Street Journal analysis of data from research firms HFR Inc. and Morningstar Inc

It sees the conference organizers didnt quite have their story straight on attendance..not too good a sign about how they do on reporting fund manager performance:

A SkyBridge spokeswoman later said 2,100 people registered for the conference, up from 1,800 the year before.

You can find comprehensive reporting on hedge fund performance here

What Do Hedge Funds Really Do ?

One thing that is certain is that hedge funds dont do much hedging. They also dont necessarily have very unique investment strageies.

One widespread strategy is called merger arbitrage NYT:

Historically, merger arbitrage has been the calm hinterland of the investing world. Traders usually buy up shares in the company that is being acquired; those shares tend to trade slightly below the buyer’s offer price, often by just pennies. Once a deal is done, that gap closes, and arbs will make money on the difference. (Some trades involve hedging through the acquirer’s stock as well.) Such trading has been considered low risk for small returns.

The information about these transactions is public (or "curiously" all the arbs seem to know the terms of mergers yet to be announced)..meaning that all the hedge funds using this strategy pile into the same trades.

Lately many proposed mergers have not come through leaving much blood on the streets where hedge fund managers reside. Nothing very unique in manager skill in this strategy so it shold not be surprising that when the deals fall about the "top perfroming managers" have turned into dismal performanc. Among major deals that have fallen through recently due to regulatory or court rulings or just market forces have included Office Depot/Staples,  Allegran and Pfizer (that deal alone was valued over $150 billion), Halliburton and Baker Hughes and Energy Transfer and Williams Company. The total value of these broken deals involving was well over half a trillion dollars.

While last year set a record for the amount of money spent on corporate mergers — $4.7 trillion — this year is so far setting a very different record: the dollar amount of deals that have come undone....Broken deals have whipsawed hedge funds that focus on merger arbitrage, a type of trading that places bets on the likelihood that deals will be completed. As one “arb,” as traders in merger arbitrage are known, described the current mood of the industry: Every day is like showing up unsure of whether to wear a helmet or a diaper.
You’re definitely seeing a hangover from the M.&A. party from 2015,” said Aly El Hamamsy, a partner in Cadwalader, Wickersham & Taft’s mergers-and-acquisitions group, which occasionally advises arbs. “Things will stay interesting for a few months at least.”
Anxiety is higher than many arbs say they have experienced in years. Merger arbitrage was the worst-performing investment strategy in April 
And it seems hedge funds using the merger arbitrage strategy are now loking at ways to hedge their risk by actually doing more research before jumping into trades:
Taking a cue from these troubled deals, some investment funds that do merger arbitrage trading are working with lawyers to pore over agreements to make sure they are placing trades on deals that are not likely to come apart.

Macro strategies 

Another strategy that has performed poorly of late has been "global macro" which involves trading based on forecasts of global economic events. It shouldnt be much surprise that the world is more complicated and difficult than it seems and exceedingly difficult to forecast. Reversals in trends in oil prices and the dollar among other developments caused losses for these funds. the hedge funds research institute index of macro strategy hedge funds shows a 5 year return of .23% vs 4.7% for the total world stock index and 10.9% for the S+P 500

Hedge Fund Managers turn out to be not much different than other investors.

Despite their reputation for being sophisticated n their research and investing it turns out that hedge fund managers behave pretty much like everyone else showing all the pitfalls n their strategies. They tend to pile into the same trades as others, often simply because it has become a "hot trade" and then show reluctance to adjust to new information that challenges their assumptions. Since the hedge funds take large often leveraged positions when things go bad and they all attempt to reduce the trade at the same time prices drop sharply, liquidity dries up and the losses mount.
The poster child for this scenario has been Valeant. Bill Ackman considered one of the hedge fund geniuses took a huge position in this company. At an annual event open to all willing to make the appropriate charitable contribution (or following the news reports and gossip afterwards) Ackman joined other top managers in pitching their single best idea. Ackman's pitch : Allegran.

Apparenly other investors didnt do much more research other than listen to Ackman's speech and followed Ackman into thte trade. As the NYT reported:
Not coincidentally, big names like Paulson & Company, Viking Global Investors and Brahman Capital have also lost billions, collectively, by betting on Valeant — underscoring a growing phenomenon of hedge fund groupthink. It is a reflection of big-dollar investors chasing too few ideas and getting tripped up when things turn poorly for a company they have set big markers on.
“The bottom line is, hedge fund herding is not going away anytime soon,” said Andrew Karolyi, a professor of finance at Cornell University. “If anything, we are now seeing the early signs that this type of hedge fund herding is spilling over into herding of large institutional investors. To the extent that that spillover grows and expands, then we will be concerned.”
Hedge funds piled into Valeant as the stock soared more than $200 a share last year, even as warning signs about the company’s leadership and business practices began to appear. The stock is now trading around $36 a share, as Valeant prepares to install a new chief executive and races to meet a deadline to file a delayed financial report.
Despite their teams of "highly skilled" and highly paid analysts it seems the hedge funds cut lots of corners follwing the herd (much like the least successful of individual investors.Another exampe is  Sun Energy touted by another "top hedge fund manager" David Einhorn at another conference in October 2014 when the stock was trading in the mid teens....the company declared bankruptcy  and its stock is now trading at 17 centrs. Other top ranked hedge funds including Greenlight Capial, Glennview Capital and Omega Advisors piled in. Omega Advisors run by long time hedge fund star Leon Cooperman recenly told the SALT conference the industry is "under attack" and mulled leaving the industry in te wake of large redemptions from his fund.
How could this happen ? It seems these top hedge fund managers managing billions of dollars and receiving fees that make them among the highest paid and wealthies people in the world behave much like individual investors trading investment ideas at a cocktail party:
That so many hedge funds remained bullish on Valeant despite months of turmoil — as questions were raised repeatedly about its accounting practices — reflects the difficulty managers sometimes have with changing course.
We all get lazy and when an idea seems to be working — inertia tends to take over and you stop paying attention,” said James Chanos, the founder of Kynikos Associates and one of Wall Street’s best-known bearish investors. “That’s on full evidence with Valeant and SunEdison too,” he added"
With this track record it is not surprising that institutional investors are rethinking their hedge fund investments discovering that the emperor indeed wears no clothes. A combination of simple index funds and ETFs including those that easily and inexpensively access alternative weighting strategies such as value and momentum...strategies which actually would often profit from the foibles of the "genius" hedge fund managers.
The head of China's investment Company had some pretty harsh words for the hedge fund industry on their investment strategy both generally and with regard to investing in her home country. Leading to a shouting match among some of the wealthiest men (yes the rest were all men) in the world.

Hedge Fund Managers Ditch Decorum in Shouting Match Over China (bloomberg)

China Investment Corp.’s Roslyn Zhang and others found themselves on the defensive on Wednesday’s panel. The CIC executive said hedge fund managers, many of whom have never been to China, were succumbing to a “herd mentality” in betting against the yuan.
“They really don’t know much about China but they just spend two seconds and put on the trade,” she said. “Should we pay 2 and 20 for treatment like this?” she said, referring to industry fees, traditionally 2 percent of assets and 20 percent of profits.
On the performance and skill of hedge funds the Chinese official pulled new punches in pointing out that the Kings of Finance may be not nearly as skillful as their reputations suggest: WSJ

China Wealth Fund ‘Disappointed’ in Hedge Funds

One of the biggest backers of hedge funds is having second thoughts.
“I have to say, the past few years I’m sort of disappointed with the performance, to say the least, of the industry,” Roslyn Zhang, managing director overseeing hedge funds for China Investment Corp., said at the hedge-fund industry’s annual SALT conference. CIC is the sovereign wealth fund for the world’s most populous nation.
The CIC official later told The Wall Street Journal in an interview that she was booting managers from her approved list and beginning the process of evaluating whether to slash the fund’s investment in hedge funds overall.
That amounts to a rather terse rebuke of the industry at this usually-buttoned up annual confab. China’s sovereign-wealth fund is one of the world’s biggest investors in hedge funds; it has more-than $20 billion in its “absolute return” investment category, which includes hedge funds, according to its annual report.
Much of the hedge-fund industry’s growth and hefty paydays in recent years have been thanks to a constant spigot of new money from deep-pocketed investors like Ms. Zhang.
 “Many people blame Chinese retail investors [for a] herd mentality, but I see the herd mentality among hedge-fund managers now almost everyday,” she said.
Hedge fund managers much as is the case of individual investors may very much reside in Lake Wobegon where everyone is above average
She sad she was looking for more “skillful” partners to navigate markets than she had found so far among hedge funds.
“My experience with the hedge-fund industry is probably only 10% of managers are capable of adapting to the new reality. But I’m sure 90 percent of hedge-fund managers think they are the 10%.”

Individual investors investing in hedge funds usually invest in "funds of funds" adding fees on top of the fees paid to the hedge fund managers. They seldom if ever pay less than "2+20" fee structure(2% of assets under management+20% of profits) sometimes even pay more while larger institutional investors at times can negotiate discounted fees. This of course drives investor performance even lower

Institutional investors often hire high priced consultants to choose funds and these consultants are prone to chasing performance by moving their clients in an out of hot funds.

With the poor performance of hedge funds and the availability of capital weighted and alternative weighted strategies for .20% or less not hard to understand why the hedge fund industry fees "under assault". 

Update on the Forecasts of the "Smart Money"


Bloomberg May 16

Goldman Surprised by Sudden Oil-Market Turn as Glut Vanishes

Goldman cut its crude price forecast for the first quarter of 2017 to $45 a barrel from $55 previously, but sees oil rising to $60 by the end of that year. The bank expects global oil demand to grow by 1.4 million barrels a day in 2016, versus 1.2 million predicted earlier
Crude Oil One Year


Is the sun setting on the dollar rally?

Dollar Jump Catches Traders Short in One More Currency Calamity

Just when investors thought they’d finally made a good call in the currency market, the dollar’s advance messed it up.

The U.S. currency on Friday capped its best week all year versus its major peers, shortly after hedge funds finally switched to betting on dollar declines, known as going short. That’s not the only wrong move foreign-exchange managers have made this year -- an index tracking their returns shows they’ve failed to turn a profit in 2016.
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Where is the "smart money" placing its money now ?

Gold is the best-performing major metal this year after silver amid rising concern over negative rates in Europe and Japan and whether the Federal Reserve will be able to tighten further. Demand jumped to the second-highest level ever in the first quarter, according to the World Gold Council, and billionaire hedge fund manager Paul Singer has said gold’s rally may just be beginning. Investors are being driven to gold on a structural shift in investment demand, according to Bernard Aw, a strategist at IG Asia Pte.
The great gold rush of 2016 is gathering pace. Holdings in exchange-traded funds have now surged by a quarter, with investors taking advantage of lower prices over the past two weeks to enlarge stakes on rising concern about central bank policy making worldwide

Based on the performance of the "smart money" trades in currencies and  oil...let's say some skepticism would be warranted.
Gold one year:

Wednesday, May 11, 2016

More on Hedge Funds...Wait Till Next Year...While We Collect the Fees


Rubenstein Says He’s Surprised Macro Hedge Funds ‘Got It Wrong’

Carlyle Group LP’s David Rubenstein said it was unexpected that so many hedge funds made wrong macro bets, leading to the industry’s worst start to a year since 2009.
“It does seem surprising that so many macro people got it wrong,” Rubenstein said Wednesday in an interview with Bloomberg Television’s Erik Schatzker. "But many of them will probably do pretty well in the future. I suspect when returns come back the industry will thrive again."
In aggregate, the $2.9 trillion hedge fund industry is having its worst start to a year in performance and investor withdrawals since global markets reeled from the most severe financial crisis since the Great Depression. Third Point, the hedge-fund firm founded by Dan Loeb, last month said the industry is in the first stage of a “washout” after a “catastrophic” performance this year.
Hedge funds lost 1.9 percent in the first quarter, according to Hedge Fund Research’s global index, the poorest performance since 2008. The industry had net outflows of $16.6 billion in the past two quarters, the most since 2009, according to HFR. In 2015, 979 funds closed, more than any year since 2009, according to the research firm.

Tuesday, May 10, 2016

Hedge Funds: A Great Deal for The for the Investors..It's Quite a Different Story


Hedge Funds Faced Choppy Waters in 2015, but Chiefs Cashed In

For many managers, collecting large pay, even when performance was not tops, has become a side effect of growing bigger.
“Is the goal to continue to make money in a risky environment or is the goal to preserve assets on which you collect fees?” Mr. Petzel added.
Other managers hauled in large pay packages despite losing some of their investors money.
Daniel Och, the founder of the Och-Ziff Capital Management Group, made $140 million in 2015. His firm’s flagship fund, OZ Master Fund, lost 0.28 percent last year. Other funds within the firm fared well, with its OZ Asia Master Fund up 9.64 percent.
But the firm has come under regulatory scrutiny over whether its dealings in Africa violated the Foreign Corrupt Practices Act. The publicly listed hedge fund firm has set aside $200 million to deal with a potential regulatory action.
Michael Platt, the founder of BlueCrest Capital Management, took home $260 million, according to Alpha. It was a difficult year for his firm, once one of the biggest hedge funds in Europe with $37 billion in investor money. He lost investors in his flagship fund 0.63 percent over the year and then told them he was throwing in the towel.