What Buying a House and Structuring an Asset Backed Security Have in Common
(May 2013)
When you buy a house, it's generally a good idea to get it inspected so you know if there are any expensive problems you might have to pay for after the deal closes. It's also a good idea to make sure that the person inspecting the house be independent, knowledgeable and perhaps most importantly objective -- not paid by or otherwise conflicted with the seller. Otherwise, they might overlook problems to make sure the deal goes through.
Asset backed securities (ABS) -- such as mortgage backed...
Variable Prepaid Forward Contracts
(May 2013)
Recently we've been working a lot with variable prepaid forwards (VPFs) in our casework and we decided to take a step back and explain these complex investments. A VPF is an over-the-counter contract between two parties involving a stock position, an upfront payment and option positions. VPFs are often used to defer taxes on appreciated stock, which has been a matter of some controversy.
Perhaps the best way to explain a complex investment is by example. Consider an investor who purchased...
Equal Weighting versus Market Capitalization Weighting
(Apr 2013)
We often hear about different stock market indexes in the same breath: on the evening news, you might hear that 'the Dow was up half a percent, the S&P gained three quarters of a percent, the NASDAQ was down a tenth of one percent'. While it may seem that these indexes tend to move together on most days, there are important differences between equity indexes. The one we hear about the most is that they are composed of different stocks: the Dow Jones Industrial Average tracks only 30...
Do ETFs and Mutual Funds with Higher Fees Outperform?
(Apr 2013)
There was a great comment on our post about FINRA's Mutual Fund Expense Analyzer.
Is there a positive correlation between fees and gross returns? In other words, are investors who pay higher fees compensated by higher returns?
On the one hand, one might expect that in order to garner high fees, a fund would have to earn higher returns; but on the other, it may be the case that higher fees simply erode profits and yield lower total returns.
We looked at data provided by Bloomberg on all...
Are ETF Flows Costly to ETF Investors?
(Apr 2013)
Exchange-traded funds (ETFs) are often lauded for their ability to efficiently create or redeem shares in response to changes in demand for the fund (known as fund flows). However, new research suggests that some ETFs that hold international securities may face transactional frictions that prevent them from tracking their benchmarks as well as other ETFs.
When there is an imbalance between supply and demand for an ETF, authorized participants (APs) create or redeem shares of the ETF to...
New Study Comparing Indexed and Actively Managed Funds
(Apr 2013)
NerdWallet, a San Francisco based personal investing site, has performed a historical study of the returns on almost 8,000 mutual funds and ETFs over a ten year period and found that passive indexed funds tend to outperform actively managed funds on average. In fact, they found that only 24% of actively managed funds outperformed the average return of the indexed funds. These results are consistent with the annual SPIVA Scorecard produced by S&P Dow Jones Indices, which found in both 2012...
Persistence and Mean Reversion in VIX Rolling Futures Indexes
(Mar 2013)
In our last post we followed up on Jason Voss's discussion of the Hurst exponent as a measure of persistence or mean reversion in market data. We compared the Hurst exponents of the S&P 500 to that of the VIX index, and found that the S&P 500 is largely a random signal (Hurst exponent near 0.5) but that the VIX exhibits characteristics of a 'switching' or mean reverting signal (a Hurst exponent between 0 and 0.5).
Much has been made of VIX mean reversion in the financial blogosphere. One idea...
Persistence and Mean Reversion in Market Data
(Mar 2013)
Jason Voss at the CFA Institute has recently written a very interesting series of posts on the Hurst exponent, which is "a method for detecting persistence, randomness, or mean reversion in financial markets." The Hurst exponent measures the degree to which a signal depends on previous values--a phenomenon known as autocorrelation--and specifically whether values tend to 'switch' (e.g., high values followed by low values) or 'persist' (e.g., high values followed by other high values). Jason...
Evolution of Absolute Return Structured Products
(Feb 2013)
From 2006 to 2009, a type of structured product known as an absolute return barrier note (ARBN) was issued by a variety of major investment banks. ARBNs are interesting because they are linked to the absolute value of the return on an underlying, not just its return, and therefore are considered non-directional bets. We've done a lot of work on ARBNs here at SLCG, including a research paper that values a sample of ARBNs and finds they are worth on average 4.5% less than their purchase price...
How Big of an Effect Does Securities Lending Have on ETF Returns?
(Feb 2013)
We earlier posted an analysis that compared ETF returns to their stated index net of fees for funds that lend securities and those that do not. IndexUniverse subsequently suggested an approach with methodological differences from our original work and we wanted to address some of those differences here.
For our sample, we used Bloomberg's ETF function to collect all US-domiciled, USD-denominated exchange-traded funds and removed any with active trading strategies, leverage, or inception dates...
