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Weekly Summary of Research Findings: 10/8/18 – 10/12/18

Below is a weekly summary of our research findings for 10/8/18 through 10/12/18. These summaries give you a quick snapshot of our content the past week so that you can quickly decide what’s relevant to your investing needs.

Subscribers: To receive these weekly digests via email, click here to sign up for our mailing list. Keep Reading

Equity Index Options to Exploit Stock Market Volatility Spikes?

Under what conditions should speculators buy protective equity options when they expect realized stock market volatility to increase? In their September 2018 paper entitled “Being Right is Not Enough: Buying Options to Bet on Higher Realized Volatility”, Roni Israelov and Harsha Tummala analyze the relationship between: (1) long volatility return (delta-hedged options) and same-interval changes in realized volatility; and, (2) the volatility risk premium (VRP, implied volatility minus realized volatility) and same-interval changes in realized volatility. They specify long volatility as a portfolio of cash-settled equity index options, reformed monthly, that:

  • On each options expiration date, buys one-third of a -25 delta put option, one-third of a +25 delta call option and one-sixth each of at-the-money put and call options. All options initially have about a month to expiration.
  • Each day until expiration, hedges option deltas via equity index futures. 
  • Holds the options to expiration.

They also examine sensitivity of outcome to different portfolio initiation and termination points relative to significant volatility increases. They focus on the S&P 500 Index, using VIX as implied volatility and hedging via S&P 500 Index futures, during January 1996 through December 2016. They also consider for robustness testing corresponding data for Eurostoxx 50, FTSE 100 and Nikkei 225. Using daily data as specified, they find that:

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Credit Spread as an Asset Return Predictor

A reader commented and asked: “A wide credit spread (the difference in yields between Treasury notes or Treasury bonds and investment grade or junk corporate bonds) indicates fear of bankruptcies or other bad events. A narrow credit spread indicates high expectations for the economy and corporate world. Does the credit spread anticipate stock market behavior?” To investigate, we define the U.S. credit spread as the difference in yields between Moody’s seasoned Baa corporate bonds and 10-year Treasury notes (T-note), which are average daily yields for these instruments by calendar month (a smoothed measurement). We use the S&P 500 Index (SP500) as a proxy for the U.S. stock market. We extend the investigation to bond market behavior via:

  • Vanguard Long-Term Treasury Investors Fund (VUSTX)
  • Vanguard Long-Term Investment-Grade Investors Fund (VWESX)
  • Vanguard High-Yield Corporate Investors Fund (VWEHX)

Using monthly Baa bond yields, T-note yields and SP500 closes starting April 1953 and monthly dividend-adjusted closes of VUSTX, VWESX and VWEHX starting May 1986, January 1980 and January 1980, respectively, all through August 2018, we find that: Keep Reading

Rough Net Worth Growth Benchmarks

How fast should individuals plan to grow net worth as they age? To investigate, we examine median levels of household (1) total net worth and (2) net worth excluding home equity from several vintages of U.S. Census Bureau data. We make the following head-of-household age cohort assumptions:

  • “Less than 35 years” means about age 30.
  • “35 to 44 years” means about age 39.
  • “45 to 54 years” means about age 49.
  • “55 to 64 years” means about age 59.
  • “65 to 69 years” means about age 67.
  • “70 to 74 years” means about age 72.
  • “75 and over” means about age 78.

We also assume that wealth growth between these ages is constant via compound annual growth rate (CAGR) calculations. Using median levels of total net worth and net worth excluding home equity from 2000. 2005, 2010 and 2014 Census Bureau summary tables, we find that: Keep Reading

Real Bond Returns and Inflation

A subscriber asked (more than six years ago): “Everyone says I should not invest in bonds today because the interest rate is so low (and inflation is daunting). But real bond returns over the last 30 years are great, even while interest rates are low. Could you analyze why bonds do well after, but not before, 1981?” To investigate, we consider the U.S. long-run interest rate and the U.S. Consumer Price Index (CPI) series from Robert Shiller. The long-run interest rate is the yield on U.S. government bonds, specifically the constant maturity 10-year U.S. Treasury note after 1953. We use the term “T-note” loosely to refer to the entire series. We apply the formula used by Aswath Damodaran to the yield series to estimate the nominal T-note total returns. We use the CPI series to calculate inflation (12-month change in CPI). We subtract inflation from the T-note nominal total return to get the T-note real total return. Using annual Shiller interest rate and CPI data for 1871 through 2017, we find that: Keep Reading

FactSet S&P 500 Earnings Growth Estimate Evolutions

A subscriber, citing the weekly record of S&P 500 earnings growth estimates in the “FactSet Earnings Insight” historical series”, wondered whether estimate trends/revisions are exploitable. To investigate, we collect S&P 500 quarterly year-over-year earnings growth estimates as recorded in this series. These data are bottom-up (firm by firm) aggregates, whether purely from analyst estimates (before any actual earnings releases), or a blend of actual earnings and estimates (during the relevant earnings season). Using these data and contemporaneous weekly levels of the S&P 500 Index during April 2011 through late September 2018, we find that: Keep Reading

Weekly Summary of Research Findings: 10/1/18 – 10/5/18

Below is a weekly summary of our research findings for 10/1/18 through 10/5/18. These summaries give you a quick snapshot of our content the past week so that you can quickly decide what’s relevant to your investing needs.

Subscribers: To receive these weekly digests via email, click here to sign up for our mailing list. Keep Reading

Are U.S. Equity Momentum ETFs Working?

Are U.S. stock and sector momentum strategies, as implemented by exchange-traded funds (ETF), attractive? To investigate, we consider five momentum-oriented U.S. equity ETFs with assets over $100 million, all currently available (in order of decreasing assets):

  • iShares Edge MSCI USA Momentum Factor (MTUM) – holds U.S. large-capitalization and mid-capitalization stocks with relatively high momentum.
  • First Trust Dorsey Wright Focus 5 (FV) – holds five equally weighted sector and industry ETFs selected via a proprietary relative strength methodology, reformed twice a month.
  • PowerShares DWA Momentum Portfolio (PDP) – invests at least 90% of assets in approximately 100 U.S. common stocks per a proprietary methodology designed to identify powerful relative strength characteristics, reformed quarterly.
  • SPDR Russell 1000 Momentum Focus (ONEO) – tracks the Russell 1000 Momentum Focused Factor Index, picking U.S. stocks that have recently outperformed.
  • First Trust Dorsey Wright Dynamic Focus 5 ETF (FVC) – similar to FV but with added risk management via an increasing allocation to cash equivalents when relative strengths of more than one-third of the universe diminish relative to a cash index, reformed twice a month.

Because some sample periods are very short, we focus on daily return statistics, but also consider cumulative returns and maximum drawdowns (MaxDD). We use two benchmark ETFs, iShares Russell 1000 (IWB) and iShares Russell 3000 (IWV), according to momentum fund descriptions. Using daily returns for the five momentum funds and the two benchmarks as available through mid-September 2018, we find that: Keep Reading

Active Mutual Fund Management Still Worthless?

Does recent research on active mutual fund performance challenge conventional wisdom that: (1) the average fund underperforms passive benchmarks on a net basis; and, (2) individual fund outperformance does not persist. In their September 2018 paper entitled “Challenging the Conventional Wisdom on Active Management: A Review of the Past 20 Years of Academic Literature on Actively Managed Mutual Funds”, Martijn Cremers, Jon Fulkerson and Timothy Riley review academic research on active mutual funds from the last 20 years to assess the degree to which it supports this conventional wisdom. They focus on U.S. equity mutual funds but also consider bond funds, hybrid stock-bond funds, socially responsible funds, target date funds, real estate investment trust (REIT) funds, sector funds and international funds. Based on this research, they conclude that: Keep Reading

Active vs. Passive U.S. Equity Mutual Funds in Recent Years

Do active U.S. equity mutual funds beat their passive counterparts in recent years? In the September 2018 version of his paper entitled “The Historical Record on Active vs. Passive Mutual Fund Performance”, David Nanigian compares risk-adjusted annual performance of active versus passive U.S. equity mutual funds as categorized and monitored in the Morningstar Direct survivorship bias-free database. He measures rise-adjusted performance based on the Carhart 4-factor model (accounting for market, size, book-to-market and momentum factors) alpha. He considers both value-weighted (VW), based on fund assets under management at the end of the prior month, and equal-weighted (EW) combinations of funds. In addition to the full sample, he considers separately funds in the bottom fifth (quintile) of expense ratios. He also compares active and passive funds paired based on similar expense ratios. Using monthly fund data as specified during 2003 through 2017, he finds that: Keep Reading

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