Category Archives: Financial


Learn and understand that word.  It means only one buyer (as opposed to monopoly, meaning only one seller).

It is the cause of wage depression and a major contributor to inequality.

Here’s a great article about it from Jonathan Tepper:


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Fiduciary, please.

Josh Brown really has this explanation down.  He is 100% correct.  I have bolded the really key parts here:


“Private Banker”


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Dylan Grice on Value Investing

From Advisor Perspectives, by Robert Huebscher:

Grice is a portfolio manager at Switzerland-based Calibrium AG. He previously served as an investment strategist at Societe Generale, and he spoke at that firm’s annual investment conference in London on July 9.

1. Value investing is an intellectual fraud

“What is investing if not for value?” Grice asked, rhetorically. He defined traditional value investing as betting with the odds in your favor or buying dollars for $.75.

The “value” adjective is not necessary, Grice said. “It is like fast sprinting or wet swimming.”

Grice then drew a distinction between fundamental, Graham and Dodd-style value investing, and factor, or quantitatively-based, strategies. He acknowledged that the 1992 Fama-French research showed that you could exploit statistical patterns of cheapness.

He then presented data comparing the small-cap Russell 2000 index relative to its value counterpart, going back 15 years. The annual value premium has been -44 basis points, Grice said. It is not just the Russell indices where value has failed. He said that using the MSCI world index data, the value premium has been -38 basis points over the same period; with emerging markets it was -12 basis points.

It is widely known that growth stocks have outperformed value in the U.S. over most of the last decade, and that value has been the winning strategy over longer time frames. Grice’s analysis was important because he compared value to a broader index and over multiple markets, using only the last 15 years.

But what he said next should be carefully considered by devotees of quantitative investing.

The value premium is not like the liquidity premium, Grice said, which inherently justifies a higher return for its risk. The same is true of the premia associated with credit risk or duration.

“Why should I get persistent risk premium for a cheap multiple?” Grice asked.

“Value investing is far too easy,” he said. “Anyone with a Bloomberg for Factset terminal can do this. It was a historical anomaly because it was cheap.”

“It’s now gone,” Grice said. “The value anomaly has been arbed [arbitraged] out. Value does not equal cheap.”

Quantitatively-based value investing is not the same as fundamental research, he said. Fundamentally-based investing is “hard,” he said, “and it’s got to be harder than quantitative analysis.”

The challenge for advisors is that there is no way to conclusively prove Grice’s claim. We know that quantitatively-based value strategies, unlike the broad capitalization-weighted index, cannot be pursued by all investors. Eventually capital flows to value strategies must erode returns, but we have no way to know for sure when this will happen – or if it already has.

Grice’s assertion should not be dismissed. One cannot be certain that value will “revert to the mean” and resume its long-term outperformance relative to growth the broader market. We’ll have to await further research to see the extent to which asset flows to value strategies, which have been substantial over the 15-year period he studied, have eroded returns.

This is really an interesting claim, and one that I (and I’m sure many others) have wondered for years  now.  There’s another important piece of this claim that is not discussed in this piece – idk if Grice addressed it or not.  That is, what if the value premium is gone? What does that mean for investments based on that premise? What should an investor expect from that portfolio relative to a growth portfolio or a balanced portfolio?  My question really concerns forward looking returns.  If the value premium is gone, does that mean value stocks and all the rest of the stocks now have the same forward looking return? If this is the case, then value investing may not be an advantage, but it may also not be harmful.

2. Absolute return is a myth (everything is relative)

It is generally understood that valuations, using metrics such as the Shiller CAPE ratio, are predictive of returns over long time horizons. The U.S. market is in the top quintile of historical valuations, Grice said, implying a sub-2% real return over the next decade.

“That seems clear cut and obvious,” he said, “but look closer and you see cracks.”

Grice provided data on the range of those return forecasts. Top decile valuations imply returns ranging from -2.4% to 8.7%. Thus, for the next 10 years one could “quite reasonably” make 8.7%, he said. “So how practically useful is this information? It should be a warning sign.”

Using U.S. equities, Grice then compared a buy-and-hold strategy to one based on market timing. His timing model was based on the CAPE ratio and it adjusted allocations depending on the quintile of historical valuations (he did not provide more specific details). His market timing model beat buy-and-hold, he said, but the bulk of the returns came in 1920s.

“There was no value added in the last 70 years,” he said. In addition to the S&P 500, Grice said that finding held for the FTSE 100, DAX 30 and Nikkei 225.

“Valuations matter,” Grice said, “but they’re difficult to measure and get right.”

Forward-looking return estimates are better than naïve extrapolations, he said. But the problem with focusing on U.S. equities is that there have been only seven signals in 100 years, based on valuations being in the top or bottom quintile. “There is not enough data to have statistically significant results,” he said. “The problem is that we don’t get enough movement.”

But if you look at signals across multiple asset classes, you get more useful data. Grice has analyzed valuation-based strategies using bonds and equities. He constructed a model that determines the equity-bond allocation based on the relative valuations of the two asset classes, and said that it outperforms a naïve buy-and-hold strategy. (He said his model used mean-variance optimization based on Sharpe ratios, but did not provide additional details.) Indeed, he said, his relative performance-driven portfolio “did very well.”

“The importance of valuation reveals itself when you add more asset classes to the portfolio,” he said. He has tested his findings for markets in Japan, across Europe and in different European countries. “Valuation is phenomenally powerful but only on a relative basis,” Grice said.

Right now, he said, equities are attractive relative to bonds. “Equities are not that bad,” he said, “given the unattractiveness of the opportunity set.”

OMG I could not love this more.  I had the same issue trying to make an investment model out of CAPE.  My conclusion was that 7 signals in 100 years can only lead to a model that is data-mining, in addition to being basically useless.  I wonder how this compares to Meb Faber’s dynamic allocation model?

His third point is “there is no bond bubble.”  You can click on the link to read that part, bonds are boring.

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New tax law impact on capital markets

From Bloomberg, via MSN Money:

Farewell, Ireland: It looks like corporate America will finally bring that cash home.

For years, the likes of Apple Inc. and Microsoft Corp. have stashed billions of dollars offshore to slash their U.S. tax bills. Now, the tax-code rewrite could throw that into reverse.

The implications for the financial markets are huge. The great on-shoring could prompt multinationals — which have parked much of their overseas profits in Treasuries and U.S. investment-grade corporate debt — to lighten up on bonds and use the money to goose their stock prices. Think buybacks and dividends.

It’s hard to say how much money the companies might repatriate, but the size of their overseas stash is staggering. An estimated $3.1 trillion of corporate cash is now held offshore. Led by the tech giants, a handful of the biggest companies sit on over a half-trillion dollars in U.S. securities. In other words, they dwarf most mutual funds and hedge funds.

“There is going to be a significant unloading,” particularly of Treasuries, said Reuven Avi-Yonah, a professor who specializes in corporate and international taxation at the University of Michigan Law School. “The general consensus is that the best use of the funds is to distribute it out to shareholders.”

That conclusion runs counter to the long-held promises of the Trump administration and Republican lawmakers, who repeatedly suggested their tax rewrite would encourage U.S. companies to bring the money home to hire workers and invest in their businesses.

The $14.5 trillion Treasury market, of course, can absorb the selling pressure of even the largest corporate holders. There’s little to suggest multinationals will immediately liquidate their investments. Many analysts say companies, rather than selling, could just let their holdings gradually mature.

Yet even at the margin, a drop-off in demand could add to the government’s burgeoning funding costs. Not only are interest rates on the rise, but the most sweeping tax cuts in a generation, which could end up mostly benefiting shareholders, risk leaving the government with trillion-dollar shortfalls for years to come — an expense that taxpayers would ultimately have to bear.

And since Treasury yields are the global lending benchmark, any upswing could also ripple through the real economy in the form of higher rates on everything from credit cards to mortgages. Since September, 10-year yields have climbed over a half-percentage point, hitting a high of 2.595 percent this month.

More Acute

While multinationals may be less inclined to sell their corporate bonds, at least initially, the impact could be more acute, analysts say. In recent years, firms such as Apple and Oracle Corp. have become some of the top buyers of company debt. Apple alone holds over $150 billion in the bonds, exceeding even the world’s biggest debt funds. The market itself is also less liquid, which means it takes far less to move the needle.

Big corporations could dispose of a “few hundred billion” dollars of their total debt investments, said Aaron Kohli, strategist at BMO Capital Markets.

a close up of a map: More Expensive, More Permanently© Bloomberg More Expensive, More Permanently

Repatriation has come back into focus ever since President Donald Trump signed the tax overhaul into law in December. Besides reducing taxes across the board, it did away with a decades-old provision that allowed companies to put off paying taxes on foreign profits until they brought the money home.

Of course, it’s important to understand that for most multinationals, offshore cash is really only “offshore” for accounting purposes. Under the old tax system, earnings attributed to foreign subsidiaries, often based in jurisdictions with low taxes or lax regulations like Ireland or Luxembourg, could be repatriated and remain earmarked as “held overseas” — so long as it was stashed in U.S. securities. Apple, for example, manages its hoard from Reno, Nevada, where its internal investment firm, Braeburn Capital, is located.

“The term overseas cash can be a bit of a misnomer, as it doesn’t have to be overseas and in fact a lot of it isn’t,” said Michael Cahill, a strategist at Goldman Sachs Group Inc. That should limit any appreciation in the dollar related to repatriation over the longer term.

Now, multinationals have eight years to pay a one-time tax on the accumulated income. Foreign earnings held as cash or equivalents — previously taxed at a 35 percent rate when repatriated — would be subject to a 15.5 percent rate. Non-liquid assets would be taxed at 8 percent.

Hot Topic

“Most multinationals will no longer tie themselves up in knots with their Treasury function with a big pile of cash that’s trapped in a foreign corporation and invested in securities and that they can’t use,” said Richard Harvey, a former top tax official at the Internal Revenue Service and Treasury Department, who now teaches tax law at Villanova University.

Goldman’s Cahill predicts corporate cash will be a hot topic on conference calls as earnings season heats up. Any repatriation will likely come from money already parked in U.S. securities.

“Repatriation headlines from the earning calls could cause investors to react,” Cahill said.

His analysis showed that eight firms — led by Apple, Microsoft and Google’s parent Alphabet Inc. — accounted for almost two-thirds of the overseas cash held by S&P 500 companies. According to the most recent filings, they had over $500 billion in U.S. government bonds and corporate debt, data compiled by Bloomberg show. (The top companies generally hold securities due in under five years, according to Bank of America Corp.’s Hans Mikkelsen.)

Sheltering Profits

Apple, which has become something of a poster child for multinationals accused of sheltering profits overseas, had $60 billion in government debt and about $153 billion in company bonds. Microsoft held almost all its cash in Treasuries and debt issued by federal agencies, totaling $122 billion. Alphabet had $66 billion, with about two-thirds in government securities.

How much money multinationals eventually repatriate is anyone’s guess. But tax experts and analysts agree that whatever they raise from selling bonds will likely go to enrich shareholders.

According to a recent study by Bloomberg Intelligence, the tax overhaul could lead to buybacks jumping by more than 70 percent on an annualized basis to $875 billion. The analysis was based on the growth in completed repurchases in 2004-2005, the last time a tax repatriation holiday was in place.

a screenshot of a cell phone: Tax Repatriation a Boon for Buybacks?© Bloomberg Tax Repatriation a Boon for Buybacks?

Apple may increase buybacks by $69 billion, adding to the $166 billion it spent on repurchases from June 2012 to September 2017, according to Gene Munster, a co-founder at Loup Ventures.

“There will be reasons for some very large bondholders to maybe shake some of these bonds out of the portfolio,” said Guy Moszkowski, a banking analyst at Autonomous Research.

Apple spokesman Josh Rosenstock declined to comment, as did Microsoft representative Sarah Elson. Google’s Winnie King declined to discuss the company’s plans for its overseas cash before its earnings in February, while Cisco spokeswoman Andrea Duffy said the company is reviewing the tax changes and that it will address the subject on its earnings call next month.

Big multinationals have good reason to bide their time, according to Richard Lane, a senior analyst at Moody’s Investors Service. Because their debt investments are so extensive, companies could end up inflicting losses on themselves with any large-scale selling.

“I don’t think there will be a rush to the door by these companies to sell this debt and causing increasing yields and lower pricing,” said Lane.

Regardless of what happens, what’s clear is that U.S. multinationals will have little incentive going forward to hoard low-yielding Treasuries or investment-grade corporate bonds as a way to avoid the IRS. Under the new tax law, companies that pay relatively low global effective tax rates — a sign they’re using tax havens — would pay a minimum U.S. tax.

Even if companies don’t sell outright, there’s going to be a “demand shock,” according to Michael Cloherty, head of U.S. interest-rate strategy at RBC Capital Markets. The longer-term risk is that “the biggest buyer in some of these markets disappears.”


Keep in mind the data from my last post when thinking about this.  $500M in assets, held in corporate and government debt, versus outstanding debt of $230T, with central banks holding (and having to buy to maintain) nearly $20T.  It’s not really “the biggest buyer,” but still substantial.

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Corporate profit margins and income inequality

Really interesting paper from the Jerome Levy Forecasting Center.

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Is Passive crowding out Active?

FTSE Russell recently reported that market share of passive ETFs and mutual funds has grown from 12% in January 1998 to 46% at the end of December 2016.  They carefully define “passive” as funds that are intended to replicate market capitalization weighted indexes by holding the underlying assets.  Specifically excluded from this definition are other than cap weighted indexes and funds that hold options instead of the underlying.  Goldman Sachs agrees with this trend if not the exact number, reporting a change from 17% passive to 38% between 2005 and 2016.
This trend has not gone unnoticed by the active management world.  Analysts at Bernstein warn that the rise of passive investing may be worse than Marxism.  Similarly, analysts at CLSA call it “investor socialism.”  There is fear that the blind investment into all companies on a cap weighted basis will overwhelm the impact of active managers, who invest based on their research and due diligence efforts.  Additionally, the momentum effect of passive investors might be expected to result in the largest and most often index-listed companies growing to even larger market capitalizations with higher valuations, and being added to even more indexes, regardless of their economic value.  However, available data has not borne this out.
Jim Rowley from Vanguard recently posted this chart on his blog (  It shows that the percentage of stocks with significant under and over performance has not changed.  Interestingly, a chart using this same data but starting in 1998 was used to show that dispersion has gone down in a different blog post:

No historical relationship between index fund asset percentage and dispersion

Source: Vanguard calculations using data provided by FactSet and Morningstar, Inc. Index fund asset percentage is the percentage of assets in U.S.-domiciled equity funds invested in index funds. Sector funds are included.

Note: Dispersion is defined as the percentage of stocks in the Russell 3000 Index that have either outperformed or underperformed the index by at least 10 percentage points.

Data from shows that the equities comprising the S&P 500 individually have betas ranging from -0.02 to 2.79.  Recognizing that this is a somewhat circular reference, only one stock has a negative beta, meaning that when the market moves up, on average they are ALL moving up.  This data implies that it may be difficult to implement a long-short strategy, because the equities that underperform in a rising market are still rising, even those that underperform the most.  Beta is defined here as a 5 year calculation based on monthly returns.  This is important, because it means that the betas are based entirely on bull market data.  So they are all moving up together, but not equally.  Active opportunities exist.

Another measure of active opportunity within the stock market is the CBOE implied correlation index.  If passive investing really overwhelms active, you would expect to see correlations rise.  This effect has not been seen in the data.  See detailed explanation from Henry Ma,

Another way to look at how passive holdings might impact market function or efficiency is to compare price volatility of individual stocks in comparison to the proportion of their shares that are held in passive funds.  If passive funds are holding and not trading shares, liquidity may suffer causing spreads to increase.  Savita Subramanian at BAML has found that as the passively held proportion increases, prices become stickier; equity price adjustments based on earnings surprises are not as quickly reflected in price.  In contrast, Pravit Chintawongvanich of Macro Risk Advisors looked at realized volatility versus percent passive ownership and did not find any effect.

Arbitrage price theory posits that if an arbitrage is available, market participants will make that trade until prices reach an equilibrium where the arbitrage is no longer available.  This suggests that if the market is becoming less efficient, active traders should have an advantage and active funds should show better results.  It is only one data point, but the most recent SPIVA report ( shows that active fund performance has been improving over the first half of this year.

Although active managers continue to suffer outflows to passive funds, there is scant evidence to this point that passive investing has distorted the market to the point that active investors cannot impact prices.  Active investing is necessary and, in fact, makes passive investing possible by providing price discovery for passive equity buyers.

In a separate but related topic, The New Yorker reported last year on impacts passive investing may have on the economy, (

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Fundamental Indexing

Consider the purpose of a market index.  We use an index to define the value of the market, overall.  When we use a market index as a benchmark for any specific holding or portfolio, we need to be able to rely on that index as a reasonable measurement for what “the market” is worth at any given moment, and over time.  If you are an efficient market hypothesis believer, market capitalization weighting is the only accurate way to measure the economic value of any specified market.

But what if you think that at least some of the time, prices for individual companies, sectors, and even the whole market can diverge from their true economic value?  This premise is the basis of factor investing, “smart beta,” and behavioral investing.  Several “fundamental” weighting schemes have been developed to try to measure economic value in ways other than equity price.

Dividend discount model is a simple and common method of determining the economic value of a stock.  Free cash flow models based on earnings are also widely recognized.  WisdomTree has offered both dividends and earnings weighted funds for over 10 years.  Jeff Weniger offers a thorough explanation of the advantages of earnings weighting at and Jeremy Schwartz published a white paper in 2016 detailing dividend weighting,  Pacer US Cash Cows 100 Index selects and weights the largest 100 companies by free cash flow.  The associated ETF, COWZ, just opened in December 2016.  They describe their approach here:  Please note that this is a new index as well, so it really doesn’t have a track record other than backtesting.

Oppenheimer weights by top line revenue, as explained by David Mazza, The tech bubble is used as an example here.  You can see how at the height of the bubble, a minority of the stocks with increasing prices came to dominate the cap weighted index, but not so much the revenue weighted index.

Oppenheimer Revenue Weighting – graph from page 16 of Oppenheimer presentation – used with permission.

Rob Arnott (arguably the originator of fundamental weighting) and Research Affiliates (RAFI) have developed 3 unique indexes, which weight companies with varying combinations and definitions of sales, cash flow, dividends, and book value.   The FTSE RAFI US 1000 Index consists of the 1000 largest companies as calculated by their economic value, using a formula including total cash dividends, free cash flow, total sales, and book equity value.  Invesco, who sponsors the ETF for this index (PRF), shows the converse of the Oppenheimer example:  during the last crisis, the financial sector became under valued, and thus under weighted in the cap weighted index.

Invesco chart – used with permission.

Critics of the fundamental approach to indexing call it value investing by another name.  This is true by definition.  However, the difference between a value index and a fundamental index is that the fundamental index is not using the equity price in any form to determine inclusion or weight in the index.  A value index will always include some form of the price in its inclusion and/or weighting calculations, usually in a ratio (P/E, P/S, etc.).  The amount of value tilt changes over time for a fundamental index, while it is defined for a value index.  Issuers of fundamental indexes consider this a feature, not a bug.  The goal of the fundamental index is to represent the market constituents weighted by their economic value or economic impact, not to determine which equities or sectors are “incorrectly” priced.

What about performance?

As of 6/30/17 3 yr 5 yr 10 yr
YTD 1 yr 3 yr 5 yr 10 yr sd beta sd beta sd beta
S&P 500 TR Index 9.34 17.9 9.61 14.63 7.18 10.35 9.56 15.21
FTSE RAFI US 1000 Index 4.69 16.92 7.89 14.82 7.68 10.25 0.96 9.73 0.99 16.02 1.04
WisdomTree LargeCap Dividend Index 6.7 14.23 9.08 13.19 6.72 9.87 0.93 9.12 0.92 14.63 0.93
OFI Revenue Weighted Large Cap TR 7.41 16.49 8.7 15.55 7.29 10.38 0.98 9.9 1.01 16.51 1.07
WisdomTree US Earnings 500 Index 9.39 22.29 9.46 14.65 7.35 10.81 1.03 9.91 1.02 15.03 0.98
Pacer US 100 Cash Cows Index 6.74 23.15 9.02 16.98 10.32 13.46 1.2 12.41 1.2 19.83 1.21
Russell RAFI US Large Company Index 4.8 14.2 7.75 14.3 7.91 10.25 0.96 9.73 0.99 16.02 1.04
*Data from ETF providers and Morningstar

Please note that the outlier in this group, Pacer, reflects backtesting data prior to 2017.  The three year betas less then one suggest that the fundamental indexes are not performing as well as the S&P 500 over this portion of a bull market, and they are not.  A full market cycle would be the best way to evaluate performance.  The 10 year betas less than one might be what is expected – a dampening effect from removing the impact of excess pricing at market highs, and oversold equities at market lows. Another way to look at it would be that the market tends to overshoot at both extremes – the real economy is not moving as much.  But of the 6 indexes, only 2 reflect this theory.

What explains this?  The fundamental indexes are rebalanced quarterly or annually, while a cap weighted index self-rebalances on a continuous basis, other than adjustments for changes in listings and float. Rebalancing also adds trading costs as well as possible tax liabilities.  RAFI methodologies use 5 year averages of data, so they will be slower to respond to changes in issuer value than the cap weighted index.  The Oppenheimer and WisdomTree indexes are also capped by issuer and sector.  Similar to smart beta, it’s just more complicated to implement these strategies than cap weighted.

The ETFs based on fundamental indexes generally charge around .25% – .50%, while the cap weighted index ETF can be bought for .03%.  The 10 year returns net of fees are very similar to the cap weighted index.  Other cost considerations are size and trading cost of the ETFs, as well as tax implications. Obviously dividend weighted funds will have higher taxable income than cap weighted.

In summary, the theory of the fundamental index is quite compelling, but the current indexes somewhat less so. It seems likely that this reflects the difficulty in implementation rather than flaw in theory.

Disclosure:  I do not currently hold or plan to add any fundamental weight products for myself or clients.  Do have positions in cap weighted funds and ETFs.



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