Seeking Alpha

ETFreplay's  Instablog

Send Message
Come watch our Introduction video on homepage: Career experiences of founders: buyside portfolio manager, investment banking, institutional & high net worth asset management, website construction & professional trading. We have no affiliation with any financial... More
My blog:
  • What does my US domestic small cap stock have to do with Greece? Perhaps a lot more than you think.

    First, a chart of GLD vs the FXE Euro Currency ETF is a simple yet powerful way to show the primary issue in the world right now:

    This EC (Euro currency) crisis has brought on a volatility storm (sharply rising volatility/VIX).   It is common to hear analysts and/or PM’s say --- what does a Greek default have to do with my US domestic small cap stock??   Well, a lot actually if the Greek problems lead to a crisis – as a crisis will cause overall market volatility to rise.

    Correlations RISE in times of crisis.  This is not just a random statement, it can be viewed mathematically using the Capital Asset Pricing Model (CAPM) framework.

    In CAPM, the correlation between two assets can be expressed as a function of their Betas and the variance of the market.  If we assume that both assets have a beta of 1.0 and identical residual risk, then it becomes mathematically true that correlations rise as variance rises.  Thus, some type of crisis causes overall variance to rise (in this case it’s the escalating debt problems in Europe)--- and then this rising variance will cause correlations to rise.  

    Note the serious divergence of small cap US stocks and the MSCI ETF Europe (correlation at first drops on the lower chart) -- and then the subsequent increase in ETF correlation when VIX/volatility increased sharply.  


    Disclosure: none
    May 16 11:46 AM | Link | Comment!
  • Vanguard ETFs

    Recently, there has been a price-war in the ETF marketplace which is a very significant development. Schwab moved first, Fidelity raised Schwab -- and now Vanguard has pushed all-in. Neither Schwab nor Fidelity has been a strong player in the ETF market. But now industry heavyweight Vanguard has made each and every one of its 46 Vanguard ETFs free to trade --- assuming you have your account at Vanguard.

    If this story sounds familiar, it's because the same thing happened many years ago in the mutual fund business. Prior to the 1970’s, banks and trust companies controlled most of the assets in the industry. Then the mutual fund became the product of choice and this was a multi-decade trend that led to eventual $25 trillion mutual fund industry. Along the way, funds went ‘no-load’ – that is, no transaction fee. This was a very significant development as transaction costs like commissions and loads take money out of the investors pocket.

    Today, we sit in the early innings of a major transition away from mutual funds and towards exchange traded funds. This current price war will serve to accelerate that transition.

    Here is a breakdown of the ETF line-up at Vanguard. We do not view this as a complete list - as it fails to capture many of the interesting things that are likely to occur on a global scale over the next 10 years.   That said, Vanguard has recently launched fixed-income ETF’s so this at least begines to round-out a very heavily 'U.S. Equity' view of the world. We respect Vanguard as perhaps one of the most investor-friendly institutions in the world so we enthusiastically support this ETF list – but treat it for what is, a US dominated list.


    Disclosure: no positions
    May 13 4:08 PM | Link | Comment!
  • MSCI World Index
    The MSCI Indexes are quite useful as a starting point for ways to think about the global investment landscape.  Moving from a domestic to a world focus expands the individual equity universe to well north of 8,000 securities (vs the typical Russell 1000 focus of domestic managers).   Global exports are increasing on a secular basis as the world increasingly trades goods and services with each other ---- globalization is unstoppable.   
    Ironically, I say all of this as our models have been favoring domestic over international ETFs for months now and being short (or avoiding) Europe in particular seems like more than just a short-term trade.
    Nevertheless, over the long-run it makes sense that more choices will offer diversification benefits in terms of enhancing return (long and short) and likely reducing risk (though this benefit becomes less as globalization increases).  Without going into a long dissertation on this topic, I will just instead show the current relative valuations of the MSCI World Index ETF (NASDAQ:ACWI).   
    Note that approximately 2/3 of this index is in the United States and Europe.   It is not AS out of balance as it may seem as countries like those in China have very low profit margins --- so a company like Google might not contribute a lot to GDP – but it does have very high overall profits.   Similarly, Wal-Mart contributes a lot to U.S. GDP but has very low margins – and China supplies Wal-Mart so you can imagine how their profit margins look.    So each country will have GDP changes and profit margin cycles to think about --- its not just about population and level of future GDP.   
    Over the long-run though, these percentages will change in favor of countries with strong demographics --- (the above chart should only be viewed as a snapshot in time).  Importantly, it is not going to be a smooth ride as countries like China and India grow to be much higher percentages of the total.  The next chart from the ETF Portfolios page re-creates the MSCI World Index ETF as a sanity check.  We can do this with regional and country funds.   It won’t be perfect because there are some anomalies with indexes regarding 'sampling' and starting vs ending weights etc.…
    So within the context of a dynamic (changing) and volatile global marketplace, is based upon – finding quantifiable, back-testable methods to help the investor think about balancing reward and risk.  In other words,  to participate in global strength and to avoid (short) regions of the world showing global weakness (money flows out).
    Finally, I want to show a look at our ETF Screener.    The ‘ Selected Betas’ grouping has most of these indexes scattered within it.  We don’t think its complete to just look at regions of the world --- we like to view Relative Strength across asset-classes as well, not just equities.   Note here that this is not properly done unless you are tracking total return  --- dividends and distributions can make a significant difference --- even with non Fixed-Income funds  -- you need clean data to properly calculate relative strength -- especially across asset classes. 

    Disclosure: none
    May 05 4:47 PM | Link | Comment!
Full index of posts »
Latest Followers


More »
Posts by Themes
Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.