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Rajeev Seth
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Rajeev Seth is the Managing Director of BeatIndex, an investment management consulting firm. Specializing in quantitative investment management, he has consulted for many diversified asset managers, and startup hedge funds. The philosophy of BeatIndex is that one can indeed beat indexes, by a... More
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  • Quantitative Investments: Tactical Asset Allocation Among The Ten US Sector ETFs: IYH, IYF, IYW, IYK, IYE, IDU, IYC, IYJ, IYZ, IYM

    Captured here is my quantitative method for you to do Tactical Asset Allocation (TAA) among the ten US sector slices using ETFs.

    This TAA process calls for shifting the asset mix in the short term based on a prediction of relative excess returns expected in the ten sectors of the US stock market. I performed this method by taking the ten US sector ETFs from

    http://us.ishares.com/product_info/fund/index/EQ.htm

    I then got fundamentals data (one based on consensus earnings forecast, one based on trailing earnings, and some others) for each constituent stock in the ETF, formed a market-cap weighted average data-set and derived the values for a typical stock in the universe constructed of all the stocks that are examined.

    The ETFs are then ranked based on their under-valuation percentage. The results are shown below for the data analysis performed at market close on April 11, 2013

    ETF TickerETF NameNumIssuesLastFMV% Overvalued
    IYMiShares Dow Jones U.S. Basic Materials Sector Index Fund6369.81115.08-39.34
    IYZiShares Dow Jones U.S. Telecommunications Sector Index Fund2625.8336.38-29.00
    IYJiShares Dow Jones U.S. Industrial Sector Index Fund22481.94110.40-25.78
    IYCiShares Dow Jones U.S. Consumer Services Sector Index Fund18299.79134.27-25.68
    IDUiShares Dow Jones U.S. Utilities Sector Index Fund6499.66133.30-25.24
    IYEiShares Dow Jones U.S. Energy Sector Index Fund8545.158.38-22.75
    IYKiShares Dow Jones U.S. Consumer Goods Sector Index Fund12086.2889.12-3.19
    IYWiShares Dow Jones U.S. Technology Sector Index Fund13672.9855.4331.66
    IYFiShares Dow Jones U.S. Financial Sector Index Fund26269.0946.3549.05
    IYHiShares Dow Jones U.S. Healthcare Sector Index Fund114100.117.91458.89

    The advantages of using this bottom-up TAA process are that it:

    • takes into account all available information for all stocks in each ETF, and therefore its US sector.
    • reflects a synthesis of expectations and experience of all industry analysts that follow each constituent stock of each ETF in detail

    The method recognizes that truth in the data is only apparent when one examines the aggregate. If every analyst is too optimistic, it will show up when you add up their collective wisdom. Trees simply don't grow to the sky, and while each individual analyst won't say that in his EPS forecast, it will be clearly apparent that some sectors are implying that trees will grow to the sky when you add up all of their EPS forecasts

    Here is how you can use these results:

    My fundamental insight is that cheap will beat expensive over time, so mean reversion is expected to occur. Without getting bogged down on the exact over-valuation percentages calculated in the table above, you may want to recognize that the ETFs at one extreme are overvalued or undervalued relative to each other. IYH or iShares Dow Jones U.S. Healthcare Sector Index Fund is the most grossly over-valued sector based on my method of forecasted fundamentals
    So, to perform TAA, you might want to go long or overweight

    IYMiShares Dow Jones U.S. Basic Materials Sector Index Fund
    IYZiShares Dow Jones U.S. Telecommunications Sector Index Fund
    IYJiShares Dow Jones U.S. Industrial Sector Index Fund

    while selling short or avoiding or underweighting

    IYWiShares Dow Jones U.S. Technology Sector Index Fund
    IYFiShares Dow Jones U.S. Financial Sector Index Fund
    IYHiShares Dow Jones U.S. Healthcare Sector Index Fund

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Apr 15 10:41 AM | Link | Comment!
  • Quantitative Investments: Long Short Paired Trades For Better Risk Adjusted Returns Than Cash

    I have two new long-short paired trade suggestions for the long-short trades portfolio we started to assemble on April 7, 2013

    Trade suggestion #1 was to:

    Sell short 200 shares of PRINCIPAL FINANCIAL GROUP (NYSE:PFG)

    Buy 257 shares of LINCOLN NATIONAL CORP. (NYSE:LNC)

    This trade is in a solid 5% profit in 4 days

    Trade suggestion #2 to enter on Apr 12 is to:

    Buy 200 shares of ANALOG DEVICES INC

    Sell short (251) Shares of TEXAS INSTRUMENTS INC

    These are in the Semiconductor - Broad Line industry group

    At time of trade initiation on Apr 11, 2013, the spread looks as follows

    Apr 11, 2013

    With the 50% margin made available by brokerages, you would need a margin of about $9023 to enter this paired trade.

    To bet more or less, you may scale this trade to a higher or lower amount simply by multiplying it with a factor like 5 or 0.5 to get the new number of shares to buy or sell short

    Trade #3 to enter on Apr 12 is:

    in the Oil & Gas Equipment & Services industry group, we have our trade # 3 to

    Buy 200 shares of CAM or CAMERON INTERNATIONAL CORP

    Sell short (217) shares of FTI or FMC TECHNOLOGIES INC

    At time of trade initiation on Apr 11, 2013, the spread looks as below

    Please refer to my instablog everyday where I plan to update the progress in the convergence of all the paired trades in my portfolio and keep a running PnL there.

    As mentioned in an earlier article, these long-short stock trades have a track record over many years of providing an annualized return in the range of 15-20% with super-low draw-downs of less than 8% and low annualized volatility of about 6%. The buy and sell short signals for the matched paired trades are generated from my quantitative investment system. Individual investors need to open a margin account with their brokerage and be approved to sell short stocks on the margin. When a trade signal is given here, you would buy one stock while simultaneously selling short another with the goal of seeing the spread between the two trades converge over time. The time taken for the spread to converge can be one to two weeks. This trading system has been tested for many years, and is a way for individual investors to earn returns better than cash, without having to figure out the direction of company, sector, or stock market movements as you have to do with fundamental or technical ways of investing.

    Apr 15 10:30 AM | Link | Comment!
  • Our Paired Trade On PFG-LNC Continued To Converge Today And Shows More Profit

    This is an update on the paired trade as of market close on Wed, Apr 10, 2013. The trade was entered based on prices on market close of April 5, 2013

    Sell short 200 shares of PFG (PRINCIPAL FINANCIAL GROUP)
    Buy 257 shares of LNC (LINCOLN NATIONAL CORP)

    The trade is now showing even more profit after 3 trade days,

    (click to enlarge)

    An individual investor with 50% margin a brokerage account would have needed a margin of about $7300 if she used the trade quantities of -200 PFG and long 257 LNC. With the $311 profit it now shows, she has a return of over 4% on the amount of margin used in only 3 days. What's more,the volatility of this return is much lower than that of alternative strategies that would rival cash. I will demonstrate the low volatility, drawdown etc of this strategy in my future articles, and show how effective it is as an alternative to a dividend strategy

    As the picture below shows, after 3 trade days, the spread on this paired trade is continuing to converge even more. My system shows that it is still fine to enter this paired trade even now. You still have time to capture more profit by entering this trade if you have not already done so.

    You may compare this figure above to the figure for each of the prior 3 days shown below to see how the spread is converging to 0.

    Apr 10 4:31 PM | Link | Comment!
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