Investment Strategies Exam 2

China squeezes US in rare earth move

china said they would do full restriction of rare earth minerals that would disrupt global economy; mkt is freaked out over this; one of the biggest cards china can play b/c they produce 90% of rare earth minerals and the US needs this to produce semi-conductors for AI and chips

regional bank tie out

fifth third is buying comerica bank after pressure from activist investor; comerica activist investor threatened a board fight if they didn’t sell to fifth third; shares popped 13% on announcement of the sale so activist won

more working class americans are in the stock mkt

people are getting into equities at a younger age; homeownership has moved further out of reach as access to equities has increased;

health of the consumer

about to enter busiest shopping season of the year w/ black friday and christmas eve telling us the health of the consumer, which retail companies did a good job of inventory management, and who can offload their bulked up inventory w/o killing margins

car loans fall behind on payments

portion of low credit auto loans that are in delinquency are 6% which is dramatically higher compared to past years; lots of repossessions meaning people are falling behind on car payments; worse sign would be if people fall behind on mortgage payments b/c these are the last things people want to be behind on

passive management

objective is to match the return of a market index

benefits of passive management

diversification, lower costs, simplicity

potential risks of passive management

total mkt risk (you are a price taker, if index goes down you go with it), lack of defensive measures, performance constraints

active managements

objective is to outperform a market benchmark or to achieve a specific investment objective

potential benefits of active

opportunity for outperformance, utilizes in depth research, defensive measures (minimize losses by avoiding certain securities, etc)

potential risks of active

underperformance, higher expenses

S&P global SPIVA scorecard

gauges how good active management has been for large cap domestic equity funds; majority of funds underperform after all the fees; fixed income and mutual funds have underperformance over long periods of time w/ 93% underperforming after 20 years

closing of underperforming funds

when funds don’t do too well wall street buries the body by renaming the fund’s objective (which resets the performance stats) or closing it and moving you to a different fund; lot of funds don’t survive for 2 decades and lot don’t make it past first couple years

active mutual fund investment performance

mutual fund performance is on average less than broad mkt performance b/c of (loads, high expense ratios, high turnover ratios); by 2005 only 3 out of 355 equity funds in 1970 survived and mounted a record of sustained excellence

money goes to where money is treated best

fund manager who is generating alpha in the retail space will likely get poached by a hedge fund or even start his own fund

mutual fund skin in the game

1155 mutual funds where at least 1 manager has more than 1MM of their own money in the fund, 5185 where they have 0 invested; funds w/ skin in the game do better than w/o 

arguments for active exposure

passive is settling for average (not settling for average, you’re winning b/c active funds LOSE you money); passive investors are price takers (that’s the goal, I want the mkt risk, if there’s lot of passive money then how come funds don’t make more money easily); expert knowledge of foreign mkts (EM, frontier mkts, global FI); investors that seek different exposure than provided by an index (not mkt cap weighted, aggregate bond indices, high yield constituents, international geographic allocations)

Mkt weighted bond indices (junk bond mkt)

mkt cap weighted in bonds means companies in the junk space w/ most junk bond debt outstanding gets the largest weighting; this basically means you get the largest weighting to companies that are likely to go bankrupt; there is where you’d want an active management policy and not passive that invests on mkt cap weighted

international geographic allocations

investors could desire different international and sector allocation that the index provides; if you don’t want certain weighting in the index you have no choice besides going active; maybe you don’t want japan b/c they’re a demographic time bomb

active funds concerns

tax impact, high cash holdings, style drift, herd behavior, closet indexing, window dressing

style drift

getting outside of your core competency; sometimes happens b/c of success; happens a lot in small caps, running small cap fund and after some good years you buy mid/large caps; b/c of success but rules and constraints often push people into other holdings outside competency which kills success

herd behavior

sometimes easy b/c we have terms for stocks w/ herding behaviors (mag 7, FAANG, hedge fund hotel); like walking up the stairs w/ people pushing you up but like going down w/ people pushing on your back 

closet indexing

active mutual fund or ETF where you pay high expenses and the goal is alpha but holdings heavily resemble the index w/ very little tracking error and maybe only overweighting some stocks; this is bad b/c you’re getting an ETF; easy way for fund manager to not get fired by doing this strategy

window dressing

false marketing; underperforming but you want to give the appearance that you’re better than you are so you start putting multiple names of the top 10 performing stocks in your top 10 holdings; issue is you’re holding them after buying at a premium and your portfolio is then set up for failure next year b/c you bought high and potential reversion to the mean

common characteristics of active outperformance

low fees and expenses, low turnover, high active share, firm wide focus on a core competency, close alignment of interests

high active share

large tracking error b/t portfolio and benchmark; don’t resemble each other; on the list of best performing funds but also on worst performing funds

ETFs and mutual fund conceptual idea

lets investors invest in specific asset classes and countries/regions; wrappers around assets, risks and return characteristics based on assets held in the fund; underlying asset is what matters such as their liquidity and pricing

thematic funds

ESG was very popular w/ the idea that companies w/ good ESG would have lower cost of capital; issue is that there was no consensus on ESG rating and that most of these funds underperformed index funds and became closet indexes; new thing is AI funds

target date funds

become more conservative as an investor ages, used as a set it and forget it retirement solution w/o considering an individual’s personal risk tolerance; 2 issues is that is has generic asset allocation for generic risk tolerance and even if matching your risk then you get hit w/ expenses for the ETFs that the fund is holding and expenses for the target date fund

banks had a good Q3

all big banks beat top and bottom line expectations; when you see a cockroach there’s never just one (company bankruptcies)

silver sets first record since 1980

1980 was last all time high b/c of a manipulation scheme around silver by the hunt brothers; supply and demand imbalance for silver b/c its used in jewelry, solar panels, central banks and investors hoarding silver and trading down from gold

crypto bet reaps 160MM

2 accounts shorted crypto before trump announced tariffs on china

these funds can go to zero

ETF levered funds are designed to lose money, they’re not investments they’re speculation

closed and open ended funds

closed end: specific number of issued shares and may trade at premium or discount to NAV (you can arb this), open end is no restriction on # of shares and they can be created or redeemed based on demand

expense ratio

covers operating costs of running the mutual funds, includes management fees (salaries and research), administration fees, and marketing fees (12b-1); sometimes fix bid ask spread to get rebate in form of soft dollars which they can use to cover operating costs which lowers expense ratio while having high trading costs so you simply move expenses hidden; for full story look at turnover ratio and every turnover means add a basis point to the expense ratio (300% turnover means add 3% to expense ratio)

operating expenses

costs incurred by mutual funds in operating portfolio

front end load

commission or sales charge paid when purchasing shares; you get nothing for loads, never invest in a fund w/ a load

back end load

exit fee incurred when selling shares; withdrawal fee

12b-1 fees

annual fees charged to pay for marketing and distribution costs; fees for TV ads

ETF advantages

trade continuously throughout the day; can short and purchase on margin (really only advantage for institutional traders); potentially lower tax rates; lower costs (no loads or 12b-1)

active funds and fees

all funds have stated objective, need to analyze to see if they are living up to it, avg expense ratio is around 1%, underperformance is worse when loads are included

passive funds tracking index can have different performance due to

replication strategy, transaction costs, expense ratio (high expense ratio for index is a rip off b/c there’s no due diligence they’re simply just tracking the index, want below 0.10%)

before putting money to work in funds

understand fund’s strategy/benchmark/replication strategy; understand why active underperforms; focus on fees and how they impact performance; don’t chase past performance; don’t trust morningstar ratings; avoid excessive risk taking funds like 3x daily levered

AI bubble inflates energy stocks

pre-revenue energy companies have ridiculous valuations; group of non revenue generating energy companies have blown up in valuation in hopes that these start ups will be used for power creation; lot of them are going to blow up

fiduciary

one who acts in utmost good faith, in a manner he or she reasonably believes to be in the best interest of the client; legal obligation to put you in only the very best products they can and they must act in YOUR best interest not their own

suitability

requires individual handling your money to invest in products that are suitable for your objectives, means, and age; doesn’t require brokers to find the bets products but ones that are suitable for you; pretty low bar

registered investment adviser

RIA are required to act as fiduciary; must put your interests over theirs and declare any conflicts of interest; usually paid annual fee for advice and service based on 1% of AUM; pay structure helps reduce inherent conflict of interest that brokers posses

broker

no fiduciary requirement; can put their interests above yours when recommending investments as long as they are suitable; investment sales where they get paid by commissions on product sold; many use title of wealth manager/investment consultant/financial advisor, and are part of national chains like edward jones

dual registrant

fee based advisor offering advisory and brokerage services; 2/3rds of these charge both fees and commission, 11% charge only commissions and 23% charge only fees; can give you advice depending on the hat they’re wearing such as giving you fiduciary advise and then broker advice to get commissions

investment advice for RIA or broker

only applies when making recommendations; doesn’t require brokers to routinely recommend lowest cost funds; need to ask people if they’re fiduciaries, how they make money, and if they get commissions

robo advisers

use algorithms and model portfolios to allocate investments according to client’s objectives and risk tolerance; automated solution for asset allocation, rebalancing, reinvest dividends, and minimize effect of taxes; issue is that big benefit of wealth adviser is hand holding and stopping you from liquidating losses so this full automated method doesn’t work so they switched to hybrid model

beyond meat

meme stock, sells fake meat and was short squeezed

kelce joins activist investors for 6 flags

jana partners brought him in as they normally bring in celebrities to gain more attention to their campaign; wants 6 flags to improve marketing and customer experience at the parks

how to shield portfolio from AI bust

equal weighted S&P; defensive stocks; international shares; software stocks (idea is that these are recurring revenue but if AI does bust this kills them); gold (might be a bubble)

chart formations

TA argue chart formations are graphical representations of unchanging diverse human behavior by investors indicated by price changes; charts are a visualization of the human mind and emotions as expressed in the financial mkts

history of TA

charles dow pioneered TA; dow theory was a play against the dow jones index and the rail index to determine what the trends were going to do

TA price movements capture:

supply and demand; fear, greed, deceit, manipulation, fraud, & naivete; public mood or investor sentiment; investment constraints and conflicts of interest; earnings estimates; monetary policy and economic cycles; the unconquerable emotional desire for humans to be right

TA of stock trends by edwards and magee

3 principles: 1) stock prices tend to move in trends 2) volume goes w/ the trends 3) a trend, once established, tends to continue in force (can’t last forever but TA says they can give you advanced warning to let you shift your portfolio to prepare for this, can it beat buy and hold after taxes and transaction costs?)

assumptions of TA

price is determined solely by interaction of supply and demand; S&D are governed by numerous factors both rational and irrational; stock prices tend to move in trends which persist for an appreciable length of time; changes in trends are caused by shifts in S&D, charts send advanced warnings of shifts in S&D in form of price and volume patterns

mkts overreact: contrarian indicators

odd lot trading (small investor is always wrong, if odd lot sales are up then good time to buy, vice versa), mutual fund cash positions (mutual fund cash positions have been greatest at the bottom of a bear mkt and lowest at peak of bull mkt, starting to hold less true b/c lots of other players have dry powder and ETFs exist), investment advisory opinion (ratio of advisory services that are bearish, when ratio hits 60% start buying w/ idea that retail investors being overly bullish means euphoria has set in

contrarian indicators: shift in supply and demand

breadth of the mkt (measures # of stocks in the mkt that have advanced compared to those that declined); support and resistance lines (if either is broken the mkt is poised for a major move); moving average (moving average line smooths out fluctuations and lets chartist see trends in stock price)

Market breadth

if you have more stocks hitting 52 week highs compared to 52 week lows then you have bull, want to also look at 4 week highs/lows to see if its ending soon

simply moving averages

very clear buy and sell signals; when 50 is above 200 and crosses below this is a sell, 50 below and crossing above is a buy; short bear mkt this strategy doesn’t work too well works good in long bear mkt

fibonacci retracements

countertrend where after a movement in one direction prices tend to retrace a portion of the previous trend before resuming the move in the original direction; countertrends fail at certain predictable percentages calculated from fibonacci sequence; trend will be tested at support lines and if we start busting through then that shows strength of the trend

bollinger bands

bands 2 standard deviations above and below a 20 day simple moving average, price should remain within the bands 95% of the time; width of the bands are narrower during less volatile periods and wider during volatile periods; decisive price move breaking through band suggests that strong momentum should push the price further in the direction of the breakout

market slow learners: momentum indicators

mkts learn slowly so investors who are quicker than mkt will earn excess returns; there is evidence that prices drift up after significant news announcements, w/ beating earnings having price drift up in first 30 days w/o major mkt news and those that got beat drifting down meaning investors need time to digest this info and make portfolio/investment thesis moves

RSI

relative strength index: measures velocity of a security’s price movement to identify overbought and oversold conditions; above 70 is overbought, below 30 is oversold; can be good enter/exit indicator; issue is that you can’t look at it solely such as for stocks like robinhood and lululemon

earnings season takeaway

firms are relatively unscathed from tariffs and that people are reporting solid news

china US show optimism in trade dialogue

meeting b/t trump and xi on thursday; cooperation on fentanyl, agriculture, and access to rare earth minerals which cooled off the mkt

inflation accelerates to 3% but was less than expected

previous CPI was 2.9, expectation was 3.1, we got 3; this is good b/c we got less than expected and mkt interpreted this as the fed will cut rates

foreign mkts have outperformed S&P500

international stocks are on pace to outperform US by largest margin in 16 years; 1 reason is b/c dollar has weakened ; us stocks still best their international counterparts over long haul; us is best performing stock mkt in history of the world

MACD

moving average convergence divergence; comparing fast moving average that’s more sensitive w/ slow moving average w/ smoothing effect; confirmation line that helps confirm after crossing of the signal lines

investors who lead markets

specialist short sales (people who short are very confident and if large short interest that is a sign stock will go down); insider buying and selling (if size of buying is extremely large and a big portion of individual net worth then that’s a signal they think stock is truly undervalued; don’t listen to board just saying things or people dumping stock)

elliot wave theory

predicts price movements by observing and identifying repetitive wave patterns that provide a subjective view of the future direction in the mkt; believes consumer confidence, greed, fear, are all important and you need to look at the psyche of the crowd which moves in waves; big waves show momentum and trend while smaller waves crashing test the trend over time; impulse waves: 5 subwaves moving in same direction as trend of next largest size; corrective wave: 3 subwaves moving in opposite direction as trend of next largest size; current signal is bull mkt

determinants of TA success

back testing to ensure it can deliver returns across different periods; does it beat buy and hold on an after transaction cost and tax basis?; if it underperforms then do buy and hold

value investing stock characteristics

lower multiple than broader mkt; P/E and P/B; companies that pay dividends; companies that are out of favor due to economic cycle or overreaction to recent news but still have strong fundamentals; mature industries

characteristics of successful value investors

patience; appropriate temperament; ability to stay calm and emotionally intelligent during bouts of short term volatility; self-confidence

ex of traditional value industries

banks, insurance, utilities, O&G, consumer staples, telecommunications; JPM, Berk, walmart, exxon, J&J, home depot, P&G, BofA

origins of modern value investing

graham and dodd at columbia business school; security analysis first published in 1934; the intelligent investor

buffett performance

used to have a cigar butt theory where he wanted to buy company for less than liquidation then bankrupt and liquidate for profit; munger convinced him to buy great companies at fair prices; has even invested in AAPL and BYD

original value screen from graham’s security analysis

want to consider going rates in bond mkt, compare company against itself in recent history to buy when stock is trading cheap, make sure debt is still serviceable, trying to find stable CF predictable stocks 

P/B screenings

screen for stocks where equity trades at less than book value or at least a low multiple of the book value of equity; not clear that low P/B outperformance happens anywhere else besides US

P/E ratio screen

screen for stocks where equity trades at a low multiple of equity earnings; low PE actually outperforms but PE can’t be used in isolation to generate alpha

dividend yields screen

screen for stocks w/ high dividend yields; normally institutional investors hoard these stocks such as asset liability managers and pension funds; will leave if company cuts dividend b/c they need CF

P/BV ratio screen

less useful in past as companies don’t have as much PPE on balance sheet; companies w/ a cost of equity > ROE should trade below book value of equity b/c it is destroying value as it grows; overpaying basically for growth

fed decision

cut rates by 0.25%; ending quantitative tightening; both moves are dovish and fed is focusing on labor mkt

layoffs hit white collar workers

perfect time to coincide w/ the fed mandate; stagnant job mkt; uncertainty around tariffs, inflations, and politics are also reason for layoffs not just AI

fed top 5 finalists for spot

2 fed governors, white house national economic council director, former fed governor, rick rieder who is blackrock global fixed income director and is a dark horse, also a practitioner and not phd educated economist

huntington buying another bank

7B to take on cadence bank; diversified their deposits in the southern area of the US

nvidia hit 5T mkt cap

on the back of trump saying he is willing to discuss the sale of blackwell chips to china; teaming up w/ eli lilly for drug research; giving 1B to nokia

fund managers are all in on the hot mkt

cash levels hit lowest as % of AUM; stocks could be poised for reversal but we still have lots of money sitting in money mkt funds

western union to launch a stable coin

supposed to be pegged to the dollar and a form of digital currency; used for tax evasion, terrorism, human trafficking, etc; only good use is that it lets customers settle transactions faster than the telegraph which means more efficient and faster; issue is that they won’t lower their fees b/c why would you worsen your business model; getting rid of physical money could let the fed take rates negative letting banks charge you for interest … could happen

super investors of graham and doddsville

if a concentrated set of winners follow a strategy then you can’t call their success luck; number of successful value investors who generated alpha from value investing can’t be chalked up to luck it has to be skill

buffett advice from video

need a good framework; doesn’t take high IQ to figure out stocks are cheap but it takes certain temperament to step up and act as well as ignore others; most important thing is to be able to define what things you can make an intelligent decision on and which ones you can’t (don’t have to be right on a thousand companies just one); ted williams science of hitting (wait for your pitch, in investing there’s no 3 strikes); college advice (punchcard to make 20 investment decisions in your life you would be very rich b/c you would think hard and only invest in what you know is a winner); we have competitive advantage b/c we’re tech savvy and can spot disruptions faster than older generation in tech world

is the US public corporation in trouble?

companies are now in different industries; we now have less PPE b/c we invest more in R&D; capex is on balance sheet but R&D is expensed on income statement so can’t use book value anymore; fewer publicly trading firms b/c of massive waves of M&A; inventory holdings are down b/c of just in time supply chains

Concerns w/ P/E ratio

companies w/ high risk earnings (risk of low PE ratios stocks is that accounting earnings is susceptible to manipulation); low growth (low PE is warranted b/c they expect future growth to be low); tax costs (low PE have large dividend yields generally); lots of manipulation around earnings and PE

variant on earnings multiples

EV/EBITDA = (mkt value of equity + debt - cash)/EBITDA; argue its better than PE b/c less impacted by financial leverage and focused on a CF measure not earnings; push back saying it isn’t FCF and you need to be careful about checking for risk in EBITDA and low growth

dividend yield warnings

companies paying too much in dividends will be unable to sustain and it is likely so high b/c price dropped a ton and they will soon adjust dividend down; low growth (returning more in dividends); taxes

tips for value screens

screen using pricing multiples to identify possible value stocks; look for low risk; have minimum growth requirement; screen for high quality growth w/ an ROIC above cost of capital

value investors’ tools for success

accounting checks (normalize metrics); the moat (want long term strategic advantage over decades); margin of safety (build buffer onto investment decision to protect yourself against risk)