Monthly Archives: March 2016

Active Share, a way of looking at portfolio management (i)

March 10, 2016 By in Active Share, Uncategorized Tags: , , , , 1 Comment

I’ve been reading lately that Europe is in the midst of a regulatory hunt for money managers who profess to be active managers and are charging high fees for this service, while doing nothing of the sort.  Rather, they are “closet” indexers–meaning that their portfolios look, for all intents and purposes, like their benchmark indices.

I can understand the horror EUers must feel at the wealth devastation wrought by European active fund managers, whose performance, both from my experience and the published figures I’ve seen, I regard as far weaker than their US counterparts’ (who admittedly don’t cover themselves in glory).  Being charged high fees for poor outcomes must sting.  On the other hand, the self-aware EU manager must realize that an index fund is the best product he’s capable of producing for his client.  So in a funny sense the closet indexers are doing their clients a favor–except for the fee part.

But that’s not what I want to write about.

Active Share

The tool regulators are using to detect closet indexing is called Active Share (AS).

It’s something I began using to control the risk in my portfolios in the 1980s, while working at TIAA.  The advent of more powerful computers spawned its widespread use in the industry through performance attribution software during the following decade.  But it only earned its capital letters when two Yale academics published an article (“How Active is Your Fund Manager?  A New Concept That Predicts Performance”) about the concept in 2009.

The idea is straightforward.  Find all the positions where the portfolio holds more than the index weighting and total all the “extra” money in those positions (if the manager holds something not in the index, the entire position counts as extra).  Do the analogous thing with positions where the portfolio holds less than the index weighting.  Take the absolute value of both sums, add them together and divide by two.  Calculate the result as a percentage of the total portfolio value.  The result is the portfolio’s AS.

An example:

The index has four stocks, A, B, C and D.  Each has the same 25% weight.

Each portfolio manager has $100 to manage.

Portfolio manager X puts $25 into each stock.  He has an AS of 0.  He’s an index fund.

PM Y puts $26 each into A and B, and $24 each into C and D.  His overweights total $2; the absolute value (minus signs turned into pluses) of his underweights is $2.  His AS is 2%.  He’s a closet indexer.

PM Z puts $30 into A $40 into B, $20 into C and $10 into D.  His overweights total $20;  the absolute value of his underweights is $20.  His AS is 20%.  He’s clearly an active manager.  In the real world of asset management, he’d be regarded as very aggressive.

The Yale researchers conclude that high ASs are a good thing.

More tomorrow.

 

 

closet indexing

March 9, 2016 By in closet indexing, Uncategorized, Vocabulary Tags: , , , 1 Comment

“Closet indexing” is the term used to describe the practice of portfolio managers who claim to be active managers–and charge correspondingly high fees–yet maintain holdings that replicate the structure of their benchmark indices extremely closely.

What’s wrong with this?

On the one hand, the empirical evidence is that the average active portfolio manager in the US consistently falls below the performance of his benchmark index, so indexing–even closet indexing–is a viable strategy for beating most of one’s competitors.

On the other, the justification the much higher fees active managers charge is to compensate for maintaining a research department of investment professionals and for skill in figuring out a portfolio structure that both differs from the index and provides superior performance.

The issue, then, is that the closet indexer offers the client a low-cost index product in a very expensive package.  This is socially acceptable, even desired, in some circumstances–like when a luxury car dealer charges $200 for an oil change that goes for $35 at the neighborhood Jiffy Lube.

I have some sympathy for closet indexing, although not a lot.  Unlike the luxury car dealership, where by paying six times the going rate for services the customer makes a status-building public display of having money to burn, investors of all stripes have a severe aversion to underperformance.  As one of my old bosses was fond of putting it, “The pain of undereperformance lasts long after the glow of outperformance has faded.”  Outperforming is also hard to do.  So I can see how an “active” manager can drift toward the index as a strategy.

Still, to justify collecting active management fees, one should at least make an effort.

 

More tomorrow.

more on demographics: Millennials vs. Boomers

March 8, 2016 By in Millennials vs. Baby Boomers, Millennials vs. Boomers, Uncategorized Tags: , , 1 Comment

Market intelligence company NPD recently published a paper titled “Winning Millennials, Gen X and Boomers with the Five Ws.”  It analyzes shopping habits of Americans in different age categories based on item-by-item data from individual consumers collected by the NPD Checkout Tracking service.

Its conclusions:

brick and mortar shopping

–as one might guess, the younger the consumer, the greater the preference for online.  The older the consumer, the greater the preference for bricks and mortar.

Baby Boomers are now seniors, meaning they are adjusting down their spending in line with reduced pension–as opposed to salary–income.  Boomers want stability, stores they’re accustomed to, availability of necessities, value for money and one-stop shopping. …in other words, warehouse clubs, where they spend on all sorts of items.  Pretty boring.

Boomers do frequent convenience stores, but mostly for gasoline.  Food accounts for less than a fifth of what they spend there.

–Millennials like convenience stores.  They spend more than other age groups on gift cards there (why, I don’t know).  But they, and Gen X also buy a lot of food in C-stores.

Millennials and Gen Xers ( go to warehouse clubs, but strictly for groceries.

online

Amazon is the king of online for all generations, making up 20% – 25% of individuals’ total online spending.

Millennials spend the largest part of their budgets online, Boomers the least.

Millennials use mobile apps of all sorts–like Uber, Seamless, GrubHub, Airbnb,and Etsy.   (Interestingly, NPD also mentions Target among Millennial favorites.)  Boomers, in contrast, stick with department store websites, QVC and travel services.

The younger the consumer, the more likely the purchase will be something that’s available primarily online or easiest to get online–meaning books, music, software or tickets.

my thoughts

Data from Washington show that Millennials are the largest segment of the US population.  They also show that Millennials’ income is at present about half the size of Boomers–but that Millennials pay is rising as they gain more work experience, while Boomers’ income is being more or less cut in half as they retire.  To my mind, this secular trend argues for investing where Millennials shop.

I hadn’t known how important convenience stores are to Millennials.

I’m more surprised, though, by the characterization of Boomers as a group already deep into a low-income retired lifestyle.  I’d have guessed that was still years off.  More reason to look for where Millennials shop.

 

 

the February 2016 Employment Situation

March 4, 2016 By in employment, Employment Situation report, Uncategorized Tags: , , , , 1 Comment

The Bureau of Labor Statistics released its monthly Employment Situation report at 8:30est this morning.  The highlights:

–job gains for February came in at +242,000 new positions

–December and January figures were revised up a total of +30,000 jobs

–the unemployment rate remained steady at 4.9%

–wages, which had gained $.12 on a base of $25.26 per hour last month, fell by $.03 in February.  Although this is just one month, the figure threw some cold water on speculation generated by the strong January figure that wages–and therefore inflation–were finally beginning to rise at a more comfortable level after more than half a decade of mammoth monetary stimulation targeted in part at achieving this result.

All in all, good news.

Nevertheless, S&P futures, which spiked a bit on the announcement, are trading slightly below the pre-announcement level as I’m writing this.

mining

One figure that caught my eye was the situation for the mining industry (including oil and gas as well as metals).  Since the employment peak for the sector in September 2014, mining has lost a total of -171,00 positions, including -19,000 last month.  Despite this, the economy as a whole has created around 4 million new jobs over the same period. Yes, Texas, Oklahoma and North Dakota… have been hurt by the sharp decline in oil prices, and yes, the oilfield-related jobs typically pay very high wages.  But I continue to find it hard to figure where the evidence can be for the persistent belief on Wall Street that somehow the decline of the oil and gas producing industry offsets most of the benefit to everyone else of lower hydrocarbon prices.  that just can’t be the case.

another aside

Window 10 was doing a massive update to my laptop as the jobs report was being made public.  So I turned on the TV to hear the news.  My fingers skipped over Bloomberg on the remote and went to CNBC.  I guess I’ve begun to admit to myself how stunningly bad Bloomberg has become at delivering informed financial comment.  (I assume this is the result of a new management emphasis on physical appearance rather than brain power, but I don’t know.)

In any event, CNBC is now clearly better.  Making Andrew Ross Sorkin the chief moderator certainly helps.  Conferencing in qualified outsiders does, too.  I’ve never cared for the comic relief provided by Rick Santelli, though.  I  find it hard to tell how much he actually believes of the nonsense he spouts, and I find it vaguely offensive.  But this may be tongue in cheek that I just don’t get.