(Not so) Smart Beta

[DeepState]

Yeah, our rates are pretty expensive by comparison! The main difference is that in the US your shares are not held in your own name, they are held in the name of the broker in trust for you or something like this. So there is some risk if the broker goes bust, which is not the case here in Aus with our CHESS system. But they have an insurance policy through the "SIPC" that covers them for this to some extent. Some investment banks in Aus use a similar structure to give margin loan rates around 4% or so, but still not as cheap as Interative Brokers. There's a few other differences, like no margin calls, ie. they can just sell the shares when you breach the max LVR without telling you and the max LVR is about 50%, so much lower than you can get here. They recently just stopped offering margin to Aus investors due to some licensing issue in Aus, but only for accounts in your own name, trust accounts were still ok the last time I checked. I would consider using them for only a portion of my lending, but for peace of mind have stuck with regular Aus margin lenders to date.

Something just isn't right. Here's Merrill Lynch's US margin rates for comparison.



They enjoy the same S&P rating as IB (via BofA).

..and for Chase (JP Morgan)



JP Morgan has a 1yr CDS spread of slightly over 50bps. IB lends for a 50bp margin over that to stock speculators? Really? What do you get for the price? Or, from another perspective, what did you have to give away to receive that price? Consider that IG charges a spread more than twice that figure...

There looks to be some very significant risk being taken somewhere that is not immediately evident. On a quick scan, I don't exactly know where it is. Absence of proof is not proof of absence though. The price of debt as quoted tells me it almost certainly exists. Just be careful with your dough. The SIPC is very specific about what it protects and mixing of assets on a net basis, securities not held in your exact account etc... are all issues. Check out the term re-hypothecation (which is going on)....and ask what it means not to have the stock in your account in your name...just for example. I think the super cheap rates arise from taking risk on IB and then IB's stock lending counterparties and then their counterparties etc. This is something that would not happen in more vanilla arrangements. The mechanics of these things in a blow up are terribly messy and could mean client losses are large without recourse to SIPC because all you had was a swap arrangement with the broker...the underlying assets were never in your name. This is not theoretical.

 

[TPI]

Yeah their rates do seem too good to be true, and as you say may reflect underlying risks not so apparent. There's a thread in the brokers sub-forum here where others currently using IB may be able to offer their thoughts.

 

[craft]

Warren Buffett adds to his lead in $1 million hedge-fund bet

http://fortune.com/2015/02/03/berkshires-buffett-adds-to-his-lead-in-1-million-bet-with-hedge-fund/


I guess the moral of the story is smart beta ideas the hedge funds employ just don't return enough to justify the fees charged.

See bet details here.

http://longbets.org/362/

Broad based, low cost, low turnover, non synthetic - ahead at the 7 year mark.

 

[ROE]

Classic human behavior people like sexy and complex stuff

hedge fund sound cool because of what they do, they get head line of 100% return or massive double return every so often and this draw in the crown

but history has proven boring and simple stuff usually works best.
Which one sound more sexy?

I am a stock market traders and I make 10% gain today or
I am a investor invest in business for yield, sound pretty ****ty and low return no mentioned of capital gain

 

[Ves]

Warren Buffett adds to his lead in $1 million hedge-fund bet

http://fortune.com/2015/02/03/berkshires-buffett-adds-to-his-lead-in-1-million-bet-with-hedge-fund/


I guess the moral of the story is smart beta ideas the hedge funds employ just don't return enough to justify the fees charged.

See bet details here.

http://longbets.org/362/

Broad based, low cost, low turnover, non synthetic - ahead at the 7 year mark.

I'm not surprised by all of this. The passive alternatives have a lot of merits.

What I'm interested in, and this may belong in another thread, is some views from DeepState and yourself, about indexing and other passive alternatives in Australia. My main concern with such a strategy is that our major indexes are highly skewed towards a small amount of companies (Big 4 banks, big mining companies, Telstra, and the two consumer discretionary conglomerates). I don't think the S & P 500 has this feature. With passive investment, it appears that most would not question that, and up until now it has worked fabulously well, but is there a way to alleviate the reliance of these companies for future index returns? I realise you can buy ETFs for international exposure as well, and that would be part of any good strategy.

Obviously there is always risk and you (hopefully) get rewarded for bearing it.

 

[craft]

I'm not surprised by all of this. The passive alternatives have a lot of merits.

What I'm interested in, and this may belong in another thread, is some views from DeepState and yourself, about indexing and other passive alternatives in Australia. My main concern with such a strategy is that our major indexes are highly skewed towards a small amount of companies (Big 4 banks, big mining companies, Telstra, and the two consumer discretionary conglomerates). I don't think the S & P 500 has this feature. With passive investment, it appears that most would not question that, and up until now it has worked fabulously well, but is there a way to alleviate the reliance of these companies for future index returns? I realise you can buy ETFs for international exposure as well, and that would be part of any good strategy.

Obviously there is always risk and you (hopefully) get rewarded for bearing it.

As you have indicated the large market caps have outperformed the rest of the market recently as people chase "safe yield" you just need to compare XJO against XSO to see it clearly. If you expect this to mean revert - then somewhere ahead lays underperformance for a market weight ETF vs an Equal weight ETF. However if your time frame is long enough - you can safely ignore this, you will catch both sides as the relevant performance swings.

To me the risk with an equal weight index for the very long term passive approach is that there is a risk that you will not capture the full economic growth of the society which you are trying to gain exposure too and that outweighs any rebalancing benefit that such a fund may achieve.

International exposure for broad based passive ETFs - The core questions for me are what economies do I want to gain exposure too? What economies produce the goods and services I want to consume over my lifetime.

 

[Ves]

Another way of looking at it possibly. The top 10 on the ASX is about 35-40% of the entire market from what I recall. The S & P website seems to indicate roughly the same (top 20 is 46% of market cap, top 10 is 81% of the top 20).

So if the top 10 lost 30% due to some kind of drastic mean reversion.... the whole index would only fall about 12% (making the big assumption that there was no mean reversion in either direction for the balance of the constituents).

Is this basically where you were going with the limited impact on an investor with a very long time horizon?

 

[craft]

Another way of looking at it possibly. The top 10 on the ASX is about 35-40% of the entire market from what I recall. The S & P website seems to indicate roughly the same (top 20 is 46% of market cap, top 10 is 81% of the top 20).

So if the top 10 lost 30% due to some kind of drastic mean reversion.... the whole index would only fall about 12% (making the big assumption that there was no mean reversion in either direction for the balance of the constituents).

Is this basically where you were going with the limited impact on an investor with a very long time horizon?

What you lose when the pendulum of relative performance swings one way, you pick up when it swings back the other way. See enough swings and an awful lot of relative performance volatility is neutralised in the wash. Be around for only a swing one way and where you get on and off maters a lot. ie if you are only investing for a few years the possibility of the big market caps reverting to some sort of lower mean of relative performance is a big deal. Over the long term it matters a lot less.

 

[TPI]

Warren Buffett adds to his lead in $1 million hedge-fund bet

http://fortune.com/2015/02/03/berkshires-buffett-adds-to-his-lead-in-1-million-bet-with-hedge-fund/


I guess the moral of the story is smart beta ideas the hedge funds employ just don't return enough to justify the fees charged.

See bet details here.

http://longbets.org/362/

Broad based, low cost, low turnover, non synthetic - ahead at the 7 year mark.

The smart beta ideas spoken about here in this thread are in the context of passive index funds or ETFs, they are just slight variations on Vanguard's approach, still broadly diversified, low cost, low turnover and passive. As distinct to the actively managed, higher cost, higher turnover, alpha-seeking hedge funds. So not sure about this comparison you make here...

 

[luutzu]

Warren Buffett adds to his lead in $1 million hedge-fund bet

http://fortune.com/2015/02/03/berkshires-buffett-adds-to-his-lead-in-1-million-bet-with-hedge-fund/


I guess the moral of the story is smart beta ideas the hedge funds employ just don't return enough to justify the fees charged.

See bet details here.

http://longbets.org/362/

Broad based, low cost, low turnover, non synthetic - ahead at the 7 year mark.

I heard that Buffett said "Beta doesn't tell you a dam thing."

So beta = "doesn't tell you a dam thing."

Smart beta = smarter way of not telling you a dam thing (and will charge extra for it).

 

[The Falcon]

RAFI US 1000 now on asx, ticker QUS for those interested

http://www.betashares.com.au/products/name/ftse-rafi-u-s-1000-etf/#each-overview

 

[galumay]

I heard that Buffett said "Beta doesn't tell you a dam thing."

So beta = "doesn't tell you a dam thing."

Smart beta = smarter way of not telling you a dam thing (and will charge extra for it).

There are plenty of other studies that show that Beta is not a good measure of risk, its not a metric I look at after reading the research.

 

[The Falcon]

Yeah their rates do seem too good to be true, and as you say may reflect underlying risks not so apparent. There's a thread in the brokers sub-forum here where others currently using IB may be able to offer their thoughts.

Very keen to understand these custodian account risks, the margin rates are very sharp. Through Deutsche Bank OZ private wealth 4.9% AUD and 3.3% USD are available on $1m facilities (min initial draw down 250k) I hear. No doubt available elsewhere too.

 

[Faramir]

Picture taken from Smart Investor Magazine April 2015, Page 64. Article written by James Frost.

I can't find a website to the article.

If anyone brought Australian Financial Review today and received the magazine insert, please read the article and comment on its relevance to this thread.

Russell Investments High Dividend Australian Shares ETF (RDV) 3.44% (1 year)
Russell Investments Australian Value ETF (RVL) 2.04% (1 year)

Thank you.

These are two paragraphs that I can understand:

"Smart beta strategies run a filter over the benchmark index and tweak allocations according to a formula. They typically charge a basis point or two more than index funds, and product-makers like to say they deliver alpha for the price of beta."

"The moral is investor can't afford to take claims at face value. For every impressive performer there is an equally underwhelming underperformer. Buying a product marked as "smart beta" is no guarantee you will get what you pay for."