The Insider Report

How to Deal With Excessive Risk Concentration?

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Jonathan Jacob of Forethought Risk, an independent risk advisory firm, sent me his Benefits Canada article, How to deal with excessive risk concentration:

In my previous column, Examining portfolio risk, we discussed ex-ante risk, ex-post risk and how both measures can provide greater understanding of portfolio risk. In this column I would like to discuss the options that are available to a pension fund manager that discovers excessive risk concentration in a fund through ex-ante risk reports.When a pension fund utilizes the services of multiple investment managers, there is potential for overlap of risk, causing excessive concentration of risk. Excessive risk concentration can be found in exposure to a single company, a sector of the economy, or a currency among others. If the pension fund manager receives ex-ante reports on risk which aggregate all investment manager portfolios, he or she may recognize an exposure as excessive prior to a potential blow-up.

One potential approach to the excessive risk is to ask one of the investment managers to trim risk to the asset with excess exposure. The investment manager will likely disapprove the request, justifiably claiming that the initial agreement did not include such restrictions and any future measurement of their performance will be tainted by this decision.

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Pat on the back

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You don’t have to be a MIT quant physicist to make money in the market.  In fact you ony have to be right 55% of the time to stand out.  I made a couple of calls in December of last year that proved to be very prescient.  I recommended to our readers that in spite of the fact I loved Apple, I thought you would make more money on Dell this year.   Rule #1 Don’t confuse a good stock with a good company.  They can be and usually are two very different things.  Apple is in rarefied air,  perhaps the best company ever but … Read more

Investors Turning to Active Commodities Strategies?

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I hooked up for lunch with commodity relative value fund manager I spoke to on Monday. He’s looking to raise raise capital for this new fund which he will be managing with other experienced traders and we went through his pitch book. 

I’ve sat with some of the best hedge fund managers in the world. The best of the best know the theory but more importantly, they can give you tons of examples of actual trades that went for and against them. That’s exactly how this manager presented his views. He has the academic and industry credentials, but it’s his actual commodity trading experience in Canada and the US that came through as he walked me through one trading example after another.

I love talented alpha managers. I’ll repeat what I’ve been stating the last few posts, there is exceptional alpha talent in Quebec that is being underutilized or worse still, totally ignored. I met two of Montreal’s best hedge fund managers today and I wouldn’t bat an eyelash to invest in either one of them (the other is an equity market neutral manager).

The question I get from outside-Quebec investors is if they’re so good how come the Caisse and other large Quebec institutions don’t invest in these new and existing hedge funds? There are a lot of reasons. First, reputation risk. There have been quite a few scandals in Quebec with institutions getting burned with funds like Lancer, Norshield, Norbourg, and other frauds. The last thing any institution here needs is to read that some hedge fund they invested with blew up, especially if it’s a local fund (the media in Quebec are merciless).

Second, unlike other places, Quebec lacks the entrepreneurial drive to develop the absolute return industry here in Montreal. There

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Second Automotive Fund Now Available

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First Trust Advisors last week (5/10/11) introduced the First Trust NASDAQ Global Auto Index Fund (CARZ).  CARZ becomes the second fund to focus on the global automotive industry and the first in an ETF format.  The underlying index is a modified market capitalization weighted index of companies classified as automobile manufacturers.  The index caps the five largest stocks at 8% and all others at 4% during each quarterly rebalancing.

CARZ presently has 32 holdings, and the annual index reconstitution is scheduled for next month.  The ten largest stocks are Daimler AG (DDAIF) 7.9%, Ford Motor Company (F) 7.8%, General Motors Company (GM) 7.2%, Toyota Motor Corporation (TM) 7.1%, Honda Motor Co., Ltd. (HMC) 7.0%, Hyundai Motor Co. 5.2%, Kia Motors Corporation 5.0%, Volkswagen AG (VLKAY) 4.3%, Bayerische Motoren Werke AG (BAMXY) 4.2%, and Nissan Motor Co., Ltd. (NSANY) 3.9%.

Nine countries are represented in the fund with Japan at 32.7%, Germany 20.2%, U.S. 17.7%, South Korea 9.9%, France 7.0%, China 5.2%, Italy 5.0%, Taiwan 1.4%, and Malaysia 1.0%.

Fidelity Select Automotive (FSAVX), the first automotive industry fund, was launched nearly 25 years ago in June 1986.  It limped along with assets under $40

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Stock Price Gaps – Why They Happen And How To Trade Them

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By Kirk Du Plessis

Beginning traders were probably shocked the first time they experienced a stock price gap. I guess even the most experienced traders still get taken back when there is an unexpected stock price gap in a stock they are trading. Either way I wanted to cover once again why they happen and what you can do (if anything) to trade them.

It Happens When The Market Is Closed

Nearly all stock price gaps happen in pre market trading or during after hours trading. Call them Black Swans if you want since they seemingly come when you least expect it.

Generally speaking gaps are rare for the normal stock. Most mutual funds, ETF’s, and other illiquid assets actually gap more frequently which make the gaps less important.

How The Actual Price Gap Is Created

A price gap is created when a stock closes at say $91.50 (as AAPL did below) for the day which is at 4:00 PM EST and then the next day opens dramatically higher or lower than it’s previous closing price of $91.50.

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Just Another Manic Monday?

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On Monday, I hooked up for lunch with someone who works at a successful Montreal hedge fund. He complimented me on my blog and then we started talking about alpha talent in Quebec. There are some exceptional hedge fund managers in this province that are being totally ignored by Quebec’s large institutions (for God knows what reason!). 

I would like all the global funds that read my blog to contact me (LKolivakis@gmail.com) and I’ll be glad to share more information on our alpha talent in Quebec. Many managers have worked in London, New York, Chicago and decided to move back to Montreal for personal reasons. I want to support them as much as possible because Montreal’s hedge fund community is small but offers tremendous potential. I want Montreal to become the fastest growing hedge fund center and will do everything I can to support our talented alpha managers.

The person who I had lunch with today introduced me to another person who is in the process of starting a relative value commodity fund. I spoke with this manager late this afternoon and was blown away by how sharp this guy is. Unlike most commodity fund managers who mostly trade front end oil futures, this manager and his small team have years of experience trading all commodities, including energy, metals, corn, sugar, and other soft commodities.

We had a great discussion on the financial crisis. Like me, he was extremely bearish back in 2006. I told him I was researching all these complex CDO-squared and CDO-

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On Systemic Risk

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There are five factors for systemic risk.  Here they are:

  1. Asset size of the institution, including synthetic exposures.
  2. Degree of leverage of the institution, including synthetic exposures.
  3. Asset-Liability mismatch, particularly financing long assets with short liabilities (including derivatives and margin agreements — think of AIG, or mortgage REITs on repo).
  4. Degree to which the institutions owns financial companies equity or debt, or vice-versa, where other financial companies have claims on the institution in question.
  5. Riskiness of the assets owned by the institution in question.

Contributing to the risks include easy monetary policy, which can lead/has led  to the neglect of risk control.  Personally, if I were a regulator of systemic risk, I would throw my effort at companies that fit factors 1 and 2, and analyze them for the other three factors.

Systemic risk is layered levered credit risk. A lent to B, who lent to C, who lent to D, who financed a bunch of bad mortgages.

#5 is underwriting risk

#4 is connectedness risk

#3 is liquidity risk

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25 Best Financial Blogs according to Time Magazine

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I didn’t know Time magazine was still in business.  I thought it might be a table book company but then I found this very handy list of financial blogs on their website.  I don’t believe reading these blogs for the most part will consistently or even rarely make you money.  But sometimes nothing will.  And for those times, reading about making money will have to do:     The 25 Best Financial Blogs From Paul Krugman to Freakonomics to the Consumerist, we compiled a list of the most influential (and useful) finance blogs out there and then asked some of … Read more

Weekend Reading

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Weekends are a great time to catch up on some of the good reads from the week… Goldman’s O’Neill Sees Investors Missing Stock Rally on ‘Black Swan’ Fears (Bloomberg) Facebook’s Stealth Attack on Google Exposes Its Own Privacy Problem (Wired) Lessons From The Flash Crash (Forbes) The People vs. Goldman Sachs (Rolling Stone) A Crude Guess About The Future (Freakonomics) Is College a Rotten Investment? (Slate) The World’s 26 Best Cities for Business, Life, and Innovation (The Atlantic) On the Floor Laughing: Traders Are Having a New Kind of Fun  (The Atlantic) Gloom and Doom, and How to Profit From … Read more

How to Shrink the Deficit

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It annoys me that Republicans argue against elimination of special tax benefits for anyone, calling it a tax increase.  Let’s get things straight here: tax increases are things that affect everyone. The tax code needs to be cleaned up, as do subsidies.  It is not the proper place of government to be handing out special favors.  If the Republicans want to do what is right they need to trade — eliminate a subsidy/tax break that some of their constituents like in exchange for eliminating a subsidy/tax break that the Democrats like.  Rinse, lather, repeat, until we are back to something … Read more

Inflation Speculation

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When currencies do not serve as a long-term store of value, economic actors search for ways to preserve future purchasing power, which often mean purchasing commodities. But most commodities are not cheaply storable over long periods, so actors get forced into the few that do: gold, silver, etc. There is a problem here, stemming from dumb money. When dumb money shows up for purchase of generic “commodities” distortions follow: backwardation, large storage demand, and warped market incentives.

Eventually overproduction catches up, but the volatility when it breaks can be huge and self-reinforcing, with c0unterparties raising margin to protect themselves.  Extreme volatility causes exchanges to raise margin requirements substantially, which reveals which side of the trade is inadequately financed, which typically is the side that was winning, which leads to a reversal in price action.  The dumb money is revealed.

Now after a washout, the dumb money often assumes that powerful entrenched interests colluded against them to deny them their long-deserved free ride to prosperity through speculation.  The exchanges are in cahoots with the other side.  Well, no, the exchanges have two interests, which are solvency and transaction volume, which drives their profits.  Solvency is a more primary goal for an exchange, because the second goal can’t exist without it, and exchanges are not thickly capitalized.

Many different types of financial systems are subject to these risks.  Think of AIG: they were rendered insolvent by rising margin requirements as their creditworthiness was downgraded, largely because the rating agencies concluded they were going to lose a lot of money off of their many bets on subprime residential credit.  Think of all of the mortgage REITs that got killed as repo haircuts rose on all manner of mortgage-backed securities at the time that values for the securities were depressed.  Alternatively, think of Buffett, who entered into derivative trades where he received money and bore the risk, but his agreements limited the margin that he would have to post.

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‘s Left With The Bill for the Eurozone Bail-out

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The latest chapter in Europe’s never-ending sovereign debt crisis comes about a year after Greece received a 110 billion euro ($158 billion) bailout package from the EU and IMF. That bailout was supposed to buy time for Greece to adopt austerity measures without having to tap the public debt markets. Lets take a look at exactly where funding is coming from for the various PIIGs bailouts. The total €865 billion ($1.2 trillion) pot available for euro-area rescues is rather enormous. (Whether it will be sufficient to cope with Greece, Ireland and Portugal’s needs is yet to be determined). The sources … Read more

Some very interesting insider buys today

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Finally the CEO at GM stepped up and bought $900,000 worth of stock on 5-11.  I originally posted on GM on March 12th.  GM and the Japan earthquake disaster present a compelling opportunity.  We’ve traded in and out of the stock a couple of times mostly sucessful.  Today we stepped up again.  I’m not crazy about the chart but we took a major position anyway.  It was very interesting listening to hedge fund legend, Leon Cooperman opine on CNBC today about the merits of investing in GM.  I’m sure I’ve made more money it on than Leo but I dont’ … Read more

Analysis of New High Beta and Low Volatility ETFs from PowerShares

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Invesco PowerShares brought out two new and unique ETFs last Thursday (5/5/11).  PowerShares S&P 500 High Beta Portfolio (SPHB) and PowerShares S&P 500 Low Volatility Portfolio (SPLV) are innovative products that employ quantitative beta-weighting and volatility-weighting as part of the underlying index construction.  As with any new investment strategy, you need to understand how these new ETFs will function before putting them in your portfolio.

– PowerShares S&P 500 High Beta Portfolio (SPHB) (SPHB overview) tracks the new S&P 500 High Beta Index, which consists of the 100 stocks from the S&P 500 with the highest sensitivity to market movements, or beta, over the past 12 months.  The 100 stocks are weighted proportional to their 12-month beta coefficient at each quarterly rebalancing.

– PowerShares S&P 500 Low Volatility Portfolio (SPLV) (SPLV overview) tracks the new S&P 500 Low Volatility Index, which consists of the 100 stocks from the S&P 500 with the lowest realized daily volatility over the past 12 months.  The 100 stocks are weighted inversely proportional to their 12-month realized volatility at each quarterly rebalancing.

Beta & Volatility

Beta is one of the most misunderstood investment terms, and it is often incorrectly assumed to be a word that is interchangeable with volatility.  However, that is not the

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Commodity Flash Crash Part II – Senators Demand Immediate Position Limits In Crude Oil

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Feeling the fury of this bipolar market, the liquidation surge has arrived, right at the front door of the commodities family, with an emphasis on crude oil, gas, and silver. What started off as a sharp correction in silver is quickly turning into a sell-off of historic proportions.  With a four-day decline of almost 30% the selloff in silver is one of the most severe selloffs in the history of the metal’s futures contract. Sheer panic at the CME, 5 margin hikes in 8 days on Silver futures, is unheard of!!

Although we saw signs of a recovery early this week, it was Deja vu in the commodities markets today, with another flash crash similar to the one last Thursday. Crude-oil futures settled below $100 a barrel Wednesday, and gasoline plunged nearly 8%, after the CME Group briefly halted trading in oil, heating-oil and gasoline futures on the New York Mercantile Exchange after the June gasoline contract hit its daily price limit. The CME also boosted daily price limits for crude oil to $20 and for heating oil and gasoline to 50 cents. According to James Williams, an economist at WTRG Economics “A short trading halt only occurs when there is high volatility in the price to give the market a little breathing space.”

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Profits From New Global X Food ETF Will Help Fight Hunger

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Global X introduced a new ETF targeting the global food industry on May 3, and said it will donate all profits to help fight world hunger.  The Global X Food ETF (EATX) tracks the Solactive Global Food Index, consisting of the 50 largest global firms with significant business operations in the food industry. The index targets companies that derive the majority of their revenue from the production, development, or distribution of food or food ingredients.  Stock weightings are determined by free float capitalization, but to ensure diversification, positions are capped at 4.75% at each 6-month rebalancing. There are seven stocks … Read more

New IQ Global Oil Small Cap ETF Is A Viable Alternative

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Index IQ launched IQ Global Oil Small Cap ETF (IOIL) last Thursday (5/5/11), the first ETF to target small cap stocks in the global oil industry.  The underlying index defines small caps as stocks in the bottom 10% of the entire oil industry’s market capitalization.  The sub-sector breakdown shows Refining & Marketing at 40.5%, Exploration & Production 36.9%, and Equipment, Services & Drilling 22.6%.

The fund’s 61 holdings are weighted by float-adjusted market capitalization.  While no stock is supposed to exceed a 10% allocation at the quarterly rebalancing, presently no holdings need to be capped.  The largest position is Sunoco Inc (SUN) at 6.2%, followed by Oceaneering International Inc (OII) 5.3%, Core Laboratories (CLB) 5.2%, Tesoro Corp (TSO) 4.5%, Petrominerales Ltd (PMGLF) 4.3%, and Alliance Oil Company Ltd (ALLZF) 3.9%.

The IOIL portfolio currently spans 14 countries, including both developed and emerging markets.  I was somewhat surprised to see Thailand with the third largest allocation but Russia and Mexico not represented at all.  My guess is that this reflects the large size of oil-related companies in those places.  The rest of the list was no surprise with the U.S. at 45.1%, Canada 11.7%, Thailand 7.5%, Colombia 4.3%, Japan 4.0%, Sweden 3.9%, U.K. 3.9%, Finland 3.0%, and six others combining for 13.5%.

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Fun with Dick (AGQ) and Jane (ZSL) and Spot (SLV)

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Seventeen years ago we saw the first leveraged mutual fund with daily reset.  Now we have dozens of them along with ETFs that work the same way.  Yet after all this time, many investors still don’t understand what leveraged funds can and cannot do.  Even professional investors ignorantly called these products “failures” because the long-term performance is not a multiplicative factor of the unleveraged performance.

Numerous hypothetical examples attempt to “prove” that leveraged funds will lose money over time.  To paraphrase a famous line: “Hypos?  We don’t need no stinkin’  hypos.”  Why use hypothetical examples when we have real-life actual examples right in front of us?

Today we will examine the performance of leveraged performance over more than one day.  This is not rocket-science.  It is elementary school math.  So in our real-life example I will call on some old friends from elementary school: Dick and Jane, and their dog Spot.

Being just a dog, Spot doesn’t know much math so he just follows the prevailing price, which is why it is called the “Spot” price.  We will use silver to illustrate.  The iShares Silver ETF (SLV) doesn’t buy stocks; it holds actual bars of silver in an attempt to track the spot price.  Therefore, SLV will represent our Spot.

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Weekend Read with an Eye to Profits

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One reason I’m a news addict is that I like to game the news. What I mean is can you make money off a headline, can you get insight into a macro trend? So here are my eye catching reads of the weekend and a way to profit from it. I’d love to hear your comments. Number of the Week: Class of 2011 most indebted ever. WSJ May 7th : The article states, “The Class of 2011 will graduate this spring from America’s colleges and universities with a dubious distinction: the most indebted ever.”.    The reason the class of 2011 … Read more

ETF Stats for April 2011: 1,216 and Counting

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A barrage of product introductions in April resulted in 23 new ETFs and 20 new ETNs coming to market.  The number of launches matches the 43 in June 2008 while falling short of the record, 50 in January 2007.  The month-end quantity now stands at 1,216 (consisting of 1,053 ETFs and 163 ETNs).  Actively-managed ETF listings remained unchanged at 34.

April became the fourth month in a row without any closures.  However, the streak ends there as BXDD, Barclays’ 3x no-reset inverse S&P 500 ETN, becomes the first casualty of 2011 later this week.  The four-month stretch of no closures is the longest since 2007.

Trading activity plummeted in April, with total ETP dollar volume declining 30% to less than $1.3 trillion.  There were only 13% fewer trading days than March, so daily trading activity was down as well.

The number of ETFs in the Billion Dollar Club, those averaging more than one billion dollars in daily trading activity, dropped from eleven to just seven.  However, those seven funds accounted for more than 56% of all ETP dollars traded.  New to the list this month was iShares Silver Trust (SLV), which saw unprecedented trading activity of $67 billion due to the strong rally in silver.  SLV was the third most active ETF behind SPDR S&P 500 (SPY) at $374 billion and iShares Russell 2000 (IWM) at $84 billion.

Products averaging more than $100 million of trading per day numbered 67, a decrease of eight from March.  Those 67 funds, just 5.5% of all ETPs, accounted for 89% of all dollars traded.

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Is it time for the US to disengage the world from the dollar?

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The week before last on Thursday the Financial Times published an OpEd piece I wrote arguing that Washington should take the lead in getting the world to abandon the dollar as the dominant reserve currency.  My basic argument is that every twenty to thirty years – whenever, it seems, that American current account deficits surge – we hear dire warnings in the US and abroad about the end of the dollar’s dominance as the world’s reserve currency.  Needless to say in the last few years these warnings have intensified to an almost feverish pitch.  In fact I discuss one such warning, by … Read more

New Wall St. Slogans to replace the aged “Sell in May & go Away”

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Check out this great clip of proposed replacement sayings for that old adage of “Sell in May and go away.” Here are a few of my favorites: “Buy today’s cause it’s early May“, “Buy tomorrow with funds you borrow“, “Buy all commodities without hesitation, but don’t dare we have inflation“, “Buy the REITs cause real estate is on fire, but don’t you dare become an actual home buyer” What is your favorite?   [youtube=http://www.youtube.com/watch?v=_FHWqIneWY4&feature=player_embedded&h=400&w=500]

Wells Fargo- How to Rob the Bank

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I originally alerted readers of the Sax Angle to a profitable trading opportunity on Wells Fargo stock.  See Two new insider buys today piqued my interest for the details of that post.  Since then we have nearly doubled our money on two options we purchased, the June 30 calls and the May 30 calls.  Both options looked cheap and after today’s move in Wells Fargo, they look even cheaper.  What we mean by that although the options are nearly twice the price, the chart of Wells Fargo is far more bullish than it was when we first invested.  Needless to say, we did not sell and actually are buying more.  We first noticed Wells Fargo after the new CFO picked up 10,000 shares following its recent earnings report.  When we bought it the stock was oversold and the technical picture hadn’t set up so well.  It now looks much stronger.

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