Tag: ETF

Fund Alpha Over ETF Baskets

shyam May 16, 2017

A fund’s alpha – returns over a benchmark – is often quoted and widely misunderstood. The root of the misunderstanding comes from investors assuming that alpha is a constant – which it is not – and the funds using benchmarks that the investors cannot actually invest in. Even if an investor decides to go “passive,” there is still an active choice that needs to be made regarding the basket of ETFs he needs to invest in. Let’s answer the first question: What exactly is the active manager’s value add?

Alpha over a basket of ETFs

We select three ETFs, NIFTYBEES, JUNIORBEES and M100, since they are popular and span a fairly decent spectrum of traded stocks in the market. Then, we do a rolling (window of 200) linear regression of returns over 200 days of a few midcap funds (selected at random.) The intercept is the alpha of the fund vs. the ETFs. Here’s how the alpha varies over a period of time:

Two out of the three funds have negative alpha over the ETF basket right now. However, that doesn’t mean that they will stay there.

As an investor, you can use the betas obtained by the regression over the ETFs to “replicate” the fund at a point in time. For example, if you set the start date as the date at which each of the funds had peak alpha and just held onto the basket, here’s how the relative performances look:

In all cases the basket fixed at the peak performs at par or better than the fund. However, you never really know what the “peak” is when you are living through it. What if you fix the basket right at the beginning?

In two out of three cases, we see funds beat ETF baskets.

Summary

We use linear regression to measure a fund’s alpha over a basket of ETFs.
Alpha varies over time. Out/under performance is sensitive to begin and end dates.
If a fund’s peak alpha can be pegged, then a basket of ETFs with those betas will outperform the fund.

Categories Investing Insight, Your Money Tags ETF, mutual funds, returns

The Non-Existent ETF Volumes

shyam July 19, 2015

ETFs don’t trade in India

The NIFTYBEES ETF – an ETF that is indexed to the NIFTY – has less daily volume than RELIANCE. Median daily volumes of NIFTYBEES is around 31,000 whereas RELIANCE sees more than 3161,000.

NIFTYBEES:

RELIANCE:

In spite of paying dealers to provide liquidity

The NSE introduced a Liquidity enhancement scheme (LES) for market making in equity exchange traded funds (ETFs) effective from December 15, 2014 till February 28, 2015. It was then extended to June 30, 2015 (see appendix). The results have been mixed.

BANKBEES:

JUNIORBEES:

M100:

Daily volumes of M100 went down during the program. Here is the full list, volumes in ‘000s:

The program might have resulted in tighter bid-ask spreads but there was no surge in volumes. Retail investors remain disinterested in ETFs.

Appendix

Categories Investing Insight, Your Money Tags ETF

ETFs vs. Indices

shyam May 29, 2014September 9, 2014

ETFs (Exchange Traded Funds) offer investors a convenient way to gain exposure to a particular index. Since these funds are not actively managed, they are measured by their how cheap they are (in terms of asset management fees) and their tracking error. Before we begin, some key terms:

Kurtosis

Kurtosis is a measure of “peakedness” of a distribution. For a normal distribution, Kurtosis is 3. Positive excess Kurtosis indicates fat tails while negative indicates peakedness.

Skew

Skewness is a measure of asymmetry of a distribution. Positive skew indicates a long right tail while a negative skew indicates a long left tail.

How effective have Indian ETFs been? Lets pull up some histograms and see for ourselves.

NIFTYBEES vs. CNX Nifty

The Nifty ETF actually shows a -ve skew and a lower kurtosis compared to the index. This is how tracking error and fees manifests itself in daily returns. However, their impact on cumulative returns is minimal. The story for less liquid and higher-fee ETFs are different.

PSUBNKBEES vs. CNX PSU BANK

Notice the big difference in kurtosis and skewness? This is tracking error personified. The story for the Juniors’ are not that different.

JUNIORBEES vs. CNX NIFTY JUNIOR

Given that there really isn’t much of a push either from investors or from asset management firms on ETFs, the dynamics are unlikely to change in the short term.

Categories Investing Insight, Your Money Tags ETF, returns

To SIP an ETF or Not?

shyam February 2, 2014

The two holy grails of investing: dollar cost averaging and low-cost investing come together if you systematically invest in an index ETF. We took a look at returns on doing an SIP on JUNIORBEES, an ETF that tracks the Junior Nifty index, that was introduced in 2003.

Summary of Returns

Start Year (Jan)	IRR
2004	10.77%
2005	9.48%
2006	8.66%
2007	8.47%
2008	9.81%
2009	8.70%
2010	4.91%
2011	7.40%
2012	8.58%
2013	5.33%

The experiment

The question we set out to answer was: What would typical returns be if you systematically invested in a low-cost index ETF over different periods of time?

So we assume that the investor buys Rs. 5,000 worth of JUNIORBEES at the closing price on the last day of each month. We accumulate the units, the cost basis and the P&L over different periods of time, starting at 2004 and moving forward in one-year increments.

The dollar cost averaging ensures that you buy more ETF units when the index goes down and less of it when it trades higher. And by tracking the IRR we ensure that we normalize returns for the investment period.

Conclusion

We expected nominal returns to be higher than what we observed. Between 2004 and 2014, inflation was often running in double digits. So even a 10% IRR would actually be negative real returns. Investors probably would have made better returns if they had kept the money in a bank fixed deposit instead. So from a purely returns perspective, an SIP on an index ETF doesn’t make sense.

Caveat: Just because the real returns were negative with this approach in the past, doesn’t mean that it will be so in the future.

Categories Your Money Tags ETF, returns

On why passive investing is a risky strategy

shyam April 8, 2013April 8, 2013

If you are buying an investment fund, there are two main strategies you’ll encounter – active management and passive management. Passive investing is essentially the replication of an index or benchmark. For example, buying the NIFTYBEES ETF that replicates the Nifty 50 index. The aim of active investing is to deliver returns that are superior to the stock market that the companies sit within. An actively managed fund can offer you the potential for much higher returns than what a particular market is already providing. The debate as to which of these strategies is better has been raging on for the better part of the last 20 years. Whenever stock-market indices recover from a crash, the debate re-emerges.

The problem with passive investment is that passive management is only theoretically possible.

any evaluation of passive investment funds to be complete should include withdrawal activity during draw-downs, something that can be viewed as active management by the part of the investor imposed on the passive fund.

Also, most funds that call themselves “active” are actually “passive.”

the representation of closet index funds and traditional index funds have risen to the point where they now represent approximately 40% of the active universe—making the exercise of differentiating them from true active managers more important than ever.

Traditional passive investing, using indices weighted according to market capitalisation, works best in the kind of long bull markets that ignore fundamentals, because at the end of the day, you effectively end up buying high and selling low.

Investors should be careful of simplistic arguments and biased data while allocating capital. While I remain a fan of ETFs to get broad-market exposure, it is by no means the be-all-end-all of investment choices.

Sources:
Passive Investing in Stock Indices Involves Substantial Risks
Re-thinking the Active vs. Passive Debate

Categories Your Money Tags ETF