By Robert Powell, MarketWatch
BOSTON (MarketWatch) — Big bet or safe haven? At times like these, times that try one’s brokerage account, you would not be alone in thinking that those are the only two possible moves to make given current market conditions.
And of the two choices, a chorus of institutional investors is suggesting that making a big bet right now just might be a big mistake for most average investors.
“My advice would be don’t bet the house,” said Lubos Pastor, a finance professor at the University of Chicago. “Stock volatility is currently at more than double the normal levels, so we can expect large price moves, up or down, in the next few days. Not everyone is in a good position to stomach that volatility.”
Others are singing the same tune. “My thoughts are very simple: big bets, either direction, are easy and dangerous,” said Rob Arnott, the chairman of Research Affiliates, LLC. “There are 2x and 3x ETFs, there are index puts, and there are stock index futures for shorting. All of these are a fast way to gain or lose money in a directional bet. I far prefer smaller bets, at most 25% of my net worth. Patience wins the marathon.”
And David Stepherson, a CFA charterholder and the chief investment officer of Hardesty Capital Management, added more of the same: “My advice to investors wanting to make bigger bets is this: Be sure you are ready to lose a commensurate amount of money. Adding risk works both ways. Everyone wants to make a lot of money and not lose any. Quite simply, the more risk you take the more money you can lose. As volatility increases, the opportunities to place bigger bets are more abundant. There is nothing wrong with taking bigger bets. Just make sure you are right because the losses could be just as great.”
And Lane Steinberger, a CFA charterholder and chief investment officer of Redwood Wealth Management, is yet another not fond of the big-bet approach. “I am not a big believer in ever taking big bets,” he said. “When people do this, they become gamblers, not investors.”
And still others took more analytical approach to the question. For instance, Nathan Erickson, a CFA charterholder and portfolio manager at Miller/Russell & Associates, suggested that investors consider the odds of success for using the big bet approach. “In most cases they are slim, and the end result is actually gambling,” he said.
Consider his analysis: There’s been 189 trading days through the end of September. Of that 189, 105 — using the Dow Jones Industrial Average as the proxy – were positive and 84 were negative. “So making a big bet on a particular day is roughly a 50/50 bet,” he said. “This sounds a bit like gambling.”
Furthermore, to make a big bet, you either need a big move, or leverage, he said. So, “if you’re looking for a big move, say greater than 1 standard deviation of the first 189 days, you would need a move of over 144 points on the Dow in one direction or the other,” Erickson said. “So far this year that’s happened 19 times up and 23 times down. So now for your investment to be successful, you not only have to guess the direction correctly (50/50), but also the magnitude. The probability of getting both of these correct based on 2011 is about 5%. One would have better success making a big bet like this pay off on the roulette table in a casino.”
To be sure, there are ways to use leverage so that you only have to guess direction, he said. For instance, Direxion Funds offers 2 times and 3 times leveraged ETFs, which are ideal for day trading. And, one could buy either the Direxion Russell 1000 Bullish 3X ETF BGU +6.86% (3x the Russell 1000), or the Direxion Large Cap Bear 3X Shares ETF BGZ -6.89% (3x the inverse of the Russell 1000), so that if they guess the direction right, the bet pays off triple, said Erickson.
However, even with this strategy it’s hard to generate a big payoff, said Erickson, who noted that the average daily return of the market (as measured by the DJIA) over 189 trading days is just 0.2%. “Guessing the direction right, a Direxion ETF would pay off on average 0.6%,” he said. “However if you guess the direction wrong and end up on average down 0.6%, you now need greater than 0.6% to get you back to even.”
So, let’s say you not only guess wrong but also catch one of those more than one standard deviation days (more than 1.25% in either direction), you would end up losing 3.75%, he said. “If you keep your position in hopes of a reversal (which only happened 25% of the time where a down day was followed by an up day or vice versa), the loss compounds even more with leveraged ETFs and you end up needing to gain exponentially more to recover,” said he said.
Safe havens?
So if not big bets, perhaps a safe haven? To some institutional investors, the answer is yes. The hard part, however, is trying to figure out what’s a safe haven.
“Cash is the obvious safe haven, especially since inflation is not a major issue at the moment, said Pastor. “I don’t view gold as a safe haven; the past couple of weeks have shown that gold is not immune to turbulence, and I expect more turbulence in gold given how expensive it is.”
Cash is one safe haven, but there are others. “Cash and short-term bonds — less than one year to maturity — are probably the safest place in this environment,” said Stepherson. “The risk profile of just about every other major asset class, including gold, has increased dramatically.”
And then there’s U.S. Treasuries and bank CDs, according to Steinberger, added this caveat. “As we have found out over the past couple of years, these are not necessarily safe havens any more,” he said.
Said Erickson: “In terms of safe-haven investments, clearly U.S. Treasuries have continued to fulfill that role in the face of fear and uncertainty in global markets and economies. However, I think most people would agree that at the level Treasuries are at now, there is significant potential to lose money should widespread confidence return. The 10-year yield is below the dividend yield on the S&P 500, without the earnings upside.”
Erickson said another safe haven — given the strong balance sheets and earnings potential of corporations — might just be a short-term corporate bond fund or ETF such as the iShares Barclays 1-3 Year Credit Bond fund ETF CSJ -0.28% . Such should be stable in most environments, according to Erickson. “If rates go up, the constant maturing and reinvesting of portfolio holdings will allow the fund to track current yields as they invest in new issues at higher rates,” he said. “If rates continue to move down, the capital gain on the bonds will offset the loss in yield.”
Erickson noted that the iShares Barclays 1-3 year ETF has a current yield of 2.08%, with a price range of returns between $103.60 and $105.25, less than 1.6% difference from highest to lowest price.
Others, however, say there’s no safe haven better than a well-diversified portfolio. “My ‘safe haven’ is broad diversification, spanning a wide array of markets, paired with large allocations to low-volatility asset classes,” said Arnott. “I’d be looking to ramp up risk materially, only when investors are truly terrified. We’re not there yet.”
Arnott is not alone in that sentiment. “A wise investor always spreads their money among different asset classes in fixed percentages and then reallocates back to those fixed percentages every year,” said Steinberger. “This approach is a proven strategy.”
Source; http://www.marketwatch.com
No comments:
Post a Comment