Things to be Thankful For

What are we most thankful for at the Yinzer Analyst this year?  That sometimes we do good work that stands up and gets noticed.  Not take all the credit for this, but our recent post on how to spot managers who are really closet indexers and charging you serious fees in the process has gotten some serious notice and someone is doing something about it.

European markets watchdog examines closet trackers

“The European markets watchdog is probing “closet tracking”, which critics say is enabling fund managers to charge high active fees while in practice doing little more than hugging an index.

A letter from Steven Maijoor, chairman of the European Securities and Markets Authority, to consumer organisation Better Finance For All, seen by FTfm, said the regulator was “gathering more information to assess the scope of this issue”.

Better Finance wrote to Mr Maijoor last month highlighting an investigation by Finanstilsynet, the Danish regulator, that found overpriced closet index funds were widespread.”

Plenty more that you can read about here.

And to all those mutual fund investors out there….you’re welcome.

Sunday Night Recap: Shades of 2011?

For the Yinzer Analyst, Yogi Berra’s greatest line of all time has to be “It’s déjà vu all over again” and while we may not be watching the greats like Mantle and Maris, the expression holds just as true in the equity markets. Last Friday reminded me of the quote when it seemed like we were stuck in a time warp back to 2011. With one central bank contemplating how it wants to tell the markets that rate hikes are coming possibly sooner than expected, others around the world are literally throwing the kitchen sink at the dual problems of weak confidence and low aggregate demand. While there are still a few more weeks in 2014; I’m starting to get really excited about what changes could be coming down the reallocation pipeline for 2015.

We’ve talked extensively in the last few weeks about Europe and Mario Draghi did not disappoint on Friday. Not to be outdone by the PBOC’s first rate cut since 2012, he indicated that inflation in the Eurozone needs to return to the 2% mark “without delay” and from there, it was off to the races. Now I know we’ve heard a lot of talk from the ECB and yours truly has been among the first to label most of Mr. Draghi’s statements as “pillow talk” but now I’m beginning to wonder if a major change is afoot for investors.

Let’s start with a daily chart of the iShares MSCI EMU Index (EZU) and picking up where we left off last Monday, you can see that the ETF was indeed range bound between prior support and the downtrend line so score 1 for the Yinzer Analyst. Honestly I can’t say I am disappointed by the outcome, I would have been far more disappointed if it weakened and fell back below the downtrend line that has held it in bondage for most of the fall. But with Draghi’s commitment to creating inflation (something the Fed hasn’t been able to accomplish) and by inference expanding their balance sheet, EZU was off to the races on Friday and recent laggards like Italy, Spain and event France outperformed Germany and EZU.


What makes it more important is that unlike domestic equities, EZU traded in a fairly narrow band for the day with the close almost at the midpoint between the high and low of the day which was at the prior support/resistance band around $37.80. SPY on the hand closed significantly closer to the low of the day and even then was only saved by the afternoon ETF buying. For small and mid-caps the situation was far worse with IWM giving up nearly all of Friday’s gains to close only slightly above that of Thursday’s.

spyNow before you think I’ve fallen completely in love with my investments, you should know that while the Yinzer Analyst is a lover and not a fighter, he always keeps a wary eye where money is concerned. While the recent performance is a great start, it’s only that…a start. You can see on the following charts that EZU has a long way to go before it can crack the relative momentum downtrend line that formed early in 2014. Until then, I’m treating last week’s outperformance as an interesting early sign and part of several trends, all as yet still in their infancy, which could spell a major shift in the market dynamics. Let’s start by looking at a few of the other throwbacks from 2011.

EZU-SPYEZUDTEquity Precious Metals:

Let’s begin with the big shiny yellow rock that most investors have come to hate, gold or in this case the gold miners. After a painful fall (no pun intended), GDX has finally cracked that downtrend line that held back its progress although it seems to be losing steam as it approaches the simple 50 day moving average. If it can clear that, there are legs to the downtrend line between $21 and $22 but then nothing but sweet air until the 200 day moving average at $24.01 and then prior support at almost $26.



The first big central bank announcement on Friday where the PBOC announced its first interest rate cut since 2012. While the hikes of the last two years were attributed to the need to cool off rampant speculation in the housing market, I subscribe to the school of thought that says the true purpose was to prevent and then slow a capital outflow that has seen large amounts of investable funds transferred to overseas markets by Chinese nationals. Normally I’d say the proof is the Vancouver, New York or Boston housing markets, but I’d encourage you to check out Michael Pettis’ blog for more (here.)

Look at the Shanghai Exchange, were the multi-year underperformance relative to the S&P 500 ended this summer after the market finally reached rock bottom in March on concerns over the health of the Chinese banking sector and the various off-balance-sheet financing vehicles. While still in its infancy, this recent trend has still pushed Shanghai above the S&P 500 in 2014 and not too surprising considering that 100% of 2014’s returns have come from earnings growth rather than multiple expansion. It’s entirely possible that as the Federal Reserve begins to seriously consider rate increases to cool the economy and with valuations as stretched as they are already, investors may have to shift their focus overseas if they’re seeking larger equity returns.


2014 S&P 500 Return Attribution: Source: Yahoo Finance, Standard&Poors, The Yinzer Analyst

Brazil and Mexico: “So far from God and so Close to the United States”

And while China may have been the only emerging market on anyone’s mind last Friday, the real action was south of the border where investors found a whole bunch of new reasons to love Brazil again. In many ways, the story of Brazil and Mexico closely resembles the European model; in Brazil the story or rising rates, weak growth and political uncertainty surrounding the re-election of Dilma Rousseff contrasts sharply with Mexico where a stronger economy with its deep ties to the U.S., combined with the election of Enrique Peña Nieto and promises for major reforms to the state-dominated energy sector has helped make the country a darling for international investors. Before Friday’s rally the iShares MSCI Mexico Capped ETF (EWW) was up .68% in 2014 compared to a negative 3.41% for the iShares MSCI Brazil Capped ETF (EWZ) while over the last three years EWZ has an annualized return of-5.97% to EWW’s 10.41%.

What prompted this stunning reversal of relative momentum? On the surface, EWW enjoyed a solid 1.44% advance on Friday as investors digested lower economic growth forecasts for 2014 and 2015 while EWZ rallied sharply, up 6.83% and with the Real gaining ground against the dollar for the first time in almost a month on news that President Rousseff may be close to a new economically savvy finance minister. But on deeper inspection, the real story may be the shift in political instability from Brazil to Mexico. President Peña Nieto continues to deal with the fallout from allegations of crony capitalism as well as the murder of 43 student teachers while the instability surrounding the recent elections in Brazil as well as alleged corruption at Petrobas begins to fade. Given the weight of Brazil in the largest Latin American tracking ETF, the iShares Latin America 40 ETF (ILF), at 45% compared to Mexico’s 31.7% and the relative underperformance of EZW to EWW over the last three years could signal a change in relative momentum could help lift ILF from its multiyear momentum lows versus the S&P 500.

EWWWhile the recent outperformance of Brazil among Latin American markets may yet prove to be short-lived, it does raise the question of whether Mexico can expect to trade-in line with its peers to the south or its larger trading partner to the north. Given the highly integrated nature of our two economies, Mexican stocks could find themselves being left behind by other international markets if U.S. equities do begin to lag as investors seek out markets with more liberal monetary policies. Porfirio Diaz may have it right after all.

Saying Anything Part Deux?

Ask any of my co-workers and they’ll tell you that I’ve been the biggest cheerleader for investing in Europe since 2012 and while It’s been nearly two weeks since the last post devoted to Europe; I slook at yesterday’s big move in European-oriented ETF’s as a lot of energy expended on Mr. “Say Anything” Draghi and an investor sentiment survey. Having some capital to put to work, I’m very tempted to load up on some Eurostock exposure, but instead I’m going to pull a Costanza and not do anything. It’s very easy to get caught in the excitement over the sector starting to show signs of life, now is precisely the time when it pays to take a step back and instead of selling my mint-condition G.I. U.S.S. Flagg carrier so I can buy more EZU I need to decide what my targets should be and what I expect for this position.I know, totally Debbie Downer. But I’ve fallen in love with Europe before and been burned, so this time, we’re going to have some ground rules baby.


  • Momentum is improving: Both on an absolute basis compared to its recent history as well as versus the S&P 500, Euro stock sentiment is heading in the right direction. Looking strictly at EZU’s history, two weeks ago the ETF was literally at rock bottom. Both the short and long term rankings were so low they didn’t deserve a percentile score and worst yet; it had been that way for some time. Momentum, like volatility, tends to persist so winners will continue winning and losers losing until the trend changes. When you’re winning, low rankings tend to be followed by positive performance over a certain time frame, in the case of EZU, it was followed by more losses. But there may have been a trend change and momentum scores are just to the median indicating that more gains, however marginal, could be had.  On a relative basis, EZU has broken the downtrend line that formed in September and while I’d like to see a retest of the line to see if EZU can stay above it, the situation is improving. On a longer-term basis, we’re still in a downtrend channel which is why I’m reserving judgment on whether there has been a major trend change.ezuspy2ezuspy
  • U.S. Stocks are overbought: With today’s strong large-cap performance, the S&P 500 has crossed the 70 threshold for the RSI 14 score while short-term momentum scores have pushed all the back to the 100th percentile. Longer term scores are still outside the top quartile, but only just and the overall momentum rankings haven’t been this high since early June. Doesn’t mean the situation is going to reverse, but U.S. stocks are way too strong and need a cooling off and opening up the possibility for spill-over to other regions.SPY
  • Seasonality: Speaking from personal experience, late November and early December are the prime-times for strategic allocators to start reviewing their allocations and making changes. Typically those were done in the last two weeks of December but the light volume has pushed a lot of that into early December. After the mixed year, the annual re-balancing from U.S. out-performers to Euro under-performers won’t be as strong as last year but some of the big sell-side firms are raising their targets for Eurozone stocks versus the U.S. so we could see major strategic shifts.
  • Long Term Monetary Situation: Probably the most overused argument for investing in Europe (and I should know, I’ve used it like a thousand times) is that at some point, the ECB will HAVE to start expanding their balance sheet and be aggressive about it. With the balance sheet back to 2012 levels, Europe is suffering from a major shortage of walking-around-with money (not actual currency) and will have to start throwing everything including the kitchen sink at the problem. Normally I’d say that this argument carries as much weight as “demographics” but I know it to be true and compared to the U.S. which is undergoing a form monetary tightening and potentially more fiscal tightening next year, I still say invest where the money is cheaper or going to be.


  • Valuations are Rich: That whole, “they have to start printing argument” that everyone uses? Well EVERYONE has heard it already invested so from a valuation standpoint, most Europe oriented ETF’s are already seriously overbought and trading at extreme valuations. That’s always the downside of waiting or worse yet, following the herd. The best time to buy European stocks was in 2012. Now you should be adding to positions, not taking on whole new ones. If you looked at the most recent factsheet on the iShares website, EZU had a trailing 12 month p/e of 22 as of 10.31, pretty rich compared to the S&P 500 at a little over 19. Compared to prior history, if you haven’t done so yet, sign up for a free trial at (note, the author isn’t paid by them, he just thinks they’re really cool) and then go type “EZU” into their quant screener. Under fundamentals, you’ll see their P/E ratio close to historic highs.
  • Since when do fundamentals really matter? It’s been a while, I’ll grant you that. My concern is that if the ECB finally does s%$t instead of getting off the pot, the losers will be anyone who buys more equities at these levels. Remember the run up EWJ had in early 2013 after the announcement of “Abenomics?” It peaked in May of 2013 and then started consolidating and didn’t see that old high until the summer of 2014 and has only been above it briefly since. U.S stocks had a similar experience in May of 2010 after the bottoming out in 2009 where we had to consolidate and let earnings catch up to prices which didn’t happen until October of 2011 by when the P/E ratio had fallen over 30%.
  • Short Term Technical Outlook: So on a daily chart; EZU has just PLOWED through another downtrend line from September and ran smack into prior support right at the high of the day. The real question is how much strength it has to push higher? And it has to do it Wednesday because EZU is literally sitting on the downtrend line. So it pushes higher, clears resistance and then hopefully cools off to retest it, breaks down, or literally goes nowhere. Sounds like we might have a chance to buy at a better price than Tuesday’s close.ezuD
  • Political Reality: Listen, I love Mario Draghi as much as the next man. He’s the real super Mario in my book and he’s vying for my #1 central banker spot with Stanley Fisher, but the man can only do so much with what he’s given. This isn’t Washington where the Chairman rules with an iron first; only the Germans can do that and they still don’t want to play ball. Draghi will have several more opportunities to jawbone the market before the end of the year but for me, the proof is in the pudding.

So far ECB covered bond purchases have amounted to a whopping 10.5 billion Euro’s which compared to the Federal Reserve is like bringing a knife to gun fight. Asset backed purchases should start this week but total issuance per in the first 3 quarters of 2014 was something like 154 billion euro’s….in 2008 it was over 800 and most are retained by the banks to use as collateral for loans. So they only way the ECB can buy what it intends would be for banks to issue hundreds of billions more…by extending loans (that they don’t want to make) and only to the highest quality buyers (who don’t want them) because that’s all the ECB will buy.

So when does the recovery start again? I stand by what I’ve said before; until Germany begins to feel some real economic pain, they have no incentive to make quick changes to their views on ECB policy and with the latest ZEW survey results, I’m sure they think the pressure is off.

For me, the next couple of days are going to be crucial. I think the recent experience with Japanese and Chinese ETF’s and their strong and unexpected performance reminds me of a great lesson I learned at my last employer. We were discussing a certain investment and someone said, “yeah, but I can’t see what the catalyst is going to be that drives it higher from here?” Does anyone EVER actually know exactly what the catalyst is going to be…ever?

If you were playing the long game in late 2013, you would have been thinking that China wouldn’t let their financial sector collapse, especially in the midst of a regime change. It was a tough quarter but after an inverse head and shoulders pattern, the Shanghai exchange took off and never looked back and is still outperforming the S&P 500 by around 500 bps in 2014. And who can keep up with the latest political machinations out of Japan but after the slowdown from their retail tax increase, it was predictable that more QE would be the solution (for investors anyway.)  And for all the wailing about European lagging America, from July 2012 up until this summer EZU was actually outperforming the S&P 500, it was only after the latest weakness that Europe lagged and is now performing in-line with domestic equities.


Trading Strategies:

ezu3If you’re really determined to buy some Europe and don’t want to check out some great mutual fund managers, I’d say it’s hard to go wrong with good old EZU. Like I said, EZU is literally stuck between Scylla and Charybdis or in this case, prior support turned resistance and the downtrend line that held it back for so long. Best case, it breaks through $38, makes a push towards $40 where it fails and falls back to hold at $38. It would be a lot easier to be confident about EZU then, especially if it diverged from Japanese and U.S. sentiment, preferably by outperforming on the downside.

Given the amount of volatility we’ve seen in 2014 and the distinct possibility that everything coming from Frankfurt is hot air, I’m also inclined to keep my eyes on a new offering from iShares, the iShares MSCI Europe Minimum Volatility ETF (EUMV.) It’s a relatively recent offering with a limited track record and thinly traded compared to EZU but according to it was down 2.44% over the trailing three months and up 6% in the trailing one month compared to down 4.26% and up 5% for EZU. Not a huge fan of “smart beta” strategies and low vol only works when market volatility is high like in 2011 or 2014, but assuming Europe doesn’t have its act together, this could be a winner.

Sunday Night Recap: The Pause that Refreshes

I don’t know about any of you, but last week had to be one of the most boring since the end of the 2nd quarter. I know, you read here last week that the S&P 500 needed to take a pause to allow it’s nearly overbought conditions to stabilize but it’s so damn hard to get excited about hitting new highs every day when that involves an advance of about 4 points on the back of declining volume. In fact this week was one of the lightest since mid-September…right before everything went to heck. Behind all that snoozefest though, the S&P 500 saw a great deal of sector rotation that saw some of this year’s biggest winners lose ground.

Take a look at the sector table for a better look at this rotation:

SECAfter lagging in the October rally, telecoms finally began to gain ground while tech stocks and materials continued their recent momentum. On the laggard’s side of the column, we see the same names we talked about last week with healthcare underperforming the broader markets while financials and reit’s continue to get hung up over legal concerns and rising rates. The biggest loser this week were the utilities, with a weak sell-off on Tuesday turning serious on Wednesday and pushing XLU back into neutral territory and close to support around $44.50. How long will this weakness run for is another story.


xluspyIn fact, one of the big success stories for the week was that the gold miners managed to advance for two consecutive weeks for the first time since, well, I can’t remember when.  Partly on the back of stories about Russian gold hoarding and partly on a dollar that may be topping out, GDX is closing in on prior support at $20, let’s see if it can break above it and stay there before getting too excited about going long.

GDXUUPBut even with the sector rotation, breadth has remained noticeably unchanged. The % of stocks above their 200 day moving averages dropped slightly while those above the 50 day increased slightly on the change in sector leadership although that wasn’t enough to keep the new hi/lo indicator from continuing it’s divergence. What has it done? It’s allowed the recent momentum to cool off and give the market a fighting shot for another push higher.

spyHILOWhen the market closed on the 7th, the S&P’ short term momentum was in the 3rd percentile while longer term momentum scores were back to the 40th percentile. It doesn’t sound like much but on October 16th the short term scores were in the 99th percentile as were the 1,2, 3 year scores, about as weak as momentum has been for the S&P for a very long time. If we have advanced another 20 points from the 2031 close on the 7th, all of these scores would have been in the 1st percentile and setting the ground for a sustained pullback below 2000 to let the market cool off. For now, the most likely route for the SPY is a slow drift back down to $202.

ASHRThe real action for the week was overseas; and not in China where the A-share market continues to plow higher before the beginning of cross listings between Shanghai and Hong Kong. The Euro managed to gain a slight amount of ground against the U.S. dollar on….well it’s hard to tell what these days. Less bad GDP forecasts? Countries beating their incredibly low GDP forecasts? Who knows these days, but FXE has bounced off the lower boundary of its symmetrical triangle pattern indicating a more sustained bounce might be in the forecast. Meanwhile Eurozone stocks, represented by EZU, bounced higher and actually outperformed the S&P 500 on very light volume.

While a nice turn of events, EZU still has a long way to go before challenging its downtrend line or regaining some of the lost momentum versus the S&P.


ezu2Besides industrial production on Monday and the Fed minutes on Wednesday, it’s going to be another quiet week for the markets so use this opportunity wisely. Do your research, watch your charts and figure out just how long you want to be heading into Thanksgiving.

Good hunting!

Know Your Mutual Fund Managers: Watch out for Closet Indexers

First, apologies for the long gap between posts.  The Yinzer Analyst has been feeling a little under the weather and what with having already seen every episode of the Venture Brother’s twice and a slow week for the markets, I figured now was the perfect time to play catch-up and finally publish the once promised and often delayed posting on how to spot my least favorite category of fund managers; closet indexers.

There is literally nothing that upsets me more than people who take your money for a promised service and then fail to deliver. It’s happened to me dozens of times in my personal and professional lives and it’s always an infuriating experience. Investing in mutual funds is in an easier and more liquid way to invest with some of the greatest money managers in the world despite what you may have heard from any number of investment “professionals” you see on the nightly news. Finding myself increasingly as one of the few who’s still willing to defend mutual funds and active management, I decided it was time to man up and try to arm you with the tools you need to spot managers who whisper into your ear about their great process only to hand you lackluster performance. Of course, anytime you have a system that involves trillions of dollars, vague benchmarks and misaligned rewards systems, you have the potential for a handful of managers to abuse the public’s faith in the system.

How does it go? Well first, you’ve got cash and you need to invest it and being of sound mind, you search for a great mutual fund, do your research (or often your adviser claims to have done it for you) and you invest in a fund that promises NOT to outperform a particular benchmark but simply that it has system it believes adds long-term value. Looking at some very glossy and sexy handouts, you you’re your investment (hopefully without paying a load of some kinds) and in your naivety feel it’s okay to pay an “average” fee for the potential to outperform. What happens then? Well you most likely you forget about the fund until it’s time for your annual review or if your fund family is hopeful, you forget you have the account until it’s time to retire. That’s when you discover this top-rated fund managed to deliver hopefully “blah” performance in line with the median fund in the category and soaked up about 1% to 1.5% of your annual performance doing it.

Now I haven’t come to bury active mutual fund managers but rather to sing their praises and I’ll be the first to admit, managing money is not easy. Even when you have a well-defined benchmark with a specific subset of stocks to choose from, people are always demanding more and if you fail to meet the benchmark for one to two years, you’ll probably find yourself out of a job and hence the origin of the expression “career risk” and why managers in certain categories tend to cluster, all holding the same securities in similar amounts lest they get left behind. When it comes to managing a mutual fund, there’s no sin in being the average performer, but if you find yourself in the lower quartile once too often, you’ll be managing money for the “Widows of Retired Circus Freaks Retirement System” and guess what that pays?

So how do we go about spotting a closet indexer? First we have to take a deeper dive into the terrifying math behind the concept of “Tracking Error!”

Tracking Error:

Tracking error is actually a fairly simple concept that even a liberal arts major like myself can understand. Before we get into the basic formula, remember that every mutual fund has a benchmark, which for the lay people in the audience is simply an index that the manager of the fund has decided best represents his universe of available investments and has accepted as a valid metric to compare his performance to. For the rest of this paper, we’ll be looking at the universe of managers that Morningstar has pegged as “large cap blend” managers where the typical benchmark is either the S&P 500 Total Return index or the Russell 1000 Total Return Index. All the managers we will be reviewing have the S&P 500 TR listed as their primary benchmark and came from a Morningstar Direct list of 309 mutual funds where the only search parameter was their category and oldest share class. For the sake of simplicity, all share classes other than “A”, “Investor” or the lowest possibly minimum investment for that fund have been eliminated.

Tracking error is simply defined as the difference between the return of the portfolio in a given period minus the return of the benchmark. Using monthly returns, this would be represented as (Rp-Rb) but the number generated is typically useless by itself, so we look at the tracking error over a longer period of time. For example, if I had sixty monthly returns for the XYZ Fund and the S&P 500, I would simply calculate the tracking error for each month, find the standard deviation and then multiply it by the square root of 12. This gives me a more practical number that can be compared to funds across the same segment of funds to determine how closely they track their index.

It’s easier to understand tracking error by looking at a basic example and since the Yinzer Analyst is about as basic as it gets, this should work for us:

Sticking with the Large Blend theme, what if you could actually have invested $100 in the S&P 500, reinvested those dividends and resisted the urge to up and bail in the summer of 2012 like everyone else? Well as you can see below, 2013 was a very good year for the large cap stocks and you would have ended the year up 32.41%. Not too shabby, except for the fact that you can’t actually invest in an index but have no fear, Vanguard is here. No, I don’t work for Vanguard (although I do invest in their funds), I just like stupid rhymes.

So if you had purchased $100 worth of the Vanguard 500 Index Fund (VFINX) you would have earned the return of the S&P 500 minus about 17 bps for expenses. But those 17bps, while on the low end of the fee scale, introduced a certain amount of tracking error into process. For the sake of simplicity, let’s assume the .17% or 17bps fee is deducted monthly in equal installments throughout the year instead of quarterly or annually.

Now if you looked at our table, you’d see that each month a few cents are deducted from your account as the fees are liquidated and paid to Vanguard for its trading and record keeping. By the end of the year, you’d see both a slight difference in performance and minor tracking error from the fee liquidation. So tracking error isn’t a negative, it’s an inevitable part of the investing process. Anytime you look at the difference between your investment returns and a particular benchmark you have referenced your investments against.

VFINXVFINXTENow what if you decided to come to The Yinzer Funds (Ticker: YINZX -trademark pending) to invest in our new Large Cap Core Super A Awesome Fund where we charge an industry average fee of 1% or 100 bps annually and then just take your money and index it to the S&P 500? Well, to reuse the same tired chart, you’d see the following:

YINZXYINZXTEYes, literally all of the tracking error in these last two examples comes from fees, not from having holdings that aren’t part of the S&P 500 or over/underweighting sectors/individual securities. Literally, just whacking money out of your account (often to repay your adviser for investing with me in the first place) gets you a tracking error of 1%.

Now this was a very simple exercise to show you how to calculate tracking error, in practice it’s much more difficult because you first have to establish what the appropriate benchmark for the fund is. You would think that fund companies have a vested interest in presenting you with the most relevant and pertinent information but truthfully, they like having the process be opaque. As I mentioned before, there are two indexes that are commonly used for benchmarking large blend funds, but how do you determine which to use?

You can find everything you’ll need to do a quick-and-dirty check for closet indexers on the free side of First type VFINX into the quote field and then look at “Ratings and Risk” and scroll down to MPT Statistics. You can see here that the Best Fit and Standard Index both use the S&P 500 and the R2 (how much changes in the index affect changes in the mutual fund) is 1, indicating that all of the change in the fund is due to changes in the benchmark. The beta is also 1 and the alpha is slightly negative, exactly what we would expect from an indexed mutual fund.

Now I understand that many of you reading this have no interest/desire to actually download returns and calculate tracking error manually, so is there a quick and dirty way to get it from a website devoted to mutual fund information like Nope and there’s a great reason why. Tracking error is half of what’s needed to derive the information ratio, which is simply the active return of the fund (Rp-Rb) divided by the tracking error. It’s one of the most powerful tools used to analyze how effective a manager is at adding value against a benchmark, so logically the last thing they would want is for it to be something you could easily find on any website. These tools are available either by downloading the returns of the mutual funds from Yahoo Finance, sometimes from the fund families themselves and to those who subscribe to the more advanced Morningstar systems, Factset, Bloomberg, etc.

Now that we know what tracking error is as well as some of the more common tools for analyzing mutual funds, let’s start tracking down our closet indexers.

Index Funds

So how can we use tracking error to sort out the true active managers from the closet indexers out to collect your fees for below average performance? First I re-screened my list of 309 mutual funds in the large blend category looking at their five year tracking error versus the S&P 500 TR index and pulled together a list of true passive index funds as an example of how they would appear.


You can see a few common traits that are easy to find on

  1. They actually have index in the name. Very obvious but always start by eliminating the obvious!
  2. Holdings: They typically have the same number of holdings as the index
  3. Average Market Cap: Their average market capitalization is close to the index
  4. Fees: Typically very small; index replication is pretty easy and a very competitive market.
  5. Risk Statistics: If you go to, type in any of these tickers and then go to Risk, you should look at their Alpha generation. It should be slightly negative as their simply replicating the index minus their small management fee. Beta should also be close to 1.

Two obvious questions that stand out are why is PIIAX’s tracking error/fee so large relative to the other 4 and why does PREIX has a large number of holdings? Large banks typically offer their own index funds as a convenience to clients and often will charge a higher fee as the client prefers the convenience of having all of their assets at one institution to opening a separate account to save on fees (and potentially losing the savings in ticket charges.) PREIX might be a case of semi-active management that we’ll be discussing later on.

And now that you can spot the index funds, here are a few examples of true active managers that I culled by picking 4 managers with a relatively high R2 to the S&P 500 and tracking error below 10, 1 manager with a lower R2 and a high tracking error that indicates a misfit benchmark.


What stands out? Typically they have smaller and more concentrated positions. Second, their performance is all over the map. Remember, just because they have higher tracking error doesn’t mean they actually performed any better; just that these fund managers actually try to outperform and you’ll have the opportunity to stand out more from the pack. Doesn’t mean they’re any good at it. Once you have a short list of funds, you have to go beyond the quantitative to the qualitative. USA Mutuals Barrier Fund is more commonly remembered by its former name, the VICE Fund. Supposedly focused on companies in very specific industries, it really screened stocks based on a strong name brand and prohibitive barriers to entry or other economic moat.

So now that we know what to search for to spot index funds (again besides looking at their names), how can we spot closet indexers? First we need to delineate closet cases from what are probably best called “semi-active” managers. Semi-active managers (“semi”) represent a perfectly valid strategy where they tend to hug the benchmark but will have small, active mis-weights against the index. For example, they might benchmark 90% of their assets to the index but overweight healthcare stocks while underweighting energy, which would have helped them, be in the top tier in 2014. In fact, Hartford Disciplined Equity has followed almost that exactly playbook and is nearly in the top decile for the trailing 1, 3, and 5 year periods. Their goal isn’t to drastically outperform the benchmark but to generate a small amount of alpha over time that should compensate investors for their fee’s plus a small return.

CLOSETLooking at the table, the semi active managers are distinguished from the dastardly closet cases by a few key characteristics:

  1. The semi’s typically have a slightly lower R2, slightly less negative or even positive Alpha and slightly higher tracking error. The first three managers all meet this criteria so I classified them as SA for semi-active.
  2. ClearBridge Appreciation might seem to be a borderline case of closet indexing, but if you look closely at its beta and average market cap, you’ll see that it’s really a giant core fund being shoved into the Large Blend category by Morningstar. For the amount of systematic (market) risk the fund has taken on, they’ve nearly generated enough of a return to compensate investors (less negative alpha.)
  3. The next four funds all meet my standard for closet indexers. High R2 to the index, High Beta, negative alpha and greater than -1 and most importantly, their tracking error less net expense ratio is typically around .5 to .6. These funds…are closet indexers. PNC Large Cap recently had a change in management in October of 2014 and hopefully their new team will be taking the fund in a more active direction.

The worst of the managers still in the closet is the Spirit of America Large Cap Value Fund, a fund so awful it’s in the lowest quartile on a 3 and 5 year annualized basis. Of couse, with all the difficulties active managers have had in the last year, it’s actually only trailing the S&P 500 TR by 127 bps in the last year. This fund represents almost everything I hate about closet indexers but if you’re wondering why you’ve never heard of the fund before, it’s because SOAVX is only available on one platform, the David Lerner Associates; a Long Island based broker dealer with around $9 billion in assets (according to their website.) And why would they use this fund. Spirit of America Funds was created entirely to provide products to David Lerner Associates which is probably the reason behind the high expense ratio and above average 12b-1 fee of 30 bps.

So to recap, why do I hate this fund? It charges high fees for essentially indexed performance and was designed and marketed solely to retain assets of clients who probably don’t know any better and never check their portfolio statements to see how much they’re missing out on. Over the last five years, VFINX has returned 15.53% annually versus 12.03% for SOAVX and that may not sound like a big difference; think about what that 3.5% difference would look today. If you have invested $10,000 in VFINX you’d have $20,581 through the market close yesterday compared to $17,647 with SOAVX. That’s over $2900 you would have missed out in just fees!

Weekend Recap: Time For Dividends Again?

This weekend has not been kind to the Yinzer Analyst. First someone accused him of being “funemployed” and when he had to look it, he felt even older than usual. Then hours were spent raking leaves before capping the fun parade off with the NY Jets breaking their losing streak by beating the Pittsburgh Steelers. This is serious people, it’s like if France ended its streak for military defeats by taking on America and not only winning, but making us all eat a big block of Limburger cheese while singing the Marseilles. So it’s a perfect time to turn to the markets to provide some hope and solace in this dark hour for Yinzer’s everywhere.w1IlmWy

Market Re-Cap:

If you were watching the tape this week, you could be forgiven for thinking the clocks got set back a little too far like to last July. The volume wasn’t much greater this week then it was then and the spread between the high and the low for the week was the narrowest it’s been since the beginning of September. While it’s tempting to simply write this off because we’re finally past the old highs and the market’s climbing the wall-of-worry, this is a good time to take a look at the internals to see how much juice there might be to push up higher.


Let’s start by looking at the market breadth and being a simple yinzer, I like to keep it simple by checking out a few choice charts. The first are the % of S&P 500 stocks above their 50 and 200 day moving averages. You can see that we’re right back to levels where the market has typically found itself running out of steam. It doesn’t necessarily mean that anything bad is about to happen, just that the powerful move from October 17th to November 9th consumed a lot of energy and the rally has entered a late state. The next chart is the ratio of new highs to new lows and here we can see a clear divergence. Utilities and energy stocks had 1% days on Friday, but that wasn’t nearly enough “umph” to help keep the rally alive, especially in the face of strong selling pressure in the healthcare sector.




Why the pressure in healthcare? While it’s always tempting to say “profit taking” the healthcare sector is probably the most sensitive to political issues and with the Republican win on Tuesday night, another round of votes to repeal the Affordable Care Act are sure to be in the offing early next year. Concerns over the ACA helped depressed P/E multiples for several years until the Supreme Court decided the issue and those old fears are coming back to the fore.
So all in all, breadth is okay, not fantastic.


The most widely followed of sentiment surveys, the American Association of Individual Investors Sentiment Survey showed bullishness at the highest levels of 2014…in fact we’re right back to the highs seen in late December 2013 before the market went exactly nowhere for 3 ½ months (but in a really erratic and volatile manner.)  More from Marketwatch here. MW-CY543_optimi_20141106134122_ZH


Now after one of the strongest rallies in years; the S&P 500 can be forgiven for needing to take a breather and there’s strong support just below us around the $201.50 level. After breaking through to new highs, it would be surprising if the S&P didn’t need to stop and retest prior resistance. But fingers crossed it doesn’t break through this level because there are a whole bunch of gaps that needed to be filled after this advance.


As we talked about last week, the picture for small and mid-caps is mixed. After closing the week of October 27th with a x.x, this week confirmed the weakness with a back-and-forth action that ended with a measly .13% gain and a potential hanging man pattern (we think, looks a lot like the hammer) indicating that there might be more weakness ahead.


Dividends and Bonds:
In fact, for the first time in a long time, bonds pulled it out of the fire on Friday and racked up some very impressive gains with TLT up 1.15% on the day as the “Search for Yield” continues.  And check out the long-term chart of the ten year bond yield; it just keeps walking down the 2007 downtrend line as if it was drawn to it like a magnet. But doubt remains as to how much of it is yield seeking and how much is defensive buying although we’ll grant you that one doesn’t necessarily exclude the other. High yield bonds (using HYG) lagged this week after putting in a respectable month as doubts about the future of corporate earnings in a reduced-deficit, no Fed easing world persist.


ten year yield

Back with equities, dividend payers continue to rack up points both in the broader equity index ETF’s and in the sector plays with defensive names like consumer staples and utilities outperforming their more cyclical inclined brethren. REIT’s lagged although some of this must have to do with the fallout from American Realty Capital. But this brings me to the second thrust of this article, “Are Dividends Cool Again?”

Show me the Money!

If there’s been one sector that surprised all forecasters with its performance in 2014, its utilities where the Utilities Select Sector SPDR (XLU) began outperforming the broader market in January and now is up 24.99% YTD versus 9.93% for the S&P 500. According to Factset, in the third quarter, the utilities sector saw their earnings grow 2.8% compared to the broader market’s 7.6% and while the market typically doesn’t reward the sluggards, in this case it’s made an exception. If earnings are going to be more important going forward, why are utilities outperforming so handily in 2014? Partly because among the companies that have offered forward guidance, their expectations for future growth are among the most stable.

So far 55 companies have offered negative guidance versus 18 with a positive outlook for the next quarter. The spread between positive/negative outlooks is of skewed with tech stocks having the widest ratio (7.5X) while the lowly utilities sector has only one name offering forward guidance and of course, it’s positive. Given that analysts have trimmed their 4th quarter earnings forecasts since the end of the 3rd quarter by 53%, this stability clearly offers a lot of attractions in this brave new world without a backstop from the Federal Reserve but it comes with a heavy price. Factset now estimates that utilities are the most expensive sector based on the 12 month forward P/E ratio. While this strong performance, along with that of REITS was attributed to either annual sector rotation or a quest for yield, the Factset Earnings Insight Report leaves little room for doubt that consistent earnings and expectations for more of the same are also playing their parts.

While the financial sector theoretically has the third highest earnings growth this quarter at 16.4%, according to Factset if you removed J.P. Morgan it would drop to 2.8% putting it in-line with the utilities and even with a 5/4 positive to negative announcement ratio, investors aren’t feeling too generous to the banks. Continuing uncertainty over future lawsuits and settlements including the FOREX scandal has led to more cash hoarding to build up reserves while also lowering investor optimism. Factset’s 12 month forward p/e estimate for the financial sector is currently 13.5, the lowest for all the sectors of the S&P 500 and that’s been weighing heavily on some ETF’s offering a focus on preferred stocks in the financial sector such as PowerShares Preferred Portfolio (PGX) and iShares S&P US Preferred Stock Fund (PFF) both making the short list and offering dividend yields in excess of 5.5% compared to the 1.8% offered by SPDRS&P 500ETF (SPY).

For now, dividends are back on top!





ECB Governing Council – Say Anything

Draghi1Another day, another Central Bank meeting that ends in more pillow talk from central bankers, this time from the second mostly widely known Italian with the first name Mario. Saying that expectations were supposedly low going into the meeting would be a massive understatement. First of all, the new covered bond buying program is only a month old and secondly, this is the ECB we’re talking about. As prior history has shown, outside of an existential crisis they prefer to debate rather than to do. As most ECB watchers laid out, the sole determinant of success for this meeting was whether that the Governing Council somehow managed to stay united behind a single objective and leader instead of revolting against Draghi’s management style of making promises and then expecting you to deliver. It’s a pretty darned low bar and investors, including yours truly, might just about be at the breaking point.

Now why should I be so upset by this? I’m a rationale and seemingly educated human being who knows the main job of any central banker is to present the image of a well-meaning bureaucrat who’s monetary measures can help stimulate the economy while actually avoiding doing anything at all until their hands are forced. Using that logic, Draghi and the ECB have done a magnificent job up until this summer, heck even better than the Federal Reserve. From July 10th 2012, the day when Draghi promised to do everything and anything to save the Euro, to say July 10th, 2014 the iShares EMU Index (EZU) rose over 64% while the S&P 500 was up 45% and what makes it truly impressive is that it was entirely a confidence move with no follow-through. Ben Bernanke had to deliver multiple monetary easing operations in an effort to boost the FED balance sheet and instill confidence. Draghi mostly just made promises that the German’s have managed to tie up in various constitutional courts for the last 18 months while the EU balance sheet continues to contract. Pretty darn impressive if you ask me. Draghi might be the real Super Mario.


But since July 11th, 2014, the situation has deteriorated and badly with the S&P 500 up 3.23% while EZU is down 10.44%. What’s holding back the Eurozone and setting it up for long downward deflationary spiral like Japan in the pick-a-decade? YfHdABdThose dastardly Germans of course! Remember, Germany is following one of the most basic economic growth models; restrain wages to increase competitiveness, grow your economy through exports (something to the tune of 50% of GDP) and hope that your citizens never actually start to spend some portion of their savings. Think China with really good domestic beers. Following the economic slowdown that was reunification, Germany updated its model and became a leading proponent of the Eurozone single currency plan for a number of simple reasons:

1. To sell more to their southern neighbors. With a common currency and common monetary policy, the southern EU members could borrow at historically low rates and the common market/currency made German exports more attractive.
2. As the largest economy in the EU, Germany has disproportionate influence on the ECB so there was no real control over German monetary policy being given up.
3. By running a capital account surplus, the Germans have accumulated capital to use as leverage against other EU states. Be good or Germany won’t loosen the purse strings. Remember, they have ALL the money. Yes, that’s a gross understatement but just roll with it.
Those diabolical Germans. I guess the Simpsons had it right after all. And what changed this summer? Yes there’s Vladimir Putin and the prospect for lost sales to Russia, there’s the continuing weakness in the PIIGS as Italy slips into another recession. The Scottish referendum and concerns over the UK departing from the Eurozone didn’t help. But really, what happened is that German growth began to falter as a strong Euro, low unemployment and modest wage growth led Germans to actually begin IMPORTING more than they export to the rest of the world, lowering their current account surplus. The fiends. Of course, that’s exactly what’s supposed to happen when you run a current account surplus (else how are they supposed to get the Euro’s to buy your goods) but don’t tell the Germans. Remember, they’re still afraid of hyperinflation.

So why did I go through all of this? To illustrate a few core concepts that I think are necessary to guide any European trading strategy:

  1. The chances of the northern states forming a new “Northern” Euro or a return to the DM are zilch. A new DM would skyrocket against a rump Euro made up of the southern states, making German goods incredibly expensive.
  2. So Germany has the most to gain by continuing the current economic arrangement, hence their intransigence (had to look that one up) within the ECB Governing Council. The concerns over hyperinflation are just a false flag to cover their true motives.
  3. Germany will try to continue its export-driven policies that have worked for decades and a weaker Euro will appear to be the key to that.
  4. Given that, it’s likely that the Euro will continue to weaken but survive, with Draghi waiting for another crisis point to force the hand of the ECB council into agreeing with anything he says.
  5. Germany will try to huff and puff but recognizes that they have the most to lose if a coalition of France, Italy and Spain join to ease monetary and fiscal policy within the EU. You’ve seen Merkel back down before when confronted about austerity measures even to the point of agreeing to “ease” targets and underwrite small business loan schemes. In the event that the UK decides to hold its referendum and leave the EU (since they foot an increasingly large portion of the EU budget, this is likely), Germany will have no choice but to back down.

So where does that leave us? In the worst place of all, with the status quo remaining as it is until another deflation crisis begins.

Short-Term Trade Ideas:
So just to broad stroke some ideas let’s start with a common denominator, Euro weakness. With the common currency seemingly stuck in a very long-term symmetrical triangle pattern, negative investor sentiment and with most Euro institutions and leaders devoted to weakening the currency; it’s hard to find a potential catalyst to push it higher with the possible exception of short Euro positions being back to their July 2012 highs. In fact, if you had shorted the Euro on 7/11/14 or just bought the Proshares Short Euro ETF (EUO) you’d be sitting on a 9.76% gain at this point. But with all the potential for weakness, I’d be hesitant about shorting the Euro for an extended trade.

Start by looking at the daily chart of FXE below. The Euro seems stuck in a downtrend channel and given the amount of pressure it’s under, I’m concerned it would only take a small rally to get a lot of short covering so I’d like to see a failed attempt to breakout around the $125 before going long with EUO.


On a weekly chart, you can see FXE is almost back to the 2012 lows with no more prior support to help prop FXE up before hitting the $120 level. I wouldn’t be surprised if there’s a bounce of some kind at these levels with prior support around $126 acting as a natural resistance point. An even longer-term chart of the last six years shows us in a possible symmetrical triangle pattern and about to hit the lower bound. Without a major negative catalyst, like another German minister talking out of turn about new budget cuts for pick-a-nation, I think a bounce is in order.



What about equities? While we all hold our breaths on whether the ECB will come up with another plan the German’s can object to, if there is a confidence booster in the Eurozone you might see a Euro rally meaning the time to have your European equity positions in dollar hedged ETF’s like the Wisdom Tree Europe Hedged Equity ETF (HEDJ) are numbered. While HEDJ has held in better than EZU since the summer sell-off, during the great 2012-2014 run-up, EZU gained 64.28% while HEDJ was up 40.30%. There are times you want that currency return, even if just temporarily and in this case, it’ll be temporary. We’ve seen a noticeable breakdown in the historically positive correlation between the Euro (here using FXE) and EZU. If equity sentiment improves, there’s a reasonable case to be made it’ll be on the back of a weakened Euro a la Japan in 2014.



But looking at the straight picture without worrying about currencies; while European stocks could be setting up for a momentum turn around against the S&P 500 (probably off annual reallocation’s here at home), it’s hard to see a short-term catalyst to change the picture.  On a daily basis, EZU looks to be losing steam after today’s as-expected ECB press conference without challenging either the down-trend line around $37.50 let alone overhead resistance at $38 while hedged HEDJ gained .89% on the day.

For my two cents; I’d wait for FXE to bottom out and make signals like it’s ready for a push higher.  If FXE blows through $125, close out a short Euro, long HEDJ trade and be ready to plow back into good ole EZU if FXE can find the energy to get back above $126 and stay there.  If it fails, it’s reasonable to assume FXE will then be retesting $120 and there’s no reason to hold long unhedged equity positions or currency exposure for that pain trade.  But if we do get back about $126, it’d also be reasonable to assume there’s a confidence booster of some kind at play and unhedged equity exposure via EZU could be just the ticket.

Sunday Recap – Tale of Two Central Banks

It was the best of times, it was the worst of times…it was the age of easier monetary policy and, well, slightly tighter policy. While you may not have thought much about Charles Dickens since high school (or even then), I’m taking time out of the Steelers/Ravens game to debate whether Japan’s new round of Quantitative Easing should be renamed “Great Expectations.” Wednesday’s FOMC press release may have brought the much anticipated ending of QE3 and a lot of debate about the exclusion of the word “significant” but Japan stole the show in Friday. With the simultaneous decisions by two supposedly separate bodies to expand the total amount of quantitative easing in 2015 to around 15% of GDP while also lengthening duration and then the Government Pension Investment Fund finally deciding to shift its asset mix to a more equity heavy posture that FT calculates could result in nearly $200 billion being reinvested in domestic and foreign equities.

While more than a few prognosticators on Monday will tell you that the easy money has already been made, given the positive correlation between equity returns and quantitative easing in multiple markets, I think it’s worth investigating whether there’s the possibility for more room to run in Japan.

Let’s start by looking at the primary victims of QE programs, and as you can imagine, QE hasn’t been kind to the Yen now down over 6% in 2014, and back to levels last seen in the second half of 2008. While FXY might be oversold after Friday with a weekly RSI (14) score back to 26.21, it has been trapped beneath its 50 week moving average since 2013 and those Friday press releases won’t be adding any lift to the Yen anytime soon. But after years of little investor interest, only 4 funds targeting currency exposure are currently marketed.


Switching to equities, one of the strongest performers in the Japanese space this year is the WisdomTree Japan Hedged SmallCap Equity Fund which does appear to be overbought in the short-term with a big gap to fill between $31-$32 (DXJS) which besides having nearly 25% of its equity exposure in small-cap industrials that in theory should benefit the most from a weakened Yen offers hedged exposure to prevent further declines in the Yen from hitting your portfolio statement too hard. If you think the currency doesn’t matter, compare DXJS to its non-hedged equivalent the WisdomTree Japan SmallCap Dividend Fund (DFJ) up 1.78% YTD after Friday compared to 7.78% for DXJS.


With Japan having gone nuclear with its monetary policy, all eyes are now sure to shift towards one central bank with a contracting balance sheet and the ECB Governing Council which is meeting this week in Frankfurt and will feature Mario Draghi doing his best to convince you that the ECB will actually attempt something…at somepoint…someday. While consumer prices have ticked up slightly by .4% in October, core inflation remains significantly below the 2% threshold while EU unemployment remains high at 11.5%. While the ECB has been reluctant to put the pedal to the metal, I remember the old adage to “buy the rumor and sell the fact.” The only difference is that the ECB lacks the structure and decision making process to make quick decisions…hence the fact they’re still in this situation instead of keeping the recession in the rear view mirror.


As you can see above, the Euro appears to be stuck in a long-term descending wedge pattern as periods of Euro strength/dollar weakness appear to be shorter and shorter in duration and with far smaller peaks.  Is it possible that a future QE announcement could help propel the Euro below the $118 level?  On a more positive note, the historically positive correlation between the Euro and European stocks seems to have reversed as Euro weakness brings in buyers.  Not surprising given the high current account surplus for the Eurozone as a whole…weaker Euro, stronger imports, could be a winning formula for EU leaders and how they have to sell it to their citizens.