Avalanche of products

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Looking out at the forecast that is calling for more snow in California, NY and CO, I am reminded that the same forecast can bring very disparate reactions. In NY our guess is that they would rather not trudge through snow and slush to get to work while in California to some degree they are happy for some precipitation in spite of some of the flooding. Here in Colorado there are some who are ready for spring although by the look of 1-70, some are quite content with some more powder. We will leave it up to the reader to decide if this author is happy or sad at the prospect of more snow.

The mudslides in CA and the potential avalanche in the mountains of CO remind me of the massive amount of investment products that seem to continually build up in the product development departments of major financial institutions until they create and release an avalanche of new “innovative” products. The adviser and investment committee is now buried under the weight of massive amounts of new products and information. Bring your beacon.

Your attitude toward these products is very dependent on your perspective and how useful you deem the deluge of material to sift through. Our unbiased attitude is borne out of years of insight into the construction methodology and intent of use of these products.

A significant amount of the products out there are either chasing the same benchmark with a slight nuance or they are attempting in some cases to provide a “hedge” for your traditional investment portfolio.  In a competitive world where fees and margin in many cases are on the decline, fund houses even create ETFs to express the same views inherent in their flagship funds. This massive flow of funds into ETFs of fund managers who have won by name recognition in a lot of cases is worrisome at best. The well intended fund families who bring new innovative ideas and products need to be fully vetted as many of this is newly created and untested. Back testing against a hypothetical index does not count.

Here are a few thoughts as you sift through the avalanche of information and products.

1. Beware of products being sold as “diversification” tools. Really worry if they are touted as hedging techniques. There are very few pure hedges out there and inverse index products should be approached with caution.

2. Be open but cautious with products that tout their superior intelligence such as “smart beta”. Beta by definition is not that bright.

3. If a fund complex touts active management AND inexpensive passive management, please ask why.

4. Advisers may not get fired for holding big names with mediocre performance but to live up to the highest fiduciary standard takes a extra step or two.  a. Do not be afraid to replace big name managers or entire fund complexes if they have seen better days or if there is too much institutional risk with one firm’s horse (Seabiscut). b. Seek out unique talented managers who do not create product after product until they are the Walmart of fund complexes. That thoughtful non asset bloated manager could just be a great fit for your clients.

5. Really examine your true goal with regard to risk management and what you are attempting to garner out of the capital markets prior to an allocation in a product. Every placement is client capital. Make it count.

Whatever your snow forecast, equip yourselves with a shovel, a plow, some boots or maybe a pair of skis to simply ride over the piles of new snow. There will be a firm-wide retreat this Sunday to go skiing. That is a wrap from Zenith in Colorado.


Tom Koehler-CIO



Total Return for the core?

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A significant amount of bond portfolios in the Wealth Management and 401-k space hold as a strategic long term holding a “core” and potentially add specialty managers as satellite positions.  In many cases there is a large percentage of the portfolio in one position such as a “total return fund” that bolsters the core. Given the significance of the core in terms of assets, we will examine a couple funds that hold a lot of assets and that hold a position in many investors portfolios.

The Barclay’s US Aggregate Index is the main index for most core funds benchmark. One of the problems is that it has not evolved with the growth and dynamics of the overall bond market. It holds a 38% position in Government Debt as well as a 28% holding in Mortgage Backed Debt. 20% is in corporate debt and cash represents 13%. This breakdown explains the modest 2.18% yield. There is a chance that this index does well in a “risk-off” environment or in the case of continued disinflation but that is a lot of sector risk for a core portion of a portfolio.

We are not predicting an imminent demise of the Treasury and Mortgage Backed markets but if an investor has a total return fund as its core with the Barclay’s US Aggregate Index as the benchmark, they possess a lot of interest rate risk over the next few years.

PIMCO has a fund for most asset classes and its flagship Total Return Fund has been a strong option for investors who do not want to invest passively in a core ETF such as AGG. As a core holding, the PIMCO Total Return (PTTRX) has done a very good job at absolute and risk adjusted performance as well as gathering assets. It has over $236 Billion in just its original Total Return fund.

You are paying a 50 basis point fee for Mr. Gross and company’s view on major debt classes and right now they hold Treasuries and Mortgage Backed Debt at about 82%. This may pay off and they have had years of sizable out performance so this is not out of the question as they can make money on capital appreciation in the future but the current SEC yield is only 1.45%.

While they can use derivatives to help bolster returns and to enhance liquidity and expand into additional segments such as emerging market debt and credit, these tools did not help returns over the last year as they were essentially flat.  Remember, this fund is in a significant amount of 401-k programs and exposes the investor to institutional and sector risk. Long term, it makes sense from a risk perspective to expand the choices and to carve up the core to include other managers with alternative views on the markets.

The West Coast has another bond powerhouse TCW that runs a $4.6 Billon dollar Total Return Fund (TGLMX). Tad Rivelle is at the helm after Jeff Gundlach moved on to form his own firm. This potentially core holding given its Total Return label has a major focus on mortgage backed securities as you pay .44% to own a core fund that as its mandate will own at least 50% in mortgage backed securities. This includes prime, sub prime and alt-A debt.  Current yield is 3.14%  with a 4.22 duration and the fund regularly beats its benchmark, the Barclay’s Aggregate Index, so it does its job. We would however consider it primarily a mortgage backed fund and should potentially be used as an alpha producing sector fund.

Both PIMCO and TCW have flexibility in their respective Total Return Funds although as a core holding, we would suggest paring back on these as their mandate may not be flexible enough given their benchmark going forward. The forces that helped Government Debt and Mortgage Backed bonds may not disappear overnight but they will not be around forever. A long term strategic core position needs additional managers in sector specialties or in a fund that has much less constraint.

PIMCO feeling constrained by the core mandate created the Unconstrained Fund (PFIUX) to expand your opportunity set. This $26 Billion fund is also managed by Mr. Gross and places a lot of investor’s assets behind the macro bond outlook by this seasoned and successful veteran. This fund also has a lot of money in US Government related and Mortgage Backed bonds totaling about 51% and an additional 13% in non-US Debt. They have flexibility as the duration can range from negative 3 to positive 8 and is around 3.54 currently. With that risk you garner an SEC yield of .91% with a fee of .9%

This fund with an opportunity set that includes most global bond classes and nimble flexibility with regard to interest rates has returned on average 2.46% over the last three years. That is not an acceptable return stream in our view. We do like the nimbleness with regard to credit markets, duration management and the global opportunity set but this unconstrained fund is simply not worth the investment. We will have an exclusive piece on additional funds in this space that do warrant consideration.

We sense that investors are at a tough juncture with regard to their fixed income allocation since the traditional core holds a low yield and the potential for a real impairment of capital if rates rise substantially. For firms that are not allowed to move 100% into equities or alternatives, bonds remain an asset allocation fact of life. Given that reality, does it make sense for a firm to slice off a portion of the core to an unconstrained fund? We feel that it warrants further review given the massive amount of money piled into Treasuries and Mortgage Backed Securities under total return products.

While we respect both Pimco and TCW, there is simply too much institutional, personality and sector concentration for a continued long-term strategic placement in these total return funds.  We understand the complexities of the bond market and the sense of security with these big names but now is a great time to truly review your core fixed income to explore additional opportunities.


Tom Koehler, CIO

“Bond markets represent a complex asset class and while we covered a small amount, there is a lot more information needed prior to making an investment decision. Let us know if we can provide more information to help in that process.”

Managed Futures-A Primer

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Many investors are familiar with commodities but less familiar with the futures contracts that represent corn, wheat, oil and gold. As we mentioned in a prior post, most commodities are simply not available in physical form to most investors. To obtain exposure to this asset class, they are compelled to buy potentially value eroding commodity futures based funds or ETFs such as the Pimco Real Return Strategy or DBC-the Deutsche Bank Commodity ETF.

Most of the funds in this category are only long commodities without the mandate to short them if they feel that the fundamentals or trend has changed. The investor is in essence stuck in a basket of commodities that may not have legitimate forward looking potential. As we mentioned in our prior piece, a lot has to go well for these type of funds to do well on an absolute or risk adjusted basis. However, if there was a fund structure and mandate that allowed the team to go “long” the areas of the commodity complex they favored and also able to go “short”, it may be worth the time of an investment committee. Let’s take an initial look.

Managed futures at their core attempt to manage the risk inherent in these markets by expanding their mandate to include shorting those markets that they do not favor.

Their goal is to provide an investor with a non-correlated return stream that adds diversification to a portfolio. We have been highly skeptical for years on this asset class and thought we would take another look.

Managed futures as a category were not a great place to be invested generally over the last three years although they are touted as solid diversification tools.  The Credit Suisse Managed Futures Index and its return for the trailing three years was an average annualized -1.99%. That is only one of a few major indexes in this space as funds chose the index they track.

Fund managers attempt to achieve this diversification and potential return through a range of strategies centered on buying and selling futures contracts on a wide range of asset classes. As opposed to futures based long-only commodity funds, most of these products have exposure to commodity, currency and interest rate futures. An investor hopes that the manager is long and short the correct futures in the markets they trade in such as wheat, corn, euro dollars, or Treasury bond futures.

In attempt to achieve consistent returns, many managers will adhere to systematic trading in the short, intermediate or long term. Getting the trend correct regularly is imperative since these funds typically are exposed to a lot of markets. While a long only stock fund can focus on the factors that drive the selection for one asset class, managed futures managers need to have a deep team in order to keep track of all these markets either systematically or through discretionary assessment.

A glimpse into a well know ETF provider (Wisdom Tree) and its managed futures product WDTI may shed some light on a complex product.

“WDTI seeks to achieve positive total returns in rising or falling markets that are not directly correlated to broad market equity or fixed income returns. The Fund is managed using a quantitative, rules-based strategy designed to provide returns that correspond to the performance of the Diversified Trends Indicator™ (“DTI Index” or “Benchmark”).”

“The Fund intends to invest in a combination of U.S. treasury futures, currency futures, non-deliverable currency forwards, commodity futures, commodity swaps, U.S. government and money market securities. The Benchmark is a widely-used indicator designed to capture the economic benefit derived from rising or declining price trends in the markets for commodity, currency and U.S. treasury futures.”

It holds about $143 million in assets and has been around for roughly 2 years and its rules based methodology has as its current weightings;  commodities 41%, 58% financials and cash at about 11%. They are able to rebalance on a monthly basis the DTI index that is comprised of 24 liquid financial or commodity futures contracts.

Since this is a trend following index, it has the potential to do well in up and down markets. In flat or oscillating markets, it can perform poorly. For .96% an investor can have access to this 40 Act fund that requires no K-1 for tax purposes. That fee actually seems reasonable given the complexity of the strategy except that the cumulative returns since inception Jan 5th 2011 have been negative 16.88%.

Most relatively new products such as this, appeal to the need for additional ideas in a portfolio and for the advisers’ desire to “diversify” but a close look is imperative into this asset class given the high fees, disparate underlying indexes, overall complexity and the reasonably high disappointment in performance over the last couple of years.

We will continue the insight into the managed futures asset class in additional articles in part to uncover the amount of underlying indexes and to examine more managers.


Tom Koehler CIO


“Managed Futures represent a complex asset class and while we covered a very small amount, there is a lot more information needed prior to making an investment decision. Let us know if we can provide more information to help in that process.”

Global Bond Review Part Four

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ZPSLLC Global Bond Manager Assessment and Insight-Part Four

Our last piece on the emerging market debt segment of the larger global bond market focused on ETFs that we believe are not appropriate for most investment firms given the complex nature of this area of the capital markets and the nuanced construction of the various products. 

We would like to introduce two active managers that possess two very different profiles although they are both under the world bond umbrella. These funds possess some of the characteristics of the ETFs we described in our last two investment briefs on developed and emerging market Exchange Traded Funds.  

American Century International Bond Fund (BEGBX)-$1.1 Billion in assets

This funds’ goal is to provide exposure to non-dollar, non US government and corporate debt. Since they limit the funds hedge back to dollars at 25% it has the highest chance of reasonable performance when the dollar has periods of weakness.


  • Benchmark-Barclays Global Treasury Index-ex US
  • Duration 6.76 with an SEC Yield .69%
  • Credit-AA or better
  • Derivative use-Yes
  • Process-Yes, although the results have not been compelling given the number of portfolio managers and analytical tools.

Zenith Thoughts

This fund needs to change its mandate to expand its opportunity set as the index it mirrors has a very low yield and is heavily tilted to developed country’s bonds. Top ten holdings include a large percentage in Japan where rates are abysmally low and the UK which are also not compelling.

While they have added value at times, their adherence to a low performance potential index hamstrings this management team significantly. Even if interest rates do not move against this fund, there is simply no reason to pay for a yield of .69%. If they do move against the current positioning, it would be a negative return. The major chance that this fund has for capital appreciation is for serious disinflation in the major countries in the fund so that real yields become more attractive and the bonds have the chance to go up in value.

Given the serious complexity of the global bond and currency markets and the limited scope of this fund, we would recommend that investors sell this holding until this area of the market offers a better risk to return scenario or they have a solid thesis on the funds underlying holdings and believe that the management team can extract value.

Templeton Global Bond Total Return TGTRX-$8.3 Billion in assets

While this fund is not new to many investors, it is worth reviewing for its stark contrast with the American Century fund. The opportunity set is much wider for this fund as it can invest in government debt of any nation, supranational entities, corporate debt including convertible and preferred debt, private placements, and municipal debt.  The holdings can be any maturity and any denominated in any currency.

  • Benchmark-Citigroup World Bond Index
  • Duration 1.8 with an SEC Yield 2.99%
  • Credit-They are able to take advantage of lower rated bonds for higher income and possible appreciation due to a credit upgrade.
  • Derivative use-Yes
  • Process-Yes, robust and the results have been very strong long term although they have had a tough time in a tough market over the last year or so.

Zenith Thoughts

This fund has a wide mandate and the willingness to go well off benchmark regularly is key to their process and results. These results are not without volatility but by working within a defined risk budget among its segments of risk, they are able to mitigate a decent amount of the extra risk that accompanies these markets.

They have done well over five years as they have produced average annual returns over 8% while American Century only a little of 4%. Both managers face difficult bond market dynamics as monetary policy is changing here in the US and around the globe.

The underlying thesis for this fund lies in the global variation in monetary policy. They believe that the G-3(US, Europe and) continue to undertake very loose monetary policy which renders the value of the currencies lower than fundamentally stronger Emerging Market currencies.

This is important to note since this is a global bond fund and yet they are morphing into an emerging market bond fund by virtue of their thesis. They do however maintain much more flexibility than pure emerging market funds as they can hedge back into the dollar to the extent they believe is appropriate.

We believe that the American Century Fund is not worth the cost as it has not done very well in the past and is not equipped to take on the dynamics of the global bond market in the future. Templeton has the resources and a dynamic mandate to mitigate some of the risks inherent in the global debt market while capturing value over time. This fund is one of the global debt funds that we would place in the lineup for your investment committee.


Tom Koehler, CIO


Equity Storm “Snowfall”

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We decided to name the recent equity volatility after the amount and ferocity of the snow storms that continue to hit a significant part of the country. The storms that were in the West, East and Midwest have even hit the South and the equity weakness that was largely in Emerging Markets and select Asian Countries has even hit the US markets that seemed until recently, untouchable.

Will the storms that continue to make life miserable for much of the East and Midwest continue and will the equity market down drafts paralyze investors?  We here at Zenith hope for some reprieve for all places except for the mountain regions where a foot of snow is welcome.

As we mentioned in one of our latest blogs, the structural imbalances in some Emerging Countries will likely lead to more volatility in spite of reasonable positive growth here in the U.S.  We would like to take a look at a few areas of the Asian region represented by passive ETFs and then present an active fund to compare volatility in this short time period.

I-Shares MSCI All Country Asia Ex Japan (AAXJ) -8.03% This ETF has holdings to varying degrees in all of the countries listed below. The largest holdings are as follows; China 26%, South Korea 20%, Taiwan 15%, Hong Kong 12%. The rest of the countries are below 10%.

These are individual country ETFs created by Blackrock I-Shares.

I-Shares MSCI Honk Kong (EWH)  YTD -7.43%

I-Shares MSCI Singapore (EWS) YTD -7.74%

I-Shares MSCI Korea (EWI) YTD-10.45%

I-Shares MSCI Taiwan (EWT) YTD – 6.73%

I-Shares FTSE China 25 (FXI) YTD-11.02%

I-Shares MSCI  India (INDA) YTD-5.53%

I-Shares MSCI Indonesia (EIDO) YTD+2.5%

I-Shares MSCI Malaysia (EWM) YTD-6.64%

I-Shares MSCI Thailand (THD) YTD-2.65%

Generally speaking if at the end of 2013 an investor wanted to gain exposure to this area of this area of the world they could have taken one of three major approaches. An equal weight approach to the nine country specific ETFs above would have returned approximately negative 6.17% while the All Country ETF described above lost approximately -8.03%. This is largely due to the overweight positions in China and South Korea in AAXJ.

While there are many other items to consider, the main issue with the all-country Asia ETF approach is that the investor is hamstrung by the current weights of country exposure which may or may not work well. The second approach is more flexible but will ultimately incur more trading which takes up valuable time. In addition, the countries listed in this piece have reasonably disparate growth and risk profiles.  A manager might be able to understand and to mitigate the risks in this region as well to identify the best growth prospects.

An investment  in Aberdeen Asia Ex-Japan (AAPEX) has returned negative 6.20% YTD. That is not too impressive as active managers garner the high fees to reduce risk in times of stress in the system. They are supposed to over and under weight countries and sectors that prospectively add value and reduce risk.

The active manager saved the investor close to 180 basis points in losses compared to AAXJ but charges over 1% for this ability. They were close with the individual country specific ETF approach but a fee and turnover analysis would need to be done before you sent this to your trading desk. The question for your investment committee is whether or not this or any other fund in this very specific segment of the equity market can over longer periods of time, add consistent value above broad-based Exchange Traded Funds.

Another more subtle question is whether or not it makes sense to invest into each sliced up area of the equity markets. The Asia-Pacific region offers a lot of opportunity but is defining it by this particular index the correct way to go, or would it make more sense to find a global manager that seeks value in many regions including this one but is not tethered by a specific regional mandate.

We believe that placements in funds in these specific segments must take valuation and volatility into consideration as well as a process examination so you understand if your placement with a manager is simply expensive beta or if it could truly mitigate risks in turbulent times.

We covered briefly a very specific area of the equity world with a snapshot in time of only a little over a month for the returns.  We suggest that you examine the valuations and growth prospects that your funds possess and to look back a variety of time periods to determine if value was created.

With an unending stream of new funds and ETFs being created seemingly weekly, it can be overwhelming. Sadly a lot of these products created to mirror an index of any kind are not materially solid investments and are typically not vetted to the degree they need to be examined.

As your firm reviews its current or prospective placements in non-US markets such as this, we suggest you develop a robust process for equity fund or ETF inclusion.


Tom Koehler, CIO

“Equity markets represent a complex asset class and while we covered a very small amount, there is a lot more information needed prior to making an investment decision. Let us know if we can provide more information to help in that process.”