From India to Indiana,

Fri, 2016/11/04 - 1:06pm | Your editor

How lucky we are that I dropped my stake in Paddy Power plc, the Irish-owned bookie firm. It lost buckets on the UK referendum over Britain staying or leaving the European Union, because its odds were based on polls which proved to be wrong.

The Truman vs Dewey upset has not yet been hit again in the US election, but once again PDYPF jumped the gun. Two weeks ago it began paying off people who had bet on a Clinton victory, based on polls that now look excessively optimistic, well before the FBI reopened the investigation of her server. Paddy is not legally allowed to offer odds to US punters, although in fact on the Internet the old saying is true: “nobody knows you're a dog.”

Thanks to Berkeley (Cal.) reader LD for reminding us that Hillary Clinton is not the first woman our generation could vote into the White House, nor was Barrack Obama the first African-American. LD voted for Shirley Chisholm who was both black and female.

The Harvard men's soccer season was canceled after members persistently produced “scouting reports” which made sexual comments about the women's soccer team members. They have been rating the woman players for attractiveness since 2012 and then lied about this when The Harvard Crimson broke the news.

It is quite a change from Tom Lehrer's “Fight Fiercely Harvard” where the football and soccer players sing “Albeit they possess the might, Nonetheless we have the will.” It ends: “How we will celebrate our victory. We shall invite the whole team up for tea.”


Today we have news from Israel, Switzerland, The Netherlands, Germany, Britain, Sweden, Spain, Mexico, Canada, Denmark, France, from India to Indiana, and Norway. Read more »

Passive Investing Index Problems

Thu, 2016/11/03 - 1:36pm | Your editor

With two grandchildren born in Chicago but living in Cleveland now, I was sure to find the World Series victory of the Cubs or the Indians a happy outcome. But for statistical reasons the Cubs winning after 108 years of losses was clearly a message not to assume that past is prologue. It applies to Index Exchange-Traded Funds.

Your editor yesterday evening listened to pitches for global index-based exchange-traded funds and derivatives from people who create them, starting with the creator of the Deutsche Bank country funds, Herb Blank, whose guest I was.

Not the only skeptic there by any means, I was treated to a lecture about how the real disaster with index-based ETFs is that they cannot stop growing. Unlike a mutual fund which can close, or a closed-end fund which has a limited number of shares outstanding, an ETF is created to allow the shares out to meet demand More shares are created if there is demand for them, thanks to its use of institutional investors to create (or cancel) the shares outstanding.

As an active manager stressed to me (I am respecting his wish to remain nameless) this creates a potential Nifty Fifty situation, where the biggest holdings in a portfolio become bigger still—until something goes pop, which he thinks is statistically inevitable at some point in the future. (If you don't remember the Nifty Fifty, google it.)

There was also plenty of evidence in the presentations by the creators of indexes that they are not in fact representing the chunk of the market they are supposed to. Susan Quinn was the presenter for FTSE-Russell Global indexes, supposedly a way to invest in different asset classes, styles, and strategies. The reality is not as broad.

She was followed by presenters of derivatives, Russell Rhodes of the CBOE on index options, and Giovanni Viscioso of CME on index futures. For baseball reasons the Chicago presenters did not stay long, which is why I will focus on Ms. Quinn.

The main FTSE 100 index, supposedly a proxy for a $2.3 trillion market, actually is nothing of the sort. Ms Quinn's presentation revealed that about a quarter of the index is just 5 shares, which moreover are multinational corporations not really reflecting the British economy: HSBC, a global bank which I am a NY customer of; whose origins of course are in Hong Kong and Shanghai; British American Tobacco, BATS, which is buying up Reynolds here; BP plc, an oil company which got into trouble in the Gulf of Mexico in 2010; Royal Dutch Shell which has dual nationality; and global pharma giant GlaxoSmithKline.

Smaller indexes are worse. The FTSE China 50 index is only invested in long-term internationally accessible Hong Kong traded shares, despite the recent “Shenzhen connect” and “Shanghai connect” which are supposed to link up Hong Kong's stock market with Mainland Chinese ones. The reason may be that having gotten access to indexes via MSCI Global (which is adding China stocks to its indexes), China is refusing to cooperate with other index-makers. That is the theory of one of the Chinese-American techies I spoke with at the gathering, who also wanted to remain anonymous.

The result is that the China 50 is chockablock with troubled Chinese banks traded in Hong Kong, with financials accounting for nearly 54% of the total index positions. Again the list is pretty narrow. The 5 largest holdings account for over 38% of the index: Tencent; China Construction Bank; China Mobile Telecom; International & Commercial Bank of China; and Bank of China.

Things are not better at the FTSEW Emerging Markets Index which is tracked by about $1 trillion in asset management. The top holdings are not as concentrated, accounting for only 14.4% of the total, but they are again not what they seem: top holdings are Tencent (No. 1 again); Taiwan Semiconductor; Naspers of South Africa (which owns 39% of Tencent!); and Hong Kong listed CCB and CM.

Is Hong Kong China? Is it even an emerging market? I am not sure, but it is certainly an easier market to access that Ouagadougou.

Note that the messy and dated Financial Times daily reports on stocks rising and falling in the markets of Europe is not to be blamed on the FTSE-Russell indexes. They are prepared by Reuters while the indexes are produced by the London Stock Exchange. But that doesn't make their defects unimportant. In addition to the indexes and ETFs tracking them, there are trillions of dollars in options and futures based on these indexes traded here—mostly in victorious Chicago on the CBOE and the CME. Whatever the punters on these derivatives think they are buying it is not a British, Chinese, or emerging markets benchmark. It is not hedging positions they are long or short in these markets. It is not enabling them to weight their portfolios with expected market-tracking ETFs. It doesn't allow them to go bearish or bullish on the markets the FTSE is supposedly covering.

The biggest users of these strategies are Vanguard Funds, not strictly speaking ETFs, but a major in promoting cheap index-tracking funds. It also generates chartist patterns which do not reflect the real market either. This is a very dangerous setup.


The British High Court has thrown a spanner into the rush to exit the European Union, requireing that Parliament must approve the Tory government's activation of EU article 50 to start the process of negotiation for the terms and conditions for leaving. The consultation requirement increases the uncertainty over British economic prospects with delays. It also boosted sterling and cut British stock prices.

More for paid subs about Britain, China, Hong Kong, Israel, France, Sweden, Canada, South Africa, Mexico, Chile, Peru, and Colombia, Spain, The Netherlands, and India.

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Passive Investing in Emerging Markets

Wed, 2016/11/02 - 2:08pm | Your editor

Analysts at Alliance Bernstein, a respected fund manager, have taken up cudgels against passive investment in emerging markets exchange-traded funds, arguing that they are riskier than investors realize. Their article which follows is called “The Passive Slippery Slope”:

“Investors are increasingly using passive portfolios to boost exposure to emerging markets and keep volatility under control. We see better ways to reduce the risks while sourcing returns from across the developing world.

“Emerging stocks and bonds have strongly outperformed this year, as return-starved investors fled the bleaker prospects on offer in developed markets. Flows are also showing signs of life. Brightening EM economic conditions, rebounding earnings growth and attractive valuations suggest that the EM equity rally has room to run. In developing markets, however, greater opportunity comes with greater risks. Though volatility across global stocks has diminished since 2012, the EM equity market is nearly 6 percent more erratic than its developed counterpart (Display). It's critical to stay attentive to risks that could derail performance.

“Investors manage EM volatility in several ways. Many of them have gone the passive route. Investor interest in low-volatility strategies reached a fever pitch earlier this year. Flows into the dominant low-volatility EM exchange-traded fund (ETF) surged nearly 70% to $4.4 bn through September, twice the pickup of flows into the MSCI Emerging Markets ETF for the same period.

“But, by tethering themselves to a low-volatility index, investors are also tethering themselves to risky concentrations in pricey sectors. Telecom, consumer staples and utilities stocks have massively outperformed for the past several years as investors gravitated to bond proxies offering stable earnings and high dividends. These now make up one-third of the MSCI EM Minimum Volatility Index, double their share of the MSCI EM Index, and trade at some of their highest valuations of the past 20 years. They are also highly interest-rate sensitive. Because low-volatility indexes are largely based on historic patterns, they can't adapt when conditions diverge from the past. This may leave passive investors especially vulnerable to a major about-face in rates, risk sentiment or the macro climate.”

I was asked to justify my strictures against the Financial Times daily European gains and losses tables. If you want an example of a share price never updated in recent memory check out Industrivärden, a Swedish holding company which is cited almost daily as having dropped in price by the same amount and reaching the identical price.

Numbers matter. As a shareholder in Alcoa, now also owner of Arconic, I am flying solo because the analysts are in such disarray over the spinoff.


The real issue in giga data—garbage in, garbage out, my subject today. We have examples today from several shares on which I report below for the paid subscribers, along with other news from Canada, Britain, Israel, Ireland, Australia, Demark, China, The Netherlands, and Japan—plus gold.


Thanks to all my relatives and readers who corrected my spelling of Wayne Gretzky's name and how he defined the difference between good ice-hockey players and great ones. I said it was knowing where the ball would be rather than where it is; of course he said “puck.” I note that all those who wrote were males who lived part of their lives near the Canadian border, where ice hockey flourishes. It has been corrected.

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Seven Rules

Tue, 2016/11/01 - 1:25pm | Your editor

The odds have just lengthened on my ice hockey-mad eldest grandson taking over my job. Performance Sports Group, the Canadian producer of hockey, lacrosse, and (alas) baseball and softball equipment and uniforms, has just filed for bankruptcy. After it took over the US ball game businesses, over the protests of my ice-hockey grandson I put a sell on what was then PSG. We bought in 2012 and sold early last year when he was 14 for profits of over 90%.

How can we make money from robot errors and blind spots when index-tracking exchange-traded funds are created without human intervention? That is the subject that is currently keeping me busy. It is not as easy to work with macro lists and data covering hundreds of shares gobbled up by some ETFs in their market dominance. It is also not easy to spot over-concentration by them in a small number of shares (usually in a foreign market or narrow sector) where there aren't enough liquid stocks. The trick is to look for self-fulfilling prophecies, where a lot of buying in the past leads index trackers to buy more, however stupidly, now. Read more »

Drugs, Finance, Cars, and Fuel

Mon, 2016/10/31 - 12:58pm | Your editor

On Weds. I will be defending my skepticism, boosted by Grant's Interest Rate Observer, on indexed Exchange Traded Funds at the Qwafafew club of Quant analysts some of whom created the whole idea of country fund ETFs. I was mistaken when I said Grant's has an ownership link with Horizon Kinetics whose “Alice in Indexland” research it promoted in confabs and publications. HK was merely a contractor for Grant's. I will go into the lion's den to listen the CEM Group, CBOE, and FTSE Russell equity index suppliers and if I am truly brave express my skepticism about robo-indexation.

I will start by tackling the completely out-of-date daily high and low figures for European markets published by the Financial Times, co-manager of FTSE Russell. This is only updated weekly at best and the FT blames Reuters for the lapse. Surely they would do better not to publish this trash data at all?

Today the Neue Zuericher Zeitung revealed another aspect of the Swiss National Bank investment in what it thinks is the total US market. In fact, we have argued that it is buying any share traded in the US, including lots of Canadian shares and plenty from the Far East and Europe—and even Switzerland! The purpose of the black box index buying is to stop the Swiss franc from rising against the dollar and wiping out exporters. But the SNB in fact is buying lots on non-US stocks according to its careless reports to the US SEC, which effectively are indirectly weakening the dollar. But there is a good side to this according to the NZZ today:

In Q3 the Schweizerische Nationalbank (SNB) had a further SwFr 7.4 billion gain in the book value of its stock portfolio which reached 28.7 Swiss francs” the daily blog write [my translation]. “With holdings of over 720 billion Swissies, the smallest change in valuations and interest rates can lead to billions in rises or falls in the SNB portfolio. In H1 this year the stated gain was SwFr 21.2 bn vs a loss the year before of 49.9 bn francs.

With the exchange rate against the euro virtually unchanged in Q3 and the price of gold high and also unchanged [in Swiss francs], the rise was entirely from prices and dividends from SNB stock positions.”

What this program has allowed the Berne CB to do is to stop flight capital moving into Swiss francs from currencies with negative interest rates, like the euro. The total of Swissie bond issues outstanding was flat year to year.

The badly programmed robot investor of course can again suffer a stock holding loss as it did in 2015. But the fascinating fact that the SNB wound up buying euro-denominated and Canadian stock which happens to have American Depositary Receipts or other stock trading here still shows up the idiocy of indexation.

Swiss reader JH writes to tell me what we really should do is buy shares of SNB on the Zürich Stock Market. Each of the 26 Swiss cantons has a sharehold and the returns from that are very important for some cantons.

Your editor's view that Brexit cannot happen without a new general election in Britain is now seen as likely by John Llewellyn of with which we trade issues. He wrote today after the Nissan deal with PM Theresa May to give it access to the European Union market no matter what happens in the talks on a fine deal “put her head in a noose”. The former deputy chief economist of the Organisation for Economic Cooperation & Development, whom I know from Paris, writes:

“Industries in a similar situation to Nissan will clamour for similar treatment while dissimilar industries will demand to know why they are being discriminated against. The matter may well end up having to be decided in Parliament, if not by a general election fought largely on this issue.” I agree.

More today on the auto industry, oil services, drugs, finance, and a few other sectors.

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October Sales

Sun, 2016/10/30 - 12:54pm | Your editor


When the weather turns cold I think about taking profits and losses for the year. Today is the last time I will be preparing performance tables before November when profit-taking and loss-harvesting gets going, and I expect more action will take place only after the election here. So I am moving first. To see our closed positions table, pre-subscribers can visit and take a peek at what has happened so far over the course of the year.

But you have to be a paid subscriber to view our new moves, because we don't want to give our strategy away for free. Join up and make money.

More for paid subscribers follows with several important trades.

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Indexation Risks IV

Thu, 2016/10/27 - 7:32pm | Your editor

This is a pre-report of news for Friday so I can take off for my cousin's funeral.

Here is more from the Grant's Interest Rate Observer presentations on exchange-traded funds, this time on bond funds.

Under the heading: “Why Wendy’s should reincorporate and refinance in Lebanon”, their affiliate Horizon Kinetcs wrote about “benchmark yield sobriety tests. Here are the yields year-to-date for various holdings and their ratings:
“U.S. Treasury 10-Year Note 1.7%; Russian Federation, BB+, 14-year bond 2.3%; IBM Bond, AA-, 10-Year Note 2.5%; Petrobras, BB , 4-year note 6.4%; Wendy’s Bond, CCC+, 10-Year Note 6.9% ; Lebanese Republic, B-, 5-year note 6.2%; iShares High Yield Corp. Bond ETF 5.6%; and iShares Emerging Mkts High Yield Bond ETF 6.3%. (Source: Bloomberg data as of 9/13/2016.)
“Would anyone seriously argue that these yields are adequate compensation for the risk assumed? (That is, could you sell a Lebanese Republic bond in the open market at 6.2%?) If not, do the prices result from some other factor, such as artificial supply-and-demand pressures?
“In Emerging Market High Yield, new money is allocated based on float. In other words, the more debt a nation issues, the greater the allocation to its bonds because it has a greater capitalization. That is the mathematical model, and that is entirely logical – to a point.
“There is, really, no price discovery. And if there’s no price discovery, is there really a market? In which case, what is emerging market high yield really worth?

”For the first time since the late 1940, stock and bond yields have converged. Once upon a time—say for the prior 80 years—investors demanded higher yields for stocks since the risk was greater. Could both be overvalued?

“In this historically low return environment—in the last 5000 year!--we are in untested territory. The cash-as-liability mentalit is very likely creating balance sheet bubbles. Investors wish for the cash on balance sheets to be spent throuhg share repurchases, dividends, or acquisitions. But this is productive [only] if the transactions are done at attractive valuations. And float adjusted valuations make sure that this is impossible when buying Exchange-traded funds investing in stocks—or bonds.'

“The Swiss National Bank does not engage in equity selection; it only invests passively. It first decides in which markets it wants to invest, and then replicates appropriate broad equity indices. If the equity portfolio were managed actively, this could send undesirable signals to the market, and might also lead to the politicization of investment decisions.” This from its statement to the SEC.

The Swiss robo-managers managed to include a couple of listed ADRs in their buying program for (haha) American stocks, The following lists only NSB positions worth over $25,000: Norwegian Renewable Energy Corp; Swedish Autoliv; Dutch Schlumberger Ltd, NXP Semiconductors, CNH Industrial nv, Fiat-Chrysler nv; Ferrari nv; Mylan nv; Mobileye nv; Qiagen nv; Asian ADRs Netease, Alibaba, Michael Kors, Baidu, Ctrip; and Canadians like Molson, Manulife, Goldcorp, Yamana, Franco-Nevada, Dollar Tree, Potash of Saksatchewan, Canadian National Railway and Resources, Canadian Pacific, Imperial Oil, D R Horton.

That is intended to show you that I didn't only find small caps that the Swiss CB could be forgiven for being unfamiliar with. These are blue chips or large caps, every one.

Correction: the Reuters article I quoted misstated the amount of Facebook stock owned by Zuuckerberg which is more than the Swiss National Bank holds, according to a reader more familiar with the California rich than me.


More follows from Belgium, The Netherlands, Norway, Denmark, India, Australia, Argentina, Bermuda, Brazil, emerging markets, and Britain:

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Indexation Risks III

Thu, 2016/10/27 - 1:13pm | Your editor

Tomorrow's blog will be late because I am going to a cousin's funeral. Walter Hanau was born in the Saarland. His family became Luxembourgeois after the Nazis got the Saar back from France, because they could not become French as one of his great-aunts had been a famous French swindler. This saved their lives because the German Nazi occupiers turned against Jewish former Saarlanders including his cousins with a different last name living in Lyons. It also gave the Hanaus easier access to the US as refugees than people from larger countries. I am not sure there even was a Lux quota. They were able to take their wealth and possessions with them to America, unlike German Jews like my parents or his German-born wife's family.

Walter's marriage to Reni was the most romantic event of my childhood. He was an officer in the US Air Force during the Korean War. at his marriage, fellow-officers formed une haie d'honneur (a tunnel) with their swords on the stairs down from the synagogue for the newly-weds to walk under. I was not invited to the wedding but saw them leave for their honeymoon.


By hard slog I managed to find a Swiss incorporated firm the Swiss National Bank thought was American and on which it reported its purchase to our SEC. In fact I found two, Transocean (RIG) and its former sub Transocean Partners LLC, which was merged into the parent company in August under pressure from Carl Icahn. The SNB fired its head a half dozen years ago for speculating in currencies using his American wife's account. So now they are pure as the Alpine snow and stupid as the Alpine cows.


Horizon Kinetics reporting for Grant's Interest Rate Observer begins by noting that Exchange Traded Funds are growing very rapidly. It then addresses their huge annual share turnover—which is not cost-free to ETF buyers. It then looks at the unknown but terrifying risk from ETFs' concentrated and or misleading holdings:


The Exodus: $1.1 trillion+ into indexed equities, $800 billion+ out of active management. In 2005 there were 204 ETFs in the US; in 2015, 1,594, as the number of listed stocks declined.

Turnover rates for two of the most popular ETFs are higher than 3500% (!), an average holding period of about a week. That is dozens of times greater than the trading liquidity of even its most liquid constituents. It has been estimated that ETF providers collect about $6 billion/yr from management fees. But roughly $9 billion is collected from market-making spread [compared to corporate shares]:

“ExxonMobil 90%; IBM Corp. 128%; Vanguard 500 Index Mutual Fund (VFINX) 42%; SPDR S&P 500 ETF (SPY) 3507%; iShares Russell 2000 Index (IWM) 3624%.

“Turnover rates for two of the most popular ETFs are higher than 3500% (!), an average holding period of about a week. That is dozens of times greater than the trading liquidity of even its most liquid constituents. It has been estimated that ETF providers collect about $6 billion/yr from management fees. But roughly $9 billion is collected from market-making spread.

Diversification with ETFs and Country ETFs?

“Do investors in the iShares US Energy ETF (IYE) who presume to be buying a diversified portfolio--fleeing idiosyncratic risk--know that 50% of the fund is in 4 holdings: Exxon Mobil Corp 25.0%; Chevron Corp 13.1%; Schlumberger Ltd. 7.6%; Occidental Petroleum 4.1%;/

Total weight of 4 largest holdings 49.8%!

“The same top-heaviness exists in iShares MSCI Spain Index ETF (EWP). The top 10 companies are a 64% weight and get most of their revenues from outside Spain. Does an asset allocation program or robo-advisor know that 6 of the top 10 holdings of iShares MSCI Spain Index get 70% or more of their revenues from outside Spain?

[The first number is the share in EWP held by the stock and the second how much of its revenues come from outside Spain.]

Banco Santander 13.1%; 88%; Telefonica 9.0%; 73.7%; Banco Bilbao Vizcaya Argentaria 7.6%; 71.6% ; Iberdrola SA 7.1%; 55.0%; Inditex 6.8%; 82.3%; Amadeus IT Holdings SA 4.9%; 96.2%; Repsol S A 4.8%; 47.6%; Red Electrica Corp SA 3.8%; 2.1%; Aena SA 3.6%; 5.9%; Ferrovial 3.5%; 72.2%

Weight of 10 largest holdings 64.3%

“There is also a valuation consideration. Relatively few companies of sufficient stock market value and trading volume are in great demand, simply as raw material for index funds. Might these megacap global stocks have outperformed truly local stocks in Spain due to their [being] global multinationals [with] systemic risks. So what does country allocation measure?

“The index universe has become a big momentum trade. It is the most crowded trade in the history of investing.

“As the saying goes, once everyone's in, there's only one place to go. Remember that this state of affairs is not a new phenomenon. In prior eras it was known as go-go investing or trend following. Now it takes the guise of index-based asset allocation. All such phenomena have ended unpleasantly.”


More for paid subscribers follows including no less than five company quarterly reports and news from Finland, Brazil, Mexico, Britain, Canada, India, Bermuda, and Australia. Oh, and the USA.

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Indexation Risks II

Wed, 2016/10/26 - 1:21pm | Your editor

The second indexation risk is stupidity.


The Swiss National Bank, their central bank, in August increased its investment in equities, focused on US equities to SwFr 127 bn, 41% of its reserves, to spread its risks. Half of the total, $62 bn, is supposed to be in US stocks.
The idea was to buy US equities and it is now the 8th largest equity investor. They use the $650 bn in foreign currency--mostly greenbacks--amassed by buying dollars to keep the franc from
appreciating and hurting the sales of Swiss firms like UBS, Swiss Re, Credit Suisse, Swatch, Nestle, Novartis.

But instead of buying red white and blue shares they are buying pure Star of David stocks.

The strategy is based on buying an index and not trying to pick individual shares. So the SNB owns more shares in Facebook than its founder, Mark Zuckerberg, $741 mn worth, 0.28% vs Zuckerberg's 0.17%. It started buying stocks in 2005 after it was allowed to add them to its bond holding under a new law.

By the end of the second quarter in July, the SNB reported to our SEC that it had $61.8 bn of US equities vs 54.5 bn a month earlier and a mere $41.3 bn at the end of 2015, a rise of 50% in H1. But the SNB is using funny money to buy stocks and moreover has no idea what it is buying. Welcome to the world of indexation!

Jim Grant (of Grant's Interest Rate Observer) commented: "The SNB creates Swiss francs out of thin Alpine air. Then they go and call their broker and go on a tour of the US Stock exchange. They get involved in important companies from the S&P which create real profits, and they do that with money created out of nothing." Jim Grant was talking to Finanz und Wirtschaft newspaper.

Grant's firm sponsored a conference and research by Horizon Kinetics, a related company which writes about the SNB's purchases:

Does the Swiss National Bank have a special affinity for Israel? or a subtle asset allocation sub-strategy? why does it hold 17 Israeli stocks in its US equity portfolio? B Communications Ltd; Caesarstone Ltd; Cellcom Israel Ltd; Check Point Software Tech; Cyberark Software Ltd; Elbit Systems Ltd; Israel Chemical Ltd; Ituran Location & Control; Kormit Digital Ltd; Mellanox Tech Ltd; Neuroderm Ltd; Orbotech Ltd; Radware Ltd; Taro Pharma Industries; Tower Semiconductor; and Wix Com Ltd.

The Bank's 2581 stocks are not chosen by actual analysts. They're chosen by machine. The machine must be programmed.

Do the programmers in Zurich know that a cusip that begins with a letter, as opposed to a number, signifies a foreign company? why would they? So the Swiss National Bank affects the clearing prices of Israeli as well as US stocks. And they don't even seem to know it.”

Actually the situation is worse than that. The SNB's misplaced purchases were not confined to Israel although there was another Israeli firm Grant's didn't spot, Gazit Globe.

The SNB loaded up on Canadian funds from Brookfield Asset Mgm; Hortonworks; Denison Mines; Intrepid Potash; Barrick Gold; Pico Holdings and dozens more.

The SNB bought non US shares like Euronav nv of Belgium; Liberty Global plc of Britain; Indian bank ICICI; and Fang Holdings, a Chinese real estate portal (covered by both Credit Suisse and UBS analysts!)

Does the fact that Wilhelm Tell's aim is bad affect anything more than the Swiss themselves? The answer is yes. There are relatively few stocks with enough liquidity and market value to be bought by index funds in big volume. They are very much in demand, mostly because they are going up. And the reason they are going up is that index funds are buying. This becomes a self-fulfilling prophesy.

The foreign companies put into the SNB's supposed US portfolio are particularly vulnerable now that Jim Grant and Vivian have exposed the rotten apple at the core of SNB's portfolio. The Swiss will exit with some rapidity and the result will be a drop in the share price for no good reason.

Today I will start by telling my readers about mistakenly purchased shares that Swiss will sell. Then I cover two shares which reported today.

Tomorrow I will continue the run-down of indexation risks covering country funds; and Friday I will write about bond funds and about factors to watch when tracking indexes.

We have news from Canada, Israel, Bermuda, Britain, Spain, Cuba, India, Brazil, Sweden, Colombia, and Finland.

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Indexation Risks

Tue, 2016/10/25 - 12:08pm | Your editor

Today I begin a series about the problems of Index Funds. They are a major cause of US investors moving into exchange-traded funds and away from high-fee managed mutual funds. But the system which works in a large market like the USA may not work in smaller foreign markets, or even for foreign markets as a whole. Or even always in the USA because of weighting.

This results from the fact that many markets are overweight in one sector or even one stock. Start with our near neighbor Canada. Until about the year 2000, Canadians could watch their money rise thanks to one single stock, Nortel, which accounted for about 35% of the total Toronto 300 stock index. Then--boom-- Nortel lost 94% of its value in one fell swoop in 2001 taking the index funds down with it.

The same thing happened a second time more recently with Blackberry, which became a hugely overweight part of any Canadian index-tracking fund. Even today every index fund covering Canada is overweight energy, materials, and financials—not the safest sectors currently.

And in an admittedly much smaller Finnish market, for years the index was dominated by as much as half the money going into a single vulnerable stock: Nokia.

Even in the bigger USA investors using indexes lost on almost all financial stocks: Lehman Brothers, WaMu, AIG, General Growth Properties, Fannie Mae, Freddie Mac, Ambac, XL Capital, and others all of which lost over 90% of their value.

The US SEC is investigating the risks from the dependence on US stock funds on ETF inflows and worries about the failure of tracking programs to properly value bonds in ETF portfolios. Index ETFs have gained because traditional mutual funds charge high fees for underperformance. So led by Vanguard's John Bogle, successful creator of mutual funds to track indexes back in 1976, investors are buying indexes and benchmarks. It's not that easy.

Tomorrow we will address the vulnerability of US index tracking ETFs. But for those aiming to go global, the message is simple: you need stock pickers, not indexers. As my newsletter practices in stock-picking, so my message is also self-serving.


More for paid subscribers today from India, Australia, Brazil, Germany, Switzerland, Britain, Israel, Ireland, Finland, Sweden, the Netherlands, Bermuda, Panama, and the Cayman Islands.

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