Category: Investing 101

Bond Vs. Equity Returns

Bond and equity returns consist of capital gains and cash distributions. Bond returns consist mainly of periodic interest payments. Equity returns consist mainly of capital gains when you sell, although some companies pay cash dividends as well. The total return of your portfolio depends on your mix of stocks, bonds and other assets, as well as overall economic conditions.

Bond Returns
Bond returns depend on several factors, such as interest rates and the credit quality of bond issuers. Bond prices rise when interest rates fall because demand increases for older bonds with higher coupon rates. Prices rise until yields match prevailing market interest rates. Yield is the ratio of annual interest payments to market price, expressed as a percentage. Conversely, bond prices decline when interest rates rise, because demand falls for older bonds with lower coupons. The credit quality of bond issuers also affects bond yields, because investors demand higher returns for holding riskier assets. For example, Treasury bond yields are lower than corporate bond yields, because Treasuries are risk-free investments. Bond prices can also benefit from safe-haven buying, which occurs when investors move funds from stocks to high-quality bonds during volatile markets.

Equity Returns
The factors influencing equity prices include overall economic conditions and the competitive environment. Rising interest rates slow down consumer and business spending, which hurts corporate profits and equity returns. Conversely, falling interest rates drive economic growth, which means higher profits and rising stock prices. The competitive environment determines a company’s ability to gain market share, increase prices and drive profit margins. Smaller companies often have difficulty generating consistent returns because they must compete against larger companies with diversified global operations. However, small companies in certain industries, such as technology or health care, or in certain geographic markets, such as Southeast Asia and Latin America, can generate substantial returns because of high rates of sales growth.

Considerations
The mix of stocks and bonds in your portfolio depends on your investment time horizon and tolerance for risk. You may prefer growth stocks and high-yield bonds if you are young and have started your first job, for example, because you want your portfolio to grow as quickly as possible. You can take on more risk because you have more time to recover from market downturns. However, if you are nearing retirement, government bonds and blue-chip stocks might dominate your portfolio, because you count on the regular income and safety of principal.

What Are GDP, CPI and PPI & Why Do They Matter?

One of the things that can be daunting for those new to the investing and trading world is the plethora of acronyms and abbreviations that those with more experience throw around. They are often to do with analyzing an individual stock or its performance, but some refer to economic data that, taken together, help you to form an opinion on and, more importantly an outlook for, the broader economy.

GDP, PPI and CPI all fall into the latter category and understanding what they are and why they matter will help to make you a more successful trader or investor.

GDP: GDP stands for Gross Domestic Product. It is a measure of all economic activity in a country. It is usually calculated by the expenditure method, which adds up total consumption (spending on goods and services by consumers), investment, government spending, and net exports. In the U.S. the data is compiled and analyzed by the Bureau of Economic Affairs (BEA) and the results are released quarterly.

What is important about the overall economy is the rate at which it is growing, so GDP is usually expressed in terms of the increase from quarter to quarter and year to year. Thus, a 2.9% read of GDP means that the economy grew by 2.9% in the preceding quarter as compared to the same quarter last year. Obviously, more growth is better for the economy and therefore the companies in it, so the stock market usually goes up if GDP growth beats what is expected, and down if the number disappoints.

CPI: CPI stands for Consumer Price Index. It is a measure of the change in prices paid by consumers for the things that they buy. It is useful as a measure of the amount of inflation (price increases) in the economy, and is compiled by the Bureau of Labor Statistics.

Most economists look at what is known as “core” CPI for that purpose, which is the change in prices other than those for food and energy, both of which can be very volatile and distort the numbers. The level of inflation in the economy has a bearing on several things; most notably the Federal Reserve takes it into account when setting interest rates. They try to keep CPI increases to around 2% a year. Much above that and they are likely to increase interest rates to slow the economy down, much below it and they will reduce rates to give it a boost.

PPI: PPI stands for Producer Price Index. It is a measure of how much manufacturers and other businesses are receiving for their goods and services, in other words the prices that the producers are charging as opposed to what consumers are paying. PPIs are compiled for each different industry and business type and an average of them is released each month. In the U.S. that information comes from the Bureau of Labor Statistics (BLS).

Changes in producer prices are important as they tend to lead consumer prices, and therefore can give advanced warning of the onset of inflation. Like CPI, PPI is compiled and published by the BLS in America and is released monthly.

Successful investing and trading demand knowledge of the basics of economics, and that can be a hard thing to acquire if you don’t understand the abbreviations usually used for important data. Hopefully, that is now no longer a problem and you can now concentrate on the implications of GDP, CPI and PPI and with them come to an informed opinion on the state of the economy.

What is CFD trading?

Contracts for Difference (CFD) give traders all the benefits of owning a particular stock, index, or commodity position – without having to physically own the underlying instrument itself. It’s a simple and inexpensive trading option, to trade the change in price of multiple commodity and equity markets, with leverage and immediate execution. A customer enters into a contract for a CFD at the quoted price and the difference between that price and the price when the position is closed is settled in cash – hence the name “Contract for Difference” or CFD.

CFD trading works like this: Instead of purchasing 1,000 Google or Facebook or Gold shares from a stockbroker, a customer could instead purchase 1,000 CFDs of that asset on Markets.com. A $10 per share fall in the price of that particular asset would give the CFD customer a $10,000 loss. Alternatively, a $10 per share rise in the price would give the customer a $10,000 profit, exactly as if the trader had bought the actual shares on the Stock Exchange.

It’s important to mention though, that with CFD trading, you can profit no matter which way the market moves. You can use CFDs to go “short” when you believe markets will fall (and close the position later by selling), or you can go “long” when you expect prices to rise (and close the position later by buying). Of course, selling at a higher/lower price than the purchase price produces a gain/loss accordingly.

Online CFD trading is increasingly growing in popularity over the past few years and we believe it is one of the best ways to trade the financial markets – period.

Benefits of CFD trading:

CFD trading gives you the power to trade against market price movements without making any physical purchase. CFDs are quick and accessible, removing the need to trade through a broker. And selling any market is easy, so you can use CFDs to make a profit when prices are falling.

Because you are trading on margin, CFDs can enhance the risk/return on your investment capital. This means that, when you trade CFDs, you don’t have to put up the full contract value of your position. Instead you pay a deposit or margin to cover any potential loss on the position. This is typically a fraction of the full contract value.

All you need to know about Hedge Funds

Hedge funds are alternative investment vehicles that explicitly pursue absolute returns on their underlying investments. The term “hedge fund” has come to incorporate any absolute return fund investing within the financial markets (stocks, bonds, commodities, currencies, derivatives, etc) and/or applying non-traditional portfolio management techniques including, but not restricted to, short selling, leveraging, arbitrage, swaps, etc.

Initially devised in the US in 1949, hedge funds really took off in the late eighties, and now form a key part of both institutional and private client portfolios. They are normally used in a portfolio context rather than being considered as stand-alone investments.

Hedge funds are usually included as a medium to long-term investment in a traditional portfolio of stocks and bonds. As the performance of hedge funds in general tend to be lowly correlated to traditional investments – especially in declining markets when correlations tend to be low – they offer a good source of diversification for most investment portfolios. By blending a variety of skill-based approaches to investing in a diverse range of financial instruments and markets, hedge fund portfolio construction process aims to achieve a specific return/risk profile, as well as proper diversification and balance in the overall portfolio.

Traditional versus hedge fund investments

One of the main differences between traditional and hedge fund investments is that, for hedge funds, it is the skill of the manager (‘alpha’) rather than the performance of a market or an asset class (‘beta’) that drives returns.

Traditional asset managers generally allocate capital on a ‘long-only’ basis to stocks, bonds and cash. Portfolios are managed against a passive benchmark which they aim to outperform. The relative weighting of positions tend to have little deviation from the benchmark itself, resulting in very similar return profiles. Consequently, this makes it difficult for traditional managers to make money when markets are falling.

In a financial context, the term ‘hedge’ can be defined as ‘guarding against risk of loss’. As such, any inference that hedge funds are riskier than traditional investment strategies may be misguided, especially considering that the long-only approach has fewer options to protect itself from the fundamental risk of market downturns.

The underlying philosophy of the hedge fund industry is that, the skill of the manager (‘alpha’), rather than the performance of a market or asset class (‘beta’), should principally determine the success of the strategy. This key difference is also reflected in the performance-related remuneration of managers and the freedom that they are given to invest in a much broader range of financial instruments and assets.

Hedge fund managers employ a diverse and constantly evolving range of trading strategies to generate returns. Therefore, hedge funds can provide opportunities to manage risk as well as diversify in both bull and bear markets.

 

Traditional investments Hedge funds
Restricted opportunity set Can exploit wide range of price distortions
Mainly dependent on beta Focused on alpha generation
Relative return objectives Target consistent performance
Flat fee structure Alignment of manager/investor interests
Limited diversification sources Large number of strategies
Inefficient dispersion of risk Enhanced risk/reward trade-off

 

Benefits and Risks:

Benefits:

Performance consistency

Managers are typically unrestricted in their choice of investment strategies and have the ability to invest in any asset class or instrument. As such, managers target consistent, absolute returns rather than outperformance of a benchmark.

Low correlation

By utilising a range of investment strategies/financial instruments, and by being able to profit in both rising and falling market conditions, hedge funds have the ability to generate returns that have little correlation to traditional investments.

Downside limitation

Hedge funds seek to limit against, and potentially profit from, declining markets by utilising various hedging strategies.

Hedge funds may be well positioned to deal with falling markets because they:

  • capitalise on declining market prices (through short selling)
  • use dynamic trading strategies
  • benefit from greater diversification and active asset allocation

Risks

When considering alternative investments, including hedge funds, investors should consider various risks including

  • Loss of investment
  • Liquidity issues
  • Use of leverage
  • Speculative investment practices
  • Difficulty valuing certain assets
  • Higher fees
  • Limited regulatory protections

Hedge Fund Styles:

There are five main hedge fund styles representing a wide range of risk/return characteristics, each of which has a number of sub-strategies.

Equity Hedge Funds:

Profits from taking up long and offsetting short positions in undervalued and overvalued stocks with a fixed or variable underlying net long or short exposure.

Managed Futures:

Global trading in futures and derivatives on financial instruments and goods (systematic, long-term trend-following models, discretionary strategies and short-term, active trading strategies)

Event Driven:

Buying and short selling of securities of companies experiencing or involved in substantial corporate changes (merger, arbitrage, distressed securities and special situations)

Global Macro:

Analysis of shifts in macroeconomic trends to capitalize on upward and downward directional opportunities across various markets, asset classes and financial instruments.

Relative Value:

Exploitation of mispricing and changing price relationships between related securities (convertible bond arbitrage, fixed income arbitrage, statistical arbitrage)

As with any investment, hedge funds can lose money as well as profit. Investors should always seek professional advice before considering any investment.

What is Basis Trading

An arbitrage trading strategy that aims to profit from perceived mispricing of similar securities. Basis trading relates to a trading strategy in which a trader believes that two similar securities are mispriced relative to each other, and the trader will take opposing long and short positions in the two securities in order to profit from the convergence of their values. The strategy is known as basis trading, because it typically aims to profit off very small basis point changes in value between two securities.

For example, a basis trader may view two similar bonds as mispriced and take a long position in the bond deemed to be undervalued, and a short position in the bond which would then be seen as overvalued. The trader’s hope is that the undervalued bond will appreciate relative to the overpriced bond, thus netting him a profit from his positions. For the trader to make a worthwhile profit, he would have to undertake a large amount of leverage in order to increase the size of his positions. This use of large degrees of leverage is the greatest risk involved in basis trading.

What are Aggressive Growth Funds

A mutual fund which aims for the highest capital gains and is not risk-averse in its selection of investments. Aggressive growth funds are most suitable for investors willing to accept a high risk-return trade-off, since many of the companies which demonstrate high growth potential can also show a lot of share price volatility. Aggressive growth funds tend to have a very large positive correlation with the stock market, and so they often produce very good results during economic upswings and very bad results during economic downturns.

Aggressive growth funds have large betas, which means they have a large positive correlation with the stock market. They tend to perform very well in economic upswings and very poorly in economic downturns. An aggressive growth fund may also invest in a company’s IPO and then quickly turn around and re-sell the same stock to realize large profits. Some aggressive growth funds also invest in options to boost returns.

Countertrend Trading

A type of swing-trading strategy that assumes a current trading trend will reverse and attempts to profit from that reversal. Countertrend trading is a medium-term strategy in which positions are held between several days and several weeks. Countertrend trading can be used as part of a diversification and risk-reduction strategy. To limit losses in the event that a trend does not reverse, traders should consider using strategies such as stops and time-based exits. Countertrend trading is one of the most common tools used by contrarian investors.

The most commonly used technical indicators for countertrend trading strategies are moving averages, range indicators, such as Bollinger Bands, and momentum indicators such as the ADX, MACD or Chaikin Oscillator.

Confirmation of a countertrend can come from looking at price in relation to a range indicator. For example, was price near the top Bollinger Band when the countertrend movement began? Or, it can come from looking at momentum indicators for possible divergence between momentum and price. Confirmation may then lead the trader to initiate a position in the opposite direction of the trend. Further price movement and technical analysis then confirm a major trend change or the resumption of the existing trend, allowing the trader to position him or herself accordingly in the market.

Attribution Analysis

Attribution analysis is performance-evaluation tool used to analyze the ability of portfolio and fund managers. Attribution analysis uncovers the impact of the manager’s investment decisions with regard to overall investment policy, asset allocation, security selection and activity. In this type of analysis, a fund or portfolio’s returns are compared to a benchmark to determine whether a manager is skilled or just lucky.

Fund and portfolio management costs money, so attribution analysis helps determine whether that money is being well spent. This technique is commonly used by institutional investors and is not widely used by individuals. Such an analysis helps large investors enlist the best managers and maximize their returns

Attribution analysis attempts to distinguish which of the two factors of portfolio performance, superior stock selection or superior market timing, is the source of the portfolio’s overall performance. Specifically, this method compares the total return of the manager’s actual investment holdings with the return for a predetermined benchmark portfolio and decomposes the difference into a selection effect and an allocation effect.

Commodity Selection Index – CSI

CSI is a technical momentum indicator that attempts to identify which commodities are the most suitable for short-term trading. The larger the CSI value, the stronger is the trend and volatility characteristics associated with the asset. This indicator should only be used by traders who can handle large amounts of volatility as it indicates strong trending, but reversals are always possible.

Short-term traders know that the key to making money is movement, which is the reason that they mainly focus on the highly volatile assets. This index attempts to lessen the amount of risk taken, and make it easier to trade by incorporating trend characteristics. Some traders will only trade the commodity with the highest CSI value, while others will make transaction signals when they see a sharp increase in this value.

What is Tender Period

Tender period refers to the time period before the expiry of futures contract. It generally has a time line of few days. Tender period gives members of the contract to make decisions till the time the contract expires.

The parties of the contract have the liberty to change the terms of the contract during this period. Once the tender period is over, they have no other choice but to honour the contract as specified in the contract.