Dance of Investing Styles Doesn’t Signal a Downturn

The U.S. stock market notched yet another record on Wednesday, and many investors are anxiously looking for signs of a slowdown.

Perhaps not coincidentally, researchers at Sanford C. Bernstein & Co. say they’ve spotted one. According to Bloomberg News, Bernstein has found that correlations among investment styles — or factors — such as value and momentum “have shot to all-time highs.”

That means they are moving in the same direction, and that is apparently a bad omen. As Joseph Mezrich, managing director at Nomura Securities International Inc., told Bloomberg, “In the past factor correlation has tended to rise in periods of macro stress.”

The concern is likely to interest more than just wary investors. Factor investing is increasingly popular. Investors have poured $352 billion into value, momentum, quality and other factor exchange-traded funds since 2013, according to Bloomberg Intelligence, nearly double the $191 billion in factor ETFs at the end of 2012.

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Mid-Cap Stocks Aren’t Ready for a Starring Role

I can’t open a web browser lately without seeing a banner promoting State Street Corp.’s new digital series “Crazy Enough to Work” starring actress Elizabeth Banks — who, I must confess, I think is fabulous.

The series profiles four midsize companies. The first two episodes showcase EPR Properties and the New York Times Co. and have already been released. The final two feature Dunkin’ Brands Group Inc. and the Boston Beer Co. and will be available on Aug. 29 and Sept. 12, respectively.

It’s all a plug for State Street’s SPDR S&P MidCap 400 ETF, which makes me wonder about those algorithms supposedly customizing my online experience. I’ve never expressed any interest in buying a mid-cap stock fund.

It’s not that I have anything against mid-caps. On the contrary, I own them like nearly everyone else. I’m defining mid-caps as stocks with a market value of $1 billion to $10 billion. If you own a large-cap stock fund, chances are you own some mid-caps, too.

Consider that there are 458 mid-cap stocks in the Russell 1000 Index, which collectively make up 8.9 percent of the index. Mid-caps make up an even bigger chunk of the broader market. There are 1,429 mid-caps in the Russell 3000 Index, accounting for 14.6 percent of the index.

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FAANGs Are More Solo Acts Than a Tech Supergroup

It’s time for FAANG stocks to break up, at least in investors’ minds.

Facebook, Apple, Amazon, Netflix and Google parent Alphabet can’t get away from one another. Every time one grabs the spotlight —  as Apple did last week when it became the first  U.S. company with a $1 trillion market value — it brings along the other four.

They’re alternately hailed as the hot stocks, technology’s brightest lights and indispensable growth companies, and jeered as a worrisome sign of a frothy and top-heavy market. But look closely and it’s no longer clear why they should be lumped together at all.

Let’s start with the technology moniker. Amazon is a retailer and Netflix is an entertainment company, which is why, contrary to popular perception, the Global Industry Classification Standard, or GICS, tags them as consumer discretionary companies, not tech. And as of the next GICS reclassification in September, Facebook will move from the tech sector to telecommunications, where it belongs. Only two of the five FAANGs, in other words, are true technology companies.

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Funds Like Magellan Need Gamblers Like Bill Gross

I know why investors don’t care about Fidelity Magellan’s comeback.

As Bloomberg News reported on Monday, the mutual fund made famous by hall-of-fame stock picker Peter Lynch is enjoying a resurgence after years of mediocre performance. The fund fell into a “15-year funk” after Lynch’s successor, Jeffrey Vinik, left in 1996. But ever since current manager Jeffrey Feingold took over in September 2011, “Magellan has bested the S&P 500 index every full year but 2016.” The fund has also “outdone more than 90 percent of funds with a similar investing style over the past one, three, and five years.”

Despite Feingold’s apparent success, however, investors are yanking money from the fund. The knee-jerk explanation is that investors have lost faith in active management, no matter what the results. A more accurate one is that investors no longer need the vast majority of actively managed funds, including Magellan.

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Investors Can Miss the Forest for the Smart Beta Trees

A battle is raging among finance theoreticians, and investors should stay out of it.

There’s a growing recognition that a handful of active investing styles — also known as factor investing or smart beta — can be expected to beat the market over time. Among them are value (buying cheap stocks), quality (buying profitable and stable companies), momentum (following the trend) and size (buying small companies).

The evidence is compelling. The cheapest 10 percent of U.S. stocks — sorted on price-to-book ratio and then weighted by market capitalization —  returned 11.9 percent annually from July 1926 through March, including dividends, according to numbers compiled by Dartmouth professor Kenneth French. That’s 1.8 percentage points a year better than the S&P 500 Index during those nine decades and 3.1 percentage points a year better than the most expensive 10 percent of stocks.

Value also won over shorter periods. The cheapest 10 percent of stocks beat the S&P 500 roughly 72 percent of the time over rolling 10-year periods, and they beat the most expensive 10 percent of stocks 73 percent of the time.

The results are similar for stocks sorted on profitability, momentum and size.

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Hedge Funds No Longer Need the Star System

Hedge funds’ brightest lights have fallen on hard times, but don’t shed a tear for the industry just yet.

The list of once-revered-now-humbled hedge fund managers is growing. Alan Fournier is shutting Pennant Capital Management after nearly two decades, acknowledging that “recent returns have been disappointing.” David Einhorn’s main hedge fund at Greenlight Capital was down 14 percent in the first quarter  after a decline of 4.1 percent annually from 2015 to 2017. Pershing Square Capital Management’s Bill Ackman calledhis recent returns “particularly unsatisfactory,” and investors apparently agree. Ackman’s assets under management shrank to $8.2 billion as of March from $18.3 billion in 2015.

Despite the travails of star managers, however, the hedge fund industry is doing fine. The HFRI Fund Weighted Composite Index returned 0.3 percent during the first quarter, compared with a negative 0.8 percent for the S&P 500 Index, including dividends.

Granted, hedge funds haven’t kept pace with the stock market in recent years, but they’ve fared better than many of the stars among them. The HFRI index has returned 4 percent annually from 2015 through March, compared with 10.2 percent for the S&P 500.

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Vanguard Disrupted Active Investing. Now It Could Save It.

Indexing pioneer Vanguard Group may be stock pickers’ last hope.

Investors are increasingly turning their stock picking over to computers. So-called smart beta exchange-traded funds track indexes that replicate traditional styles of active management such as value, quality and momentum. Investors handed $184 billion to smart beta ETFs from 2015 to 2017 while pulling $308 billion from equity mutual funds, according to data compiled by Bloomberg Intelligence.

It’s not surprising. Smart beta ETFs are cheaper, and investors are skeptical that human stock pickers can beat the bots by more than the difference in fees. According to Morningstar data, the average expense ratio for smart beta ETFs is 0.47 percent a year, and the asset-weighted average expense ratio — which accounts for the size of the ETFs — is just 0.26 percent. That compares with 1.13 percent and 0.7 percent, respectively, for actively managed mutual funds.

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Warren Buffett Is Even Better Than You Think

Warren Buffett is an even better investor than you think.

The Oracle of Omaha released his latest annual letter to shareholders of Berkshire Hathaway Inc. on Saturday. It’s a good excuse to marvel anew at Buffett’s track record, particularly at a time when stock pickers are losing their aura.

Buffett famously likes to invest in companies that are highly profitable and selling at a reasonable price. That formula has routinely beaten the market, according to University of Chicago professor Eugene Fama and Dartmouth professor Kenneth French.

The Fama/French US Big Robust Profitability Research Index — which selects the most profitable 30 percent of large-cap companies — beat the S&P 500 Index by 1.2 percentage points annually from July 1963 to 2017, including dividends, the longest period for which returns are available. The profitability index also beat the S&P 500 in 81 percent of rolling 10-year periods.

Similarly, the Fama/French US Large Value Research Index — which selects the cheapest 30 percent of large-cap companies — beat the S&P 500 by 2.3 percentage points annually from July 1963 to 2017, and in 82 percent of rolling 10-year periods.

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Investors Resist Golden Age of Active ETFs

ETF enthusiasts gathered recently in Hollywood, Florida, for the “Inside ETFs” conference, the industry’s biggest party of the year. By many accounts it was the swankiest celebration yet.

And for good reason. When Inside ETFs first convened in 2008, ETFs managed $500 billion, or one-twentieth of the money managed by mutual funds, according to Broadridge. ETFs now oversee $3.4 trillion, or one-fifth of mutual fund assets, according Morningstar data.

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Low-Cost Care Threatens High-Quality Health Stocks

The health-care industry may have finally met its match.

There have been many efforts to reform the U.S. health-care system over the years, but the one announced on Tuesday by the triumvirate of Amazon.com Inc., Berkshire Hathaway Inc. and JPMorgan Chase & Co. may be the most ambitious yet.

The announcement was light on detail, but it hinted at big plans. JPMorgan CEO Jamie Dimon said the “goal is to create solutions” that deliver “transparency, knowledge and control” to the three companies’ employees “when it comes to managing their health care.” Those qualities are conspicuously missing from the U.S. health-care system.

As my Bloomberg Gadfly colleague Max Nisen pointed out, a key line in the release is that the new venture will be “free from profit-making incentives.” That’s a big deal. Just ask low-cost investing pioneer Vanguard Group what’s possible when profits aren’t a consideration.

The obvious question for investors is what impact the effort will have on the health-care industry. Amazon is a formidable foe, as every industry that competes against it will attest. But health-care companies are no pushovers. Or, as factor investing aficionados might put it, health-care companies are high-quality businesses.

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