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The flow of capital into passive investment strategies has intensified into a veritable deluge. Last week, BlackRock, Inc. reported third quarter net inflows of $96.1 billion, bringing its year-to-date influx to $264.3 billion, and easily surpassing 2016’s take of $202.2 billion. ETF industry assets, under its iShares umbrella, posted 32.1% year-on-year gains in the third quarter.
BlackRock’s primary competitor Vanguard Group is seeing an even more pronounced surge in popularity, attracting a net $291.7 billion in new funds for the first three quarters of 2017 to put John C. Bogle’s not-for-profit enterprise on pace to eclipse last year’s inflows of $323 billion. Count current Vanguard chairman and CEO F. William McNabb among those surprised by the prodigious 2017, in an interview last Tuesday with The Wall Street Journal he noted that “last year was one that I never thought we’d see again.”
The potent force of momentum — shown here in the dual form of the longstanding bull market and growing popularity of indexation strategies — plays a starring role in the cash pile up.  So too does a helpful nudge from regulators.  Both in Europe (in the form of MiFID II regulations set to take effect in 2018) and in the U.S. (with the Department of Labor’s fiduciary rule requiring increased disclosure on commissions), investors are being herded to lower cost products.  On BlackRock’s second quarter conference call in July, chairman and CEO Larry Fink cited the government paradigm: “We’re seeing regulatory changes change the ETF environment. We do believe we’re seeing accelerated flows because of MiFID II, because of the movement toward the fiduciary rule in the United States.”
First you get the assets… BlackRock‘s five year stock price. Source: The Bloomberg
The bourgeoning popularity of indexation isn’t translating into better economics for its architects. To the contrary: Judging by recent moves from smaller industry players such as State Street Global Advisors and Charles Schwab, a full-on price war is underway.  Last week, Barron’s reported that Charles Schwab launched the Schwab 1000 Index ETF, which covers 90% of the entire U.S. equity market according to the company, at an expense ratio of just five basis points (by comparison, institutional cash equity trading commissions used to frequently top 10 basis points). This morning, State Street responded in kind, slashing its own fees on 15 separate ETFs.  For its SPDR Portfolio Total Stock Market ETF, three basis points is the new expense ratio, down from 10 basis points.
The capital gusher into ETFs and other passive instruments corresponds with the almost-robotic upward march in the stock market.  A dispatch in Bloomberg Businessweek detailed the somnolent environment at the midtown prime brokerage desk of Credit Suisse Group AG.  Noting the absence of client reaction to the escalating tensions with North Korea in August, Credit Suisse’s global head of risk advisory Mark Connors marveled that: “Two rockets flew over the land mass of Japan and nothing happened. There were no calls. That’s absolutely crazy.”
Fueled by unprecedented conditions such as negative nominal interest rates in large swaths of Europe and sustained central bank asset purchases despite the absence of recession in any major economy, the bull market continues apace.  The severe dislocations of many ETFs relative to their underlying net asset values seen back on August 24, 2015 (in which one-fifth of all equity ETFs experienced price movements of 20% or more, compared to just 4% of individual stocks, according to Bob Rice of New York-based Tangent Capital) begs the question of what becomes of the passive uprising if and when conditions do shift.
As always, the timing of any such potential sea change remains a mystery. Daniel Wiener, editor of the Independent Adviser for Vanguard Investors, says: “I don’t think there’s much that changes these flows until we have a negative market. I can’t tell you when that happens, but when it does there will be a lot of very surprised investors.”

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Asymmetry in the market deals with probabilities and expectations. Probability is nothing more than a math calculation that tries to deal with uncertainty or the unknown, which is of course the future.

Volatility is low. Lower than it has been for, well almost forever. Articles are being written on how low volatility is, what it means, is this a new paradigm, etc.

Obviously this is a time to buy volatility, that should it return, could provide that asymmetrical outcome sought. My favourite target in these circumstances are yield hogs. These chaps buy high yield, mostly junk, for the returns as against say treasuries.

With volatility so cheap…you can buy volatility a long way into the future, to allow time to work in your favour, for pennies. That will be my trade on Monday when the markets re-open. My candidate is prepared.


Greece. I have no idea what will finally eventuate, but you have to think that the country continues to exist in some form and that its productive businesses continue. So you buy Greece now, while the blood is in the street.

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IN THE SEARCH FOR THE NEW and different indexes that will power a new and different ETF, back-testing plays a critical role. Index providers, including S&P, Dow Jones, MSCI, Russell, Zacks and others can index just about anything. You want to rank the companies in the S&P 500 by earnings growth, then take the 50 top firms and weight them equally? Weight them by market capitalization? Go long the top 50 and short the bottom 50? They can build it. And then they back-test it. Indexes that look good in hindsight have a shot to become ETFs. Those that don’t, don’t.

Given our quantitative roots, we are sympathetic to the fact that backtests are often used as an input into making investment decisions. But past returns, as we all know, do not predict the future. And we think backtested results may be particularly problematic today. Very little fundamental data for US equities extends back more than 30 years, but the last 30 years were a period generally accompanied by two related phenomena: increasingly easy monetary policy and falling interest rates. In particular, the wave of liquidity and stimulus provided in the wake of the Tech Bubble coincided with unprecedented levels of credit expansion, rising asset correlations and record earnings volatility.

I’m not really posting this for the returns, it just gives a quick guide to what ETF’s are available.