Now What After Dow Jones Industrial Average Hits 20,000?

Now What After Dow Jones Industrial Average Hits 20,000?

The Dow Jones Industrial Average hit 20,000. The aftermath was a barrage of media stories—some encouraging, others less optimistic.
 

The positive stories prompted investors to buy more equities in expectation of more future gain; the cynics foretold the forthcoming correction with a warning: Get out of stocks. The one common theme all the articles share is that, yes, something is going to happen next. And this something will likely show gains and reverses, followed by more gains and more reverses.

The problem investors have to wrestle with is the “when”, the “how much” and the reasonable amount of risk they can handle based on their life’s circumstances, goals and values. Predicting the markets is a treacherous affair that may bring riches—but if history is any indication, it is more likely to leave your net worth plummeting.

But, we’re only human. We can smell a rally, a hot stock or a winning manager, right? It’s tough being a spectator, sitting on the sidelines while the whisper of riches is more of a shout.

We’re smart; we read the business journals, we watch cable news programs, we buy books and newsletters that may give us a competitive edge over those who miss out on the action. The noise swirling around the markets is like a cat smelling catnip—and rational thought becomes more than merely difficult.

When the urge hits and the image of a soaring market paints images of retirement in Bora Bora, stop and consider the following:

  1. For every share of stock you buy, someone has decided to sell it.
  2. Achieving your goals is less probable when your emotions are swayed to make decisions that can easily be regrettable.
  3. While you might believe you can stand risk; chances are, you may not be able to stand as much as you think.
  4. There’s more to living a fulfilling life than being plugged into the market from morning ‘til night.
  5. Any well conceived plan has an alternate “Plan B”. What’s yours?

Unbridled enthusiasm may be a warning sign of unrealistic expectations, risking the safety and security of your financial life. The markets’ history is full of rallies and corrections, new highs and dramatic pull-backs, constant movement and reactions to short-term speculation. There are winners and losers—and the contest is not played on a level field.

Given this information, protect your financial security by avoiding the noise and focusing on strategies that move you closer to your life’s highest values. Your financial security and life’s values are more important than the dream of the bit hit.

  1. Have a written financial plan that outlines your goals, both long-term and short-term.
  2. Work with a team of experts who offer guidance and advice. Make sure those experts have your best interest in mind with no conflicts of interest.
  3. Have adequate reserves allotted for unexpected events.
  4. Take risk management seriously. Understand where and how your financial security can suffer a significant loss. Think: Death, disability, legal liability, uninsured losses and the impact of sudden, swift and meaningful unforeseen occurrences.
  5. Monitor and update your plan when something changes that impacts your goals or circumstances.

Financial success doesn’t occur because the Dow hit 20,000 or any market indicator posts new highs. Financial success happens when you tune out the noise and follow your plan.

Michael Kay
Advisor
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I founded Financial Life Focus because I wanted to work with people who put your success at the forefront of everything they do; people who understand that finding balance is ... Click for full bio

Alternative Beta Strategies: Alpha/Beta Separation Comes to Hedge Funds

Alternative Beta Strategies: Alpha/Beta Separation Comes to Hedge Funds

Written by: Yazann Romahi, Chief Investment Officer of Quantitative Beta Strategies, J.P. Morgan Asset Management

A quiet revolution is taking place in the alternatives world. The idea of alpha/beta separation has finally made its way from traditional to alternative investing. This development brings with it a more transparent, liquid and cost-effective approach to accessing the “alternative beta” component of hedge fund return and a new means for benchmarking hedge fund managers.

The good news for investors is that the separation of hedge fund return into its components—rules-based alternative beta and active manager alpha—has the potential to shift investing as we know it. These advancements could democratize hedge funds and, at long last, make what are essentially hedge fund strategies available to all investors—even those who aren’t willing to hand over the hefty fees often associated with hedge fund investing.

A benchmark for alternatives


With respect to traditional equity investing, we have long accepted the idea that there is a market return, or beta—but this hasn’t always been the case. Investors used to assume that to make money in the stock markets, one needed to buy the right stocks and avoid the wrong ones. The idea of a market return independent of skilled stock selection seemed ridiculous to most market participants. Yet today, we would never invest in an active manager’s strategy without benchmarking it against its respective beta.

Interestingly, hedge fund managers have been held to a different standard. Investors have been much more willing to accept the notion that hedge fund strategy returns are pure alpha, and that their investment returns are based entirely on the skill of the fund manager. That notion explains why investors have been willing to accept a “two and twenty” fee structure just to access what has been perceived as one of the most sophisticated and powerful investment vehicles available.

In thinking about the concept of beta, consider its precise definition—the return achievable by taking on a systematic exposure to an economically compensated risk. In traditional long only equity investing, the traditional market beta has been further refined as a number of other risks have been identified that are commonly referred to as “strategic beta.” These include factors such as value, momentum, quality and size. But no one ever said that these risk factors must be long-only.

Over the past decade, as more hedge fund data became available, academics began to disaggregate hedge fund return into two components: compensation for a systematic exposure to a long/short type of risk (alternative beta), and an unexplained “manager alpha.” What they found is that a significant portion of hedge fund return can be attributed to alternative beta. That fact has turned the tables on how we look at hedge fund return. With the introduction of the alternative beta concept, hedge fund managers will have to state their results, not just in terms of total return, but also as excess return over an alternative beta benchmark.

Merger arbitrage—an alternative beta example


The merger arbitrage hedge fund style can be used to illustrate the alternative beta concept. In the case of merger arbitrage, the beta strategy would be the systematic process of going long every target company, while shorting its acquirer. There is an inherent return to this strategy because the target stock price typically does not immediately rise to the offer price upon the deal’s announcement. This creates an opportunity to purchase the stock at a discount prior to the deal’s completion. The premium that remains is compensation to the investor for bearing the risk that the deal may fail.

Active merger arbitrage managers can add value by choosing to invest in some deals while avoiding others. Therefore, their benchmark should be the “enter every deal” strategy, not cash. In fact, the beta strategy explains the majority of the return to the average merger arbitrage hedge fund. And it doesn’t stop there. Other hedge fund styles that can be explained using alternative beta include equity long/short, global macro, and event driven. Note that the beta strategy invests in the same securities, using the same long/short techniques as the hedge fund strategy. The difference is that the beta strategy is a rules-based version that can become the benchmark for the hedge fund strategy. After all, if a hedge fund strategy cannot beat its respective rules-based benchmark (net of fees), an investor may be wiser to stick to the beta strategy.

Implications for investors


What does all this mean for the end investor? Hedge funds have traditionally been the domain of sophisticated investors willing to pay high fees and sacrifice liquidity. Alpha/beta separation in the hedge fund world means that investors can finally choose whether to buy the active version of the hedge fund strategy or opt for the passive (beta) version. Hedge fund strategies can be effective portfolio diversifiers. Now, through alternative beta, virtually all investors can access what are essentially hedge fund strategies in a low cost, liquid, and fully transparent form. For investors who haven’t had prior access to hedge funds, this could be welcome news. Not only can investors look at an active hedge fund manager’s strategy and determine how it has done compared to the systematic beta equivalent, they can also invest in ETFs that encapsulate these systematic strategies.

When looking at one’s traditional balanced portfolio today, there are plenty of questions around whether the fixed income portion will achieve the same level of diversification it has provided in the past. After all, with yields still low, there is little income return. Additionally, the capital gains that came from interest rate declines are likely to reverse. With fixed income unlikely to adequately fulfill its traditional role in portfolios, there is a need to find an alternative source of diversification. This is where alternative strategies may help. For investors seeking to access diversifying strategies in liquid and low-cost vehicles, alternative beta strategies in ETF form are one option.

Looking for an alternative to enhance diversification in your portfolio?


For investors looking to further diversify their overall portfolio, JPMorgan Diversified Alternatives ETF (JPHF) seeks to increase diversification and reduce overall portfolio volatility through direct, diversified exposure to hedge fund strategies using a bottom-up, rules-based approach.

Learn more about JPHF and J.P. Morgan’s suite of ETFs here

DISCLOSURE

Call 1-844-4JPM-ETF or visit www.jpmorganetfs.com to obtain a prospectus. Carefully consider the investment objectives and risks as well as charges and expenses of the ETF before investing. The summary and full prospectuses contain this and other information about the ETF. Read them carefully before investing.
J.P. Morgan Asset Management
Empowering Better Decisions
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See how ETFs differ from other investment vehicles, learn how to evaluate them, and discover how ETFs can be used effectively to achieve a diversity of investment strategies. ... Click for full bio