Post on 03-Jul-2020
© 2017 Horizon Kinetics LLC.™
Indexation: Capitalist Tool (Delivery agent of The Great Bubble)
Some of the audience-favored slides
*Excerpts and updated presentation to the Grant’s Fall 2016 Conference. Replay to the presentation is available at: https://vimeo.com/209940152/f2154e4d3d
Valuation Sobriety Test
Semantic Mis-Investing #1: Security Diversification
Semantic Mis-Investing #2: Foreign Equity Exposure
Semantic Mis-Investing #3: High Yield (or maybe just
Low Quality)
Indexation is NOT Dependent on Individual Securities.
Really?
Semantic Mis-Investing #5: Correlation Diversification
The Pursuit and Myth of Low Beta (and accumulation
of systemic risk)
Semantic Mis-Investing #6: Indexes as Fact-Based
Investing
Are Active Managers the Anomaly, or is the Market?
Central Banks Buying Stocks, and the Destruction of
Price Discovery
The Trap: Nowhere to Go
© 2017 Horizon Kinetics LLC.™
Does an asset allocation program or robo-advisor
seeking foreign market exposure know that 7 of the
top 10 holdings of the iShares MSCI Italy Index get
an average of 68% of their revenues from outside of
Italy? That they’re essentially investing outside Italy?
The same holds true for the iShares Spain ETF. 7 of the
top 10 holdings get an average of 76% of theirrevenues from outside Spain!
Then there’s valuation. There is great demand for
the few companies of sufficient market cap, simply
as raw material for index inclusion. Might these
mega-cap global stocks out-perform truly local
Spanish stocks just due to their automatic bid? Do
global multi-nationals pose their own particular
systemic risk?
So what does manager relative performance
measure? What does country allocation measure?
Top 10 Holdings as of 8/21/2017
Source: iShares, Bloomberg, Company reports
IShares Italy ETF (EWI) % Weight
% of
Revenue
NOT in Italy
ENEL 12.5 46
INTESA SANPAOLO 10.9 24
UNICREDIT 10.5 53
ENI 10.1 62
FERRARI NV 5.0 88
ASSICURAZIONI GENERALI 4.8 62
ATLANTIA 4.7 13
FIAT CHRYSLER AUTOMOBILES NV 4.5 80
SNAM 4.1 n.m.
CNH INDUSTRIAL NV 4.0 88
Top 10 Total 71.0
IShares Spain ETF (EWP) % Weight% of
Revenue
NOT in Spain
BANCO SANTANDER SA 19.3 87
BANCO BILBAO VIZCAYA ARGENTARIA
OR10.3 74
TELEFONICA SA 8.6 75
INDUSTRIA DE DISENO TEXTIL INDITEX 7.5 82
IBERDROLA SA 4.8 50
AMADEUS IT GROUP SA 4.7 93
CAIXABANK SA 4.7 10
REPSOL SA 4.5 9
ABERTIS INFRAESTRUCTURAS SA 3.8 69
AENA SA 3.5 6
Top 10 Total 71.8%
Semantic Mis-Investing #2: Foreign Equity Exposure
How to Avoid Investing in a Foreign Market? Through Your Foreign Markets ETF
*Excerpts and updated presentation to the Grant’s Fall 2016 Conference. Replay to the presentation is available at: https://vimeo.com/209940152/f2154e4d3d
© 2017 Horizon Kinetics LLC.™
Attainment of the stated 5.44% Yield to Maturity (YTM):
• 2.4% of the portfolio has a 22.8% average YTM. The Fund will
not get a 22% YTM from these, since that is the rate on bonds
expected to default. They are temporarily paying until then.
They enhance the stated YTM by 0.55%. Without this, the YTM is
4.9%.
• If one-third of the CCC-class bonds lose only 1/3 of their value,
the YTM is reduced by 1.3% to 4.1%. Less Federal tax, the after
tax YTM is under 2.7%. And this assumes zero defaults in the
BBB-class bonds, no local taxes, no fees.
Really, a near-zero or negative real yield.*CCC: Extremely Speculative
CCC-: Default imminent, with little prospect for recovery
As of 8/21/2017
Source: iShares
iShares iBoxx $ High Yield Corporate Bond
ETF (HYG)
AUM $18.4 billion
Number of Bonds 1,032
Weighted Average Yield 5.44%
Weighted Average Maturity 4.19 yrs
Credit Quality MV%
Below BBB 98.0%
CCC* and Below 12.2%
Attainment of a Higher Return than the 5.44% YTM:
• There must be zero defaults.
• Average bond price of the entire fund is above par, at $101.2,
and the bonds must mature at 100 in an average of 4 years.
Moreover, the 79% of the bonds that trade above par have an
average price of $104.7.
Semantic Mis-Investing #3: High Yield
Not High Yield, Just Low Credit Quality
*Excerpts and updated presentation to the Grant’s Fall 2016 Conference. Replay to the presentation is available at: https://vimeo.com/209940152/f2154e4d3d
© 2017 Horizon Kinetics LLC.™
ExxonMobil is one of the most liquid stocks. Ergo, it will be found almost anywhere one can
imagine that it can be placed. It is a member of 206 ETFs.
It’s Momentum, It’s Value, Its’ a Bird, It’s a Plane…
It’s Exxon, a Stock for Every Strategy:
QUAL iShares Edge MSCI USA Quality Factor ETF
HDV iShares Core High Dividend ETF
IWD iShares Russell 1000 Value ETF
MMTM SPDR S&P 1500 Momentum Tilt ETF
PBP PowerShares S&P 500 BuyWrite ETF
TILT FlexShares Morningstar US Market Factors Tilt ETF
FTLB First Trust Low Beta Income ETF
QWLD SPDR MSCI World Strategic Factors ETF
TOK iShares MSCI Kokusai ETF
ACWI iShares MSCI ACWI ETF
SPLV Powershares S&P 500 Low Volatility Portfolio
VIXH First Trust CBOE S&P 500 VIX Tail Hedge Fund
ExxonMobil: An Exercise in Levitation
2013 2016 Change
Revenue $99.18 $54.13 -45%
EPS $7.37 $1.88 -74%
Payout Ratio 33% 159% 376%
BV/Share $40.85 $41.62 1.89%
(Net Expenditures on
Stock buybacks/share)$3.62 $0.23 -94%
Total Debt ($ bill) $22.70 $42.76 88%
12/31/12 12/31/16
Share price $86.55 $90.26 +4.3%
As of 8/21/17. Source: Morningstar.As of 12/31/2016. Source: Company reports.
Indexation is NOT Dependent on Individual Securities. Really?
The Exxon Levitation Conundrum – Or, The Problem of the Automatic Bid
*Excerpts and updated presentation to the Grant’s Fall 2016 Conference. Replay to the presentation is available at: https://vimeo.com/209940152/f2154e4d3d
© 2017 Horizon Kinetics LLC.™
Have a Hunch, Buy a Bunch!
The popular side of the ETF Divide, witnessed in the
ExxonMobil phenomenon, can be seen in almost
any large S&P 500 constituent. Money has been
structurally channeled into the most liquid securities.
It alters correlation statistics, risk statistics.
The correlation of the largest members of the S&P
500 with the index has about doubled from 20 years
ago.
Even Mexico and Japan are now more correlated
with the S&P 500 than the top S&P 500 companies
were 20 years ago!
The same holds true for Procter & Gamble, Coca
Cola and most of the rest.
Where’s the price discovery?
Correlation with S&P 500* (1/1/2008-6/30/2017)
IYW iShares US Technology 0.63
BJK Market Vectors Gaming 0.79
IYH iShares US Health Care 0.75
IYE iShares US Energy 0.71
ITB iShares US Home Construction 0.71
IYT iShares Transportation Avg 0.70
EWW iShares Mexico Capped ETF 0.67
EWJ iShares MSCI Japan ETF 0.72
Correlation with S&P 500*
Security 1995 2016 Change
Apple Inc 0.161 0.567 253%
Chevron 0.295 0.639 117%
General Electric 0.522 0.759 45%
Johnson & Johnson 0.314 0.536 71%
Microsoft 0.455 0.711 56%
Pfizer 0.191 0.495 159%
Procter & Gamble 0.370 0.513 39%
AT&T 0.425 0.431 2%
Verizon 0.436 0.471 8%
ExxonMobil 0.351 0.581 66%
Source: Bloomberg, daily returns, Horizon Kinetics Research
*Selected to show the correlation of certain non-financial S&P 500 Index constituents that have existed for more than 20 years. For illustrative purposes only. Using Bloomberg
correlation matrix.
Semantic Mis-Investing #5: Correlation Diversification
Self-defeating paradox: The failed search for diversification in ETFs
*Excerpts and updated presentation to the Grant’s Fall 2016 Conference. Replay to the presentation is available at: https://vimeo.com/209940152/f2154e4d3d
© 2017 Horizon Kinetics LLC.™
A reality: A new ETF cannot be launched without
a low Beta.
A result: These largest-in-class ETFs can
legitimately be characterized as low volatility,
since the financial sector has not been volatile
lately. And the high sector weighting enables the
ETF to attain its advertised low beta.
A rhetorical question: Is low volatility an inherent
attribute of the financial sector? Or is it perhaps
simply that the central banks of the world have
maintained an artificially low-rate environment
for a very long time?
Would anyone legitimately assert that these ETFs
will remain non-volatile if rates rise? The ETFs can’t
trade out of a low-Beta security; but they can
once the Beta rises.
Another rhetorical question: Would an active
manager of a low-risk strategy be permitted the
risk of a one-third or near-50% weighting in
financials?
Beta
What is
This
Column?
Sample Low Volatility, Low Beta, and Factor ETFs
EEMViShares MSCI Emerging Markets Min Vol
ETF-0.08 21.8%
CNY
AiShares MSCI China A ETF 0.28 27.3%
KSA iShares MSCI Saudi Arabia Capped ETF 0.30 38.6%
INDA iShares MSCI India ETF -0.01 23.6%
EIDO iShares MSCI Indonesia ETF -1.13 32.7%
FM iShares MSCI Frontier 100 ETF 0.07 44.1%
Sample Value Factor ETFs
IWD iShares Russell 1000 Value ETF 1.08 25.6%
IWN iShares Russell 2000 Value ETF 1.48 30.5%
IVE iShares S&P 500 Value ETF 1.16 27.4%
IVV Reference: iShares Core S&P 500 ETF 1.00 14.4%
As of 7/31/2017
Answer: Percentage Weight in Financials
Source: Various ETF Factsheets, Morningstar.
Source: iShares. iShares calculates Beta vs. the S&P 500
The Pursuit and Myth of Low Beta (and the accumulation of systemic risk)
The misuse & abuse of historical statistics in the ETF creation process
*Excerpts and updated presentation to the Grant’s Fall 2016 Conference. Replay to the presentation is available at: https://vimeo.com/209940152/f2154e4d3d
© 2017 Horizon Kinetics LLC.™
To translate that bewildering language into the 3-step recipe via which an egregiously
high P/E ratio is cleansed into a harmless middling sort of group average, observe the
following hypothetical portfolio consisting of a range of low, somewhat high and
egregiously high-valuations. Ponder Stock D’s treatment, and you see that the higher the
true P/E, the less and less it counts in the average.
Incidentally, a simple average of the P/E ratios of the 91 profitable companies in the
NASDAQ 100, results in a valuation of 43.6x earnings. The market-cap weighted average
(giving proportionately greater weight to the larger companies) is 41.0x. No active
manager would be permitted to manage a concentrated, high-P/E portfolio for an
institutional client. Only an index enjoys this privilege.
P/E
Ratio
Step 1:
Reciprocal of
the P/E Ratios
Step 3: Reciprocal
of the Step 2
average
Stock A 10 1/10 = 0.10
Stock B 20 1/20 = 0.05
Stock C 30 1/30 = 0.033
Stock D 300 1/300 = 0.0030_
Average P/E: 90x Sum = 0.1867
Step 2: Average of the reciprocals: 0.1867/4 =
0.0465
1/.0465 = 21.5x
Harmonic mean (From Wikipedia, the free encyclopedia)In mathematics, the harmonic mean…is one of several kinds of average…The
harmonic mean can be expressed as the reciprocal of the arithmetic mean of the
reciprocals of the given set of observations.
Semantic Mis-Investing #6: Indexes as Fact-Based Investing.
When Is A Fact Not a Fact? Or How an ETF Can Turn a 90 into 22 in Three Easy Steps
*Excerpts and updated presentation to the Grant’s Fall 2016 Conference. Replay to the presentation is available at: https://vimeo.com/209940152/f2154e4d3d
© 2017 Horizon Kinetics LLC.™
Were these active managers the
anomaly for underperforming?
And is it reasonable to believe that
they all lost their touch at the same
time?
Or was it the S&P 500 that was the
anomaly for outperforming? That
always sounds nonsensical until
after the fact.
All one can say is that if a school
consistently gave exams that 98%
of the students would fail, at least
some attention would be paid to
the teachers.
The Alpha Producers
Are Active Managers the Anomaly, or is the Market?
Fund or Holding Company
2016
Underper-
formance
in % Points (net)
2015
Underper-
formance
in % Points (net)
2014
Underper-
formance
in % Points (net)
Fairholme1 13.72% -12.88% -16.39%
Gabelli Value1 -0.36% -10.88% -12.09%
Wintergreen1 -5.29% -8.32% -15.37%
Longleaf Partners1 8.76% -20.18% -8.77%
Berkshire Hathaway2 11.44% -13.88% 13.31%
Pershing Square Hldgs3 -25.46% -21.88% 26.71%
Icahn Enterprises3 -23.59% -26.01% -21.87%
Greenlight Reinsurance3 -4.76% -21.58% -4.99%
Royce Micro-Cap1 -0.70% -8.10% -7.70%
1 Fairholme (FAIRX), Gabelli Value 25 A (GABVX), Wintergreen (WGRNX),
LongLeaf Partners (LLPFX ), Royce Micro-Cap (RMT) 2 Share price return
3 NAV per share change
Benchmark is S&P 500 Index except for Royce Micro-Cap which is relative to the Russell MicroCap Index
Source: Company Reports, Manager websites, Horizon Kinetics Research
*Excerpts and updated presentation to the Grant’s Fall 2016 Conference. Replay to the presentation is available at: https://vimeo.com/209940152/f2154e4d3d
© 2017 Horizon Kinetics LLC.™
How can a free enterprise system function if
price discovery is influenced by agencies of
government with infinite supplies of money?
An equity portfolio manager no longer
competes in the market auction process with
other buyers with limited capital. The
government, with unlimited capital, is not
motivated by ordinary considerations of fair
value. One is entitled to presume, in the
absence of evidence to the contrary, that the
aim of the Central Bank is to elevate prices. If
this is the case, what does the benchmark
mean?
Without price discovery unimpeded by
intervention, there can be no rational
allocation of capital. And without rational
allocation of capital, it is impossible to properly
evaluate the skill of the managers.
Q2 2015 Q2 2016 Q2 2017
Market value of holdings $38.6 B $61.8 B $85.0 B
Number of positions 2,581 2,581 2,643
Top 10% by weight, # of positions 258 258 264
Largest 10% as share of portfolio 74% 76% 76.5%
Average market cap of position of
largest 10% (billions)$60.4 $62.7 $70.0
Some Unexpected Holdings
Name Headquarters Name Headquarters
B Communications Ltd Ramat Gan Kornit Digital Ltd Rosh Ha'ayin
Caesarstone Ltd HaifaMellanox Tech
LtdYokneam
Cellcom Israel Ltd Netanya Neuroderm Ltd Rehovot
Check Point Software Tech Tel A.-Yafo Orbotech Ltd Yavne
Cyberark Software Ltd Petah Tikva Radware Ltd Tel A.-Yafo
Elbit Sys Ltd Haifa Taro Pharma Inds Haifa
Gazit Globe Ltd Tel A.-Yafo Tower Semicond. Migdal Ha'emek
Israel Chemicals Ltd Tel A.-Yafo Wix Com Ltd Tel A.-Yafo
Ituran Location & Control Azour
Q: Which Index Fund Would Be the 3rd Largest ETF in the U.S.?*
Source: sec.gov 13F Filings, Bloomberg
* From the Swiss National Bank: “The SNB 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.”
Central Banks, Equities and, Of Course, Indexation
Still believe in price discovery?
*Excerpts and updated presentation to the Grant’s Fall 2016 Conference. Replay to the presentation is available at: https://vimeo.com/209940152/f2154e4d3d
© 2017 Horizon Kinetics LLC.™
CRSP U.S. Total Market Index, as of 3/31/17, comprising
over 3,500 companies and $26.9 trillion.
Small-capitalization stocks (less than $2 billion), a
traditional alternative to over-valued large-cap
stocks, are no longer a practical option.
At only 4.6% of the total market, they cannot
absorb a sufficient portion of the equity pool;
they cannot be a functional alternative.
Real estate, perhaps the largest industry in the
U.S., should be an alternative. Yet, publicly
traded real estate is only 4.1% of the stock
market, so is not a practical option either.
Moreover, publicly traded real estate likewise
trades near all-time high valuations.
Accordingly, investing must now take place
outside of the indexation sphere of focus. While
that can’t take place for the majority of investors,
it can for a small minority.
80%
4.6% 4.1%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Large Cap Small Cap REIT
% of Overall Market
The Trap: Nowhere to Go
The Unavailability of Alternative Asset Classes/Sectors
*Excerpts and updated presentation to the Grant’s Fall 2016 Conference. Replay to the presentation is available at: https://vimeo.com/209940152/f2154e4d3d
© 2017 Horizon Kinetics LLC.™
Disclosures
Past performance is not an indication of future results and the value of the investments and the income derived from them may increase or decrease. It should not be assumed that any of the holdings
referenced herein have been or will prove to be profitable or that future investment decisions will be profitable or will equal or exceed the past investment performance of the holdings listed.
Indices are presented merely to show general trends in the markets for the period referenced and are not intended to imply that a strategy is benchmarked to the indices either in composition or level of risk.
Indices are unmanaged and the figures shown herein do not reflect any investment management fee or transaction costs. Investors cannot directly invest in an index. References to market or composite
indices, benchmarks or other measures of relative market performance (a “Benchmark”) over a specific period are provided for your information only.
The S&P 500 Index (“SPX”) is a broad based index widely considered as a proxy for overall market performance. It is the property of Standard & Poor’s ®.
All ETFs mentioned have fees and expenses. You should read their prospectus before investing. All material presented is compiled from sources believed to be reliable, but no guarantee is given as to its
accuracy.
iShares® and Blackrock® are registered trademarks of BlackRock, Inc.
PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC, investment adviser. Invesco PowerShares Capital Management LLC (Invesco PowerShares) and Invesco Distributors,
Inc., ETF distributor, are indirect, wholly owned subsidiaries of Invesco Ltd.
Except as noted, the portfolio characteristics shown for separate accounts relate to the composite as of the date noted above. Not every client's account will have these exact characteristics. The actual
characteristics with respect to any particular client account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) market prices of individual securities at the time of
investment and (iii) individual client circumstances. Horizon Kinetics LLC reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. The
strategies listed herein may invest in both equity and fixed income securities, among others, without regard to market capitalizations or issue size. Horizon Kinetics LLC does not necessarily fully invest portfolios
immediately after an account is funded. There can be no assurance we will ever fully invest an account. There is no assurance that any securities discussed herein will remain in an account. The securities
discussed might not represent an entire account and in the aggregate may represent only a small percentage of an account's holdings.
This information should not be used as a general guide to investing or as a source of any specific investment recommendations, and makes no implied or expressed indications concerning the manner in
which an account should or would be handled, as appropriate investment strategies depend upon specific investment guidelines and objectives. This is not an offer or solicitation to any person in any
jurisdiction in which such action is not authorized or to any person to whom it would be unlawful to make such offer or solicitation.
Horizon Kinetics LLC is not a registered investment adviser, but serves as parent company to, among others, Horizon Asset Management LLC (“Horizon”) and Kinetics Asset Management LLC (“Kinetics”), both
of which are registered investment advisers. Horizon Kinetics LLC, its subsidiaries, employees, or products managed by Horizon and Kinetics may have positions in the securities referenced in this presentation.
Horizon is the investment manager to the strategies referenced herein. All material presented is compiled from sources believed to be reliable, but no guarantee is given as to its accuracy. The information
presented is subject to further clarification during presentations.
Historical Statistic Definitions
Excess Return is the measurement of a portfolio’s return minus the return of an index.
Standard Deviation is a statistical measure of the degree to which an individual value in a probability distribution tends to vary from the mean of the distribution.
Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to a specific market index.
Turnover is the lower of total buys or total sells divided by average market value of the account. Turnover ratio source: Fiserv Security APL.
Equity yield curve is when discounted securities and their market prices realize their underlying economic values. The further out the potential investment reward, the steeper the equity yield curve will be.
Neither Horizon Kinetics LLC nor its subsidiaries provide tax or legal advice to their clients and all investors are strongly urged to consult their tax and legal advisors regarding any potential strategy or
investment. Opinions expressed are Horizon Kinetics’ present opinions only. No part of this material may be: a) copied, photocopied, or duplicated in any form, by any means; or b) redistributed without
Horizon Kinetics’ prior written consent.
All rights reserved © Horizon Kinetics 2017