Oh, the Mockery

You have to wonder whether there's a better way to manage your nest egg

By Alex Roslin
Thursday, January 17, 2008
The Montreal Gazette
Business Observer

Is it just me, or are the markets acting crazier than a zombie in a horror flick?

I bet many readers looking at their investments are thinking the same thing: Surely, there's got to be a better way to manage my little nest egg.

Here's one common investing mistake I've made from time to time. Maybe you have, too.

It all starts with some gushing news about how China or Florida real estate or some other ripping market has zipped up, up and away, straight to the heavens, leaving you wretchedly back on boring Earth with your miserably languishing investments.

If only you had realized months ago the lofty potential of this on-fire market, like everyone else on the blessed planet somehow did, why, your toes would already be sinking into the soft white Caribbean beach, instead of hiding in wool socks and boots.

So what do you do? You probably jump in anyway, of course. Maybe, just maybe, you tell yourself, egged on by bullish analysts who say the market is headed far higher, you can still catch some of the ride.

Then what happens? More often that not, the market sells off sharply. But don't worry, the analysts will say. It's just a minor correction, a sorely needed breather before the market flies to even more rarefied heights.

In fact, the selloff is really a godsend, a chance to load up even more at a lower price. What luck! Investing is so easy.

So you buy another piece of the action. At some point, though, it dawns on you the "pause" is looking more like something else -- a true correction, a rout even. You avoid the newspaper and TV news, not wanting to learn the bloodbath has worsened.

You're soon sick with self-doubt, paralyzed into indecision. Should you dump it all? Should you hold because the selling eventually must end, must it not? Or maybe you should even add to the doomed investment, seeing as how it's now so ridiculously cheap?

Eventually, you reach what traders call the "puke point." You just need the horror to end. So you sell.

Of course, you know the rest. Here, precisely, is when the carnage does stop, and the market joyfully bounds back. Oh, the mockery. You wonder if the raison d'être of the markets is to mess with your head and steal your last penny.

Sound like a familiar scenario? If so, take heart. You're not alone. We all know we should "buy low and sell high," but in reality, we often find ourselves doing exactly the opposite: buying high and selling low.

This dynamic has, in fact, been the very fuel of the markets for centuries, since well before modern history's first major speculative bubble - Holland's "Tulip Mania" of the 1630s, when the price of a single tulip bulb shot up to as much as 40 times the average yearly income, then crashed, devastating the Dutch economy for years.

Today's investors, seemingly better informed, still make the same mistakes. The dot-com disaster is one example. Now, it's happening yet again with the U.S. real-estate catastrophe.

It reminds me of what Frank Borman, CEO of Eastern Airlines, once said: "Capitalism without bankruptcy is like Christianity without hell." (Eastern went bankrupt three years later.)

Curious about all this, I recently studied data, available from the U.S. Commodity Futures Trading Commission, on how small-time traders perform in the futures and options markets.

I found something curious but sad. The crowd isn't just wrong in the markets; it's so consistently wrongly positioned in the markets, you can reliably make good money doing the opposite.

I found you could have beaten buying and holding the NASDAQ 100 index by 10 times since 1995 if you had bought the index when the small traders hit specific extremes of pessimism and sold the index short when they got excessively bullish. (Selling a security short is a way to make money when it falls in price.)

If you're wondering how the small traders stay solvent, the answer is most probably don't for long. But history shows there's always a new generation of gamblers lining up to feed their offerings into the hungry maw of our free-market system.

So what can you and I do? I think it's important to educate ourselves about how the markets really work and try to learn something from our mistakes.

As author Stephen Covey wrote, "If we keep doing what we're doing, we're going to keep getting what we're getting."

But like a zookeeper feeding a tiger, never forget your humility. After all, history is against you.

Swinging to a New Strategy

Many Canadians are playing the markets like never before thanks to a fast-growing class of leveraged exchange-traded funds

ALEX ROSLIN
SPECIAL TO THE GAZETTE
Monday, January 28, 2008
The Montreal Gazette

As markets yo-yo crazily up and down, growing numbers of Canadians are turning to a risky new investment strategy that used to be the preserve of professional speculators and big investment firms: leverage.

Ordinary investors can now play market swings like never before thanks to a fast-growing class of leveraged exchange-traded funds.

ETFs are like mutual funds that trade as stocks on an exchange. They seek to match the moves of an underlying market like the S&P/TSX composite index or gold. Unlike mutual funds, they are passively managed and charge minimal management fees.

The universe of ETFs has exploded in recent years in Canada and the U.S. as mutual funds have come under fire for exorbitant fees and lackluster returns.

The new leveraged ETFs offer yet another choice. They promise to double the gain-and-loss of the underlying market.

In other words, if the S&P/TSX 60 Index goes up $1, the related ETF aims to rise $2.

Confused? Here’s yet another twist: some of the new leveraged ETFs seek to double the inverse of an underlying market. So when the TSX 60 drops $1, the ETF goes up $2.

Horizons BetaPro, the Toronto-based financial-products company that is the only provider of leveraged ETFs in Canada so far, launched four new leveraged ETFs last Wednesday covering gold bullion and global mining stocks.

The company’s Gold Bullion Bull Plus ETF (symbol HBU) uses gold futures contracts to achieve two times the change in the price of gold.

Meanwhile, its Gold Bullion Bear Plus ETF (HBD) seeks to do the opposite—double the inverse of moves in the gold price.

Earlier in January, BetaPro launched new leveraged ETFs covering the price of crude oil and natural gas. And the company plans to kick off two more funds in early February for a basket of agricultural commodities—soybeans, wheat and corn.

The new products will bring the company’s leveraged ETF offerings to 18.

As the only leveraged commodity ETFs in the world, the products are drawing interest internationally, with assets in the company’s funds growing more than fivefold to $750 million in 2007, said president Howard Atkinson.

Horizons BetaPro offers still other leveraged vehicles in its family of mutual funds, including ones that seek to double changes in Canadian bond prices, the NASDAQ-100 Index and the U.S. dollar.

The company has hired ProShares Trust, which has launched several dozen leveraged ETFs of its own in the U.S., as the portfolio manager for its ETFs.

“Since 1999 to 2000, we’ve seen some good (market) upswings, but also good old-fashioned bear markets. In those environments, which we seem to be in now, our product can be quite useful,” he said.

But just how practical are leveraged funds for ordinary folks? Analysts have mixed feelings.

“For most investors, they’re not worthwhile,” said David O’Leary, manager of fund analysis at Morningstar Canada, a leading investment-research firm that rates ETFs and mutual funds.

“They’re very tough to own. They tend to be extremely volatile so it’s harder to stay along for the ride. What we see time and again (with these funds) is people buying high and selling low. People tend to get more greedy and excited.”

They’re more suitable, he said, for “fairly knowledgeable investors trying to play a trend.”

Jeffrey Ptak, Morningstar’s director of exchange-traded securities analysis in Chicago, agreed. In early January, he wrote a report on the worst new ETFs of 2007. One of his top picks: leveraged ETFs.

“In my opinion, they are a terrific way to blow an investor up,” he said in an interview. “For long-term investors, they have tenuous value from a risk-reward standpoint.”

Ptak’s main concern: most of the time, the ETFs haven’t actually succeeded in doubling the return of the underlying market.

For example, since it started trading on Jan. 10, 2007, BetaPro’s 60 Bull Plus ETF (symbol HXU) gained 18.5 per cent in the subsequent year. That’s 58 percent more than was gained by the unleveraged iShares Canadian S&P/TSX 60 Index Fund, which went up 11.7 per cent over the same period.

A great return, but not double.

On the other hand, BetaPro’s Energy Bull Plus ETF (HEU) lost 59.6 per cent between its launch in June and last Wednesday, while the iShares Canadian S&P/TSX Capped Energy Index Fund (XEG) lost 23.8 per cent.

That works out to a loss 150 per cent greater for HEU than XEG—more than double.

So in that case, a savvy investor might wonder, did BetaPro’s leveraged inverse energy fund (HED) make a killing? Ironically, no.

HED did gain a tidy 40.9 percent since last June. But that’s 72 per cent more than what was lost by XEG—again, short of 100 per cent.

Atkinson, Horizons BetaPro’s president, said the shortfalls arise from the mysteries of compounding and volatility. On a daily basis, he said leveraged ETFs are, indeed, able to exactly double the underlying index.

But results are less predictable over longer periods. When markets are zigzagging up and down, for example, leveraged ETFs tend to achieve less than a doubled return.

Conversely, when a market is in a longer trend, a leveraged ETF can actually more than double the underlying index.

Atkinson said investors can get around this conundrum by regularly rebalancing their holdings. Rebalancing is especially recommended in more volatile markets if an investor wants to be sure to achieve a doubled return, he said.

Horizons BetaPro offers a tool on its website to help investors figure out how much rebalancing is needed based on their holdings.

Don Vialoux, an Oakville, Ont.-based market analyst and author of the DVTechTalk.com website, said leveraged ETFs are ideally suited for shorter-term traders seeking to play a market trend.

But they can also be useful to hedge a long-term portfolio when markets take a tumble, he said.

“If you’d used that strategy over the past two weeks, you would be a happy camper.”