Cumberland Advisors Market Commentary –  Defense Expenditures

Most Americans have never heard of the Stockholm International Peace Research Institute, www.sipri.org. A few minutes surfing their website might just inspire you to add it to your list of independent research sources.

Market Commentary - Cumberland Advisors - Defense Expenditures

You can check out the role of the military in Venezuela and how it is supporting Maduro as a result of the financial support the military has enjoyed. This mutually beneficial relationship helps to explain the difficulty of regime change in that country.

One can also check out many other informative research pieces.

Try the report “Trends in World Military Expenditure, 2018” (https://www.sipri.org/publications/2019/sipri-fact-sheets/trends-world-military-expenditure-2018). Take a look at Table 1 on page two for a summary of the 40 highest military expenditures, listed by country. The US tops the list. China is second. The economic data in this report helps to identify some macro themes. Worldwide military spending is estimated at about 2.1% of global output (GDP). America accounts for more than one-third of the world’s military expenditures. France spends more than Germany does. South Korea spends more than Brazil or Italy or Australia or Canada does. Macro data helps put things into perspective when that data is combined with geography.

One takeaway for us is critical.

We know the world is a dangerous place, and it seems that it is becoming more so. Traditional diplomacy seems to be failing. The latest North Korean missile firing is an example of this failure as Dictator Kim has demonstrated after two summits with President Trump. Let me be clear. Kim is a really bad guy. This next comment is about tactics and strategies and not in any way offered to protect or defend a strongman/dictator. Whether its Kim or Maduro or others, ruthless despotic dictators are the enemy, always and every time.

Note that a physical “walking out” of a meeting can occur only once in diplomacy and then the rules of engagement are forever changed. Ending a meeting without a joint statement used to be the way to message the world and the other side about discontent. No dictator/strongman leader can tolerate a direct insult since it raises risk to him from those at his home government who want to remove him or kill him. This is particularly so with dictators and strongmen who do not need to face elections.

So all the negotiations needed to deal with dictators and strongmen have now changed. The second summit with Kim was a victim of a real estate negotiating tactic. I’ve seen that tactic personally and used it on occasion. Negotiations can be tough and hard. So, you get up in the middle of a meeting to send a message that you are serious. You walk out. You also leave a channel open to resume if that is what you want to do. But in a business transaction, you do not have to proceed. That is why merger talks and transactional negotiations get broken off and then resumed.

In diplomacy, the reopening of a negotiation can happen but the methods used now have to be changed. The change occurs in the back channels and we do not see them in the public domain.

One side cannot take any risk or insult by the other side. Once you walk out the first time, you need to rewrite the rules. Unlike a real estate transaction, the “walking out” card can be played only one time. We shall see how the US deals with that principle in its global geopolitics. Negotiations between Trump and Xi are now subject to these new rules. The world’s two largest economies are also the world’s two largest military expenditures listed in the SIPRI report.

Meanwhile, the aggregate of military expenditures worldwide is heading higher and doing so from a record level.

We also know that the technology of war is intensifying at lightning speed. Check out: https://www.sipri.org/media/press-release/2019/emerging-technologies-pose-challenges-control-biological-weapons-new-sipri-report . Destructive capacity grows and is now expanded into the cyber realm. Here is another report to digest: https://www.sipri.org/research/armament-and-disarmament/emerging-military-and-security-technologies/cybersecurity . Nothing appears on the horizon to stem this accelerating trend.

At Cumberland, we continue to hold the defense sector ETF in our US ETF accounts. We rebalance it on weakness.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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A Unique Lens on Risk Management

May 1, 2019 – Jeremy Schwartz and Liqian Ren from WisdomTree Funds hosted an investment strategy discussion that covered factor investing, U.S. sector trades and the global outlook with Matt McAleer, Director of Equity Strategies at Cumberland Advisors.

Matt McAleer, Director of Equity Strategies at Cumberland Advisors

Read about or listen to their discussion here: https://www.wisdomtree.com




Hot Reads: 3 Key Bond ETFs For Your Portfolio

Hot Reads: 3 Key Bond ETFs For Your Portfolio
March 07, 2019
Compiled by ETF.com Staff

ETF.com highlights content for their readers in this day’s “Daily Hot Reads.” They are the self-described “leading authority on exchange-traded funds, ETF.com has delivered clear, independent and authoritative news, analysis and education about ETFs online and in print since 2001.”

On this day, they highlight “Geopolitical Risks In Emerging Market Equity ETFs” on (Seeking Alpha) -The article is also available on our website here: https://www.cumber.com/geopolitical-risks-in-emerging-market-equity-etfs/

See all their picks at ETF.com




Geopolitical Risks in Emerging Market Equity ETFs

Last week included several dramatic examples of unexpected geopolitical developments in emerging markets: Two nuclear powers in South Asia, India, and Pakistan, clashed and appeared to be on the brink of full-scale war; and the US-North Korea summit in Hanoi ended badly, with Trump walking out.

Market Commentary - Cumberland Advisors - Geopolitical Risks in Emerging Market Equity ETFs

Also, unsettling markets were some negative signs about the state of US-China trade negotiations which, later in the week, were offset by some positive signs. With country-specific emerging-market equity ETFs, the risk of such geopolitical shocks is always present. It is interesting to look at how the respective national equity markets reacted to last week’s developments.

The India-Pakistan clash intensified last Tuesday, February 27, when Indian warplanes dropped bombs on a suspected terrorist camp inside Pakistan in response to a deadly terrorist attack on Indian soldiers earlier. Pakistan shot down at least one Indian plane and captured the pilot. Artillery barrages across the border followed, and thousands of troops converged. Pakistan Prime Minister Imran Khan then announced on Thursday that his country would release the captured Indian pilot, “In our desire of peace … and as a first step to open negotiations.” This move appeared to calm matters for the moment, but the situation remains tense. India’s stock market dropped sharply at first but later recovered as the situation eased. The iShares MSCI India ETF, INDA, finished the week up 0.4%. Clearly, should fighting resume, the market would tumble.

The long-standing India-Pakistan dispute over Kashmir is one of the most dangerous geopolitical risks. This clash is a reminder to investors that this risk should not be ignored. Indian stocks have been trending downward for fundamental economic reasons. Economic growth slowed to 6.6% in the fourth quarter of last year from 7% in the third quarter, which in turn was slower than the second quarter’s 8% growth rate. The ETF INDA is down 5% for the last twelve months ending March 1st and is down 2.3% year-to-date. Other emerging markets were also down last year. However, unlike Indian equities, most other emerging markets have rallied so far this year. The iShares MSCI Emerging Markets ETF, EEM, is up 8.8% year-to-date. Our International and Global ETF Portfolios are overweight in emerging markets, but we are not holding any India-specific positions.

The unpredictable North Korean regime and its nuclear capabilities constitute another dangerous geopolitical risk overhanging markets, particularly that of South Korea. The failure of the Hanoi summit appears to have resulted from inadequate preparations at a lower level and failure to recognize that the very complex and difficult issue of denuclearization could not be settled prematurely by a “deal” between two heads of state. There now is the risk that, following this humiliation for Kim, he will respond by moving to add to North Korea’s nuclear capabilities. Hopefully, seasoned diplomats on both sides will seek to restore the negotiations.

As was the case for India, South Korea’s stock market dropped in response to the bad news, with the iShares MSI South Korea Capped ETF, EWY, losing 2.2% over the week. But unlike the case for Indian stocks, the South Korean market has participated in the emerging-market rally so far this year. Despite last week’s losses, EWY is up 7.12% year-to-date as of March 1st. We are maintaining our South Korea positions in our International and Global Portfolios, while monitoring further developments closely.

The South Korean economy is strong, with close ties to the US economy. It is quite advanced and is considered by many to no longer be an emerging-market economy. The Korean equity market is large, accounting for 14% of the iShares MSCI Emerging Markets ETF, EEM, and is exceeded only by Hong Kong’s 23% share. China’s share in EEM is only 8%, but that does not yet include most of the Mainland China stocks. South Korea’s equity market is heavily weighted (40%) with technology stocks. Samsung Electronics alone accounts for 23% of the holdings. Long-term investors in South Korea’s equity market using EWY have done well: The annualized total return over the past 10 years is 12.37%.

Last week was also a volatile one for Chinese stocks, which lurched down and back up with each press comment and tweet hinting at the state of US-China trade talks or the severity of the moderation in the growth of China’s economy. In the end, the broad-based iShares MSCI China ETF, MCHI, was little changed for the week, with an increase of 0.5%.

There was a definite plus for Chinese stocks announced before the market opened on March 1st. The index publisher MSCI announced that it will quadruple the weight of Mainland China shares in its benchmarks. The benchmarks are the basis of many ETFs and funds. It is estimated that this quadrupling will lead to new passive inflows into Mainland China’s stock markets of some $US 80 billion. Chinese equities are also participating in the emerging-market recovery. MCHI is up over 16% year-to-date.

Investors who wish to limit exposure to the country-specific risks inherent in emerging-market stocks can invest in highly diversified ETFs that include stocks from a number of national markets. Two good examples are the ETFs EEM, mentioned above, and the Vanguard FTSE Emerging Markets Index Fund, VWO. Investors in individual-country ETFs need to monitor developments closely and seek to separate the noise in the daily news flow from developments that signal meaningful and lasting changes in the prospects for a market. Often events that capture the headlines for several days or more have little lasting market impact. At Cumberland Advisors we sort key signals from the noise by bringing together fundamental economic and financial analysis, technical market analysis, and geopolitical expertise.

William Witherell, Ph.D.
Chief Global Economist & Portfolio Manager
Email | Bio


Exchange traded funds may not correlate to designated indices and have additional fees and expenses, including the duplication of management fees.
 


Sources: Financial Times, Wall Street Journal, CNBC.com, ETF.com


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Considering China

China stocks surged Monday following Trump’s announcement that he will be delaying US tariffs on China. Prospects for a trade agreement between China and the US are now looking very good. It is evident that both sides need a positive resolution and are willing to compromise. Last year, China’s stock markets experienced their worst year since 2008, with the Shanghai composite dropping 24.6% and the Shenzhen composite tumbling over 33%. These markets appeared to bottom at year end and staged a strong recovery as trade tensions began to ease. This recovery is likely to continue if indeed a trade deal is reached.

The other main cause of last year’s plunge in China’s stock market was increasing signs of a slowdown in China’s economy, paired with uncertainty about the severity of the downshift. It has now become clearer that the slowdown is real but moderate, in contrast to the more dire predictions of some commentators. GDP growth is easing from 6.6% last year to 6.2% this year. In 2020, the economy is projected to expand at a similar and still very robust pace, thanks in part to the anticipated ample policy stimulus and easing of trade tensions.

As Morgan Stanley has noted, China is steadily advancing towards high-income status and a current account deficit that implies the necessity of substantially higher capital inflows. That prospect should encourage further opening up of the economy. Another technical factor that will cause passive investment inflows is MSCI’s plans to increase China A-shares weights in its EM index this year and more in future years. Similarly, FTSE Russell plans to increase the weight of China A-shares in its FTSE Emerging Index.

Changes in the structure of the Chinese economy provide some promising opportunities for investors. The economic slowdown has been mainly in the manufacturing sector, which used to be considered the most important part of the Chinese economy. According to Caixin Purchasing Managers Index data reported by Markit, while manufacturing companies’ output declined modestly in January, service-sector activity continued to expand “solidly,” with the result that the Caixin China Composite PMI for January signaled higher activity for the thirty-fifth month in a row.

It is important to note that China’s services sector became a more important contributor to GDP than its industrial sector in 2013. It has steadily outgrown the industrial sector ever since. The fact that China has already changed into a services/domestic consumption-based economy is not widely recognized.

The Chinese consumer is breaking records. Total Chinese retail sales, which surpassed US retail sales for the first time in 2017, rose a further 9% in 2018 to about US$6.3 trillion. According to 2017 figures cited by KraneShares, Chinese web sales, at US$1.14 trillion, accounted for 19.6% of total Chinese retail sales, whereas US retail web sales, at US$453.5 billion, accounted for just 8.9% of US retail sales. And there is still substantial room for China’s internet population, which is currently less than 60 % of the total population, to grow.

Investors now have 46 US-listed ETFs for Chinese stocks, excluding those ETFs using leverage. Many of these still have limited assets under management (AUM), which implies limited liquidity. There are just 10 that have AUM of at least US$100 million: FXI, MCHI, KWEB, GXC, ASHR, CQQQ, KBA, PGJ, CHIQ, and CXSE.

The largest China ETF, the iShares Large-Cap, FXI, invests in 50 large-cap China stocks traded in Hong Kong, with a heavy concentration of financials, particularly state-run banks. It is up 15.20% year-to-date February 25. The second and fourth largest Chinese ETFs invest in the “total market” (not including A-shares) with a tilt towards financial and technical firms. The iShares MSCI China ETF, MCHI, has gained 17.92% year-to-date. Similarly, the SPDR S&P China ETF, GXC, is up 17.56%.

The third largest China ETF takes a more direct aim at the Chinese consumer and internet web sales. KraneShares CSI China Internet ETF, KWEB, has gained 26.19% year-to-date. This ETF tracks only overseas-listed Chinese shares of internet-sector companies, primarily US-listed N-shares. Also of possible interest is the Investco China Technology ETF, CQQQ, which holds a broad range of technology companies, including US-listed shares. CQQQ has also outperformed this year, gaining 24.31% year-to-date.

Investors considering adding China-specific ETFs should take account of the China exposure they may already have in more aggregate ETFs. For example, the iShares MSCI Emerging Markets ETF, EEM, includes China stocks with a weight of 10.6% and Hong Kong stocks with a weight of 23.15%. Also, China ETFs have historically been subject to wide swings, and the relatively high volatility is likely to continue.

 

William Witherell, Ph.D.
Chief Global Economist & Portfolio Manager
Email | Bio


Sources: Morgan Stanley Research, KraneShares, Caixin, HIS Markit, CNBC, ETF.com, IMF


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Leveraged ETFs

Our quantitative strategy at Cumberland Advisors is a trading model that combines fundamental indicators and quantitative analysis into a binary output – either fully invested or all in cash. The strategy trades the S&P 500 in two versions: unleveraged and leveraged. Specifically, the leveraged portfolio uses a leveraged ETF as our vehicle to track 3X the market movement. As many may wonder whether one should use a leveraged ETF, we would like to express our opinions on leveraged ETFs today.

Market Commentary - Cumberland Advisors - Leveraged ETFs

First, what is a leveraged ETF? It is simply an ETF using derivatives and debt to track and amplify the return of an index. However, a leveraged ETF does not expose investors to traditional margin risk; rather, investors just pay the ETF cost. A leveraged ETF resets each day and targets to track an index’s daily movement. A leveraged ETF is usually considered a trading tool. It is typically held for less than a week at most, and oftentimes just daily. Investors are generally told not to buy and hold this type of security due to “time decay,” a term that is often misused when applied to leveraged ETFs. Time decay is a term used to describe the loss of value of an option as time approaches the expiration date. However, leveraged ETFs are not subject to option expirations. What “time decay” really refers to, in connection with leveraged ETFs, is the compounding effect. For example, if the market went up 10% on day 1 and went down 10% on day 2, one would lose 1% at the end of day 2; with 3X leverage, one would go up 30% on day 1 and down 30% on day 2, being left with a 9% loss at the end:

1 – (1+0.1) x (1-0.1) = 0.01     (1)
1 – (1+0.3) x (1-0.3) = 0.09     (2)

Time has nothing to do with the math above. It is compounding that magnifies the leveraged number. In other words, anything that increased 30% and then decreased 30% would have the same outcome regardless of leverage. Imagine that equation (2) represented a scenario where the market went up 30% on day 1 and down 30% on day 2 – one would be left with 9% loss without any leverage or so-called “time decay” effect. Another example: If the market dropped 1% a day for 10 consecutive days, one would suffer a 9.56% loss, while the loss would be 26.26% with 3X leverage:

1 – (1-0.01)10 ≈ 0.0956     (3)
1 – (1-0.03)10 ≈ 0.2626     (4)

Again, the math demonstrates that time is not the reason for the significant difference; compounded return is the master behind the scene. To understand the power of compounding, let’s take a look at a famous motivational poster that some people have as their desktop – if you improve just 1% a day, you will be much better in a year:

Chart 1. 1% a day difference
Now that we have clarified the mathematical misconception, let’s dig into the more important question: Should one buy and hold leveraged ETFs? The chart below compares the 3X leveraged ETF SPXL against the benchmark S&P 500.

Chart 2. S&P 500 vs. SPXL, 11/5/2008–11/9/2018. Data source: Bloomberg

Clearly, the 3X ETF has substantially outperformed the S&P 500 since its inception on November 5, 2008. However, not every investor would have had the stomach for the volatility that was experienced along the way. Leverage can be a powerful tool to take advantage of a bull market if used properly, but one must possess extensive risk management skills. At Cumberland Advisors, we prioritize risk control by keeping our focus on risk-adjusted returns.

If you are interested in obtaining information about our quantitative strategy, please email me.

Leo Chen, Ph.D.
Portfolio Manager & Quantitative Strategist
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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The Rise of Municipal Separately Managed Accounts 2018 Update

Cumberland has utilized separately managed accounts to execute its fixed-income strategy since its inception in 1973, long before separately managed accounts (SMAs) were popularized in the early 2000s.

Market Commentary - Cumberland Advisors - The Rise of Municipal Separately Managed Accounts 2018 Update

What exactly is an SMA? Per Investopedia: “A[n] SMA is a portfolio of assets under the management of a professional investment firm. In the United States, the vast majority of such firms are called registered investment advisors, and operate under the regulatory auspices of the Investment Advisors Act of 1940 and the purview of the US Securities and Exchange Commission (SEC). One or more portfolio managers are responsible for day-to-day investment decisions, supported by a team of analysts, operations and administrative staff. SMAs differ from pooled vehicles like mutual funds in that each portfolio is unique to a single account (hence the name). In other words, if you set up a separate account with Money Manager X, then Manager X has the discretion to make decisions for this account that may be different from decisions made for other accounts.”

The reasons for managing money in this fashion are the same today as they were then:

  • Transparency (you know what you own)
  • Flexibility to make strategic changes
  • Ability to manage transaction costs and best execution
  • Active management
  • Individually catered management of clients’ objectives, including tax management, income production, state-specific needs, cash flow-specific needs, and ability to institute investment restrictions

Many of the elements of this update are the same as last year’s because the benefits of SMAs remain; however, the markets, technology, and regulation are always changing, which can affect supply, cost of execution, and relationships to other markets. New areas discussed here are municipal CEFs and ETFs, growing algorithmic trading by specialty investors and dealers, and new regulations designed to increase transparency, requiring brokers to show markups and/or commissions in certain situations.

At Cumberland we have a top-down approach to investment management. We look at global macroeconomic conditions and policies to assess interest rates and growth prospects and position our portfolios accordingly. Each market and/or sector is evaluated as to how it fits in the global outlook as well as how its idiosyncratic elements may affect supply and credit quality. The majority of our fixed-income portfolios are managed on a total-return basis using a barbell strategy to more quickly take advantage of changes in interest-rate and technical changes. In a total-return account, the return is measured against a benchmark, which is usually an index that is widely recognized. Outperformance may mean that individual portfolio returns are less negative than the benchmark’s in addition to positive returns that are greater than the benchmark.

Fixed-income total-return investing takes into consideration price appreciation or depreciation and the effects of coupon income generated and reinvested. Coupon payments over time are a large contributor to the return of an account, but the timing of buying and selling and where along the curve to buy or sell can greatly impact returns. Other buy-sell considerations include duration, or the sensitivity of a bond to changes in interest rates; embedded options such as call features; technical features like supply and demand, and credit-quality trends. All of these can affect the performance of a portfolio relative to an index or benchmark. Finally, to quote Cumberland’s John Mousseau, ”Active management means active thinking, not always active trading.”

We have been in a 37-year rally in the bond market, but if you don’t pay attention to points of entry and the other details, you can miss out on performance. Similarly, in an increasing-interest-rate environment, points of entry and exit can affect performance. The use of a barbell strategy allows us to invest in various short-term instruments that are liquid and to use them as ammunition to buy longer-dated bonds when interest rates rise or to take advantage of the higher coupon of longer-maturity bonds compared with shorter-dated bonds. Floating-rate notes and inflation-protected securities are investments that can help returns in the face of inflation and rising interest rates. We are prepared for various scenarios; however, unemployment and inflation remain low, and growth remains steady. In a recent piece, http://www.cumber.com/its-in-the-stars/, Bob Eisenbeis opines that the FOMC would continue with gradual tightening, since policy is still accommodative, but will be prepared to change course if inflation and, importantly, inflation expectations change.

We will address municipal assets in this commentary; however, we also manage taxable fixed-income, equity, and balanced accounts. In managing equity accounts we utilize exchange-traded funds (ETFs) and actively conduct sector rotation. Exchange-traded funds allow flexibility and generally lower total trading costs than individual-stock portfolios do, and they avoid sales and purchases that mutual funds must make due to funds flows.

The benefits of SMAs have led to their increased use by investors. According to Citi Research, SMA municipal fixed-income assets, both taxable and tax-exempt, have grown from $100 billion in 2008 to $565 billion at the end of Q1 2018. The details are not separately reported by the Federal Reserve, so Citi Research uses a quarterly survey of its customers and certain Federal Reserve flow of funds data to arrive at an estimate.

2008 – Q1 2018: Mutual fund rate of growth has declined while SMA growth has increased
Source: Citi ResearchDirect retail muni assets have declined since 2010 from $1.9 trillion to $1.1 trillion.
Source: Citi Research (SMA + direct retail = Fed flow of funds Households of $1.64 trillion)

Mutual fund performance is affected by fund flows and herd mentality and thus presents opportunities for active fixed-income management. When investors are dumping assets, the mutual fund portfolio manager may not be able to fully practice active management and must liquidate funds as required by redemptions. In these cases, the most liquid and generally higher-quality assets may be sold first in order to minimize effects on net asset value (NAV). Alternatively, when assets are pouring into mutual funds, the increased demand for assets, resulting in higher prices, can present a selling opportunity for SMA managers.

Closed-End Funds and Exchange-Traded Funds

Closed-end funds (CEFs) have been around for a long time – since 1893![1] This was years before the first mutual fund or open-ended fund – Massachusetts Investors Trust was established in 1924. As the name implies, closed-end funds are closed: They operate with only the funds they raise in the marketplace and have a fixed number of shares. CEFs have a net asset value based on the assets in the fund, but shares in a CEF are traded on an exchange so the price can vary from the NAV. In addition, CEFs can use leverage. By comparison, exchange-traded funds (ETFs) are relatively new: They originated in Canada in the 1990s. They differ from CEFs in that there is not a fixed amount of assets, and the number of shares can change. (For more detail on ETFs see Cumberland Advisors’ revised second edition of From Bear to Bull with ETFs, which discusses mostly equity ETFs).

Municipal CEF holdings were $87.3 billion, or 2.3% of all municipal holdings at the end of Q1 2018 and they have bumped around that level for years. Municipal ETFs are a smaller segment of the market but have been growing recently to $30.7 billion (0.8% of municipal holdings) at the end of Q1 2018 from $19 billion in 2013.

Algorithmic trading in the municipal market

The effects of algorithmic trading in the municipal market are being closely watched by market participants. These algorithms use actual trade data as well as observed bid and ask spreads, ratings, sectors, volume, and any other data the developer of the algorithm finds predictive. Hedge funds were the first market player to use this type of trading. It is used most frequently for trading odd lots (trade sizes below $25,000), where spreads are generally wider per unit of risk and the algorithms can take advantage of mispricing in the market. The municipal market is large at $3.84 trillion at the end of Q1 2018 and consists of over 80,000 issuers that can issue many types of debt and issue sizes ranging from $75,000 to finance a fire truck to billion-dollar issues for major city projects. Market observers that I talk with think the ‘algo’ traders provide liquidity to the marketplace, and they wonder what would happen if hedge funds/algos were to leave the market. However, the use of algorithms is growing, and many trading floors employ their own algos while retaining traders and salespeople. Technology can take some of the human element out of equation, but the nonhomogeneous market still requires live human input.

Regulation

New and revised regulations by the Securities and Exchange Commission (SEC) and the Municipal Securities Rulemaking Board (MSRB) that require the reporting of markups or markdowns on bond trades could increase the transition to SMAs or wrap accounts that charge a flat fee for execution and advice. Municipal bond trading always has a markup or markdown, because there is a spread between the price to buy and the price to sell; previously, however, these markups and markdowns did not have to appear on confirmations. The size of the markup or markdown can depend on numerous factors, including size, complexity, and liquidity. The reporting of the transaction costs is designed to make the trading of bonds more transparent and could generate conversations between clients and brokers or managers. The MSRB’s Electronic Municipal Market Access (EMMA) system (emma.org) is a central repository of information and is accessible by anyone. It provides trade data as well as issuer offering statements and annual and event-driven disclosures. There are specific rules on when and how a markup is reported, so a client may not always see the markup. The rules are new, and guidance is developing, so it may take some time for the industry and regulators to arrive at a standard.

We expect the growth in SMAs to continue because of the benefits SMAs offer in comparison to direct retail investment and mutual funds.

At Cumberland we buy bonds in large lots and allocate positions to individual portfolios, which allows for better execution and pricing for our clients compared with individual trades for each client.

Cumberland has been able to take advantage of oversold situations during times of stress such as the Meredith Whitney incident (2010), the “taper tantrum” (2013), President Trump’s election (2016), and the excess supply at the end of 2017.

Cumberland’s policy of investing in high-quality bonds improves liquidity and the ability to execute an active strategy. At the end of last year, the huge volume of supply as municipal issuers rushed to access the bond market before the tax law changes went into effect (see John Mousseau’s piece www.cumber.com/tax-free-munis-continue-to-perform/) resulted in higher yields on municipal bonds and a buying opportunity.

Retail accounts do not enjoy the economies of scale that are available to an SMA manager. In addition, active SMA managers that practice total-return investing may have credit-research resources and relationships with many broker dealers that allow them to achieve competitive execution and develop strategies to optimize investment holdings to meet individual clients’ needs.

Some argue that while mutual fund shares can be purchased and sold any day in any amount, an SMA account has many individual holdings that may take longer to sell. However, when an investor sells shares in a mutual fund, the price received is calculated at the end of the day based on the net asset value of the fund. If an investor is instead invested in high-quality liquid bonds like the ones Cumberland purchases in its accounts, then barring an extraordinary event in the market, there should be ample liquidity, and the bonds will be sold at a time that maximizes price. Additionally, knowledge of our clients’ needs has Cumberland looking ahead to provide liquidity when needed. SMAs may also give every client the advantage of providing the portfolio manager with sectors or categories to be excluded or included, such as “green” or “ESG.” Customization is not possible with a mutual fund.

Separately managed accounts have higher minimum investment requirements than mutual funds do, so they are not available to all investors. But as an investor acquires more assets and develops more highly tailored goals and objectives, an SMA may be appropriate.

Finally, the management fee charged on SMA accounts can be affected by the competitive environment. The fee is based on the type of strategy and can be scaled based on the level of assets invested. There may also be custodial fees charged to the account. Mutual funds have an expense ratio, which includes a management fee as well as miscellaneous ancillary expenses, custodial expenses, and a distribution charge. Many have various levels of sales charges. So it is important to look at all expenses when comparing funds.

At Cumberland we continue to operate as our founders did, investing clients’ funds in separately managed accounts. Our approach to investing is top-down and takes account of global interest-rate expectations and credit-quality trends. Accounts are actively managed with a total-return or income orientation, depending on clients’ needs.

Patricia Healy, CFA
Senior Vice President of Research and Portfolio Manager
Email | Bio

Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Bloomberg Surveillance: The Long Party is Over, Kotok Says (Podcast)

David Kotok speaks with Bloomberg’s Tim Fox and Tom Keene

Tune in around the 24:50 mark to hear David weigh in on the “bogeys for the next several years” and the view that the long party is over.

He also talks about takeaways from Camp Kotok and Leen’s Lodge.

Tune in at 20:22 to hear the full interview.

Cumberland's David Kotok on Bloomberg Radio

Kotok: “Hateful belligerency accomplishes nothing.”

This is a Bloomberg podcast.

LISTEN HERE: Bloomberg Audio

NOTE: Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.


If you like podcasts, check out this one from 2015 featuring David Kotok talking about his background and Camp Kotok with Barry Ritholtz. They also talk about the history of Cumberland Advisors since its founding, and delve into fundamental principles of investing and valuation.


Links here
https://itunes.apple.com/us/podcast/masters-in-business/id730188152?mt=2

And here
http://www.bloomberg.com/podcasts/masters-in-business/




David Kotok speaks with Bloomberg’s Tim Fox and Tom Keene about ETFs, Bonds, Taxes, & More

David Kotok speaks with Bloomberg’s Tim Fox and Tom Keene

David was asked, “Where are you within your portfolio: cash, bonds, equities?” David responds, “ Bonds, barbelled, that’s an easy one and we’ve been in that mode for a while and we’re going to stay there. In our Leveraged Volatility, that’s a high-frequency trading strategy, were 100% in cash. In Core US 20% in cash. And in the Diversified US, 10% in cash and they are biased towards domestic, US, small mid cap, and underweighted risk elements in the international trade war sectors.”

Cumberland's David Kotok on Bloomberg Radio

David is next asked, “Where do you hide in equities? If somebody says I’ve got to be in equities but I’ve got a risk profile like D. Kotok, where do you hide within sectors and ETFs in equities?” David’s response is, “We’re overweight healthcare, were overweight the banking/financial sectors focused in the United States. We’re overweight defense in the industrial sector. And we like transports because Domestic US transport, the ETF, is just on fire and stays that way. There’s a shortage of people. Prices are going to rise, there’s pricing power in transportation, particularly truckers and rails.”

The interview continues with more questions including one about capital gains taxes and if they were indexed to inflation.

This is a Bloomberg podcast.

LISTEN HERE: Bloomberg Audio

NOTE: Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.


If you like podcasts, check out this one from 2015 featuring David Kotok talking about his background and Camp Kotok with Barry Ritholtz. They also talk about the history of Cumberland Advisors since its founding, and delve into fundamental principles of investing and valuation.


Links here
https://itunes.apple.com/us/podcast/masters-in-business/id730188152?mt=2

And here
http://www.bloomberg.com/podcasts/masters-in-business/




A Camp Kotok Debrief Plus Sector Rotation Ramifications

Excerpt from “A Camp Kotok Debrief Plus Sector Rotation Ramifications” by Jeremy Schwartz

Cumberland-Advisors-Matt-McAleer-In-The-News

Last week’s “Behind the Markets” podcast came on the back of the annual Camp Kotok investment retreat in Maine – with one of the key portfolio managers for Cumberland Advisors, Matt McAleer, joining us for a discussion on macro positioning and takeaways from the camp discussions.

McAleer discussed the continued headaches being caused by international markets – the U.S. markets remain very robust and resilient. In McAleer’s view, the 30 markets around the world are not trading well as he watches them making lower lows. McAleer’s current worry is how long the U.S. market can remain the standout while it is near highs and these other markets are trading down.

 

Read the full article at WisdomTree.

You may also listen via this embedded player:


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

Sign up for our FREE Cumberland Market Commentaries

Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.