Download complete issue - IndexUniverse.com

More documents

Recommendations

Info

Over the past 12 years, U.S. investors have faced four investment challenges that were much more severe than they were in the period from 1982 through 1999: (1) Low interest rates and higher future risk for fixed income (2) Sluggish equity returns (3) Higher correlations among many asset classes (4) Less liquidity for certain investments in times of stress In light of these challenges, many investors are exploring investments beyond the “traditional” investments of U.S. stocks and bonds. More than $25 billion has been invested in buy-write funds since the 2002 introduction of the first major benchmark for options performance, the CBOE S&P 500 BuyWrite Index (BXM). Challenge No. 1: Low Interest Rates And Higher Risk For Fixed Income Many investors think of fixed-income investments as being very safe, and many fixed-income instruments have performed relatively well during the past few decades. For example, as shown later in this article, the Treasury bond Figure 1 End-Of-Quarter Yield 18% 15% 12% 9% 6% 3% Figure 2 Yields For US Treasury Notes And S&P 500 (Mar. 1962 - Dec. 2011) 15.84% 6.21% 0% 3/62 3/74 3/86 3/98 3/10 ■ 10-Year US Treasury Rate ■ S&P 500 Index - Dividend Yield 2.10% 1.88% Sources: Bloomberg and S&P Dow Jones Indexes. The S&P 500 yields are based on the end-of-quarter price and the last 4 quarters of dividend payments. The average yields in chart above were 6.71% for 10-year Treasurys and 3.07% for the S&P 500 Index. $1.75 $1.50 $1.25 $1.00 $0.75 $0.50 Indexes Since March 2000 $0.25 3/00 3/02 3/04 3/06 3/08 3/10 3/12 ■ BXY - CBOE S&P 500 2% OTM BuyWrite ■ S&P 500 ■ MSCI EAFE (US$) $1.59 $1.16 $1.11 Sources: Bloomberg and CBOE Note: Month-end for total return indexes, rescaled to 1 on March 31, 2000. (March 31, 2000-July 31, 2012) www.journalofindexes.com index had slightly higher returns than the S&P 500 Index over a recent two-decade period. However, with interest rates so low in 2012, some commentators are noting that the outlook for U.S. fixedincome investments might not be very rosy. Professor Burton Malkiel of Princeton University wrote in a March 2012 op-ed piece: Bonds are the worst asset class for investors. Usually thought of as the safest of investments, they are anything but safe today. At a yield of 2.25%, the 10-year U.S. Treasury note is a sure loser. Even if the overall inflation rate is only 2.25% over the next decade, an investor who holds a 10-year Treasury until maturity will realize a zero real (after-inflation) return. … Given the likely trends, U.S. Treasurys and high quality bonds are likely to be extremely poor investments and are very risky. 1 Further, an August 2012 news article noted: For many investors, the appeal of investmentgrade corporate bonds is obvious. Interest rates on Treasury bonds are even lower … But skeptics say the ravenous demand for corporate bonds has pushed yields on the securities down too far to compensate investors for their risk. … When interest rates eventually rise, prices of recently issued corporate bonds will fall. “The guy buying a [new] bond today is a guy buying a certain loss,” says Anders Maxwell, a managing director at investment bank Peter J. Solomon Co. “Rates have to go higher, and when they do these low-coupon bonds will drop precipitously in value.” 2 The average yields in Figure 1 were 6.71 percent for 10-year Treasurys, and 3.07 percent dividend yield for the S&P 500. Key interest rates in the Wall Street Journal on August 20, 2012, included: • 0.11 percent: 4-week U.S. Treasury bills • 0.44 percent: 3-month Libor • 1.41 percent: 5-year CD • 1.82 percent: 10-year U.S. Treasury notes • 1.95 percent: Barclays Capital Aggregate • 5.93 percent: Merrill Lynch High-Yield 100 In light of the low yields and higher risks for many “traditional” fixed-income instruments, many investors now are exploring a variety of strategies, including the writing of index options, with the goals of enhancing yields and lowering portfolio volatility. This subject will be discussed later in this paper. Challenge No. 2: Sluggish Equity Returns Since Year 2000 Since the bursting of the tech bubble in the year 2000, many major stock market indexes for developed countries have had sluggish returns, as stocks faced crises such as terrorist attacks and the 2008 financial crisis. In the period from March 31, 2000 through July 31, 2012, the S&P 500 Index was up 16 percent and the MSCI EAFE Index was up 11 percent, while the CBOE S&P 500 2 percent OTM BuyWrite Index (BXY) was up 59 percent, November / December 2012 21
Figure 3 Net New Cash Flow For Mutual Funds $119 Billion Net New Cash Flow For Bond Mutual Funds In 2011 $500 $400 $300 $200 $100 $0 -$100 -$200 -$300 $109 $96 -$238 2007 2008 2009 2010 2011 Net New Cash Flow For Bond And Equity Mutual Funds In $Billions Sources: ICI and SIFMA Figure 4 1 0.5 0 -0.5 -1 1/71 $33 ■ Bond Mutual Funds $375 $245 -$11 -$24 ■ Equity Mutual Funds Rolling One-Year Correlations Of Weekly Returns To The S&P 500 Index Sources: Bloomberg and CBOE ■ Russell 2000 ■ MSCI EAFE ■ S&P GSCI ■ VIX (Jan. 8, 1971 – Aug. 3, 2012) $119 -$128 1/81 1/91 1/01 1/11 0.96 0.88 0.69 -0.84 as it collected S&P 500 index options premiums every month (see Figure 2). The sluggish stock market performance has been a key factor in the increased disillusionment of many investors toward equity investing. One clear sign of equity disenchantment has been the net new cash flows for different types of mutual funds. As shown in Figure 3, the net new cash flow for each of the past four years (2008-2011) has been negative for equity mutual funds and positive for bond mutual funds. Challenge No. 3: Higher Correlations Among Many Asset Classes Another challenge for investors in recent years is the fact that there have been higher correlations of returns among many asset classes, and this fact can make it more difficult to construct a portfolio that is well-diversified. The U.S. pension law known as ERISA requires fiduciaries to diversify “the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so.” 3 Figure 4 shows that the rolling one-year correlations of weekly returns have risen for some asset classes: (1) The correlation between the S&P 500 and the S&P GSCI (commodity) Index rose from negative 0.21 on Jan. 8, 1971, to negative 0.02 on Jan. 8, 1993, and then to 0.69 on Aug. 3, 2012. (2) The correlation between the S&P 500 and the MSCI EAFE Index rose from negative 0.13 on Sept. 14, 1979, to negative 0.02 on Jan. 8, 1993, to 0.88 on Aug. 3, 2012. (3) The correlation between the S&P 500 and the Russell 2000 Index rose from 0.52 on April 7, 2000, to 0.96 on Aug. 3, 2012. While the correlations among many “traditional” assets have risen over the past decade, the correlation between the S&P 500 and the CBOE Volatility Index (VIX) fell from negative 0.60 on Jan. 11, 1991, to negative 0.84 on Aug. 3, 2012. In recent years, some investors have explored the possibility of using volatility as an asset class, and using options and VIX-based products for purposes of diversifying portfolios. Challenge No. 4: Less Liquidity During Stressful Market Periods During the 2008 financial crisis, many investors became more concerned about the liquidity of their investment holdings. A GAO report on the 2008-2009 financial crisis noted: Some plan representatives described significant difficulties in hedge fund and private equity investing Figure 5 CBOE’s Options-Based Benchmarks Index Ticker Hold Stocks Or Cash S&P 500 1-Month Options Sold S&P 500 3-Month Options Bought Price History Begins CBOE S&P 500 At-the-money BuyWrite Index BXM Hold S&P 500 stocks “covered” call options None June 30, 1986 CBOE S&P 500 2% OTM 2% out-of-the-money BuyWrite Index BXY Hold S&P 500 stocks “covered” call options None June 1, 1988 CBOE S&P 500 At-the-money “cash-secured” PutWrite Index PUT Hold U.S. Treasury bills put options None June 30, 1986 CBOE S&P 500 95-110 OTM call options at 110% OTM call options at 110% OTM put options Collar Index CLL of the S&P 500 value of the S&P 500 value at 95% of S&P 500 value June 30, 1986 Source: CBOE 22 November / December 2012
Page 1 and 2: Plus Blitzer on the history of opti
Page 3: Contributors Mark Abssy Mark Abssy
Page 6 and 7: STOXX LIMITED INNOVATIVE INDEXING.
Page 8 and 9: People’s futures are in your hand
Page 10 and 11: ©2012 Morningstar, Inc. All rights
Page 12 and 13: Exchange-traded products span a wid
Page 14 and 15: Figure 5 Median notional Volume ($B
Page 16 and 17: the put spread in this example is $
Page 18 and 19: The Loch Ness Monster. Sightings of
Page 20 and 21: TAKE A NEW LINE WITH YOUR EQUITY Po
Page 24 and 25: Figure 6 $15 $12 $9 $6 $3 5 Indexes
Page 26 and 27: 500 BuyWrite Index (BXM)—was anno
Page 28 and 29: volatility that was about 30 percen
Page 30 and 31: Most investors are familiar with op
Page 32 and 33: equired to establish this position
Page 34 and 35: THE POWERSHARES DB COMMODITY INDEX
Page 36 and 37: Depression was history, rather than
Page 38 and 39: academic assessment of the very exi
Page 40 and 41: Alternative Investments 4.0% Real E
Page 42 and 43: tion and management. Within it, an
Page 44 and 45: Much ink has been spilled on the pe
Page 46 and 47: Figure 1 sectors No. of top dogs Re
Page 48 and 49: over the 30-year span. “Business
Page 50 and 51: States, the average concentration p
Page 52 and 53: Figure 10 sectors Source: Research
Page 54 and 55: investors were charging, ProShares
Page 56 and 57: of health care services, primarily
Page 58 and 59: open the Etracs Long-Short S&P 500
Page 60 and 61: Morningstar Index Funds U.S. Style
Page 62 and 63: Exchange-Traded Dow Jones U.S. Indu
Page 64 and 65: ETF Analytics Your clients want mor
Page 66 and 67: PICK THE HIGH HANGING FRUIT. Find 1
Page 68 and 69: InsideETFs portFolio management str
Page 70 and 71: ©2012, THE NASDAQ OMX GROUP, INC.
Page 72:
Crossword Thinking About Options Te
show all

Download complete issue - IndexUniverse.com

Create successful ePaper yourself

Delete template?

Save as template?