A ‘naive hedge fund’ will simply buy what has gone down and sell what has gone up, as discussed in the post What Happened to the Quants in August 2007?. How would such a strategy work in the Canadian preferred share market?
Look for the research link!
James . . . omg . . . many successful “investors” have been living . . . exclusively . . . on that strategy for years.
Here’s the reality about the preferred share market (imo lol) . . . if the bond yield is rising (as it is most days now), the pref market could mimic the bond market, and tank . . . or it could recognize the benefit of rising rates to dividend growth, and rise. We’ve seen both phenomenons play out, on any given day, several times lately. No rhyme or reason . . . it’s either going to be a rainbow pic, or a nuke blast pic the next day . . . and there’s no real explanation beyond the natural illiquid nature of these things.
The only logical conclusion is pretty much what you’ve been suggesting from the beginning . . . “you can’t time the market”. Therefore . . . if a pref share goes meaningfully down, buy it . . . and if it rises, . . . sell it and lock in the profit. (buy low, sell high . . . Hmmmm? . . there’s an idea)
Not that naive, I guess!
As far as the broader market goes . . . 20 years ago pretty much to this day, the TSX composite index closed at 20,762. Right now, it sits at 20,872. Therefore, if a general market index investor (not a pref investor lol) took a “buy and hold” perspective, that investment on a net basis would have gained “nothing”. When inflation, dividends, etc. are factored in, it would have been a money losing idea at this point. When one thinks about the on going mega profitability of the banks, utilities, etc. . . . and the recent super uplift in the energy sector, this performance is worst than lame. The TSX ranks near the bottom of the “top 100 exchange performers” for this period, behind exchanges like Croatia, Greece, and several countries I’ve never heard of. Pretty impressive for a G7, world leading economy, right?
The purpose of that little background in domestic incompetence is this: if you’re going to be a market participant in Canada, you better be prepared to be an active trader . . . and embrace the “buy low, sell high” mindset . . . otherwise, you might as well just buy some GICs.
“20 years ago pretty much to this day, the TSX composite index closed at 20,762.”
On June 2, 2002 the TSE Composite index closed at 7478. At 20,872 that is ~5.3% compound annual return, excluding dividends.
So today, we get the “prefs are bonds” effect . . . not only that, but the infamous “retail investor algorithm” effect of an issue trading down substantially, and simultaneously being offered lower than that last trading price! Yay Questrade! (example FTS.PR.K for those seeking ‘proof’!)
20 years ago today, if you bought the XIU and re-invested the dividends and did nothing, you would have a 7.85% compounded return per year for those 20 years. not terrible.
The only logical conclusion is pretty much what you’ve been suggesting from the beginning . . . “you can’t time the market”. Therefore . . . if a pref share goes meaningfully down, buy it . . . and if it rises, . . . sell it and lock in the profit.
Taking unhedged positions on such a basis would indeed be an example of market timing and those who practiced it would quickly lose all their money. The article discusses a trading strategy for market-makers (either at a dealer’s propriety desk, or (less often and less successfully) as a day trader of some indeterminate size, taking hedged positions.
Such a strategy (once elaborated, to become a little less naive!) would be useful at large ‘family-office’ investment firm, as an overlay on a big preferred share portfolio. Such a strategy wouldn’t have to worry about tax effects on short dividends and borrowing costs would be mere bookkeeping entries at worst.
This concept of trading with some reasonable expectation of mean-reversion will be a component of most trading strategies based on supplying liquidity to the market.
Nestor & Stus . . . keep in mind that a very, very large majority of market players are not “investors” in the traditional sense. They are credit dependent margin holders, highly reliant on a market that is not rocked by, among other things, unexpected geopolitical issues. Such events cause gyrations that impact not only emotional reaction, but more importantly, margin qualification. Over the past 20 years, we’ve had the 2008 credit fiasco, the 2014 OPEC price war, the 2016 “Trump thing lol”, to name a few.
I venture to say that most market participants from 2002 forward would not have been able to quietly ride through these rough waters, to just sit and enjoy that 7.85% compound return idea.
Remember, we, for quite some time now, live in a “wealthsimple” era of high expectations for immediate returns, with no downside. Any hint of that stumbling, . . . and it’s *poof* . . . bye, bye. James’ “shut up and clip your coupons” concept is understood, and probably embraced by most of our “assiduous readers” here, . . . but probably not as much by the “skip the dishes” crowd lol!
a very, very large majority of market players are not “investors” in the traditional sense. They are credit dependent margin holders, highly reliant on a market that is not rocked by, among other things, unexpected geopolitical issues.
I take issue with this. Those of us sufficiently interested in preferred shares to read this blog may well be in the market every day (or at least considering market action) in varying sizes may well consider ourselves Masters of the Universe. We may well think we’re of critical importance to the orderly functioning of our little world but in reality we’re just ants, crawling around the picnic blanket trying to eat the crumbs left over from somebody else’s cake. We provide liquidity to the ‘real money’ accounts. It’s a good job, but not of any more significance than cleaning a washroom or unblocking a sewer.
Consider some representative numbers for a typical preferred share. It trades about $100,000 per day (market value), has an issue size of $250-million (par value) and a trading price of $20.
So the market capitalization is $200-million, which means it takes 2,000 trading days for the issue to have turned over completely. That is, it takes about eight years for every share in an issue to have traded once (new issue settlement exccepted). Even this figure overstates the case, because some of those shares will have traded multiple times, while others will have stayed locked in the vault the entire time, with no other activity than dividend payments.
So we can say that the ‘average’ preferred share holder hangs on to his shares for eight years (new issues and redemptions excepted) while the median investor is even more tight-fisted.
The average investor is doing everything just right, at least as far as ‘shutting up and clipping his coupons’ is concerned.
We may well think we’re of critical importance to the orderly functioning of our little world but in reality we’re just ants, crawling around the picnic blanket trying to eat the crumbs left over from somebody else’s cake. We provide liquidity to the ‘real money’ accounts. It’s a good job, but not of any more significance than cleaning a washroom or unblocking a sewer.
This needs to be printed and taped on everyone’s screen. At least those who believe in their ‘investing prowess’.
Actually, unblocking a sewer is a hugely important job, when required! Many people here are impressive writers… if only reading could be on the same elevated level. I think my comment was exactly on point with the “ants & crumbs” analogy….but for some reason, it was interpreted differently. No worries. Not worth considering further.
“… and so it goes… “ – – Kurt Vonnegut
“I venture to say that most market participants from 2002 forward would not have been able to quietly ride through these rough waters, to just sit and enjoy that 7.85% compound return idea.”
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most “investors” would not have all their money in the TSX either. most “investors” would have a balanced portfolio, depending on their needs and goals. they would most likely have an equity portion composed of ETFS, made up of US/European/Asian/Canada/emerging markets etc. they would also have a bond portion, a preferred share portion, a REIT portion, maybe a commodity portion. maybe a cash portion etc. it all depends on the size of the account, risk tolerance, and objective.
they would also rebalance annually at the very least if needed or after big events like the ones you mention. all this would have smoothed out the dips in equities and allowed them to quietly ride out those bumps. 2008 may have been scary, but a balanced portfolio would have not been down anywhere near as badly as the SP500.
so yes, if one is an “investor” one behaves differently than a speculator.
” keep in mind that a very, very large majority of market players are not “investors” in the traditional sense.”
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i’ve been around since the early 90’s and have seen pretty much everything. today is no different. markets have a way of eventually self correcting the excesses. most of the Redit GME AMC speculators have been destroyed. only a few made money. no different than putting all your money in Nortel or Bre-X . nothing has changed in over 100 years of investing. it’s all happened before and will happen again
[…] This ties in with my essay titled ‘Naive Hedge Funds’. […]