Category Archives: T-Advisorpedia

Blockchain: the next revolution in finances

This is the buzzword right now in technologies and finances: blockchain. The most disruptive technology, something like personal computers in 1975 or internet in 1993, or, as the Harvard Business Review published: the first native digital medium for value, just as the internet was the first native digital medium for information.

But what is it? This article explains it very simply: think about a book where each page is a block with a statement of any transaction. Every time a block is filled and added to the chain (a new page), a new block is generated. Blocks are linked to each other in a chronological order, as pages in a book.

Initially, blockchain was created as the technology that sustained the cryptocurrency bitcoin. Now, banks are investing a huge amount of money here, because they perceive the disruption of this technology.

Blockchain is a huge ledger running on million of devices and it is capable of recording anything of value, as money, equities, funds, bonds, contracts…It is a safe and private peer-to-peer system because trust does not depend on central institutions, but on network consensus, cryptography, collaboration and clever code. What does it mean immediately? It is a risk for intermediaries, essentially in finances. People can sign contracts or exchange assets without knowing each other but being confident that they will not be cheated. Without intermediaries, there will be increasing savings (between $16 and $20 bn a year, from different sources).

Following a report from the international consultancy Deloitte, blockchain has several advantages:

  • Disintermediation. Counterpart risk disappears.
  • Empowering of users, because they control their information and transactions.
  • High quality data, widely available.
  • Durability, reliability and longevity, hacker-proof.
  • Immutability of transactions: nobody can erase an operation
  • Transparency, because block changes are viewable by all parties.
  • Simplification: there is an only ledger, not several.
  • Faster clearing and settlement transactions, in minutes.
  • Lower cost transactions, due to the elimination of intermediaries.

However, this technology has still some challenges. Deloitte mentions that it is a very new technology without any regulation that consumes a great deal of energy from computers. Although it helps save money, it also has huge initial costs. Finally, as it is a new technology, there are still concerns about security, privacy, integration with other systems and the leaning to accept it by the users.

Financial experts say that blockchain will change some processes as know-your-customer, due diligence and anti-money laundering. This banking compliancy costs will disappear. Once a bank did it with a customer, other financial entities will then be able to use it, because this data are under customer control. Several time-consuming processes will disappear (and the attached costs) and the role of the adviser will deeply change. It value will be linked to their knowledge, not to their ability to make transactions. This is only the beginning of the next future and its name is blockchain.

MiFID II and my roboadvisor

Next year in January, the European regulation MiFID II becomes effective. MiFID are the initials of Markets in Financial Instruments Directive. There was already a first version, but the evolution of the market and the interest of the European institutions to protect individual investors promoted this second chapter.

What does it mean? Actually, the regulation improves transparency in the markets and prices, promotes lower costs and strengthens investment protection. For instance, what investors’ protection refers, it makes heavy emphasis in communication, disclosure and transparency. The supervision is also reinforced and put the focus in management and governance in financial entities and markets.

MiFID has a high complexity, but we wonder: what will it happen if we invest through a roboadvisor? Will these platforms avoid the regulation? No, in any case. Automation does not mean at all that roboadvisors will protect less their customers. On the contrary, roboadvisor promote lower costs, standardization and transparency.

We have to consider that there are several kinds of these platforms: form full automatic services to others where there is a platform with human active management. This diversity is not linked with different levels of protection, because all of them must comply with the suitable tests to check the investment ability and knowledge of the customers and they have also forbidden retrocession if they are independent. What does it mean? In short, independent roboadvisors will not be able to sell financial products from other entities (for instance, mutual funds) to obtain a sales commission. Well, let’s explain this a bit more: if you sign up in the roboadvisor XYZ, which reports as independent, it is engaged to sell the best products depending the investors’ profile: the best from any entity. If the roboadvisor is not independent, it has to be very clear that it sells from specific entities and receive a retrocession for any sale.

Roboadvisor are platforms, but there are people behind that create portfolios. These people must have specific studies, following the rule. But the most important effect is the transparency in costs: roboadvisors (as human advisors) will have to report with details about any costs. These costs will have to be listed, not accumulated. In this part, roboadvisors are far away from human advisors. One of the first thing that you find in roboadvisors websites are the amount that you have to pay for the management, because they have very clear their advantages against traditional models.

As you see, MiFID will regulate much more to protect investors. It was developed with several learning from the crisis and from the recent fintech solutions. It tries to order these new systems and they have to accept regulations. If roboadvisors wouldn’t accept MiFID, what credibility would they keep when they say that they are transparent?

Are there different kinds of ETFs or just one?

It is maybe the asset that has deeply changed the asset management in the last 10 years. ETFs are the great trend in investments and it has continuously grown since its launch in the 1990s. We have already described what they are, their characteristics and advantages, but it is time now to wonder: how many types of ETF are there in the market?

The main group is the traditional index-based ETF, focused in tracking specific assets (bonds, market indexes or even equities that pay dividends), countries, sectors or even styles (mid-cap, large-cap). They are the majority and the broadly known.

However, there are other kinds of ETF that are also interesting in order to learn about the variety that this recent asset has reached:

  • Actively managed ETF: The first reaction is: am I reading right? Yes, you are. They are actively managed to meet a particular investment goal. It can sound contradictory and they are really a little group. They try to sum the advantages of both ETF and mutual funds, but the disadvantages are that fees are higher than traditional ETF and the transparency is a middle point between ETF (the highest) and mutual funds (the lowest).
  • Inverse ETF: These ones use derivatives to go just in the opposite direction of the market. The question that emerges is: what if the market wins? Am I going to lose? No. Inverse ETF are design to invest in short-term to hedge longer investments or take advantage of negative markets.
  • Leveraged ETF: They use derivatives to get higher returns that the reference index obtains. They try to multiply the daily earnings, but in this case, if the index loses, you will also multiply your negative performance.
  • Commodity and currency ETF: They are focused on specific physical assets, but also in the futures markets. Metals, agriculture, energy, currencies… It is a way to diversify investments in these assets.
  • Innovative ETF: Imagination has no limits and ETF also shows it. In the long list of innovations in this asset, there are ETF of ETF, Volatility ETF or Tax-Deferred ETF, just to name a few of them.

This list attempts to classify the different types of ETF, but there will be surely more in the near future. The volume of managed wealth and inflows to this assets reached continuous records and we are sure that this will not be the last time that we will write about them.

Comparing my assets with its benchmark: some figures for analysis

Comparative figures asset benchmark

As investors, we look for the best performance. A good performance is not only an absolute figure, but also a relative one, when we make comparisons. For instance, if a share in our portfolio has a performance of 10% in a year, we can think that it is a nice number, in absolute terms. But if the reference index of the share has performed a 15%… well, it is not so nice. That is why it is interesting to take into account some figures to understand if our securities have a good quality compared with their benchmarks:

  • Relative trend of the security versus index: it compares both behaviours. If the figure is positive, the security is strong versus the index. If it is negative, there is a weakness. It is one sign to detect if our stock or fund is performing properly against the index.
  • Tracking error: this indicator measures the deviation of the difference in daily returns of the security and the benchmark. A higher figures shows that the daily returns of the security has a larger difference compared with the daily returns of the index.
  • R 2: it measures the similarity of the daily behaviour of both the asset and the index. If the figure is near to 1, there is a strong parallelism. If it is near 0, there is no relation.
  • Correlation: if R 2 measures the similarity of the behaviour, this provides more specific information. If the figure is near to 1, there is a positive correlation (both move identically in the same trend). If it is near to -1, the correlation is negative (both move identically in opposite trends). If it is near to 0, there is no correlation.

R 2 and correlation are very important to find assets not linked with the benchmark if its evolution is negative, for instance, when the index drops. On the other hand, it is also interesting to find correlated assets when the index soars.

  • Alpha and beta: both are quite important to measure the outperformance and volatility of the asset compared with the benchmark. We have an extended explanation in this post. Typical investor behaviour is looking for assets with good alpha.

Of course, the analysis of a single reference is not enough to get an idea about the relationship between the asset and the index. We have to look at all data and connect them to understand in a right way if we should put our money there or just go our quickly.

What does portfolio optimisation mean?

Think about your portfolio. It does not perform as you would like and you do not know how to implement changes to improve the returns. Should you read all kind of reports? Of all possible assets? That’s nonsense. There should be a method to optimise and change efficiently your portfolio. There is actually and method: portfolio optimisation.

When we talk about it, it means the process of choosing the weights of different assets for your portfolio in order to obtain the best possible returns compared with similar portfolio compositions or risk profiles. The main measures taken into account are the expected returns and the expected volatility. Optimisation systems include limits of accepted volatility and weight per assets.

The system is linked to the Markowitz Efficient Frontier model that pretends to guide your investments maximizing your performances and reducing the risk. The main point that supports this model is choosing low-correlated or uncorrelated assets. Smart diversification is the idea behind it. An efficient portfolio means a well-diversified one.

Portfolio optimisation efficient frontier

Optimisation systems are professional tools to improve the portfolio results, but it has been implemented in T-Advisor for individuals. It is not easy, because you have to play with the following indicators:

  • Asset correlation
  • Maximum volatility
  • Expected return
  • Maximum weight per asset

The smart combination of the four indicators provides the success of the investment. They can change depending on your risk profile, but accepting a higher risk does not mean being suicidal.

Portfolio optimisation result charts

There is also another very important point: the costs. If you optimise your portfolio and follow the results of the optimiser tool, you have to rebalance your portfolio. A rebalance means trades to buy and sell in order to compose the portfolio following the optimisation indications and… it has costs. However, we have to remind that investments are for long-term and rebalances should be executed every certain time. In these cases, costs can be balanced out with the improvement of the returns. If you are a day trader, then forget this, because you are other kind of investor.

Capital preservation: more than a strategy

People out from investments usually think that this business is easy and high returns are the common rule. If you say: “I invest”, then they look at you as a rich person, when you probably try to avoid a lost of purchasing power caused by inflation. That is usually the most conservative strategy, but the idea behind that behaviour is capital preservation.

Capital preservation is defined as a conservative strategy that tries to avoid the loss of value of your investments. Some investors are just quiet if their money does not decrease, but this little ambition has an enemy: inflation. If the financial goal reduces only to that narrow meaning of capital preservation, they will surely lose purchasing power in the long term. That’s why this strategy is recommended for safe short-term investments, as bonds or certificates.

However, capital preservation means something else, because it is behind every investment strategy. Whether it is more aggressive or more conservative, it does not mean that the goal behind the scene will not be the same: to keep at least the same as we invest and keeping the same purchasing power. Possibly, someone argues that the more aggressive portfolios are designed to obtain the highest return accepting volatility, but no investor is so fool to accept losing their money without a B-plan.

This B-plan to preserve the capital is rebalancing. When an investor receives alerts from their system, he has to decide when to change his strategy. Regular investors are not traders, but they prefer to invest in the long-term. That’s why these investors have to avoid panic in certain periods when markets are bearish or react negatively due to any external reason (e.g. Brexit or similar). Investors have to look at the long term and analyse with their tools the real effect over their strategy and if they have to rebalance their portfolios. What for? First of all, to preserve their capital; secondly, to serve their strategy (more conservative or more aggressive).

In other words, as the main goal for companies is surviving in the markets, the main goal for an investor is preserving his capital. Returns will come, higher or lower, but these will be the second step. Alerts, optimising modules and bootstrapping systems (as T-Advisor has) are the tools to be successful for it.

Risk and volatility: they are not really the same

risk and volatility in T-Advisor screener

We often read comments about the high volatility of any asset, as it would be a sign of a high risk. That is not necessary true, because you can find different assets with similar volatility and different returns: some positive and some negative.

Volatility reports about the variation of an asset price in a certain period or the deviation of its returns from the average. A high volatility suggests strong ups and downs in the asset price. That means for current investors that it is more risky, as they can lose money more quickly… but they can obtain also higher returns.

The question is that volatility is not a measure of risk taken as an only figure. It has to be linked with other measures. For instance, you have to watch the liquidity, because an illiquid asset is more risky, as it is more difficult to sell and obtain your money back.

Volatility also reports about the past, because it is the mirror where you find the information about what happened with the prices till today. You cannot obtain other information about risk. For instance, it does not report about the counterparty risk, let’s say, you invest in bonds and the issuer has no money to pay your coupon. To obtain those data, you have to look at other parameters.

The list of risk is long, but you cannot perceive them through the volatility. It is very important for investors to understand the difference, as many get good returns trading with the volatility of the asset. As we commented above, it can be an opportunity.

A relevant measure for the risk is the Value at Risk, also known for their initials VaR, but you have to watch also the diversification (in the case of a fund or your own portfolio), the correlation with other assets or the liquidity. To sum up, if you consider the volatility as the only way to control the asset risk, you will make a mistake. The risk analysis is a combination of several figures that have to be linked to obtain a global perception.

Risk profile matters to build your portfolio

Basic risk profiling test in T-Advisor

Risk profile matters for investors. It is relevant information, because anybody has the same standard to resist the market changes. When we speak about risk profiling, we mean a process for finding the optimal level of investment risk for an investor, considering three items:

  • Risk required: risk associated with the return required to achieve the investor’s goals from the financial resources available.
  • Risk capacity: the level of financial risk the investor can afford to take.
  • Risk tolerance: the level of risk the investor is comfortable with.

The three components are different faces of the same process. For instance, you can be very aggressive in investments (risk tolerance), but without very much money to invest, because you are very engaged with different kind of expenditures, as a mortgage or children (risk capacity).

Investment authorities in different countries have developed several standards to test the risk profile for individuals and these tests are required to banks, wealth managers and financial adviser with their customers. These tests ask for the experience, the knowledge and the strategy. An individual with low knowledge and experience in investments cannot begin with complex products, because the risk of losing a huge amount of money is very high.

Risk profile means that individuals and their investments have to agree the same standard. From this perspective, the usual range comes from very conservative to aggressive. Usually, conservative investors prefer a lower performance if their portfolios suffer less changes and tend to keep their investments for a long term. Aggressive investors choose always a higher performance, although the assets suffer more changes and they have more probability to loss their money. They also look for short or medium-term investments.

What are the recommendations for conservative risk profiles in order to build their portfolios? Fixed-income assets (bonds, fixed-income mutual funds), cash, deposits and, if they are a bit biased to equities, the best are liquid stocks that pay dividends. On the other hand, aggressive profiles will look for equities (even in risky countries, as emergings or frontier), short-term assets and derivatives. They can provide high returns, but you can also loss everything.

What is the main recommendation over the ones above? Every investor has to honest with himself to accept his profile. If you lie yourself, you can be at a very high risk in investments. That is why you have to fill in a risk test, before you put your money in any adventure.

Active and passive management: an endless discussion

Passive management categories in T-Advisor

The boom of ETF in the investment landscape as a new kind of asset opened the endless discussion about active and passive management. First of all, what do we mean when we speak about both ideas?

Traditionally, the active approach means that a fund manager or a team design a specific fund or portfolio composed by a basket of assets. These assets are selected by the product profile (different kind of risk, asset categories or market). Then, the manager tries to beat a specific index or benchmark. The task is hard, because the manager has to deal with a lot of information related to companies, markets, policies and general trends. To attempt to outperform, the manager buys and sells regularly to improve the results.

On the contrary, the passive approach creates a portfolio or fund that copies the same structure as a specific index. That means that the result is narrowly linked with the index. Instead of outperform, the passive management obtains the same returns as the benchmark. The task of the manager is quite lighter, because he only adjusts the portfolio every certain time depending the changes in the index composition.

The question is: what is better? A usual pitch explained by passive management supporters is that active managers have a low rate of success outperforming the market, which is actually true, if we see some statistics. Usually, ETFs even beat the active manage funds. Other arguments are related to the costs: while passive management has low fees, active management costs quite more, because there is a human group behind the portfolio. Passive products are also easier to understand and agree the idea of diversification to reduce risks.

The current roboadvisor trend is based on ETF and passive management. However, it is reasonable to speak about different degrees of active management, as the financial adviser and blogger Cullen Roche proposed in his blog. Passive investing has a reduced degree of active management, but it is fair to say that the operational structure is quite lower as a traditional fund manager.

It is difficult today to defend active management, because they fail regularly in its aim of beating the market and the costs are higher. We don’t mean that it has to disappear, but it will surely evolve to a model in which technology will play a stronger role to reduce costs, so that traditional funds can compete again. Roboadvisor platforms can be a solution. The current movements in the markets are showing it, because great banks and managers are buying roboadvisors or developing their own algorithmic platforms.

External factors to take into account for your portfolio

Shares, funds and ETFs, as assets, have their own ratios and figures that help us decide whether we buy or sell them for our portfolios. As we already have written, there are several measures, as performance, volatility, risk, technical analysis and many others.

But assets are not in a parallel world and they are affected by external factors. That is why an investor must always be alert to news. You can have a very good portfolio with a nice score, but sudden and unexpected facts can take place. This is a short list of some circumstances that can change everything in our positive portfolio evolution:

  • Macroeconomics: If we invest in assets from a specific country, we have to consider the evolution of the own country. GDP, inflation rate, debt and fiscal deficit are some figures to assess. When a company, for instance, depends on internal consumption, you have to follow the variation of global consumption in that country. Also, a high debt is a risk, if we have bought local bonds.
  • Sector evolution: When you invest in a company, you have to consider the global evolution of its economic sector. For instance, oil has been in the first pages in the first half of the year and that has effects in the value of oil companies. It also affects funds and ETFs linked to a specific sector.
  • Individual company evolution: balances, financial statements and, very important, investments and expectations about future business are some facts to follow.
  • Interest rates: We live now a weird situation, because official interest rates are around zero or even negative. Interest rates have a strong link with the interests that bonds offer. They also are a condition to assess the possible profitability of different kind of assets. If interests are high, investors possibly look to fixed-income funds, bonds or even deposits. If they are low, they will surely turn to equities.
  • Politics: Money runs away from instability and tries to rest in quiet places. Social unrest, political changes by elections or confrontations between countries (not necessary a war) are situations to take into account in order to decide the safest investments.
  • The unexpected: There is also a black hole with unexpected situations, as a terrorist attack, a company bankruptcy or a sudden crash in the stock market (who could predict the Black Monday in 1987?).

Yes, we can think that we have everything under control, that the portfolio ratios are impossible to improve, but investments do not only depend on internal figures. We live in a world where many things happen and several of them have huge consequences for our wealth. Would you mention other factors to our list?