There have been a lot of discussions about the Doubleline Schiller Enhanced CAPE funds, primarily DSENX, but I'd like to make sure I know how they work before doing anything with them. I would appreciate any corrections or clarifications.
In basic terms the fund is comprised of 4 out of the 5 cheapest sectors based on CAPE and the sector exposure is adjusted monthly. The funds achieves this exposure primarily through swaps. Swaps are very flexible because 2 parties can effectively agree to "bet" against each other over a period of time and they can negotiate the specific terms. By doing this they essentially replicate the index and gain the appropriate value exposure to the chosen sectors. At the least, however, the fund has to be gaining leverage through their use of swaps. It could be that neither party is actually investing or shorting the sectors but instead they just have a "paper" bet and each party only has to be concerned about the others ability to pay if they lose where the leverage comes from not actually "buying" anything. Or it could come in the form similar to futures contracts where the investment is leveraged and you only need to maintain a small portion of the value of the investment as margin.
Regardless of how they achieve the leverage the fund has therefore gained the ability to "perform" as if they had all their assets invested in those 4 sectors without investing all their cash and they use that excess cash to buy bonds, earn income and "enhance" the return that the index achieves.
To the extent that they use most or all of their excess cash to buy bonds, part of the risk is that they'd need to liquidate bonds to pay losses when the swap expires if the fund's sector exposures lose value. This might be why they have 18% of their fixed income investments in US govt. bonds, since they wouldn't be difficult to liquidate if it was necessary. They also have 8.7% in pure cash which I guess could be a margin requirement or could simply be a way of limiting the likelihood that they'd be forced to liquidate bonds if the equity investments lose money.
I guess to the extent that any of their swaps aren't readily marketable they would have to include a provision that either party could "end" the bet at any time. This would allow them to reallocate to whatever sectors are chosen each month, but my knowledge about the details of how they're effecting these swaps is basically non-existent so its just a guess.
Maybe I'm missing something but it seems like the main risks with the fund are related to the terms of the swap, which the public probably never finds out unless someone spills the beans and whether the fixed income securities they choose are sensitive to interest rates and could more than offset the income they produce due to a loss of value. Since a good majority of those bonds, according to the fact sheet, have short durations, it would at least seem like they're not being overly aggressive with their goal of "enhancing" the index.
Comments
For what interest it holds, I reached out to DoubleLine more than two weeks ago and offered to write in April a combined profile on both DSEEX and DSEUX devoting more to the former than the latter (it's newer) because of the interest these funds have generated on MFO. I sent a contact I have at DL with our MFO Fact Sheet (our interest in covering funds and the work we do), links to my two previous profiles that MFO has run, and other information as my own "pitch book' -- professional, polite.
The result was a closed door with a cold shoulder.
After thinking this through, I suspect that in view of DL's conflict with our competitor over DBLTX and DL's lack of cooperation with them about that fund, I don’t think they want to touch MFO either. While I have had replies from my contact at DL in the past, no response occurred this time.
So unfortunately we did not learn anything, and knowing more about these swaps was at the very top of my list as a matter of inquiry. Hopefully others here can add insight. We'll keep trying. Best.
I'd like to play around with it (more for self-education than anything else), if you don't mind. DSENX is what I'd consider a "black-box" fund. To me the term to characterizes funds which (1) make extensive use of derivatives and/or (2) allow an unusually high degree of latitude on the part of the manager. I'll assume DSENX has the ability to short assets (related to use of derivatives).
Derivatives are subject to numerous risks. The linked summary prospectus http://www.doublelinefunds.com/wp-content/uploads/Shiller_Enhanced_CAPE_Sum_Pro.pdf prominently defines some of those. The Class N .89% ER is quite reasonable for this type of fund. Reported turnover is 67%. My understanding is that brokerage/trading fees are not reflected in a fund's ER, so expect a much higher amount of hidden cost compared to a plain vanilla equity fund.
If you create a 100% exposure to some type of equity index(s) through use of derivatives, while at the same time investing a significant portion in fixed income, than of course you're leveraging-out the equity exposure. Price swings on the equity side should be exaggerated compared to actual equity values. The managers, as you suggest, probably count on their fixed income holdings to moderate or offset the inherent equity volatility. Lipper's breakdown of holdings:
Bonds: 42%
Equity: 33%
Other: 18%
Where I'd take a second look, since you seem very knowledgeable about the equity orientation, is at the types of bond holdings allowed. It appears from the prospectus that fixed income (average maturity out to a maximum of 8 years) may include CMOs, high yield, floating rate, and just about anything else the manager wants to buy - including the kitchen sink. A lot of funds will try to hedge equity fluctuation with high quality bonds. This latitude in the fixed income end is a bit concerning to me. But I'm not Jeff Gundlach.
Not entirely sure what you hope to achieve through this fund. I've used black-box funds with varied success over the years, usually as hedges against equity/bond losses - but nothing quite like this one. Oppenheimer's ill-fated commodities fund (QRAAX) used derivatives to invest in various commodity futures. At times the fund would report bond holdings as high as 110% while still being fully exposed to commodities! The fund I replaced it with, Capital Income (OPPEX), is also a bit of a black-box. I trust the current manager. But in the wrong hands the fund could take a Kamakize dive at just the wrong time. Those buying DSENX are likely making a similar calculation based on Gundlach's excellent record.
FWIW: Lipper scores (3-year + old) DSENX very highly, giving 5 (its highest score) for "capital preservation" among "diversified equity" funds. These ratings are based on performance comparisons rather than any in-depth analysis. So tables could turn quickly, I suspect, if the style of investing were to fall out of favor.
This has been mentioned before. What does it mean and how would it happen? Wholesale bailing from US LC equities? CAPE tracks SP500 quite closely (regularly outperforming it to some extent) over the last 4.5y, 3y, 2y, 1y, and ytd. So 'style of investing' decline would entail overall slump in SP500, right? Anything else?
So far all I come up with for downside is broad equity crash. Maybe others can explain how tables could turn quickly otherwise.
Just a thought.
@hank- to answer your question I would just consider the fund as one of the options to get large blend/value exposure and potentially get a better return. I know that's not a completely legitimate way to think about the fund but that's essentially where I had arrived. Aside from that the fund has been very popular as a discussion topic and each time I read the discussions I kept thinking about how it works and where the risk might be so, like you, I was interested in a little education.
You said "Price swings on the equity side should be exaggerated compared to actual equity values". Price swings would be exaggerated relative to the cash they actually committed to the positions but if they've done it right then the equity portion of the portfolio should behave very close to what would happen if they had just equal weighted 4 sector etfs with all the assets of the fund.
I have some other comments based on looking at their SEC filing from December but I'll make a separate post for that.
The idea is not the the bonds moderate the volatility, but that they enhance returns. That is, you're getting 100% equity exposure for virtually nothing (hence they high leverage multiplier), and you've got cash left over to "enhance" the index returns.
The funds are not planning to buy low and sell high. They're planning to track the index, wherever it leads, but also to add alpha from fixed income. To do that, they have to make more on their (long term) loans than it costs them (short term rates) to buy index tracking derivatives.
I've not tried to work through the details, but this Kiplinger article in the WashPost a few years ago expands on what I wrote, in its description of MWATX and PSPAX, two funds that try to enhance S&P 500 returns through futures.
http://www.washingtonpost.com/wp-dyn/content/article/2008/04/07/AR2008040700711_pf.html
PIMCO claims it has been doing this since 1986.
Where would that be?
Reminders:
etf.com:
The Barclays ETN+ Shiller CAPE ETN tracks an index that selects 4 sectors in the S&P500 using longterm relative value and price momentum. The 4 sectors are equal-weighted. Stocks in each sector are cap-weighted. CAPE is a unique offering in the LC segment, as it covers just four of the nine S&P500 sectors at any time. The underlying index equally weights the four sectors with the strongest relative strength and momentum. This exposure is dynamic, subject to a monthly rebalance ...
from @MikeM, a few weeks ago:
If you believe in the axiom buy low sell high, value, this strategy does the work for you.
From the Doubleline site:
Strategy
The Shiller Enhanced CAPE strategy offers exposure to the “cheapest sectors” of the large cap equity markets using an “Index Overlay” technique while the remaining assets are invested in a fixed income portfolio...
...The Relative CAPE Ratio subdivides the S&P 500 into 10 sectors, eliminating the 5 with the highest relative CAPE ratios, leaving what we believe are the 5 better value proposition sectors. Index methodology eliminates the one sector with the worst one-year momentum, to try and avoid the value trap...
Using a total return index swap to gain the exposure to the Barclays Shiller CAPE US Sector Index, the remaining assets are then invested into, what we believe to be, a lower-risk bond portfolio with the goal of trying to outperform cash.
So, what are the risks and how likely are they? I'd be happy if others have more to add because I would suggest for a minute that my list is complete.
1. As with any investment other things can do better. If the fund's 4 sector investments don't do as well or better than other sectors then the fund would have a more difficult time keeping up with the S&P 500, for instance. The theory is that CAPE has predictive ability and that will drive better returns. The studies I've read suggest CAPE does have statistically significant predictive power but it doesn't tell you much, if anything, about what will happen in the next month. I know they've done a great job of beating the S&P 500 every calendar year since inception but I'm not aware of anything about CAPE that would make me think it'll always be that way.
2. If the equity markets crash then the fund will perform just like the sectors it's invested in but it should do a bit better thanks to the income from the bonds. They won't have margin calls based on what I can determine and they know when their swaps expire so they should be able to sell bonds in an orderly fashion to pay off losses on those swaps. Without getting into the nitty gritty it looks to me like they have enough highly liquid bonds that they shouldn't end up having to sell less liquid bonds in a fire sale.
3. The worst case I can think of would be something like hyperinflation that drives short term interest rates very high and equity markets down, like in the 70s. If the transition to that was sudden then they'd be holding bonds that would lose value and could more than offset the income they pay plus they'd be losing money in equities just like their index and they'd do worse than the index rather than better. Is that possible? Sure. Is it likely? Probably not very.
4. Could they run into a problem where the counterparty on their swaps, Barclays in most cases, experienced a crisis and wasn't able to pay what the fund was owed? I guess so although you'd have to assume that's less likely today than 10 years ago but that would only eliminate gains the fund had made rather than the cost of its investments, which would depend instead on the counterparty to the hundreds of bonds they own.
It seems to me if you like or believe in CAPE as a "factor", since that's essentially what this fund is, then it's a pretty nice approach they've developed.
@hank, I also know you suggested taking a look would be under the hood of the bond holdings. I will eventually read the prospectus but just glancing through the list of investments and the fact sheet didn't strike me as anything crazy. It looked like a Gundlach bond portfolio and to a large degree I consider that a good thing.
The financing rate on their swaps as of December was not identical for every swap but it was between 0.4% and 0.47%, so they need to make more than that rate and have the bonds hold their value in order to "enhance" the returns of the index.
@davidrmoran, I know others have said it but thanks for making this fund a popular discussion item. It's been a valuable learning experience.
You are welcome always, but again, David S gets the first and most important credit for uncovering and writing this thing up.
Question re 1:
I am having trouble thinking of a scenario where their monthly churn re the four auto-chosen SP500 sectors could underperform SP500 in aggregate. (Maybe thickheadedness on my part.) Thoughts?
Question re your last point:
Again, math denseness on my part probably, but I have been graphing CAPE, DBLTX, and DSEEX since 12/13, and it looks like the bond add (delta) to the last is somehow greater than if you just owned the etn with some fraction of DBLTX. Thoughts?
If the sectors with high CAPE just keep getting higher and outperform those with a lower CAPE, DSENX's equity portion would underperform the S&P, though it would still rise, no? Or maybe the sector they've avoided as a value trap zooms back up before they rebalance...
forgive thickness, but not seeing how:
>> subdivides the S&P 500 into 10 sectors, [every month] eliminating the 5 with the highest relative CAPE ratios, leaving what we believe are the 5 better value proposition sectors. Index methodology eliminates the one sector with the worst one-year momentum ...
Regardless of whether you see how, Shiller does. The index removes one of the five lowest CAPE sectors due to fear of a value trap (low momentum remaining low). If one of the ten sectors that ought to outperform is eliminated because it might not, then surely it's possible that a second would also fall into this trap, and a third, and a fourth.
The index is a variant of a Dogs of the Dow strategy, where you pick by sectors rather than by stocks, and look at the past ten years rather than the past year, and then throw out the worst dog. It's not guaranteed any more than the Dogs is (are?).
Correct, no guarantees, no more than of SP500.
Discussion was performance compared with SP500: how could it be worse.
DSEEX essentially gets the CAPE return for free, without investing any assets, and then gets a fixed income portfolio on top of it with the assets in the fund. That fixed income portfolio is currently shorter duration and higher credit quality than DBLTX.
The return for DBLTX is lower than CAPE so if you couldn't use the assets of the fund twice, as DSEEX does, you would reduce the overall return of CAPE for whatever portion you used for DBLTX. That could cause the effect your talking about but it would be caused by the difference in leverage.
However, if you could use the same assets to invest in both DBLTX and CAPE you would come out ahead of DSEEX... except last year when I guess the shorter duration helped DSEEX after the election made enough of a difference to pull DSEEX ahead of CAPE plus DBLTX by a couple hundredths of a percent.
If you look at the Performance page for DSEEX at M* and add CAPE and DBLTX to the graph to compare you'll see the annual returns for each below. In fact, if you go down to the bottom of the page you can even look at the monthly returns for the 3 funds and for the S&P 500, which is included as the benchmark.
"Black box" probably too harsh. My bad. They do have a clear methodology they follow.
Started tracking DSENX today based on this discussion. Will follow for awhile. Amazingly, it held up very well today. My own highly conservative portfolio came with an identical showing - off .27% for the day (and has nowhere near the growth potential this fund has). I don't know how much high yield debt he has in the fund. But that stuff can look bullet-proof for years on end and than have the bottom drop out almost overnight. And it's had a nice long run. Equities are no different in that respect I suppose, but not as apt to lull one into complacency.
Gundlach is flying high. It's hard to criticize anything he has a hand in. For some reason I keep thinking of MFLDX several years ago. Drew in big sums and was highly regarded on the board. Considered a safe conservative holding. Than went into a terrible tailspin as everybody and his brother bailed.
- nothing akin to MFLDX in it's method. No manager guessing at allocation.
- don't see it as black box either. It is pretty well spelled out what it does.
- not going to do the analysis, but I don't believe any mix of CAPE and DBLTX has achieve the same returns as DSENX.
- as far as what can go wrong, value investing can and does lag growth investing from time to time
I definitely enjoyed this thread though. This fund is one of my favorites and now a high percentage of self managed portfolio. I could sit back and say nothing lasts forever or to good to be true and not invest, but the bottom line is something with this formula is working very well. CAPE is a known commodity. Just hope it doesn't end up a group-think fund 3 years from now. I'll take the chance.
Like the other day while we were taking a stroll I said "Look! Orange Bonnets". When my wife looked crossly at me I asked her why I wasn't allowed to name flowers.
I'm just saying I don't trust anyone like M* and Lipper to classify the fund. This is a unique fund. If it was just investing in CAPE stocks it wouldn't be. However it does not do that, does it?
DSENX is as well spelled out as LMVTX used to me IMHO. It's "value" is hard to understand. I am hardly comparing it to MFLDX or any other fund. Matter of fact that's what I'm saying. Stop comparing it with any other fund - for me the definition of "alternative". Just like "orange bonnets". And this one also kicks out a bit of cash every other month. I like.
What concerns me a bit is the heavy reliance on derivatives. That's what led me first to use the term "black box" - which I later backtracked on. You are correct that the fund is quite different from MFLDX, which as I recall was a "go anywhere" fund. I'm pretty sure, however, that the latter also used derivatives.
While I have a pretty good sense of what a "derivative" is, I'd have a very hard time giving a succinct definition without citing Investopedia or some other source. Therin lies the problem I think. Derivative investing is highly complex - and you're pretty much at the mercy of the manager as far as successful execution. There's a lot of moving parts and things can go wrong.
Glad you've had good luck with this one.
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The Fund will seek to use derivatives, or a combination of derivatives and direct investments to provide a return that tracks closely the performance of the Index. The Fund will also invest in a portfolio of debt securities to seek to provide additional long-term total return. The Fund uses investment leverage in seeking to provide both the Index return and the return on a portfolio of debt securities ...
The Fund will normally use derivatives in an attempt to create an investment return approximating the Index return. For example, the Fund might enter into swap transactions or futures transactions designed to provide the Fund a return approximating the Index’s return. The transaction pricing of any swap transaction will reflect a number of factors, including the limited availability of the Index, that will cause the return on the swap transaction to underperform the Index. Please see “Index Risk — Note regarding Index- Based Swaps” in the Prospectus for more information. The Fund expects to use only a small percentage of its assets to attain the desired exposure to the Index because of the structure of the derivatives the Fund expects to use. As a result, use of those derivatives along with other investments will create investment leverage in the Fund’s portfolio. In certain cases, however, such derivatives might be unavailable or the pricing of those derivatives might be unfavorable; in those cases, the Fund might attempt to replicate the Index return by purchasing some or all of the securities comprising the Index at the time. If the Fund at any time invests directly in the securities comprising the Index, those assets will be unavailable for investment in debt instruments, and the Fund’s ability to pursue its investment strategy and achieve its investment objective may be limited.
http://www.doublelinefunds.com/wp-content/uploads/Shiller_Enhanced_CAPE_Sum_Pro.pdf
I think @davidrmoran has a good question about the impact of rotating. Even if the fund gets caught with it's pants down one month it gets another chance the following month. If the cheap sector with the least momentum takes off one month then the fund would own it the following month, unless the other cheap sectors took off as well (good for the fund) or this one sector all of a sudden wasn't one of the 5 cheapest anymore. That's all possible and it might even be fair to assume it will happen at some point, but it also seems reasonable to assume it won't happen all the time.
The fund could also run the risk of chasing its tail or being whipsawed and that's a common risk associated with mechanical strategies based on momentum. I think its worth paying attention to even though its not clear to me that you'd be able to identify the type of market that would cause those problems in order to get out or reduce for a while, nor do I think it's easy to figure out when things have changed and it's time to get back in before you give away enough gains to make the whole effort questionable.
I did look at monthly returns for DSENX (and the results could be slightly different than DSEEX but this will be more conservative) and the fund trailed the S&P 500 in 13 of its 40 months in existence so far, or roughly 1/3rd of the time. It managed to trail the S&P for 3 months in a row once and 7 of the times it trailed were negative months for the S&P out of 13 negative months for the S&P. Aside from the fact that 40 months isn't enough for any real judgments even the data itself doesn't seem to lead to any big conclusions about when you might expect the fund to do worse. Maybe you could say the fund wins a higher percentage of the time when the S&P is positive but it would be useful to see how the fund performs during an extended negative period for the S&P before considering whether its reasonable to have some expectations. If nothing else, though, reevaluating the sectors to invest in each month doesn't seem to have hurt and may have helped to keep the periods of losing to the S&P short.
Note unusual M* U/D ratio, hmm
---1y--------3y
u129.15 u124.48
d173.14 d102.02
and very different from LV
(http://performance.morningstar.com/fund/ratings-risk.action?t=DSENX®ion=usa&culture=en_US)
You'd think if the CAPE approach to the equity portion of the strategy proves consistently better than the S&P, which it has so far, then people will attempt to arbitrage that advantage away. I'm not sure it's a completely easy thing to do but people would no doubt try and computers are more than powerful enough these days to manage the difficulty.