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The new new carry trade in the age of derivatives

Investors have made money for decades by borrowing in one currency with a low interest rate and exchanging it into a higher interest rate currency.  Called the carry trade, it made a lot of people of lot of money.

A new paper out by Della Corte, Sarno and Tsiakas has found another way to profit off the carry trade.  These economists use the forward volatility in foreign exchange to derive a very profitable strategy.  According to their research, Spot and Forward Volatility in Foreign Exchange, investors can buy and sell what’s called a forward volatility agreement (FVA).

Simply put (kinda), thes FVAs attempt to predict future volatility in a certain currency.  More specifically, the FVA sets a forward implied volatility by making a guess about future spot implied volatility.  These guesses tend to be wildly off:

Forward volatility is a poor predictor of future spot implied volatility

So, if forward vol is a bad predictor of future vol, investors can design strategies to take advantages of this.

For example, buying (selling) FVAs when forward implied volatility is lower (higher) than current spot implied volatility will consistently generate excess returns over time.

Interesting idea — as for me, I’ll stick with momo stocks like $AAPL and $PCLN but this sounds like a promising strategy for forex traders.

Source

Della Corte, P, L Sarno, and I Tsiakas (2010), “Spot and Forward Volatility in Foreign Exchange”, Journal of Financial Economics, forthcoming. Centre for Economic Policy Research Discussion Paper 7893.

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When searching for stock gains, use Google (search data)

A wealth of information creates a poverty of attention

Smart investors avail themselves of all valuable resources as inputs into the investment research process.  I write about this faculty in my book Tradestream in the chapter “Co-lateral Research“.  What co-lateral research means is all the non-financial/non-traditional sources of information that can be used by investors to connect-the-dots.

I’ve written about Google Domestic Trends, search volume data Google has made public and overlayed on top of stock index charts.  GDT continues to be a good resource for investors.

And now, there’s more research to support using Google search data to auger where markets are headed.

In In Search of Attention, researchers found that Google’s Search Volume Index captures retail investors’ attention in stocks.

Among our sample of Russell 3000 stocks, stocks that experienced an increase in ASVI [me: abnormal search volume index reading] this week are associated with an outperformance of more than30 basis points (bps) on a characteristic-adjusted basis during the subsequent two weeks. This initial positive price pressure is almost completely reversed by the end of the year.

The paper also finds that increased search volume leading up to hot IPOs may be responsible for that big first-day pop! that such issues experience.

As the first paper that has really looked at search data from an investing standpoint, this should be piped and smoked.  In fact, the authors conclude the paper with a somewhat foretelling statement:

Search volume is an objective way to reveal and quantify the interests of investors and therefore should have many other potential applications in fi…nance. We leave those for future research.

Bring it on.

Source

In search for attention (Da, Engelberg, Gao), November, 2010

HT: Net//Worth

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New investment managers added to Wealthfront

Wealthfront announced the addition of 3 new investment advisors on their investment platform.

As per the firm:

Towle & Co. (Value Strategy | Min. Outside Wealthfront: $500,000)
Towle specializes in a long-term, deep-value investment strategy that seeks to uncover significant discrepancies between stock market prices and underlying company values. Through Towle, you can invest in well-run companies with strong market positions and low price-to-sales ratios: a way to buy operating leverage and economic activity on the cheap!
Barton Investment Management (Growth Strategy | Min. Outside Wealthfront: $1,000,000)
Barton believes the market fails to appreciate and correctly value the full potential of enterprises that create new markets. Its concentrated portfolio of carefully-selected younger growth company stocks allows investors to capitalize on these market inefficiencies while supporting innovation.
CWC Advisors (Small Cap Strategy | Min. Outside Wealthfront: $1,000,000)
CWC began providing investment services in 2000 to high net worth individuals, and within a few years, attracted the interest of institutional investors. Its strategy consists primarily of contrarian U.S. companies with recent price under performance, corporate liquidity and/or fundamental valuations at historically low levels. Now you can invest with CWC, too.
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Investing in the next mashup

Technology continues to run riot over a variety of industries.  Nowhere has that been felt as acutely as in the music industry.  Apple’s ($AAPL) iTunes may have changed the distribution model (selling over $1B in the last financial quarter alone), basically unbundling CDs and selling individual songs a la carte.

Music, it is a changin’

But the migration from analog to digital has been accompanied by a much more profound change — the revenue model of the music industry is undergoing a transformation.  Where the model was previously selling musical media (artists generally made lots of loot by selling records/tapes/CDs), the model is changing to charging for music experiences (see my recent piece on the business of Broadway and concerts).

Artists embracing this change have shifted their model to almost giving away music (or charging fans whatever they want to pay) in order to capture some funds at the next concert.

Fast Company has a very interesting rundown on Girl Talk, a biomedical-engineer-turned-DJ who makes music by mashing up others’ tunes.  Simply, he takes hundreds of samples of music and weaves them together, creating cool sounds but even more enjoyable live shows.  He’s putting butts in the seats because he’s providing great live value.

IPOs, Social Media and the Era of the Mashup

We’ve all read how Facebook, Twitter, and LinkedIn are gearing up to go public sometime soon.  While these services seem novel, in essence, they’re all just mashups of technologies and platforms that existed before Zuck entered his first frat party (not to sound snobby, but there aren’t frats at Harvard).

Startups and traditional companies are making lots of money just copying Groupon’s model of group discount buying.  Travelzoo , a decidedly Internet 1.0 company, has a Groupon-like clone that offers expiring travel deals to its email list of over 20m and that 4-month old business is rumored to be valued at $400M.  Abe’s Market, an Etsy-like green marketplace founded by my friend, Richard Demb, is experimenting with live selling online with its Abe’s Live, combining the breadth of vendor-driven supply and the entertainment value of a QVC.

The future of business is the mashup.  Those companies who can climb to the top of the value pyramid — by leveraging and riffing on the work done on by those along the way — will win and that’s where investors should be looking to place their bets, IPO or not.

More Resources

How Girl Talk Mashes Up the Music Biz (Fast Company)

Download Girl Talk music

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Financial voyeurism and the tradestream

Voyeurism drives a lot of our activities online.  Admit it — you’ve definitely googled or facebooked an old friend with no intention of reconnecting.  You just wanted to peer into their lifestream.

Venture Capitalist Michael Eisenberg told me once that many of today’s successful online businesses are winners because they incorporate some level of voyeurism.

If investing is about learning, we’re always interested in what others are doing, but sometimes it’s hard to figure out.  To see what a large asset manager is doing, we can check public portfolio filings.  Other times, we pick up what others are investing in over a game of pickup basketball.

Regardless of how we get this information, we place a value on it (sometimes, even a value greater than our own opinions). The collective tradestream (and dissemination tools like StockTwits and SeekingAlpha) allows us to drop in on the investing party our friends are having — at any time.  Not only can we get ringside seats into smart investors’ every activities, but we get their rationales for doing so.

It’s pure learning — both cognitive and the emotion set behind the trade.

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Recording the future using social media to predict it (podcast)

tracking future stock prices with social media

This week’s podcast contains a great conversation with Evan Sparks of Recorded Future on this week’s Tradestreaming Radio.

Evan and Recorded Future are working to bring analysis of social media chatter to a whole ‘nother level.  Combining sophisticated linguistical analysis and a solid background in devising investment strategies (Evan worked as a quantitative equity analyst previously), Recorded Future’s platform scans over online sentiment and predicts when specific events should occur in the future.

For example, if I’m sizing up making an investment in Amazon.com ($AMZN) and I know they’re looking to go toe-t0-toe with Netflix’s ($NFLX) DVD rental offering, I could use Recorded Future to handicap the likelihood that $AMZN makes an acquisition in the space and when the Internet expects this to occur (Amazon announced the purchase of a European competitor, LoveFilm, yesterday). Retail investors and institutional money managers are turning to Recorded Future to help them tap the inherent potential value in all the content in the blogosphere.

Check out the podcast below (or if you don’t see it, here).  If you use iTunes, our program can be found here. We’ve also made available all our radio archives, as well.

Read the podcast’s transcript.

Podcast Powered By Podbean

Learn more:

Recorded Future (homepage)

Recorded Future (video channel)

Predictive Signals (Recorded Future’s quant blog)

Transcript of this podcast

Photo credit: <a href=”https://www.flickr.com/photos/53264931@N03/18905239111/”>vikwaters</a> / <a href=”https://visualhunt.com”>Visualhunt</a> / <a href=”https://creativecommons.org/licenses/by-nd/2.0/”>CC BY-ND</a>

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Bond rater, heal thyself. If not, we’re bringing in new goons

The WSJ has an interesting article on a relatively new player to the bond rating game, Kroll.  If you’re asking yourself, is that the same Kroll that ran a global private security organization?  Uh-huh.  I think the world is ready for a little smackdown in sovereign debt ratings.

According to the article,

Jules Kroll created the newcomer, Kroll Bond Ratings Agency Inc., after selling his eponymous corporate investigations firm to insurance broker Marsh & McLennan in 2004.

Mr. Kroll’s new firm has provided financial strength ratings to banks and credit unions, among others, through a boutique ratings company, LACE Financial, that it acquired last August. Wednesday marks its first effort to rate individual securities through Kroll Bond Ratings.

In a move distancing itself from given practices in the bond ratings game, Kroll plans to make use of his extensive expertise in corporate frisking to go beyond what he (and everyone else) feels are too lax standards in an industry that not only missed subprime, but helped pass the buck into our current mess.

There may definitely be a new sherriff in town and his name, Kroll.  Oh yeah, he’ll also make use of K2 Consulting, a firm similar to Kroll’s previous endeavor, run by his son.

We are embracing due diligence, the legacy from my prior life

Kroll 1, S&P/Fitch and any debt issuer 0.

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Optimizing purchasing decisions and when to buy

Lifehacker had a great email yesterday entitled The Best Times to Buy Anything in 2011.

Well-researched and totally tweaked by crowdsourcing this information, this post defines the most optimal times to purchase specific items throughout the year based on varying criteria.

For example, for some reason, laptops go cheap in April as do Broadway tickets in the 3rd quarter.

My favorite?  I’ll look to buy a car in September, an off-color car in December, and as one commenter suggested, try buying a car on Super Bowl Sunday — the salespeople are distracted and open to low ball offers.

Much of this information and concepts were described in Buy Ketchup in May and Fly at Noon (affiliate link). You can find the author’s website here.

Source

The Best Times to Buy Anything in 2011 (Lifehacker)

More sources for well-timed buying (Lifehacker)

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Hedge fund index performance for December 2010

Final performance for the Dow Jones Credit Suisse Hedge Fund Index (“Broad Index”) is confirmed up 2.90% in December and up 10.95% YTD

Oliver Schupp, President of Credit Suisse Index Co., Inc., said, “The Dow Jones Credit Suisse Hedge Fund Index rose 2.90% in December, with nine out of ten sectors posting positive performance for the month. Managed Futures was the best performing sector, finishing up 5.42%. Positive performance was also seen in the Event Driven sector, which finished up 3.93%, however Global Macro remains the strongest performing sector in 2010 after posting positive performance of 2.67% in December.”

Performance for the Broad Index and its ten sub-strategies is calculated monthly. December, November and year-to-date performance numbers are listed below and are available at www.hedgeindex.com.

Category Dec 2010 Nov 2010 YTD 10
Dow Jones Credit Suisse Hedge Fund Index 2.90% -0.18% 10.95%
Convertible Arbitrage 1.16% 0.04% 10.95%
Dedicated Short Bias -5.86% -2.36% -22.47%
Emerging Markets 1.50% -0.38% 11.34%
Equity Market Neutral 1.74% -2.51% -0.85%
Event Driven 3.93% 0.15% 12.63%
Distressed 2.73% 0.33% 10.26%
Multi-Strategy 4.78% 0.04% 14.36%
Risk Arbitrage 1.14% -1.44% 3.17%
Fixed Income Arbitrage 0.61% 0.74% 12.51%
Global Macro 2.67% -0.52% 13.47%
Long/Short Equity 3.42% 0.46% 9.28%
Managed Futures 5.42% -4.11% 12.22%
Multi-Strategy 1.70% 0.30% 9.29%