This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

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nisiprius
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Re: This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

Post by nisiprius »

Uncorrelated wrote: Mon Oct 26, 2020 6:02 am Funds with a negative tracking difference are common in the Netherlands.
Negative, or positive?
The index is a total return index net index, the total return is calculated based on the withholding tax rate (30% in the US).

The fund is a Dutch-domiciled structure which reduces withholding taxes for the end customer to 0%.

End-users who invest in this fund will have a positive tracking error or dividend_yield * 30% compared to a fund that perfectly replicates the net index. This wording is fully accurate and comes at no additional risk. The outperformance (in the case of Dutch funds) is guaranteed.... it looks plausible that this is without additional risk.
So, to be clear, you think there is no "outperformance" in the usual sense, but that (possibly/probably) Lauretta's tax situation includes a tax break, which the fund's stated performance numbers include, but the index does not include?
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Re: This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

Post by Uncorrelated »

nisiprius wrote: Mon Oct 26, 2020 6:29 am
Uncorrelated wrote: Mon Oct 26, 2020 6:02 am Funds with a negative tracking difference are common in the Netherlands.
Negative, or positive?
The index is a total return index net index, the total return is calculated based on the withholding tax rate (30% in the US).

The fund is a Dutch-domiciled structure which reduces withholding taxes for the end customer to 0%.

End-users who invest in this fund will have a positive tracking error or dividend_yield * 30% compared to a fund that perfectly replicates the net index. This wording is fully accurate and comes at no additional risk. The outperformance (in the case of Dutch funds) is guaranteed.... it looks plausible that this is without additional risk.
So, to be clear, you think there is no "outperformance" in the usual sense, but that (possibly/probably) Lauretta's tax situation includes a tax break, which the fund's stated performance numbers include, but the index does not include?
Good catch. At least one fund provider (ACTIAM) uses a negative sign to refer to costs and a positive sign to refer to tax advantages. This china swap ETF appears to do the opposite.

According to my calculations 0.22% of the tracking difference is explained by tax differences between the index (TR net) and the fund. It's not clear where the other claimed outperformance comes from. It looks like the ETF holds a basket of Japanese securities that are in high demand in the Chinese market, but the actual swap contracts that do that aren't listed in the annual report. I know from earlier research that the swap rate on china ETF's is negative (i.e. if you go long with a swap, the bank pays you. If you want to go short with a swap, it's very expensive), possibly due to demand differences between the long and short leg.

Here is a chart that shows the performance of ASHR (Harvest CSI 300 China A-Shares ETF, physical) with gross dividends reinvested versus CSI300 Swap UCITS ETF 1C. The outperformance (gray) is listed on the right hand axis.
Image

I'm not sure what changed in 2017. It appears that the outperformance is quite predictive. It is very possible that the difference is caused by tax treatment, but it's also very possible that the outperformance is caused by political risks in swap products that just haven't shown up yet. The difference looks a bit large to be fully explained by tax differences. but I don't know...
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Re: This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

Post by Cpadave »

What is wrong with just market? Frankly I rather take lower risk with lower than market if I could. There are also funds that promise that but they failed miserably like low volatility SPLV). So in that case better to go with cash and lower percentage of market. If you want more return, go 100% market with more risk. But market return is not too bad. Why try to beat it?
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Re: This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

Post by Lauretta »

Cpadave wrote: Mon Oct 26, 2020 8:27 am What is wrong with just market? Frankly I rather take lower risk with lower than market if I could. There are also funds that promise that but they failed miserably like low volatility SPLV). So in that case better to go with cash and lower percentage of market. If you want more return, go 100% market with more risk. But market return is not too bad. Why try to beat it?
Nothing wrong wigh market returns. But first of al I am curious so I want to understand why this ETF deviates so much from the market. That's why I posted it in the Theory section.
And second, if with this ETF one could get higher returns without much extra risk (which I actually doubt...), why not?
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Re: This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

Post by Valuethinker »

Lauretta wrote: Sun Oct 25, 2020 1:44 am I have come across a synthetic ETF aiming to replicate the Chinese market using swaps. The description gives:
OTC Swap Enhancements=-7.44%
so that after 0.5% fees the
Estimated Tracking Difference (ETD)=-6.94%
Meaning that it it expected to beat the index by nearly 7%(!)
Here's the description (it is domiciled in Luxembourg but insofar as I have a theoretical question, I am posting it here for everyone):
https://etf.dws.com/en-gb/LU0779800910- ... ts-etf-1c/
I think the reason is the following:
because the swap can deliver a return above the index due to market regulation: for example, in China – where short-selling is banned for many stocks – a swap agreement allows a bank to go ‘short’ without having to physically short the securities, and investors are willing to pay a premium above the index to do this.
(from an article I read elsewhere).
So it seems that you might have a whopping 7% extra return. Is there a big risk (or a catch)? What could (concretely) go wrong (that would not go wrong with a physical ETF like Vanguard's)?
PS Important addition
I know very well the argument: there's not such thing as a free lunch; markets are efficient so this is impossible; if someone is promising you a 7% extra return why aren't they billionaires and retired etc. Please can you avoid making these arguments again here, since I am already aware of them?
The point is, the ETF is offered by a relatively reputable company (Xtrackers) and there are regulations so that it would be pretty hard for them to lie on their webpage.
I do understand that there should be risks associated with this extra return. What I want to do, is understand these risks so that I can then make an informed decision.
The size of the tracking error suggests there are serious problems with the implementation of this strategy.

But why go so micro? The standard EM fund is over 40% China - is this not enough? HK is another 8% or so and Taiwan another 14%? So 60% of your money is tied up in China or Chinese-connected locations.

The part of the Chinese stock market which is not available to foreigners, has volatility suggesting that it is more about government policy objectives re spending/ saving than a "fair market" stock market, where the price of a security is a good guide to its long run values.

Beware the behavioural mistake of assuming that Finance is like physics. It's not, in that there are not immutable laws or principles that can be divined.

The Boglehead strategy is composed of an acceptance that markets are far too human to be "beaten" in any long run rational sense. At least by the tools retail investors or conventional long-only funds have available to them. And hedge funds, if they do add alpha, manage to skim most/ all/ more than 100% of that alpha for the managers, in the long run.

It's a bit like Venture Capital investing. You and I cannot invest in Kleiner Perkins funds. Well, I cannot, at least. Nor can we invest in Renaissance funds in the HF world. So the existence of these high alpha investors is basically interesting but not remotely relevant to us.
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Re: This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

Post by Valuethinker »

Lauretta wrote: Mon Oct 26, 2020 9:56 am
Cpadave wrote: Mon Oct 26, 2020 8:27 am What is wrong with just market? Frankly I rather take lower risk with lower than market if I could. There are also funds that promise that but they failed miserably like low volatility SPLV). So in that case better to go with cash and lower percentage of market. If you want more return, go 100% market with more risk. But market return is not too bad. Why try to beat it?
Nothing wrong wigh market returns. But first of al I am curious so I want to understand why this ETF deviates so much from the market. That's why I posted it in the Theory section.
And second, if with this ETF one could get higher returns without much extra risk (which I actually doubt...), why not?
Have you asked the manager? They might have to make some kind of disclosure to a shareholder?
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Re: This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

Post by Lauretta »

Valuethinker wrote: Mon Oct 26, 2020 9:59 am
Have you asked the manager? They might have to make some kind of disclosure to a shareholder?
Don't understand what that means :?: :?:
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Re: This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

Post by Lauretta »

Valuethinker wrote: Mon Oct 26, 2020 9:59 am
But why go so micro? The standard EM fund is over 40% China - is this not enough? HK is another 8% or so and Taiwan another 14%? So 60% of your money is tied up in China or Chinese-connected locations.

good point. It's mainly Dalio's writings on China that made me think it might be a good idea to overweigh it. Otoh they had an article in the Guardian I think today where they said that China cheated in the values they published this year on their recovery, so it might be a bad idea to invest too much if they are dishonest...
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Re: This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

Post by alex_686 »

So I am confident I know the answer to 7% - it is the funding costs. Like I suspected.

With a swap - well - you are swaping the returns of 2 different index returns. The most common is the cost of funding the index.

The big one in the interest rate differential. The euro is around -0.5%, China a bit above 4%. Not sure when the fact sheet was created, but I am going to go with a spread of 4.5%.

The CSI 300 has a dividend yield above 2%.

This is going to get us a difference of around 7% and needs to be imputed into the pricing to make the cash flows equal. A critical bit of the behind the scenes stuff that needs to be factored in when pricing a swap but I think we can ignore it.

The return of this ETF nicely matches the total return of the underlying index.
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Re: This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

Post by Lauretta »

alex_686 wrote: Mon Oct 26, 2020 2:28 pm So I am confident I know the answer to 7% - it is the funding costs. Like I suspected.

With a swap - well - you are swaping the returns of 2 different index returns. The most common is the cost of funding the index.

The big one in the interest rate differential. The euro is around -0.5%, China a bit above 4%. Not sure when the fact sheet was created, but I am going to go with a spread of 4.5%.

The CSI 300 has a dividend yield above 2%.

This is going to get us a difference of around 7% and needs to be imputed into the pricing to make the cash flows equal. A critical bit of the behind the scenes stuff that needs to be factored in when pricing a swap but I think we can ignore it.

The return of this ETF nicely matches the total return of the underlying index.
Thanks, but then how do you explain this graph (from a post above)?
Image
I mean the interest rate differential always worked in favour of the ETF but at some times it underperformed :?: :?:
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Re: This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

Post by alex_686 »

Lauretta wrote: Mon Oct 26, 2020 2:31 pm Thanks, but then how do you explain this graph (from a post above)?

I mean the interest rate differential always worked in favour of the ETF but at some times it underperformed :?: :?:
I am not sure that the interest rate would work in favor of the ETF. Real short term rates tend to be pretty close to zero, and today may even be negative.

I believe that taxes have been mentioned. That could have some impact. I don't know the details of the EU/China tax withholding. Either the theoretical bit that the index works off of or the practical. and what Changes have occurred over the time period you quoted.

However, I would guess that the difference would be down to trading. Swaps tend to be liquid, but this is not always the case. And they tend to trade in the 5m range. So there are some difficulties there. On the flip side, the Renminbi is not fully convertible. I am wondering if that has hurt or helped the physical ETF when there have been cashflows into and out of the fund.

Taxes and trading efficiency vary over time, changing period by period. Part of the reason why I am guess this.
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Re: This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

Post by Valuethinker »

Lauretta wrote: Mon Oct 26, 2020 11:28 am
Valuethinker wrote: Mon Oct 26, 2020 9:59 am
Have you asked the manager? They might have to make some kind of disclosure to a shareholder?
Don't understand what that means :?: :?:
Contact the Asset Manager responsible for the ETF and ask them the question, simply stated.

Things like the FCA require a responsiveness to investors in a fund. SEC disclosures also (if they do file with SEC? Check Edgar).
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Re: This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

Post by alex_686 »

Valuethinker wrote: Tue Oct 27, 2020 8:57 am
Lauretta wrote: Mon Oct 26, 2020 11:28 am
Valuethinker wrote: Mon Oct 26, 2020 9:59 am
Have you asked the manager? They might have to make some kind of disclosure to a shareholder?
Don't understand what that means :?: :?:
Contact the Asset Manager responsible for the ETF and ask them the question, simply stated.

Things like the FCA require a responsiveness to investors in a fund. SEC disclosures also (if they do file with SEC? Check Edgar).
This is a reasonable idea. You may not get a fast turn around time. The PM is listed and I bet you could find them in LinkedIn. Or maybe e-mail the fund family and a flunky will get back to you. I would ask 2 questions.

1. What is the definition of "OTC Swap Enhancements" and "Estimated Tracking Difference (ETD)". I strongly suspect that there is a technical formula that has been created by the regulators.

2. Why is there a difference between their SWAP performance verses a more traditional approach.

I am sure they can point you to standardized marketing brochures or investor presentations for both.

If you do this please post back. I am very interested. If you don't, let me know. I might.
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Re: This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

Post by Valuethinker »

Lauretta wrote: Mon Oct 26, 2020 11:31 am
Valuethinker wrote: Mon Oct 26, 2020 9:59 am
But why go so micro? The standard EM fund is over 40% China - is this not enough? HK is another 8% or so and Taiwan another 14%? So 60% of your money is tied up in China or Chinese-connected locations.

good point. It's mainly Dalio's writings on China that made me think it might be a good idea to overweigh it. Otoh they had an article in the Guardian I think today where they said that China cheated in the values they published this year on their recovery, so it might be a bad idea to invest too much if they are dishonest...
The essence of the Boglehead philosophy is that markets are Type II informationally efficient.

In the absence of inside information, an investor is unlikely to be able to systematically outperform the market index. In addition, if there are investors who can do that, the majority of them charge such high fees that the outperformance net of fees is at or below the market index.

So:

1. Ray Dalio says it. And this is a good idea, why? And if Dalio is so clever, why doesn't he keep his best ideas to himself? Or maybe he does? Or is he just trying to ramp his position to get out.

I knew some pretty amazing fund managers, once. However if they told you something, it was usually to get you buying it so they could offload. (laws were a bit more flexibly interpreted in those days).

But you can bet any Hedge Fund manager that has seen an opportunity, has already moved on it, and is talking up his/ her book.

2. you read in the Guardian -- not a financial newspaper and in fact in many ways an anti-capitalist newspaper (by European standards it is not particularly far left, I'd call it Social Democratic, by North American standards it is practically Soviet-style socialist). And you read some story that something something the Chinese cheat on "values" they publish, whatever that means.

And so now you are not sure the great idea in 1 is not a great idea? What does the Financial Times say? Because that really is a financial newspaper, for better or for worse.

You have to have strongly held convictions to go against a broad indexation strategy. If you don't have strongly held convictions, and the capacity to do thorough research of your ideas, you are better to index.

Because for sure there are people who have done their homework, who are the other side of your trades.

You have said, elsewhere, that you have challenges in sticking to your investment policy. Now might be the ideal moment to progress on those challenges, by avoiding a distracting investment? I am not sure what this might add to the average portfolio?

China I have a certain impression has fairly wild-west attitudes about accounting & securities law. So 40% of the EM index funds is China, and this is plenty for me.

In fact I had an iShares Far East Japan ETF that I bought just before the 2008 Crash -- immaculate timing ;-). It has actually made money in the last 10 years, (amazingly), and +19% on last reported yearly performance (to end Q2 20 I think). And I checked the factsheet (for the first time in years) and realised that it had a large weighting in China, that duplicated my EM index funds (bought much more recently).

Thus, I sold it. That's what I think about China, right now. That I didn't want to be overweight.

My average holding period for a fund, btw, is over 10 years. I don't even trust myself to rebalance, because I know that I will be tempted to chop-and-change based on what I read in my FT at the weekend. I sacrifice portfolio efficiency for greater behavioural consistency, in other words.
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Re: This synthetic ETF has recently beaten the index it is supposed to track by 7%/yr: should I invest? What's the risk?

Post by Lauretta »

Valuethinker wrote: Tue Oct 27, 2020 1:32 pm
Lauretta wrote: Mon Oct 26, 2020 11:31 am
Valuethinker wrote: Mon Oct 26, 2020 9:59 am
But why go so micro? The standard EM fund is over 40% China - is this not enough? HK is another 8% or so and Taiwan another 14%? So 60% of your money is tied up in China or Chinese-connected locations.

good point. It's mainly Dalio's writings on China that made me think it might be a good idea to overweigh it. Otoh they had an article in the Guardian I think today where they said that China cheated in the values they published this year on their recovery, so it might be a bad idea to invest too much if they are dishonest...
The essence of the Boglehead philosophy is that markets are Type II informationally efficient.

In the absence of inside information, an investor is unlikely to be able to systematically outperform the market index. In addition, if there are investors who can do that, the majority of them charge such high fees that the outperformance net of fees is at or below the market index.

So:

1. Ray Dalio says it. And this is a good idea, why? And if Dalio is so clever, why doesn't he keep his best ideas to himself? Or maybe he does? Or is he just trying to ramp his position to get out.

I knew some pretty amazing fund managers, once. However if they told you something, it was usually to get you buying it so they could offload. (laws were a bit more flexibly interpreted in those days).

But you can bet any Hedge Fund manager that has seen an opportunity, has already moved on it, and is talking up his/ her book.

2. you read in the Guardian -- not a financial newspaper and in fact in many ways an anti-capitalist newspaper (by European standards it is not particularly far left, I'd call it Social Democratic, by North American standards it is practically Soviet-style socialist). And you read some story that something something the Chinese cheat on "values" they publish, whatever that means.

And so now you are not sure the great idea in 1 is not a great idea? What does the Financial Times say? Because that really is a financial newspaper, for better or for worse.

You have to have strongly held convictions to go against a broad indexation strategy. If you don't have strongly held convictions, and the capacity to do thorough research of your ideas, you are better to index.

Because for sure there are people who have done their homework, who are the other side of your trades.

You have said, elsewhere, that you have challenges in sticking to your investment policy. Now might be the ideal moment to progress on those challenges, by avoiding a distracting investment? I am not sure what this might add to the average portfolio?

China I have a certain impression has fairly wild-west attitudes about accounting & securities law. So 40% of the EM index funds is China, and this is plenty for me.

In fact I had an iShares Far East Japan ETF that I bought just before the 2008 Crash -- immaculate timing ;-). It has actually made money in the last 10 years, (amazingly), and +19% on last reported yearly performance (to end Q2 20 I think). And I checked the factsheet (for the first time in years) and realised that it had a large weighting in China, that duplicated my EM index funds (bought much more recently).

Thus, I sold it. That's what I think about China, right now. That I didn't want to be overweight.

My average holding period for a fund, btw, is over 10 years. I don't even trust myself to rebalance, because I know that I will be tempted to chop-and-change based on what I read in my FT at the weekend. I sacrifice portfolio efficiency for greater behavioural consistency, in other words.
The FT published an article by Dalio on China a few days ago. And other bullish pieces.
Dalio wrote about gold 2 years ago which made me increase my allocation & it's done very well since. So I don't think he just praises an Investment when he wants to offload because he's been buying gold as well since then.
I also met some good fund managers and what struck me was how uncertain they were about everything once you get behind their facade. So I think that it is healthy to have doubts it doesn't mean that you haven't done your homework on the contrary it means the more you learn the more things become uncertain
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