**Dear Reader, I hope you enjoy this article. - Vitaliy**
Watercolor is by my father, Naum Katsenelson
Why My Firm Sold Short-Term Bond ETFs and Bought U.S. Treasury Bills
Recently my firm replaced all of our short-term bond exchange-traded
funds with U.S. Treasury bills. The core motive for this decision was
not to pick up a few points of extra yield, though that's a nice
bonus. We sold these ETFs because we were concerned about the
low-probability but still possible risk mismatch in liquidity between
the ETF and the securities it holds, in the event of a
(not-low-probability) panic sell-off in the market.
Our problem with the ETFs concerned liquidity. Liquidity is measured on
two dimensions, time and price - it is the degree to which an asset
can be bought or sold without impacting its price. For instance, a house
is not really a liquid asset. If you want to sell it fast you might have
to lower the price significantly to find buyers. On the other hand,
stocks of large companies and U.S. Treasury bills are incredibly liquid.
Yet this definition of liquidity is not complete. Liquidity of an asset
may or may not be constant - it can change from one environment to
another. Today, in a benign economic and market environment, many assets
provide a false sense of liquidity. But this may change on a dime when
this artificially created calm gets roiled.
Short-term corporate bonds are fairly liquid assets, but they may prove
to be less liquid than the ETFs that buy them. During a market scare, if
investors were to sell ETFs at several times daily volume, the ETFs in
turn would be forced to go out and sell bonds they hold. Supply might
temporarily exceed demand, and thus the prices of bonds would drop.
This would cause: (a) price of ETFs to decline - creating losses for
exiting (selling) ETF holders; (b) permanent losses for remaining ETF
holders, or (c) both a and b. Something similar happened during the 2008
financial crisis to action-rate securities - they were extremely
liquid until they were not. It took investors years to get their money
back.
We don't know what will happen. But we used high-quality bond ETFs as
a cash substitute and relied on their continuous liquidity, which might
or might not have been there when we needed it most. And finally, since
our cash position is extremely high today, we cannot afford to put it at
risk of even low-probability events. Treasury bills are the safest
securities in existence today, and they are yielding 2%, so we gain
safety and increase yield at the same time.
As a side note, since we are on the topic of ETFs, today investors look
at ETFs as a panacea and a way to get around active management. They
feel secure holding them because they feel diversified. But as investors
who owned VIX ETFs recently discovered when they declined 80% in a few
days and never came back, not all ETFs are created equal. Investors in
all those "diversified" index funds (be it ETFs or just plain-vanilla
funds) may discover that when you own a diversified basket of assets
that are uniformly overvalued, as today's market is, the
diversification is not actually there to protect them.
Junk bonds were all the rage in 1980s, and then they became a dirty
word. Technology and dot-com stocks got the same treatment in the late
1990s, and you know how that story played out. ETFs are likely going
down that road as well. As Seneca put it, "Time will discover the
truth."
http://ima142.acemlnb.com/lt.php?s=e1b542c9ce4f9ce5bcf519816e7e7fce&i=266A293A5A2356
Digital Painting is by my brother Alex Katsenelson
Liszt - Schubert
I've written in depth about Franz Schubert and Franz Liszt in the
past. It is hard to find two more opposite composers. Schubert, who was
born in Austria, was a shy, sickly, secluded, classical music addict: He
composed nonstop, producing an unheard-of amount of music, over 6,000
pieces during his very short life (he died at 31). For Schubert the
piano was just another instrument. Most of his piano music is not
technically challenging because, as he himself admitted, he was not a
great pianist. (Read more on Schubert here
).
And then there's the other Franz, Hungarian-born Franz Liszt. For him
piano was not just another instrument; it was his life and his passion.
He was a piano virtuoso. Liszt traveled around Europe and gave thousands
of concerts (sometimes more than one a day). He was the first music star
- before Elvis, Michael Jackson, and the Rolling Stones. Women fainted
in his presence; he turned boring classical music performances into a
show. Liszt's music for piano was technically demanding, as he was
trying to push piano playing to previously unattainable levels. (Read
more on Liszt here
).
Why I am comparing Schubert to Liszt? I recently stumbled upon
Schubert's
**Wanderer Fantasy,** and I was shocked how Lisztonian it sounded. It
had hints of Schubert's melancholy and shyness, but then there are
huge splashes of Liszt's piano on steroids. This is Schubert's most
technically demanding work. He once said "The devil may play it" - he
was probably thinking of Liszt when he composed it (though Liszt was
only 11 years old at the time).
Franz Liszt was fascinated by this piece: He transcribed it for piano
and orchestra, adding another dimension of lyricism and melancholy, and
ironically making it more Schubertian.
Click here to listen.
**Vitaliy Katsenelson, CFA**
Student of Life
I am the CEO at Investment Management Associates
, which is anything but your average
investment firm. (Seriously, take a look .)
I wrote two books on investing, which were
published by John Wiley & Sons and have been translated into eight
languages. (Even in Polish!)
In a brief moment of senility,
**Forbes** magazine called me "the new Benjamin Graham." (They must have
been impressed by the eloquence of the Polish translation.)
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