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Fed To Hike In June? Expected ETF Moves

Taking most investors by surprise, minutes from the Fed April meeting pointed to interest rate hike possibilities in June. While this seemed unfeasible a few days back, a volley of upbeat economic data lately sparked off possibilities for further policy tightening. Also, plenty of positive vibes were felt in the market, including a healing labor market and the latest uptick in global sentiments buoyed by stabilization in China and oil. All these opened the door for a likely hike in June. Most Fed officials sought signs of economic improvement in the second quarter including a strong employment and inflation scenario. Inflation rose at the quickest clip in three years in April, as the consumer price index jumped a seasonally adjusted 0.4% (read: TIPS ETF (NYSEARCA: TIP ) Hits New 52-Week High). Upbeat Data Points Though April’s non-farm payroll reading of 160,000 was below the estimated 205,000 and the prior-month reading of 208,000, the unemployment rate was unchanged at 5%. Other key indicators including workweek and average hourly earnings showed increases. Hourly earnings in April rose 0.3% month over month and 2.5% year over year. Meanwhile, overall retail sales expanded 1.3% in April from March, representing the largest gain since March 2015. April retail sales beat economists’ forecast of a 0.8% rise . The University of Michigan indicated that its consumer sentiment index rose 6.8 points to 95.8 in early May, marking the strongest reading since June (read: Retail Sales Back to Health; ETFs to Watch ). Since consumer spending makes up about 70% of the U.S. GDP, April retail sales data indicates that the U.S. economy is progressing at a decent clip to end Q2 and is less likely to falter like it did in Q1. In the first quarter, the economy grew at an annual rate of just 0.5%, marking a two-year low. The housing market is also giving bullish signals. Lately, the economy was gifted with strong new home construction and building permits data. All these might encourage the Fed to take the next policy tightening decision sooner than expected. The last hike was seen in December 2015. Investors’ Perception Following the release of the minutes, investors’ bet over the possibility of a June hike shot up to 34% from 19% (according to CME Group) as indicated by the prices for futures contracts on the Fed’s benchmark overnight lending rate. And by late Wednesday, traders wagered on a 56% possibility of a hike by July, up from 20% on Tuesday. Possible ETF Moves Some subtle moves in various markets and asset classes are likely to be observed if the Fed goes hawkish in June or July. Below we discuss a few ETFs that were among the biggest movers and could remain in focus ahead. PowerShares DB USD Bull ETF (NYSEARCA: UUP ) As widely expected, the U.S. dollar will likely gain strength. The U.S. dollar ETF UUP was up about 0.7% on May 18. iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) The yield on the 10-year U.S. Treasury jumped 11 bps to 1.87% on May 18, following the Fed minutes. The ultra-popular bond ETF IEF shed over 0.8%. But since global growth worries are still extensive with Brexit fears looming large, the intermediate and long-term U.S. Treasury bonds should be in fine fettle. SPDR S&P Regional Banking ETF (NYSEARCA: KRE ) Banking stocks should rally if the Fed hikes in June as these perform better in a rising rate environment. KRE added 4.24% on May 18, 2016. PowerShares FTSE RAFI Emerging Markets Portfolio ETF (NYSEARCA: PXH ) Emerging markets ETFs will likely be losers if the Fed goes ahead with a hike. Dearth of cheap money inflows would hit this space. PXH was down about 1.4% on May 18. iShares Select Dividend ETF (NYSEARCA: DVY ) The dividend ETFs, one of the biggest beneficiaries of subdued Treasury yields, might stall a bit if the Fed hikes sooner than expected. However, it all depends on how the global market shapes up and investors’ appetite for risk. Vanguard Total Stock Market ETF (NYSEARCA: VTI ) Normally, the initial reaction of a rate hike is a slide in stock prices. However, the reaction should vary across capitalization and the turbulence should settle down with time. Total stock market ETF was down 0.01% on May 18, and may be under pressure immediately after the tightening move. Link to the original post on Zacks.com

Many MLP CEF Investors Are Using The Wrong Benchmark – Are You?

By James Wang Click to enlarge Today there are 95 publicly-traded energy MLP-access products on the market; a figure that nearly matches the number of MLPs [1] themselves. While having options is generally a good thing, having too many options brings up the paradox of choice [2]. So how do you objectively choose the best fund? Well, as an indexing company, we’d tell you to compare it to a benchmark. You may ask, “but isn’t the Alerian MLP Index (AMZ) already the gold standard for MLP benchmarks?” and you’d be right. (Clearly, we’re biased.) However, with the abundance of MLP investment funds, comes a variety of different product structures and nuances. We’ve launched the Alerian MLP Closed End Fund Index (AMCI) to address a particular subset of those products: closed-end funds (CEFs) which elect to be taxed as C Corporations for federal tax purposes. So what are closed-end funds and what makes them special? Well, to start with, CEFs were the first type of pooled investment products to enter into the MLP space, with Tortoise Capital Advisors launching the Tortoise Energy Infrastructure Corp (NYSE: TYG ) in 2004. Today CEFs make up about 20% [3] of all MLP investment products by AUM. As partnerships, MLPs have certain tax complexities that reduce their efficiencies in pass-through investment products. While traditional mutual funds, CEFs, and ETFs may pass on all gains/losses to their investors, funds whose holdings comprise more than 25% in MLPs must elect to be taxed as a C Corporation [4] for federal income purposes. This means that there’s an extra layer of corporate taxation that shaves off approximately 35% [5] of all gains before it even reaches the investor. Yeah, it kind of stinks, but unfortunately those are the rules, and it’s the only way to construct a pure-play MLP fund. C Corp CEFs, however, have the ability to mitigate some of that tax drag through the use of leverage. Furthermore, since the funds are “closed” in construction, unlike open-end funds (ETFs, Mutual Funds), the capital they have is permanent, allowing them to hold less-liquid investments. A potential downside (or upside, if you time it right) to the structure is that these funds may trade at a significant discount or premium to their net asset value. To make things even more complicated, there are a number of CEFs with the words MLP in their title, but they merely hold 25% of their fund in MLPs (to get around the C Corp rules). Those types of funds are referred to as “RIC-Compliant funds” and may have significantly different investment characteristics. For the purpose of the AMCI, RIC-Compliant funds are excluded, as it would not allow for an apples-to-apples comparison. Click to enlarge The Alerian Closed End Fund Index’s construction is relatively straight-forward. Today, there are 21 MLP C Corp CEFs on the market, with AUMs ranging from $19 million to nearly $2 billion. All of these funds are included and equal-weighted within the AMCI. Historical data was generated by backtesting the index back to 2004, when the first MLP C Corp CEFs were launched. Click to enlarge Examining the total return performance of the AMCI in the chart above, you’ll notice that it lags significantly behind the AMZ. This is expected and really showcases the effect of the C Corp tax drag. Even though CEFs use leverage [6] to offset some of this drag, that leverage is only helpful on the way up. On the way down, leverage exacerbates losses. Although in the past three months, the AMCI has outperformed the AMZ, over periods of a year or longer, it has significantly underperformed. When looking at the yield of the AMCI, you’ll see that it’s also significantly higher than the AMZ. While some CEFs may focus their investments on higher-yielding MLPs, it’s not necessarily a universal trend, with leverage playing a larger role in boosting yields. One important note is that since this index is equal-weighted, small funds have an outsized influence on index performance while larger funds may be under-represented when compared to an AUM- weighted index. Unfortunately, the smallest funds are also the worst-performing in the index. When looking at the price return of the AMCI as of 3/31/16, the following data points stand out. 12 of 21 funds have outperformed the AMCI on a trailing one-year basis 11 of 13 funds have outperformed the AMCI on a trailing three-year basis 7 of 8 funds have outperformed the AMCI on a trailing five-year basis 4 of 4 funds have outperformed the AMCI on a trailing 10-year basis How is it possible that the majority of index constituents outperformed the index for the 3-, 5-, and 10-year history? Unfortunately, two funds [7] dragged the entire index down by hundreds of basis points [8]. Although it’s unfortunate that these funds had such a negative impact on index performance, it also showcases that there can be large disparity between the best- and worst-performing active managers. In the end, Alerian exists to equip investors to make informed decisions about their MLP investments. There are multitudes of MLP-related funds in the marketplace today and the most important thing is to know what you own. If you’ve already made the decision to go with an active manager and are comfortable with the pros and cons of C Corp CEFs, we hope that the AMCI better equips you to make an informed decision with your investments. 2016.05.19 2:30PM CST – Edited to correct phrasing in paragraph 4 and footnote 4. Footnotes [1] There are 118 energy MLPs as of the end of April. [2] As psychologist Barry Schwartz has said “Autonomy and freedom of choice are critical to our well-being, and choice is critical to freedom and autonomy. Nonetheless, though modern Americans have more choice than any group of people ever has before, and thus, presumably, more freedom and autonomy, we don’t seem to be benefiting from it psychologically.” [3] Over $9B in aggregate AUM as of February 29, 2016 [4] This is due to the American Jobs Creation Act of 2004. Previously, MLPs could not be held at all in such funds without making a corporate tax election. [5] The federal corporate tax rate is 35%, but state taxes could push the fund tax rate higher. [6] The amount of potential leverage can be found in each fund’s offering documents, but typically a fund’s maximum debt leverage is 33% while its equity leverage is 50%, as governed by the Investment Company Act of 1940. [7] The Cushing MLP Total Return Fund (NYSE: SRV ) fell over 87% from its inclusion on December 21, 2007 to March 31, 2016 while the Cushing Energy Income Fund (NYSE: SRF ) fell over 93% from its inclusion in the index from June 15, 2012 to March 31, 2016. [8] Theoretically, if we were going to cherry-pick this index and remove SRV and SRF, the annualized 10-year total return performance would have jumped 220 basis points from +1.7% to +3.9%. The 5-year annualized performance shows similar results, jumping nearly 370 bps from -7.8% to -4.1%. Disclosure: © Alerian 2016. All rights reserved. This material is reproduced with the prior consent of Alerian. It is provided as general information only and should not be taken as investment advice. Employees of Alerian are prohibited from owning individual MLPs. For more information on Alerian and to see our full disclaimer, visit http://www.alerian.com/disclaimers. James Wang is the Director of Data Analytics at Alerian, which equips investors to make informed decisions about Master Limited Partnerships (MLPs) and energy infrastructure. Mr. Wang conducts quantitative and statistical analyses in order to bring to light historical and emerging trends in the asset class. He also oversees the firm’s efforts to efficiently integrate and utilize technology in its brand management activities. Prior to Alerian, Mr. Wang was an Associate in the Equity Research Division of Raymond James & Associates Inc, where he constructed financial models for energy infrastructure MLPs and published comprehensive research reports to discuss his findings. Mr. Wang graduated with a Bachelor of Science in Biomedical Engineering and a minor in Management from the Johns Hopkins University Whiting School of Engineering.

My Week At Oxford’s Said Business School

I just spent the last week at Oxford University’s Said School of Business on its popular week-long Private Equity Program for senior executives. Say the word Oxford, and it conjures up images of a city of dreamy spires and ancient college courtyards. Yet if you squint your eyes on a rare sunny day in Oxford, the Said Business School campus looks more like Stanford University’s Business School in Silicon Valley than a medieval college situated on an 800-year-old university campus. That’s because Oxford Said is a very new school in a very old university. Even the establishment of Said back in the 1990s was controversial, as the dons of Oxford questioned whether business was a worthy topic of study. Fast forward 20 years, Oxford Said today is a thriving commercial venture led by former Harvard Business School professor Peter Tufano. Its halls are literally overflowing with students and executives from around the world bathing themselves in the reflected glory of the global Oxford brand. The executive education programs are held in a building appropriately named after Margaret Thatcher – even as Thatcher’s alma mater, Somerville College, originally a women’s school at Oxford College, refused to give her an honorary degree because the Oxford dons protested her cuts to higher education. Thatcher Business Education Centre, Oxford Said School of Business Although Oxford is a newcomer on the global business school scene, it’s hard to imagine a more geographically diverse group of students among a class of 30. On my right sat an auditor from a sovereign wealth fund in Oman; on my left was a pension fund manager from Ghana; and across the classroom was a snarky app developer and private investor from Portland, Oregon, who regaled the class daily with his varied choice of iconoclastic headgear. Private Equity in Perspective Oxford’s Private Equity Program is led by Professor Tim Jenkinson, a spritely, athletic and affable sixty-something former rower, who teaches students private equity as far afield as India, China and Silicon Valley. Private equity, as Jenkinson defines it, includes venture capital, growth capital, leveraged buyouts and turnarounds. However you define it, private equity – “capitalism on steroids” – does have an image problem. In the U.K. press, private equity is often synonymous with greed. U.S. investors still recall Oliver Stone’s 1987 film Wall Street , which told the story of a hostile takeover of Bluestar, which many regard – rightly or wrongly – as a quintessential private equity transaction. Stripped to its essence, leveraged buyouts (“LBO”) – the most popular form of private equity transaction – are simply a way of financing an acquisition of a company with its own steady and predictable cash flows until the company can be restructured and sold at a large profit. As ruthless as that sounds to the uninitiated, this is a perfectly rational strategy. Through the lens of private equity, many publicly traded companies are under-leveraged, and they leave a lot of money on the table – especially in an era of low interest rates. And as it turns out, private equity investors are pretty good at showing their investors the money. That’s also why the Oxford endowment – whose deputy Chief Investment Officer, Jack Edmondson, spoke at the program – has allocated 20% of its funds to private equity, thereby closely mimicking the asset allocation strategy of the highly regarded Yale endowment. Calculating Private Equity Returns Private equity is all about the numbers. And in terms of headline returns, the asset class is impressive. Yet as it turns out, this has much to do with the dark arts of how investment returns in private equity are calculated. Private equity calculates returns (and fees) on an Internal Rate of Return (IRR) basis, rather than “time-weighted return. The latter is the method you are more likely to see in your mutual fund or exchange-traded fund (ETF). But there are good reasons for private equity to use IRR. After all, private equity involves constantly flipping deals and funds are never fully invested, as they are in, say, ETFs. Still, some rates of return can be staggering – and deceptive. That’s why the Yale University endowment caused such a stir when it recently revealed that its return on venture capital deals (a subset of private equity) had been an astonishing 92.7% over the past 20 years. Had Yale achieved that rate of return on its entire endowment of $4.86 billion starting in 1996, the endowment would be worth $2,422,537,000,000,000 – or 8x more than the $300 trillion of the entire value of financial assets across the globe today. But if you use time-weighted returns, Yale’s venture capital portfolio’s 20-year return drops rather dramatically to 32.3%. And once you exclude the dotcom boom by looking only at the last 10 years, even the IRR drops to 18%. That’s still impressive. But at least it’s believable. Trends in the World of Private Equity Here are three major insights about private equity I took away from the week. First, academic studies confirm that private equity investments do make more money for investors. While the managements of publicly traded companies are “fat and happy” and today spend the bulk of their time on compliance and investor communications, the board members of private companies not only have skin in the game, but also have the time and energy to focus on improving the business. Combine that with leverage and the returns ramp up fast. Second, private equity is still in its infancy. Average allocations among funds is 4%, while most are targeting twice that level. Sovereign wealth funds – say Norway with its $875 trillion – alone could have a major impact on the asset class. Private equity is also emerging as the favored approach in fast-growing emerging markets. Perhaps that explains why one-third of the Oxford class was made up of students from Africa, Latin America and Eastern Europe. Third, private equity is becoming a victim of its own success. As with any popular asset class, too much money is chasing too few deals. That means returns to investors – “LPs” or limited partners in private equity jargon – are falling precipitously. Finally, here’s what worried me most: Private equity is now the number one career choice for newly graduating Oxford MBAs. That trend ruffles my contrarian feathers. Playing the Private Equity Game So can you be a player in the private equity game? The short answer is: “Not really.” Investors – the LPs – in private equity are almost exclusively pension funds, endowments and some family offices. But there are a few indirect ways you can gain exposure to the private equity game – though they are unlikely to yield the same type of returns. PowerShares Listed Private Equity Portfolio ETF (NYSEARCA: PSP ) is an ETF that invests in many of the private equity management companies that back deals, including those funded by business development companies (“BDCs”), by master limited partnerships (“MLPs”) and by other vehicles. In terms of investment strategies, “activist investing” is a close cousin of private equity. In that space, there are a handful of publicly traded vehicles including Carl Icahn’s investment partnership, Icahn Enterprises (NASDAQ: IEP ) , and Bill Ackman’s Pershing Square Holdings, Ltd. ( OTCPK:PSHZF ) which also trades OTC in the United States. Finally, a new Global X Guru Activist Index ETF (NASDAQ: ACTX ) , launched on April 29, tracks the investments of 50 of the largest and most successful activist investors. Six of Icahn Enterprises’ top 10 positions are included, such as Apple (NASDAQ: AAPL ) and eBay (NASDAQ: EBAY ). More than half of Bill Ackman’s Pershing Square Capital Management’s holdings are represented and include Zoetis (NYSE: ZTS ) and Canadian Pacific Railway (NYSE: CP ).