Tag Archives: alternative

Building A Dividend Stream With The Best U.S. REIT ETF

Summary The uncertainty around the interest rate hike was not resolved in September. The high level of volatility is expected to continue in the coming months as well. Take advantage of the occasional dips to build a position in an income stream ETF. Back in June, after the second quarter of high volatility in the REIT sector, I wrote about the opportunity in U.S. REITs. The latest dip was marked during the first half of September towards the Fed’s decision when we saw both the REITs and utilities dropping dramatically. Since the Fed announced that it is essentially pushing out its decision to a later date, there is no reason to believe that the high volatility is behind us and that we will not see high levels of anxiety towards the Fed’s announcements, the one in October or in December. The volatility in REITs is well seen in this Vanguard REIT Index ETF (NYSEARCA: VNQ ) graph. The ETF hit $72 just after Yellen’s announcement, but in the following couple of weeks, it rallied pretty nicely, closing at $75 on September 25. (click to enlarge) Is it still the best U.S. REIT ETF? The next table compares VNQ to the other 15 ETFs that are focused on U.S. REITs. I marked the top five in each of the categories of dividend yield, management fees and the total return during the last 3 and 5 years in green. (click to enlarge) VNQ was favorable in all of the categories, delivering more than 4% yearly yield at only 0.12% yearly management fees with an impressive 72% return during the recent five years. Throughout 2015, through times of uncertainty and concerns, not only has VNQ continued to pay uninterrupted dividends, but also on top of that it grew its dividends by ~10% compared to the year before. The next graph shows VNQ’s quarterly dividends starting Q1’10 until the recent Q3’15. For Q4’15, I have plugged a $1.1 dividend, which is equal to the one paid back in Q4’14. While the other three dividends this year went up by 10%, it would be very hard to believe that the forth one will not grow, but I always like to be conservative: (click to enlarge) How can we model it forward? The 2015 dividend per share is estimated at $3.13, growing 10% year over year. An investor who wants to build a position during the next 10 years can generate some interesting strategies assuming they are willing to invest in VNQ regularly. What can one expect from this type of investment? First thing, let’s examine the dividend growth rate. Nothing can grow forever at the level of 10%. Moreover, this sector like any other sector is exposed to risks. REIT risks are associated with macroeconomic slowdown, space overflow and rental pricing. For a long-term model, let’s judge the growth rate to be 4-5% per year for the next decade. Model Assumptions Dividend rate: The current VNQ dividend rate is 4.2%. Let’s use it in the first year. Dividend growth rate: If we should pick a number between 4% and 5%, let’s go with 4.5%. Tax rate: Since not every investment can be tax free, let’s assume a 25% tax rate on the dividends. Investment: $1,000 invested per month or $12,000 yearly investment across a time period of ten years. The dividends, net of taxes, are assumed to be reinvested as well. VNQ’s price: The ETF price across the years is highly unknown. In order to mitigate that, let’s look at two scenarios. Scenario 1: VNQ’s yearly prices change at the same pace as the dividend per share. That means that in this scenario the ETF price will go up by 4.5% every year. Scenario 2: VNQ’s price remains at $75, or in other words the investment and reinvestment are taking place through the time of dips in the ETF pricing. Scenario 1 results In this case, where the ETF prices are growing alongside the dividend per share, after ten years, the investor has accumulated a holding of 2,093 VNQ shares. This holding has the potential to generate $9,739 in dividends per year. The investor invested $120,000 and therefore can expect 8.1% return on his investment in the tenth year. An income stream that potentially will continue to grow afterwards. Scenario 2 results In this scenario of flat ETF prices through the ten-year horizon, the amount of accumulated shares is ~30% higher than in scenario 1. The holding is getting to a total of 2,783 shares. It has the potential to generate a yearly income stream of $12,946 per year pre-tax. The following year, if we’re maintaining the same assumptions of reinvestment, the income stream after taxes is expected to exceed the $12,000 threshold. After ten years, the investor had invested $120,000 and expects to receive 10.8% in annual dividend return on his investment. Conclusions The anxiety regarding the interest rate will accompany us in the coming months and years. This will generate great opportunities for the long-term investor who is pursuing an income stream. The REIT sector is expected to grow even if the interest rate will rise. I find VNQ to be the best ETF that focuses on U.S. REITs. The patient investor has the potential to gain significant returns by setting their investment strategy straight. As there is no way to best optimize the entry or time the market, the investor should build a position through several purchases. And lastly, an investor should take advantage of the days of panic. These will be the days that will serve them well in the long run.

FXZ And RTM: Material Evidence

Summary An opportunity for long term investors to be pre-positioned in the materials sector. One fund is equally weighted, conservatively invested; the other more diversified and alpha weighted. Either fund challenges the investor to take advantage of the business cycle. There’s an old Wall Street adage to ‘buy low, sell high’ and based on the basic principles of investment, this statement is axiomatic. However, it does beg the questions, ‘how low is low?’ and ‘how high is high?’ So to apply this axiom, the idea would be to find an investment that is low. Anyone who has paid attention to global financial news over the past few months is well aware that the supply of strategic materials, as well as production, has run far, far ahead of demand. But just what is the ‘materials sector’? According to Investopedia : … A category of stocks that accounts for companies involved with the discovery, development and processing of raw materials. The basic materials sector includes the mining and refining of metals, chemical producers and forestry products. .. So apparently, this is a starting point: supply is high, demand is low therefore prices decline, thus profits, thus stock prices of ‘basic materials’ producers. (click to enlarge) Unless one has the time, effort, patience and knowledge to analyze and filter through the hundreds, if not thousands of global basic materials manufactures, it best to select a basic materials ETF and then a ‘plain vanilla’ one at that. Lastly, the individual would be wise to select the best fund in the class. By filter U.S.Equities => Basic Materials=> All, then excluding ‘Leveraged’, ‘Inverse’ and ‘ETN’, the very handy Seeking Alpha’s ETF Hub tool identifies nine suitable results. There are two candidates with a “least bad” one year performance and the best three year performance. First is the Guggenheim’s S&P Equal Weight Materials ETF (NYSEARCA: RTM ) and second is the First Trust Materials AlphaDEX ETF (NYSEARCA: FXZ ) . According to Guggenheim , the investment’s objective is to: … replicate as closely as possible, before fees and expenses, the performance of the S&P 500 Equal Weight Index Materials[S15] … Clearly, the 28 component holdings of the Guggenheim Materials fund are then equally weighted and readjusted quarterly according to the index it tracks. The underlying S&P tracking index: …imposes equal weights on the index constituents included in the S&P 500 that are classified in the GICS® materials sector… (Note that ” GICS ® ” is an abbreviation for G lobal I ndustry C lassification S tandard , developed by S&P and M organ S tanley C apital I nternational ). (click to enlarge) The First Trust fund’s investment objective: … is to seek investment results that correspond generally to the price and yield, before fees and expenses, of an equity index called the StrataQuant® Materials Index [STRQMT]. .. This is an: … enhanced index developed, maintained and sponsored by the NYSE Euronext or its affiliates which employs the AlphaDEX stock selection methodology to select materials stocks from the Russell 1000 Index .. The AlphaDEX methodology , as the name suggests will identify index components with the greatest potential for capital appreciation. In plain speak, the fund will weight companies in the sector which are performing better than the average company in the sector. So instead of just trying to just replicate the index, it weights its holdings more towards the best performing stocks. (click to enlarge) Observe though that both funds have performed similarly in both good and bad market cycles, but interestingly, the Guggenheim fund conservatively equally weights its holding whereas the First Trust Funds weights slightly more towards risk. The Guggenheim Fund has a far more simple subsector allocation construction, five in all and then most heavily weighted in Chemicals at 57% of the fund’s total holdings. The First Trust fund allocates among ten subsectors, also most heavily weighted in Chemicals, 34%, but also includes an allocation for Aerospace and Defense, 5%, normally part of the Industrial Sector. (click to enlarge) (data from First Trust and Guggenheim) Both companies, as might be expected, have holdings in common; 21 in all. These are listed by First Trust’s weightings; (since Guggenheim equally weights): Holdings in Common Name and Symbol FXZ Weighting SEALED AIR (NYSE: SEE ) 3.47% MARTIN MARIETTA (NYSE: MLM ) 3.12% VULCAN MATERIALS (NYSE: VMC ) 3.03% NEWMONT MINING (NYSE: NEM ) 2.70% The MOSAIC (NYSE: MOS ) 2.61% NUCOR (NYSE: NUE ) 2.42% LYONDELLBASELL (NYSE: LYB ) 2.26% ALOCA (NYSE: AA ) 2.25% DOW CHEMICAL (NYSE: DOW ) 1.89% SHERWIN-WILLIAMS (NYSE: SHW ) 1.89% EASTMAN CHEMICAL (NYSE: EMN ) 1.86% CF INDUSTRIES (NYSE: CF ) 1.65% BALL CORP (NYSE: BLL ) 1.24% AIRGAS (NYSE: ARG ) 1.18% E.I. du PONT de NEMOURS (NYSE: DD ) 1.11% WESTROCK (NYSE: WRK ) 0.76% ECOLAB (NYSE: ECL ) 0.68% AIR PRODUCTS & CHEMICAL (NYSE: APD ) 0.65% PRAXAIR (NYSE: PX ) 0.58% INTL PAPER (NYSE: IP ) 0.56% PPG INDUSTRIES (NYSE: PPG ) 0.53% Data From First Trust and Guggenheim As a general rule, the investor should take the time and trouble to compare the holdings of any ETFs in the same asset class for a reason exemplified here. Of the 28 holdings of the Guggenheim Fund, only 7 are not in common with the First Trust fund. Of those 7, four are in the Chemical subsector, 2 in Containers & Packaging and one in Metals and Mining. Further, as mentioned above, the Guggenheim fund seems rather heavily weighted in Chemicals compared to the First Trust fund; 57.06% vs. 34.09%. In Containers & Packaging the Guggenheim fund is slightly more weighted than Firsts Trust; 18.17% vs. 13.25%. First Trust is a little more weighted in Metals and Mining; 14.23% vs. 20.10%. Lastly, by applying some simple arithmetic, the average weighting of the First Trust’s holding which are not in the Guggenheim fund is just over 2%. The equally weighted unadjusted Guggenheim holding averages 3.57%. The point being that Guggenheim fund is mostly contained in the First Trust fund in terms of holdings, similar in allocation and reasonably close in average weighting. Also as noted above, the First Trust fund has two Aerospace & Defense holdings, 4.69%; a subsector more properly defined as an Industrial subsector. One is Hexcel Corporation (NYSE: HXL ) and the other is Precision Cast Parts (NYSE: PCP ) . In the case of these two companies, the sector to which it belongs just might be a matter of perspective since both companies manufacture specialized materials . Hexcel manufactures: … everything from carbon fiber and reinforcement fabrics to pre-impregnated materials… …and honeycomb core, tooling materials and finished aircraft structures … Precision Cast Parts, as the name implies, manufactures precision and complex casting using high performance nickel and titanium alloys. Hence, although classified as Aerospace and Defense companies, they do produce materials used in industry so are appropriate holdings for a materials fund. Fund and Inception Expense Ratio 1 Year Return 3 Year Return 5 Year Return TTM Yield P/E 3 Month Average Volume Beta Guggenheim [RTM] 11/1/2006 0.40% -7.48% 11.67% 10.78% 1.54% 17 12020 1.09 First Trust [FXZ] 5/8/2007 0.70% -11.43% 9.36% 10.65% 1.57% 17 85131 1.08 (Data from YaHoo!, Guggenheim and First Trust) So what it boils down to is this. RTM is investing conservatively in this volatile sector. FXZ may be viewed as an extension of RTM, with the opportunity for capital appreciation. However, in doing so its accepting a little more risk in this volatile sector. Both are good choices, but the decision of which to choose depends on the risk tolerance of the investor. Having described both funds, the original point must be reiterated: Is this the time to buy into the Material Sector? By referring to the included price divided charts, it is evident that both funds are well off their lows, both lows having occurred in the recession year of 2008. Hence both funds appreciated during the recovery years, in particular those years for which emerging market nations created a seemingly insatiable demand for materials. If those emerging market nations are correcting towards a more sustainable growth rate, then the Materials sector correction may not yet be over. However, this is precisely what is meant by the ‘business cycle’. Eventually, excess supply will be worked down and production capacity will adjust accordingly so that supply and demand will again come into balance. Hence, for a risk tolerant individual investor, a gradual accumulation in the materials sectors, in particular, by patiently dollar cost average in over a long period of time will put the investor in an advantageous position to be able to take advantage of the next, inevitable, up cycle and put to the test the old adage, buy low, sell high.

Have The Volatilty ETFs Turned A Corner?

Summary Trying to play US equity volatility has been really tough for retail investors in recent years. Over the past four years VIXY and VXX are both down over 58%. Volatility has increased in other areas of the capital markets which is a positive sign long-volatility ETFs. Trying to play pure volatility as a retail investor is tough. Not only can you not invest directly in the widely watched VIX, but ETFs that attempt to track the VIX end up with a substantial tracking error. This occurs because volatility ETFs such as the ProShares Vix Short-Term Futures ETF (NYSEARCA: VIXY ) track an index made up of VIX futures. When future prices are in contango (as is usually the case for VIX futures), this creates a negative roll yield that eats away at the ETFs price. Over the past four years, VIXY is down 58.6%. The iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ), which tracks the same index as VIXY, is down 58.5%. Out of 1081 ETFs that have at least four years of trading history, VIXY and VXX have had the 6th and 7th worst performance over the past four years, respectively. With that nasty backdrop the silver lining is that for the first time in quite a while there are indications that pure play volatility investments could begin to pay off. In general, greater volatility in one segment of the capital markets tends to lead to overall greater levels of volatility in all segments of the capital markets. For example. a month ago junk bond spreads widened out to multi-year highs and look to be on the verge of making new highs very soon. As the chart below shows, greater volatility in the bond market tends to coincide with greater volatility in the equity markets. (click to enlarge) (click to enlarge) Volatility among major currency pairs has also been substantially higher in 2015 than the majority of the last several years. FX volatility has been pointing to increased equity volatility for quite some time. Equity volatility in other parts of the world is on the rise. The VDAX, which is similar to the VIX but for the German equity market, broke out to a multi-year high a month ago. Macro risks around the world are on the rise. The Citi Macro Risk Index “measures risk aversion in global financial markets”. It tracks various CDS spreads, credit spreads, swap spreads and implied volatility across FX, equity and swap rates. As this index rises, the perceived amount of risk in the global financial system increases. After falling for most of the year, this index is sharply higher over the past six weeks. Finally, on a relative point and figure basis, both the VIXY and VXX have recently broken though a firm resistance line that has been in place for four years and they both seem to have been in a basing formation for about the past 18 months. If this base can hold than there is a tremendous amount of potential upside for VIXY and VXX. VXX relative point and figure chart VIXY relative point and figure chart The original posting of this article can be found here . All data was created by the author and sourced from Gavekal Capital, MSCI and FactSet.