Tag Archives: alternative

VWO: A Very Solid Emerging Market ETF, If You Don’t Mind China

Summary VWO offers some solid diversification among the companies and a low expense ratio. When investors look at diversification based on geography, the diversification is not as favorable. I’d like to see a lower allocation to China and stronger allocations to smaller emerging markets. When investors look at the correlation between VWO and major domestic indexes on a daily basis, the correlation looks very high. Over the long term, the high correlation breaks and there is a dramatic difference in returns even over periods of a few years. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. One of the funds that I’m considering is the Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. Expense Ratio The expense ratio on VWO is only .15%. Nice work Vanguard, this is another low cost index fund for effective diversification. Largest Holdings (click to enlarge) The holdings for VWO are fairly diversified with only 2 companies receiving an allocation higher than 2.1%. The one concern I have is that it seems like “China” keeps coming up in the top holdings. I checked the allocation by country to determine how large that exposure would be. Allocation by Country The allocation to China was 27.1% of the market. Since I’ve been a bear on China, I’m not really big on this allocation. I wasn’t bearish on China until their domestic equity market doubled. While the government in China is working hard to protect their equity valuations, I’d rather see the economy growing rapidly from people working and building both infrastructure and exports. I would prefer an emerging market portfolio with an international diversification that was closer to equal weights. It wouldn’t need to actually be equal weight, but less skewed than the current portfolio. Building the Portfolio This hypothetical portfolio has a moderately aggressive allocation for the middle aged investor. Only 25% of the total portfolio value is placed in bonds and a fifth of that bond allocation is given to high yield bonds. If the investor wants to treat an investment in an mREIT index as an investment in the underlying bonds that the individual mREITs hold, then the total bond allocation would be 35%. Given how substantially mREITs can deviate from book value, I’d rather consider the allocation as an equity position designed to create a very high yield. This portfolio is probably taking on more risk than would be appropriate for many retiring investors since a major recession could still hit this pretty hard. If the investor wanted to modify the portfolio to be more appropriate for retirement, the first place to start would be increasing the bond exposure at the cost of equity. However, the diversification within the portfolio is fairly solid. Long term treasuries work nicely with major market indexes and I’ve designed this hypothetical portfolio without putting in the allocation I normally would for equity REITs. An allocation is created for the mortgage REITs, which can offer some fairly nice diversification relative to the rest of the portfolio and they are a major source of yield in this hypothetical portfolio. The portfolio assumes frequent rebalancing which would be a problem for short term trading outside of tax advantaged accounts unless the investor was going to rebalance by adding to their positions on a regular basis and allocating the majority of the capital towards whichever portions of the portfolio had been underperforming recently. Because a substantial portion of the yield from this portfolio comes from REITs and interest, I would favor this portfolio as a tax exempt strategy even if the investor was frequently rebalancing by adding new capital. The portfolio allocations can be seen below along with the dividend yields from each investment. Name Ticker Portfolio Weight Yield SPDR S&P 500 Trust ETF SPY 35.00% 2.06% Consumer Discretionary Select Sector SPDR ETF XLY 10.00% 1.36% First Trust Consumer Staples AlphaDEX ETF FXG 10.00% 1.60% Vanguard FTSE Emerging Markets ETF VWO 5.00% 3.17% First Trust Utilities AlphaDEX ETF FXU 5.00% 3.77% SPDR Barclays Capital Short Term High Yield Bond ETF SJNK 5.00% 5.45% PowerShares 1-30 Laddered Treasury Portfolio ETF PLW 20.00% 2.22% iShares Mortgage Real Estate Capped ETF REM 10.00% 14.45%   Portfolio 100.00% 3.53% The next chart shows the annualized volatility and beta of the portfolio since April of 2012. (click to enlarge) A quick rundown of the portfolio Using SJNK offers investors better yields from using short term exposure to credit sensitive debt. The yield on this is fairly nice and due to the short duration of the securities the volatility isn’t too bad. PLW on the other hand does have some material volatility, but a negative correlation to other investments allows it to reduce the total risk of the portfolio. FXG is used to make the portfolio overweight on consumer staples with a goal of providing more stability to the equity portion of the portfolio. FXU is used to create a small utility allocation for the portfolio to give it a higher dividend yield and help it produce more income. I find the utility sector often has some desirable risk characteristics that make it worth at least considering for an overweight representation in a portfolio. VWO is simply there to provide more diversification from being an international equity portfolio. While giving investors exposure to emerging markets, it is also offering a very solid dividend yield that enhances the overall income level from the portfolio. XLY offers investors higher expected returns in a solid economy at the cost of higher risk. Using it as more than a small weighting would result in too much risk for the portfolio, but as a small weighting the diversification it offers relative to the core holding of SPY is eliminating most of the additional risk. REM is primarily there to offer a substantial increase in the dividend yield which is otherwise not very strong. The mREIT sector can be subject to some pretty harsh movements and dividends from mREITs should not be the core source of income for an investor. However, they can be used to enhance the level of dividend income while investors wait for their other equity investments to increase dividends over the coming decades. If you want a really quick version to refer back to, I put together the following chart that really simplifies the role of each investment: Name Ticker Role in Portfolio SPDR S&P 500 Trust ETF SPY Core of Portfolio Consumer Discretionary Select Sector SPDR ETF XLY Enhance Expected Returned First Trust Consumer Staples AlphaDEX ETF FXG Reduce Beta of Portfolio Vanguard FTSE Emerging Markets ETF VWO Exposure to Foreign Markets First Trust Utilities AlphaDEX ETF FXU Enhance Dividends, Lower Portfolio Risk SPDR Barclays Capital Short Term High Yield Bond ETF SJNK Low Volatility with over 5% Yield PowerShares 1-30 Laddered Treasury Portfolio ETF PLW Negative Beta Reduces Portfolio Risk iShares Mortgage Real Estate Capped ETF REM Enhance Current Income Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. Despite TLT being fairly volatile and tying SPY for the second highest volatility in the portfolio, it actually produces a negative risk contribution because it has a negative correlation with most of the portfolio. It is important to recognize that the “risk” on an investment needs to be considered in the context of the entire portfolio. To make it easier to analyze how risky each holding would be in the context of the portfolio, I have most of these holdings weighted at a simple 10%. Because of TLT’s heavy negative correlation, it receives a weighting of 20% and as the core of the portfolio SPY was weighted as 50%. Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio. Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. (click to enlarge) Conclusion VWO is benefiting a great deal from having a fairly low correlation with several of the other assets in the portfolio. The highest correlation is with the S&P 500, but even the high level of correlation established here is a function of the very short term measurements being used to measure the correlation. When returns are measured over a longer time period the correlation decreases significantly. Over the sample period the S&P 500 is up by 52% and VWO is down by 12%. Simply put, short term correlations are resulting in significantly overstated correlations for VWO. In the same manner, I think the benefits of diversifying VWO with a long term treasury ETF are understated. When investors are in a period of panic, emerging markets will tend to go down while the risk free securities will be bid higher. If investors want to use a fund like VWO to grab some international diversification (with some heavy exposure to China), I would really for treasuries to be over-weight in the portfolio. The difficulty here is that long term rates are already fairly low so the maximum level of gains on a treasury allocation is limited. All around this is a good ETF, but I would prefer international options with less exposure to China. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

You Can Buy This 11.2% Yielding, Unleveraged Equity CEF Without Paying A Premium

STK pays a distribution yield of 11.2%. The fund is an unleveraged, option-income CEF in the technology sector. There are only five unleveraged, domestic-equity CEFS with positive returns TTM. STK has the highest yield and largest discount of that set. Let’s start with a tale. There’s a domestic-equity closed-end fund that is paying an 11.2% distribution from a quarterly payout that has been stable since the fund’s inception over five years ago. It is one of only five unleveraged, domestic-equity CEFs that is in positive territory TTM; the other four are well-covered CEFs with lesser distribution yields. Its investing strategy is conservative, focused on covered-calls to generate income. At least here on Seeking Alpha, it stays well under the radar with essentially no attention from the site’s contributors. Impossible, you say? Well take a look at Columbia Seligman Premium Tech (NYSE: STK ). I’ve been writing about this fund for two years . If any other Seeking Alpha contributor has paid any attention to it, it’s not obvious. Put STK in the search box and the only thing you get is a few articles by Left Banker. Readers are no more interested than Seeking Alpha’s authors: those articles are solidly among my least. Despite its impressive numbers, STK remains about as unnoticed as a fund can be on this site. STK has $254M in AUM, which places it as a mid-size equity CEF. Trading volume is modest but not so low as to present exceptional liquidity problems. The fund invests in the technology sector. Management looks for capital appreciation from the portfolio holdings, and generated income from a covered call option-writing strategy. Calls are written on the Nasdaq 100 or its ETF equivalent on a month-to-month basis. The aggregate notional amount of the call options will typically range from 25% to 90% of the underlying value of the fund’s holdings on common stock. The fund has a managed distribution policy. It pays $0.4625 quarterly and has done so since its inception date. There had been considerable return of capital earlier, but in the last two years RoC has totaled only $0.37. At its current price, that is an 11.15% yield, just about its midpoint for the past two years. (click to enlarge) The fund has faltered along with the tech sector since mid-year, but even so it has a 1-year total return of 4.15% which places it 18th of 192 general equity funds indexed by cefanlayzer . Of those 192, only 40 are positive for this stat. Return on NAV TTM is 3.08%, which places 25 of 192 funds. STK is unleveraged. Some 60% of the 192 funds in the general equity category use leverage greater than 5% to enhance their yields. Leverage comes with risk, of course, an important risk factor that STK avoids. The fund had been priced at a premium as high as 10%. Since mid-summer, that has fallen to a discount reaching -6% early in September. The discount is climbing again and stood at -0.72% at Friday’s close. (click to enlarge) Annual portfolio turnover is 60%. As of the end of July, the top 10 holdings were: (click to enlarge ) It is the highest yielding of the 12 equity CEF that are both unleveraged and have a positive return for the last 12 months. Only five domestic equity funds pass those filters; the other seven are single-country funds. Three of these are in healthcare and one is a general equity, option-income fund. None has a distribution yield that approaches STK’s, and all but one sells at a premium. They have all turned in better TTM returns than STK, the two Tekla funds having done so by a large margin. Fund Distribution Yield TR 1yr Prem/Disc Columbia Seligman Premium Technology Growth Fund ( STK ) 11.15% 4.15% -0.72% Tekla Life Sciences Investors (NYSE: HQL ) 8.19% 35.08% 0.93% BlackRock Health Sciences Trust (NYSE: BME ) 5.36% 8.19% 4.64% Tekla Healthcare Investors (NYSE: HQH ) 8.30% 27.35% -0.32% Eaton Vance Tax-Managed Buy-Write Income Fund (NYSE: ETB ) 7.99% 7.80% 4.83% I should add here that HQL, HQH and ETB are long-time favorites of mine. If I were making recommendations in specialty equity CEFs, ETB or one or more of its sibling option-income funds from Eaton Vance would be at the top of that list. Right up there would be either HQL or HQH, which I consider must-own funds for the CEF investor. But for someone already invested in those funds and looking for opportunities for diversification in other sectors, STK is, in my view, among the strongest candidates. In conclusion, I think it’s clear that STK remains one of the most attractive options among high-income equity CEFs. Its 11.2% yield is near the top of the category. The income comes primarily from option premiums, which tends to position a fund somewhat more defensively in uncertain markets. Income is stable and, with the managed distribution policy, is likely to remain so, albeit with some risk of erosive return of capital in edgy times. On the negative side, while the fund has performed well over the past two years, its performance was erratic prior to 2013. It has also faltered since mid-2015 as its sector and the overall market started to turn sour. This may call into question the ability of management to handle less positive market environments. Disclosure: I am/we are long STK, HQH, HQL, ETB. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: I remind readers that this article does not constitute investment advice. I am passing along the results of my research on the subject. Any investor who finds these results intriguing will certainly want to do all due diligence to determine if any fund mentioned here is suitable for his or her portfolio. As always I welcome your comments and critiques, particularly from those readers who have contrary opinions.

BUI: Has It Held Up In The Downturn?

I looked at BlackRock Utility and Infrastructure Trust not too long ago. Comparing it to UTG, the big difference was the use of options versus leverage. Is that not so subtle difference playing out as expected? One of my favorite utility and infrastructure closed-end funds, or CEFs, is the Reaves Utility Income Fund (NYSEMKT: UTG ). But it’s far from the only fund out there that focuses on this space, which is why readers asked that I look at the BlackRock Utility and Infrastructure Trust (NYSE: BUI ), a much younger entrant in the space. At the time I first looked at the two together I said I liked UTG better, but that BUI theoretically should hold up better in a downturn. Well, it’s time to look at how that’s playing out. Similar, but different UTG and BUI both invest in the infrastructure that makes our modern world work. That includes electric companies, but also things like water utilities, oil companies, airports, and railroads. Both take a pretty broad look at their niche. But, in the end, they both are looking to do a very similar thing. However, that doesn’t mean their portfolios are alike. For example, at the end of June, the energy space made up around 6% of UTG’s portfolio. That number at BUI was a far more meaty 24%. So similar, but different. Which is to be expected since the CEFs are offered by two different sponsors. However, there’s another notable difference here, too. UTG attempts to enhance returns via the use of leverage. BUI looks to boost returns, specifically income, via the use of an option overlay strategy. In a flat to slowly rising market these two approaches should probably produce similar results. In a fast rising market I’d expect UTG’s leverage to result in better returns. And in a down market, I’d expect BUI’s use of options to soften the blow of the decline. That’s what I’d expect, anyway. Now that we’ve seen the utility and other income-oriented sectors fall this year, what really happened? A mixed bag Year to date through August, the net asset value, or NAV, total return for UTG was a loss of 9.3%. BUI’s loss over that same span was a more mild 6.7%. On an absolute basis that’s not such a big difference, but on a percentage basis BUI “outdistanced” (perhaps under-lost?) UTG by around 25%. That’s a pretty big difference. All return numbers assume the reinvestment of distributions. So, on the whole, I’d say that the option overlay did perform as expected. To stress the point, the Vanguard Utilities ETF (NYSEARCA: VPU ) was also down over 9% over the year-to-date period through August. But pull back some and things get a little more interesting. Over the trailing year through August, VPU was essentially break even. UTG, meanwhile, was down 3.3%. BUI was down roughly 5.5%. What gives? For starters, both UTG and BUI have broader investment mandates than VPU. And UTG and BUI are stock pickers, using human intelligence (or not, depending on your opinion of active management) to select stocks. Put another way, VPU has a much tighter focus on utilities. It also doesn’t use leverage, which through a good portion of the time was a drag on UTG’s performance. So I can understand why it did better than BUI and UTG over the trailing year, which has been a pretty turbulent time in the markets for some of the additional areas in which these two CEFs have ventured. But why has BUI underperformed UTG by so much over the trailing year? The answer is most likely the previously mentioned weighting difference in the energy sector. Oil prices, and the stocks associated with the energy sector, started to fall around mid-2014. So, it makes sense that BUI, with a much heavier weighting in the sector, would be hit harder over the trailing year period. And it’s hard to say that the oil downturn is over, yet, either. Which adds a notable amount of risk to owning BUI relative to UTG. Who wins? So, in the end, this difficult period isn’t a clear win for BUI or for UTG. It kind of depends on what period you’re looking at and how you define success. For example, looking even further afield, BUI was down 5.5% over the past year, but that was much better than the Vanguard Energy ETF (NYSEARCA: VDE ) which was down over 30% even though BUI underperformed utility-focused VPU, which was pretty much break even over the span. If you liked the extra oil exposure BUI offered versus UTG when oil was doing well, it’s hard to complain when it starts to work against you. And then there’s this year, when utilities took a hit and UTG underperformed relative to BUI. With leverage adding a helping hand to the downside along the way at UTG and option income softening the blow at BUI. So the use of options did, indeed, appear to do what you’d expect. I still like UTG. It’s a solid fund with a long history of navigating volatile markets and rewarding shareholders along the way. BUI is really seeing its first serious stress test. That said, I think it’s holding up pretty well. And, at the end of the day, I don’t think either is a poorly run CEF. Looking at the two today, UTG’s discount is narrower than normal at around 2%-about half the normal 4% or so over the trailing three years. It isn’t cheap, but then investors are likely rewarding it for its strong historical performance. A flight to safety, if you will. BUI, meanwhile, is trading at a roughly 13% discount versus its trailing three-year average discount of 9.5% or so. It’s clearly the cheaper of the two funds. BUI is also offering a more generous distribution yield, at 8.6%. UTG’s distribution yield is a more modest 6.4% or so. Neither is outlandish, but UTG’s lower yield is likely to be more sustainable over the long-term. That said, if you are looking for yield and prefer wider discounts, BUI looks like the better play-but only if you believe the oil market has stopped falling… If you are conservative, UTG is still the one to watch. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.