Tag Archives: alternative

How To Build An Alpha-Rich Portfolio Around Preferred Shares

Summary After taking a look at PFF, I decided it would be worth looking into ways that an investor could use it heavily in a low risk portfolio. The resulting portfolio underperforms SPY in a strong bull market, but does very well at limiting volatility. Looking at the max drawdown shows that over the last 4 years the worst drawdown on the portfolio was only 7.9%. If investors are considering holding cash in their portfolio to reduce the volatility, they may want to consider this style of portfolio instead. After covering the iShares U.S. Preferred Stock ETF (NYSEARCA: PFF ) and noticing that it had some very attractive risk characteristics and a very strong yield at 6%, I decided it was worth looking into the impacts of designing a portfolio for very low volatility at the portfolio level while maintaining a fairly strong yield for investors. I think this is one of the most reasonable ways to incorporate a heavy allocation to PFF in a portfolio. I built a portfolio using only a few tickers so it is reasonably simple to duplicate. Portfolio The Portfolio uses the Schwab U.S. Dividend Equity ETF (NYSEARCA: SCHD ) as the core of the portfolio since it has been noticeably less volatile than whole market ETFs, has a respectable dividend yield with dividends regularly growing, and an expense ratio of only .07%. The next major allocation is a very long duration treasury ETF, the Vanguard Extended Duration Treasury ETF (NYSEARCA: EDV ). The iShares U.S. Preferred Stock ETF gets the same 20% allocation as EDV. The next holding is the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ) because it has a fairly low beta and fits very well in portfolios designed to minimize total risk at the portfolio level. The final allocation goes to the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEARCA: EMB ) with 5% of the portfolio. This is incorporated because it has such unique risk factors that it ends up having only moderate correlations with each other investment while having a yield just over 4.5%. The portfolio is demonstrated below: (click to enlarge) The great thing about this portfolio is that over a sample period of nearly 4 years the annualized volatility is only 6.5% which puts the portfolio volatility at slightly under half of the volatility on the SPDR S&P 500 Trust ETF ( SPY). In other words, an investor holding 50% SPY and 50% cash would have witnessed a higher level of volatility in their portfolio. During the period the worst drawdown was falling 7.9%. All around this is a very resilient portfolio because the risk factors have been so effectively diversified. Alpha Investors may notice that this portfolio has materially underperformed SPY over the sample period, but it is meant to underperform SPY during strong bull markets. When SPY is up almost 77% in less than 4 years, I’m going to call that a strong bull market even if we saw some huge shocks in August. The annual rate of return on SPY is about 16%. The annual rate of return on the portfolio was 11.4%. If investors start from portfolio volatility (rather than beta) for establishing alpha, this portfolio would to create about half of the difference between SPY and the risk free rate. Since the portfolio only underperformed SPY by 4.66% annually during a solid bull market. If we round up the risk on the portfolio to being half of SPY, then we subtract (4.66% * 2) or 9.31% to find the risk free rate necessary to eliminate the entire alpha. The risk free rate that would have neutralized the alpha is 6.73%. I think it is reasonable to say that this portfolio performed very well on a risk adjusted basis relative to investors that were going 100% into SPY or another very similar broad ETF. Correlations A major reason for the strong performance is the correlation within the portfolio. The long term treasury ETF has only a slight positive correlation with the emerging market bond fund, but it is negative with everything else. Both SCHD and USMV have lower levels of volatility than SPY and PFF and EMB have reasonably low levels of annualized volatility combined with moderate correlations to the rest of the portfolio. Conclusion Over the last 4 years this ETF strategy has demonstrated very reasonable returns while being substantially more resilient to periods of weakness. In a prolonged bull market it will fall behind SPY, but on a risk adjusted basis it is still performing very well and if there was a major correction it would be in position to lose substantially less. In my opinion, this kind of strategy is the most reasonable way to incorporate a heavy allocation of PFF into a portfolio. Why would you want to build a portfolio with a heavy allocation to a preferred share ETF? I can think of one solid reason off the top of my head, a dividend yield over 6% at a time when interest rates in much of the economy fail to offer any compelling returns. Disclosure: I am/we are long SCHD. (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.

National Grid Offers Both Capital Appreciation And A Steady Stream Of Dividends

Summary Utility companies are usually in the spotlight whenever dividends are mentioned. National Grid is one of those rare companies that offers a steady dividend stream and a slice of capital appreciation for investors. With a footprint in the U.K. and U.S., this company has a very extensive network of transmission wires and gas pipelines. The company’s financial position definitely warrants a consideration for investors who are in search of both security and income. This hidden gem has been missed out by the majority of the market. Investors who come on board today stand to profit greatly. Introduction With what is happening lately in the market, it is very easy to get distracted by all the noise that is surrounding the business world and lose track of the great businesses that are serving people. As I combed the market for bargains, I picked up on one that will not only offer investors a good return on its capital appreciation but also delivers a steady and growing dividend. National Grid (NYSE: NGG ) is just that kind of a company. This is a business that has a solid balance sheet and is delivering a steady stream of cash flow to investors. Business Overview National Grid owns electric transmission wires and gas pipelines. Its stock offers a better risk to return proposition for the long-term investor. Most investors in today’s market would prefer a stock that dishes out a 5% dividend, brings about a moderate amount of risk and the chance to profit on capital appreciation as uncertainty plagues the global market. The company’s competitive advantage lies largely in its extensive network of transmission wires in the U.K. and Northern U.S. Although this business sounds like a typical utility company, there is more than meets the eye for investors as the company starts to dig deeper into what it owns and how it operates. Transmission and Distribution National Grid functions coordinates and enables the flow of electricity in both England and Wales but not in the U.S. Consumers simply pay a fee to the company in order to have the rights to use the system. This revenue structure enables National Grid’s income to be not only very stable but also predictable. Although it does not possess the toll-like characteristics in the U.S., the company has some very valuable assets and serves nearly 4 million customers. Transmission grids are often linked to one another so that electricity can flow from one state to another. Right now, the company is planning on expanding its network into Iceland, Belgium and other parts of Europe as well. As the assets of the company grow, it will be able to fetch more revenue which will allow it to expand even more, and the positive cycle repeats itself. In the U.K., National Grid owns and operates the National Transmission System, which is a gas infrastructure. The company has a distribution network that serves at least 11 million customers, along with a collection of liquefied natural gas importation terminal and storage facilities. Despite being known by many as a utility company that generates power (with the exception from the power plants in New York), National Grid earns a buck whenever power is being transmitted through the lines it owns. This toll-like business model should give investors seeking a predictable return some comfort and certainty as the majority of risk is now shifted to the power producers. What investors need to keep in mind is that much of its transmission grids are wearing out and it is almost time for the company to reinvest and repair its infrastructure. Knowing that this would be a very capital-intensive project, the company charges a high price to consumers so as to generate sufficient revenue to finance new projects and repair old ones. Most of National Grid’s revenue is fixed and dependent on the amount of assets we are looking at here. As the business and its infrastructure grows, so will the predictable stream of income. As the energy arena keeps progressing, changes are blind to happen. The U.K. has determined that utilities would need at least $300 billion in order to keep up with that change. The company has laid out an 8-year plan to invest in its assets and currently, it is in the second year of that plan. As a result of this, the company is expecting that its regulated assets will grow by approximately 5% to 6% in the U.K. over the next few years. I think that the company has made a wise move in investing in its U.K. assets as it churns the lion’s share of its operating income. In the U.S., the company is upgrading its gas and electricity systems and that will ensure that it will keep turning a steady stream of profit in the long run. Financial Position If one were to look at the balance sheet of any utility company, he or she would realize that it is more or less the same in terms of the amount of debt it has and the margins it generates. Over the coming years, I would not expect to see a drastic change in finances for the company. With expansion plans on the line, the company should be able to grow steadily at a low single-digit pace. Lastly, the dividend would likely hold steady and shareholders can sleep well at night as the company will continue to dish out dividends with a 5% yield. Potential Short Circuit In a utility business, there are two key factors investors need to keep an eye on to know whether or not the company is able to scale: demographic growth and regulation. In terms of demographic growth, it isn’t very robust in either U.S. or the U.K. On the regulatory aspect, the relationship between National Grid and regulators isn’t a bad one. However, if the relationship sours, investors might have a reason to worry. For now, investors can remain comfortable as the business is financially strong and that it can withstand the market’s volatility. Over the long run, I do not foresee people using lesser electricity. Even if solar power was to come into play, it would still require the grid and transmission lines (to a certain extend) to run on. I believe the company has ample time to adjust to the changing market and temporary hiccups should not cause a knee-jerk reaction for long-term investors. Conclusion In a market where interest rates are almost negligent, most investors would be thrilled to find a company that yields a 5% dividend while offering a chance for capital appreciation at the current price. I would recommend investors take a close look at National Grid and see how it can charge up your portfolio. Disclosure: I am/we are long NGG. (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.

Price And Return Study On Class I Railroads

Summary In our ongoing efforts to point out the value of buying the least expensive stock, we have reviewed the price performance of the Class I railroads over fifteen years. We found that the most expensive stock outperforms about 50% of the time. The more relevant finding, though, is the powerful relative performance of the “cheap group” versus the “expensive group.” We offer this (non-scientific) study as the basis for discussion. We thought we’d take a break from talking about operating yields, the value of avoiding optimism and the fact that most expensive stocks disappoint over time to talk about the value of cheap investing as it relates to railroad investing. Although this short study was in the aid of our railroad obsession, we believe the findings are relevant to many sectors and stocks. We decided to review the price performance of the six Class I railroads for which we have data available for the period 2000-2014. We looked at which company was the least and most expensive on a PE basis at the beginning of each year from 2000 to 2014 inclusive. We then calculated the subsequent yearly returns for the cheapest and the most expensive railroads. The results are interesting (to us, anyway….we know…get a hobby). Results We found that “buying expensive” in some sense beat “buying cheap.” Specifically, buying the most expensive railroad at the beginning of the year was as likely as not to generate higher returns than the cheapest railroad over that year. Before concluding that there’s no value in buying cheap, though, consider that the mean return for cheap was much greater than buying expensive. Over the past fifteen years, on average, buying the cheapest railroad has produced a return of 23.56%, while the return for buying the most expensive railroad generated only an 18.25% return on average. We include the raw data at the end of this document. Source: Gurufocus Although buying expensive may beat buying cheap in any given year, over time, buying cheap has crushed the returns of the positive railroads. In our view, there was less risk associated with these cheaper stock returns also. We acknowledge that this is not a scientifically sound study. We will expand the study to include total returns from dividends. In future, we’ll review the tax consequences of this approach relative to a buy and hold approach. We will compare these returns to a benchmark (perhaps the transportation index). Before that, though, we believe that something need not be scientifically robust to be true. Although we’ll refine the work, this is sufficient evidence that buying cheaper railroads produces higher returns at lower risk than the alternative. Conclusion Although this short study looked only at the Class I railroads, we believe there’s a wider lesson here. Although expensively priced stocks may outperform in a given year, they will perform less well over time. Given that they’re coming from a much less expensive base, cheaper stocks almost inevitably outperform over time. (click to enlarge) Source: Gurufocus 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.