Tag Archives: alternative

SGVIX: A Bond Mutual Fund For People With Few Options

Summary SGVIX has underperformed alternative options with lower expense ratios. Some employees that have their employer-sponsored accounts through fidelity may find SGVIX is the only government bond option available under tier 1 or tier 2. SGVIX has not done as poorly as I would expect based on the difference in expense ratios, but it still falls short compared to either intermediate treasuries or MBS. Fidelity does have good treasury mutual funds, like FLBAX, but employees are at the mercy of their retirement plans. The Wells Fargo Advantage Government Securities Fund (MUTF: SGVIX ) is one of the new tier two options for some employees that have their employer-based retirement accounts going through Fidelity. This is an area of interest for me because my wife recently received some literature on the new tiered options for her account. Since I handle my wife’s retirement accounts, she dropped the documents on my desk. That puts me in the unfortunate position of having to choose from a severely limited lineup of funds. The best mutual funds by fidelity have been removed from the options and investors that fail to either deal with more headache by creating a brokerage-link account or select new options will find themselves automatically defaulted to a target date plan based on their projected retirement age. There is nothing fundamentally wrong with target date plans. However, investors are stuck with being clumped together by age regardless of risk tolerance. If you are experiencing this kind of change to your retirement plan, you may notice some major problems with the literature sent out. For instance, in 19 pages there were precisely 0 actual expense ratios mentioned. If you happen to be given the same options that were available for my wife, this is the only government bond fund included in the tier 2 options. If investors want to assign an allocation specifically to government bonds, this is the only choice. Why You May Want Government Bonds Mid to long duration government bonds show a strong negative correlation with the stock market which makes them a great tool for diversifying portfolio risk. When an investor takes a small position in the long term government bonds they can immediately and materially reduce the total volatility of their portfolio because the bonds will often move up when the market moves down and move down when the market moves up. This is great for investors that would like to see a lower level of total risk and it makes government bonds a desirable asset class even though their interest rates are currently very low. For comparison sake, I ran a comparison including a couple of ETFs. I’m using the Schwab Intermediate-Term U.S. Treasury ETF (NYSEARCA: SCHR ) and the Vanguard Mortgage-Backed Securities Index ETF (NASDAQ: VMBS ). Hypothetical Portfolio I ran a quick hypothetical portfolio over the last 5 years and one month of data. Theoretically, the only reason you would own SGVIX is because it is the only option available, but for comparison sake I’m putting it in a very simple portfolio. (click to enlarge) You’ll see immediately that SCHR is offering a beta that is further into the negative territory which indicates that it will do better at offsetting the risk from a portfolio that is heavy on domestic equity. On the other hand you’ll see a lower beta for VMBS as investors may be less prone to buy into MBS when they are fearful of negative moves in the market. As a result, the negative beta is fairly low. The interesting thing about this sample period is that the total return on SCHR and the total return on VMBS are both superior to the total return on SGVIX. Correlation The chart below shows the correlation of each ETF or mutual fund with each other. 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. You can see immediately that SGVIX has a higher correlation with SCHR than with VMBS and that makes sense since the portfolio in SGVIX better resembles SCHR than VMBS. The Holdings The chart below shows the holdings: (click to enlarge) As you can see, there is a mix of treasury securities and mortgage related securities. Due to that mix, I felt it was most appropriate to compare SGVIX with both a treasury ETF and a MBS ETF. Maturity The following chart shows the distribution of maturities in the portfolio. One major weakness here is that the portfolio is so heavily focused on the short term that it is incapable of providing a higher negative beta. The other issue is that such a strong short term focus results in weaker levels of income because the yield curve is currently providing materially higher interest by the time we look 3 to 7 years out than when we are looking at maturities under 2 years. Expense Ratio The biggest problem here, a reason that I expect SGVIX to consistently underperform similar investments is that the mutual fund carries a hefty net expense ratio of .49%. It is also showing a remarkable portfolio turnover rate of 349%. Despite heavy trading, it just can’t keep up with funds like SCHR which has an expense ratio of .09% or VMBS which has an expense ratio of .12%. Since the expense ratio is about .4% higher and the time period is about five years, I would estimate that it should underperform by about 2% during that time span. In that sense, the fund has done very well since it only underperformed VMBS by .4% and SCHR by .8%. The managers are creating value through intelligent security selections, but it is has not been enough value to pay for the higher costs. Conclusion Despite solid management, the expense ratio on SGVIX puts it in a constant uphill battle to try to stay even with lower expense options. Unfortunately, some investors may find their investing options severely restricted. The portfolio is designed reasonably well, but investors aiming to reduce portfolio risk as rapidly as possible would benefit more from using longer duration treasury ETFs to gain their diversification benefits with a smaller allocation. The only rationale I see for restricting investor’s choices is to push them into funds with substantially higher expense ratios. As I have been going over several of the funds, I’ve found the best options that were previously available have been entirely removed. It isn’t like Fidelity has no low cost long duration treasury funds. The Spartan® Long-Term Treasury Bond Index Fund – Fidelity Advantage Class (MUTF: FLBAX ) would have been a solid option and has an expense ratio of only .1%. For investors that have that fund as an option in their retirement account, I would take it in a heartbeat over SGVIX. FLBAX is far more volatile than SGVIX, but a beta of negative .47 means a fairly small allocation in the portfolio would be enough to counteract the positive betas from a portfolio that is heavily invested in the S&P 500 or a broad market index. 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.

EQT Corporation: Deep Utica Update

Summary EQT released early production results for its Deep Utica test. Early-time performance looks encouraging. On the other hand, the performance by Range Resources’ deep Utica well may be sub-economic. In its latest presentation, EQT Corporation (NYSE: EQT ) provided an update with regard to its deep Utica test in Southwestern Pennsylvania. As a reminder, in July, EQT reported results of its highly anticipated Scotts Run well in the dry gas window of the Utica/Point Pleasant play in Green County in Southwestern Pennsylvania. The well is one of the deepest exploratory wells in the Utica drilled to date and is located almost 2,000 feet downdip from the previous frontier well. Due to the considerable depth and very high reservoir pressure, the well was challenging to drill and took more than half a year from spud to completion. However, EQT’s effort was ultimately rewarded. The entire ~3,200-foot lateral length was successfully completed. The well tested with a 24-hour rate of 72.9 MMcf/d with ~8,600 psi flowing casing pressure. This represents the highest initial flow rate for any shale well brought on production in the U.S. to date. Performance Update Based on the slide presentation posted by EQT yesterday, the well has produced at a pressure-managed rate of ~30 MMcf/d. Judging by the plot, pressure drawdown appears to have stabilized at ~40-50 Psi/day rate. If this rate is sustained, the initial production plateau may last for approximately six months from the beginning of production, resulting in cumulative production during the plateau period of ~5-6 Bcf. (click to enlarge) (Source: EQT Corporation, September 2015) I must emphasize that the well is a short lateral, which results in even more impressive cumulative production metrics per foot. (click to enlarge) (Source: EQT Corporation, September 2015) Normalizing production to a 5,400-foot lateral length, cumulative production during the initial six-month plateau for a medium-length lateral could be as high as 8.5-10.3 Bcf. It is obviously premature to guess about the play’s type curve and EUR at this point, as the shape of tail production in this deep and highly overpressured formation is an uncharted territory. However, it is clear already now that the test is a success and demonstrates the deep Utica’s potential for “big” wells. Whether “big” means 15 Bcf or 30 Bcf is too early to tell, in my opinion. Of note, Range Resources’ (NYSE: RRC ) Claysville Sportsman Club #11H well, another high profile deep Utica test that came online in November 2014 and had 5,420′ of completed lateral (32 stages with 400,000 pounds of sand per stage) produced “only” 1.4 Bcf in the first 88 days. Given that Range did not include an update slide with the Sportsman production profile in its most recent presentation, the well is likely producing substantially below expectation. I would not rush to interpret the Sportsman well result as an indication of Deep Utica’s poor productivity (the Sportsman’s initial rate was 59 MMcf/d), as several other data points, including Rice Energy (NYSE: RICE ) wells in Belmont County, Ohio, which are located updip, and EQT’s Scotts Run well, which is located downdip, all appear to be holding up well, at least so far. Well Cost And Well Economics EQT encountered significant challenges when drilling the well. Due to the extreme reservoir pressures encountered, the company had to replace its drilling rig with a higher-specification unit, which resulted in a delay. As a result, the well’s cost came out at ~$30 million. However, the fact that the very first well could be completed, with the planned proppant volume loaded successfully, gives hope that technical challenges are not unsurmountable. Going forward, EQT believes it can reduce its well cost in the Deep Utica to as little as $12.5 million for 5,400-foot laterals. The high cost sets the bar for well performance quite high. Assuming a $12.5 completed well cost, the Deep Utica play would need to yield EURs in the 25-30 Bcf per well range to be economically competitive versus the existing “core of the core” sweet spots in the Marcellus, where operators currently drill wells with EURs in the ~15+ Bcf range for ~$6-$7 million per well. In the immediate term, the well’s success is unlikely to materially change operational outlook for EQT (or any of its peers, for that matter). EQT is hoping to have a total of two-three wells on production by early next year and will plan further steps based on the performance results. EQT believes that it has ~400,000 net acres prospective for dry gas Utica, including ~50,000 net acres that look geologically “identical” to the Scotts Run well. Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment, tax, legal or any other advisory capacity. This is not an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice. The author explicitly disclaims any liability that may arise from the use of this material. 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.

SCZ: Do You Need Some International Small-Cap Companies For Your Portfolio?

Summary SCZ has over 1500 holdings across the globe which appear to give it great internal diversification. The term “across the globe” might be overly optimistic since over 50% of the holdings are in two locations. The weakness for SCZ is that SCHC and VSS both offer materially lower expense ratios and more holdings for enhanced diversification. Since SCZ has a beta higher than 1, it has to be expected to generate fairly substantial returns. On top of the high beta raising required returns, SCZ also needs to be able to beat out SCHC and VSS to justify the high expense ratio. One of the funds I analyzed for exposure to international markets is the iShares MSCI EAFE Small-Cap ETF (NYSEARCA: SCZ ). 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. By reducing risk at the portfolio level investors can get their best shot at producing alpha. Expense Ratio The expense ratio for SCZ is .40% for both gross and net expense ratio. That may not seem bad for international small-cap equity and an ETF with 1555 holdings. However, investors should be aware that they also have options in the Schwab International Small-Cap Equity ETF (NYSEARCA: SCHC ) and the Vanguard FTSE All-World ex-US Small-Cap ETF (NYSEARCA: VSS ). SCHC has an expense ratio of .18% and 1645 holdings. VSS has an expense ratio of .19% and 3352 holdings. It should be no surprise that I see SCHC and VSS as the strong front runners for this kind of portfolio exposure. In the interest of full disclosure, while I don’t have a position in any of these ETFs yet, I do have a pending limit-buy order on SCHC. That order is quite a ways under the current share prices and is only intended to activate if share prices start falling hard again. Geography The geography of the exposure is important in considering international equity options. The chart below demonstrates the exposure for SCZ. Japan and the United Kingdom only represent over 50% of the market capitalization of the holdings in SCZ. I’d like to see more exposure around the globe. This is international and I’m okay with excluding China since I’ve been bearish on their market for months, but I’d like to see a few more continents included. Aside from the concentration being so heavily focused on the top two options, I don’t see any other problems there. Sector Exposures The following chart has the sector exposures within the ETF: I’m not seeing this as a huge problem, but it seems interesting that the exposure is so heavily focused on a few categories again. If it were reasonably possible, I’d like to see better diversification across the industries as well as across the globe. International ETFs are usually plagued by having fairly high levels of volatility and more diversification within the sectors might reduce that volatility some. On the other hand, when financial markets exhibit significant stress factors, it is common for correlation levels to increase throughout international markets so even more diversification in the holdings might not make a material difference in the volatility. Building the Portfolio This hypothetical portfolio has a moderately aggressive allocation for the middle aged investor. Only 30% of the total portfolio value is placed in bonds and a third of that bond allocation is given to high yield bonds. This portfolio is probably taking on more risk than would be appropriate for many retiring investors since the volatility on equity can be so high. 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 REITs on the assumption that the hypothetical portfolio is not going to be tax exempt. Hopefully investors will be keeping at least a material portion of their investment portfolio in tax advantaged accounts. 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. (click to enlarge) A quick rundown of the portfolio The two bond funds in the portfolio are the PIMCO 0-5 Year High Yield Corporate Bond Index ETF (NYSEARCA: HYS ) for high yield shorter term debt and the iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) for longer term treasury debt. TLT should be useful for the highly negative correlation it provides relative to the equity positions. HYS on the other hand is attempting to produce more current income with less duration risk by taking on some credit risk. The Consumer Staples Select Sector SPDR ETF (NYSEARCA: XLP ) is used to make the portfolio overweight on consumer staples with a goal of providing more stability to the equity portion of the portfolio. The iShares U.S. Utilities ETF (NYSEARCA: IDU ) is used to create a significant 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. The core of the portfolio comes from simple exposure to the S&P 500 via the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ), though I would suggest that investors creating a new portfolio and not tied into an ETF for that large domestic position should consider the alternative by Vanguard’s Vanguard S&P 500 ETF (NYSEARCA: VOO ) which offers similar holdings and a lower expense ratio. I have yet to see any good argument for not using or another very similar fund as the core of a portfolio. In this piece I’m using SPY because some investors with a very long history of selling SPY may not want to trigger the capital gains tax on selling the position and thus choose to continue holding SPY rather than the alternatives with lower expense ratios. 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 and with the S&P 500 . 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. Conclusion SCZ is the most volatile investment in the portfolio when viewed in isolation as it has a volatility level of 18.7%. That problem is compounded by the high correlation between SCZ and the S&P 500. The combination leads SCZ to having a beta of 1.06% which is unfavorable. Under modern portfolio theory the only way to get risk adjusted returns on SCZ is for it to be outperforming the S&P 500 over the long run since it is increasing portfolio volatility. Will it outperform the S&P 500? I have no idea. The better question would probably be: “Will it outperform SCHC and VSS?” In that regard, I’m skeptical. It certainly could happen but SCHC and VSS have an advantage from having materially lower expense ratios which allow more of the returns to reach shareholders. 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.