Tag Archives: alternative

What Can Russia Offer To Your Portfolio?

Summary RSX is down over 50% since the beginning of 2011, suggesting attractive expected returns. Russian equities offer diversification benefit to U.S. investors. However, high volatility of such an investment means that the actual portfolio risk contribution will be 2.5-3 times higher than its portfolio weight. I was recently browsing Research Affiliates Asset Allocation website and one chart that drew my attention was the forecast real 10-year expected return. As can be seen from the histogram below, projected returns by Research Affiliates models for various countries and regions differ widely with Russia comfortably offering the highest expected reward: (click to enlarge) This prompted me to explore how a modest allocation to Russian equities affects a typical portfolio held by a U.S. investor. For the purpose of this article, I use the 60/40 portfolio as a proxy for a “standard” allocation (even though I still think it is flawed ), with the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) representing equities and the Vanguard Total Bond Market ETF (NYSEARCA: BND ) – fixed income. While ETFdb lists 6 Russian equity ETFs available in the U.S., the Market Vectors Russia ETF (NYSEARCA: RSX ) is the obvious choice given that its $2 billion of assets under management is almost 4 times more than the remaining funds have combined. Portfolio impact To start with, assume that we allocate 5% of the equities portion in the 60/40 portfolio to RSX. Analyzing 5 years of historical data, risk parameters of such a portfolio look as follows: (click to enlarge) Source: InvestSpy Retrospectively, such an investment would have been a real drag in a portfolio that otherwise had a stellar performance. RSX has lost 45% of its value over the last 5 years and experienced a whopping 65% drawdown. Furthermore, its annualized volatility stood at 34%, which was more than twice that of SPY. This lead to a significant risk contribution of 14% to the overall portfolio risk despite the allocation of only 5%. On the bright side, further inspection of the correlation matrix suggests that RSX has the potential to offer diversification benefits. Its correlations were 0.67 with SPY and negative 0.21 with BND (see the table below). In fact, the correlation coefficient with SPY was even lower at 0.47 over the last 12 months. Source: InvestSpy As demonstrated in this whitepaper by Salient Partners, a diversifier with high volatility is among the most powerful tools an investors has. And RSX definitely ticks the high volatility box. At the same time, it is highly unlikely that a U.S. investor would want to have 10%+ of their portfolio risk come from Russia. An investment in any Russian ETF will have 2.5-3 times higher risk contribution than its portfolio weight, thus I would not suggest a higher allocation than 2-3% of your portfolio to RSX or a related fund. One also has to bear in mind that Russian stocks will typically be included in most emerging markets ETFs and mutual funds, thus you may already have some exposure to this country. Under the hood Comparing the sector breakdown of RSX and SPY, it becomes apparent that Russian and American markets have completely different composition: RSX is largely dominated by the energy sector (43%), whilst oil & gas stocks account for only 7% of S&P 500. RSX is also heavily loaded with Materials (19%) but lacks more significant presence of companies operating in IT, health care, consumer discretionary or industrials sectors. Given that Russian stock market is so dependent on the energy sector, I have also checked how correlated to the oil price it is. Using t he United States Oil ETF, LP (NYSEARCA: USO ) as a proxy for the oil market, it turns out that over the last 5 years RSX had correlation with USO of 0.53. Although this reading does not seem exceptionally high at a first glance, I have previously shown that a coefficient above 0.5 comfortably puts RSX among top 5 single country ETFs to benefit from oil price recovery. Conclusion Russian stocks have been in a downward spiral since 2011, currently offering attractive valuations compared with other countries. RSX regained 10% in the last month and is a primary target to benefit from a potential reversal in the oil market. If the actual performance of Russian equities comes anywhere close to the returns forecast by Research Affiliates, RSX may very well be a welcome addition to your portfolio.

DEM: Emerging Market Equities With A 4.98% Yield Are Worthy Of A Closer Look

Summary The individual company allocations won’t be familiar, but the sector allocations and country allocations can be analyzed well. The expense ratio is simply too high for my taste. The sector allocation looks fairly aggressive, but I do like the idea of getting telecommunications exposure through an emerging market ETF rather than emphasizing it in domestic equity. Allocations to Brazil and South Africa are offering investors the opportunity to incorporate exposure to South America and Africa into their portfolio. The WisdomTree Emerging Markets Equity Income ETF (NYSEARCA: DEM ) offers great yields and appealing allocations to underrepresented countries and continents. The expense ratio is a pain, but the yield looks fairly nice. Expenses The expense ratio is .63%. This is certainly too high for my taste, and that is unfortunate, because there are some really nice things about this ETF. Dividend Yield The yield is currently running at 4.98%. For an income investor, this sounds like a beautiful way to get some of the emerging market exposure. Holdings I put grabbed the following chart to demonstrate the weight of the fund’s top 10 holdings: (click to enlarge) When looking at the emerging market company allocations, I don’t expect to be very familiar with the companies. Rather than focus heavily on the individual companies, I prefer to look into the sector breakdown and country allocations for the ETFs. Sectors (click to enlarge) The sector allocation here is fairly interesting. It feels like when I’m researching WisdomTree ETFs, I’ve simply come to expect high allocations to the financial sector. I’m not thrilled seeing it, but the positions are establishing a very significant amount of income for investors in this sector, and the weak income on equity investments in foreign markets can be a disincentive for retirees to grab enough foreign equity to optimize their portfolio for risk-adjusted returns. The thing I do like seeing here is the heavy allocation to the energy sector and telecommunications services. I’ve been bearish on domestic telecommunications because the market has become so competitive relative to previous years, but it is still developing in many countries. I like the idea of getting telecommunications exposure and emerging markets exposure at the same time, so that allocation is great. Investors should take note that this fund is fairly low on consumer staples and utilities, which tend to be more resilient to market weakness, so there is the potential of some fairly substantial price movements. If an investor is going to run with this kind of aggressive high yield portfolio, they should be ready to rebalance and raise allocations if the shares are falling as part of a bear market. Country The country allocations are another major area of importance for establishing proper diversification. (click to enlarge) I have to admit, this is a fairly interesting allocation. I’d be a bit concerned that the top countries receive such a heavy allocation, which would make me favor combining this ETF with another one or two to round out the international exposure. In those ETFs, I’d be looking for lower weights on the top three countries here to enhance the diversification. The nice thing is that I’m seeing substantial allocations to South Africa and Brazil, which provides this ETF with exposure to continents that are often marginalized or excluded from international ETFs. South America and Africa are the most common continents for being mysteriously left off of international funds, so I find this allocation fairly attractive for diversification. Conclusion The yield on this ETF is great, but the expense ratio is not. Since the companies represent emerging markets, they will generally be unknown to domestic investors, but the sector allocation and country allocation give us some perspective on how the ETF should be performing. The sector allocations feel fairly aggressive, and investors using this fund may want to control for that by being prepared to rebalance if the share prices take a hard hit. The country allocations are the high point of the portfolio. The countries represented in this portfolio, and the continents they are on, are often excluded or marginalized in other international funds. For this high yield, if the expense ratio was dropped down and the sector allocation was modified to be slightly more defensive, this fund would be very interesting. I should point out that the total returns on the fund left a great deal to be desired over the funds history, but the last 8 years have shown dramatically superior domestic performance than international performance, so investors should take the weak past performance with at least a few grains of salt.

DES: Strong Dividend Yields On This Small Capitalization Dividend ETF

Summary DES offers a dividend yield of 2.93%, which is a nice yield for a small capitalization ETF. The top holding has a heavy weight and offers a compelling yield of nearly 7% with an addictive product. The ETF has a mediocre expense ratio. I’d prefer to see a more defensive sector allocation to reduce the potential for losses during bearish market events. The WisdomTree SmallCap Dividend ETF (NYSEARCA: DES ) looks great. After readers suggested I take a look at the portfolio, I decided it was time to dive inside and see what I could find. This is a great ETF. Investors may quibble on whether the allocations are perfectly or merely good, but there is far more to like than to hold against the fund. Expenses The expense ratio is a .38%. I’d really prefer to see a lower expense ratio, but I find myself saying that often. When it comes to long run return projections, I have a hard time believing that gross returns on assets for ETFs with higher expense ratios will be high enough to cover that expense ratio while still providing superior returns to the market once adjusted for risk. Dividend Yield The dividend yield is currently running 2.93% according to Seeking Alpha’s numbers. I’m pretty happy with that for a dividend ETF. After accounting for this dividend ETF focusing on small capitalization companies, I’m even more impressed by that healthy dividend yield. This could be a viable option for income investors seeking a little small cap exposure in their portfolio while requiring their positions to pay a respectable dividend yield. Holdings I grabbed the following chart to demonstrate the weight of the top 10 holdings: (click to enlarge) The heaviest weighting by a substantial margin was given to the Vector Group (NYSE: VGR ). The stock has an incredibly high 6.9% dividend yield and Greg Vanderford highlighted the company as one of the most overlooked sin stocks . The company is in the cigarette business. While I’m not thrilled with the actions of tobacco companies, the dividend is very strong and their product benefits from being highly addictive. For the investor addicted to reliable income, this is an industry that simply makes great financial sense. Going a little further down the list we see SeaWorld Entertainment (NYSE: SEAS ) is another one of those sin stocks in my book. While “sin stocks” are usually used to refer to companies producing products like cigarettes and alcohol, I have to include SeaWorld in that category for their treatment of animals. Many investors may get past this, but this is a company that I’ve boycotted for a long time. The dividend yield is a strong 4.24%, but I don’t like the risk here. The potential for public backlash creates a significant risk to the business practice. This problem exists for tobacco companies as well, but SeaWorld doesn’t have the benefit of selling an addictive product. Sectors (click to enlarge) This is a very interesting sector allocation. Frequent readers know that I tend to love consumer staples as a way to reduce the risk in a portfolio, but I find those companies also tend to have respectable dividend yields. In a dividend ETF focused on small capitalization companies, the high yield was achieved while running a very different allocation strategy. Normally I think of dividend portfolios as being fairly defensive, but this is what I would consider an aggressive dividend portfolio. The industries, such as consumer discretionary, are generally expected to perform significantly better in a prolonged bull market and worse in a bear market. Despite being fairly aggressive, I have to appreciate that they incorporated utilities with a respectable weight. It may only be 11%, but many dividend ETFs underweight the utility sector. That is something the investor can deal with by grabbing a separate ETF with the utility exposure, but this one incorporated it which is nice for adding a little stability to a pat of the market that is generally going to be more volatile than the S&P 500. Volatility I ran a regression on DES and compared it with the S&P 500 since June of 2006. The annualized volatility on DES was materially higher at 27% compared to 21.1% for SPY and during the market crash shares had a max drawdown of 65.6% which is fairly massive. Since then the ETF has not been able to catch up with SPY which may largely be a function of how severe the losses were during the downturn. Conclusion DES offers investors a fairly substantial dividend yield on small capitalization investments. For the dividend focused investor, this is a viable way to get access to smaller capitalization companies, but it does have a very significant amount of volatility so investors would be wise to ensure that the position is used as part of a larger diversified portfolio. If I could change a few things, I would be lowering the expense ratio, kicking out SEAS, and increasing the allocation to more defensive sectors to reduce the potential for losses during a weak market.