Tag Archives: alternative

ITOT: A Solid Core Holding For Building An Efficient Portfolio

Summary This ETF has a low expense ratio and looks like a solid option for a core position. As a total market ETF there is very little opportunity to modify exposures. Due to the sector allocations I believe the fund is best utilized when combining it with a small position in more specialized ETFs to tailor the sector allocations. 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 researching is the iShares Core S&P Total U.S. Stock Market ETF (NYSEARCA: ITOT ). 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 for ITOT is only .07%. I tend to be very frugal with my expense ratios, so I like to see those low levels. There are a couple lower expense ratio ETFs in the categories of broad or total market, but .07% is still pretty good. Depending on where an investor does their brokerage, they may have incentives to use different ETFs to mitigate trading fees. Largest Holdings The following chart shows the largest holdings for the fund: These shouldn’t be a surprise since this is a total market ETF. The holdings across most total market ETFs will be very similar which gives investors a good reason to watch for high expense ratios, bid-ask spreads, and trading commissions to determine their long term costs. These allocations are subject to change, but I wouldn’t expect much in the way of change. Given the presence of such strong dividend champions at the top of the chart, investors might expect a strong dividend yield. Instead, they’ll find the yield is only around 2%. That’s no problem for most investors that would just reinvest their dividends anyway, but it may be less than optimal for investors in retirement seeking stronger yields to provide income without selling shares. Sectors The following chart breaks down the allocation by sector: The only sector I’ve been generally opposed to over the last several months has been telecommunications due to the aggressive price wars being waged. In this case the telecommunications allocation is just over 2.14%. In my view, that is a positive factor because 2.14% is a fairly low allocation for telecommunications among domestic equity ETFs. Using the holdings chart above, we can also determine that AT&T (NYSE: T ) and Verizon (NYSE: VZ ) combined to be about 1.92% of the portfolio, so most of the telecommunications allocation is right there. Energy Energy can be a fairly tricky sector because it can be referring to established champions like Exxon Mobil (NYSE: XOM ) or it can be referring to massively more aggressive plays such as off shore oil drilling. I like the fundamental premise of owning enormous producers of oil. If oil ever becomes irrelevant, it would be a very bullish sign for the rest of the economy pointing towards very low cost transportation and more capital available for spending on other goods and services. In order to hedge that risk, I want to see some of the established oil companies in the ETFs I use in my personal portfolios. I really wouldn’t mind seeing a higher allocation here so long as it was those established champions. They don’t have anywhere near as much upside as buying those drilling operations, but I am happy to sacrifice the upside to have dramatically reduced downside. Information Technology I know this is a growing part of our economy and it may continue to grow dramatically because information technology firms will generally have access to great economies of scale. I want some exposure to this part of the economy, but I wouldn’t mind seeing a slightly lower allocation because with great economies of scale comes the opportunity for earnings to get punished by a large drawdown in the economy or a black swan event. By definition, we won’t be able to predict black swans. However, I do believe we can estimate which industries have more exposure to those events. One Other Note There are 1509 holdings in this fund and it tracks the S&P Composite 1500 index. In my opinion a fund holding 1500 individual securities and tracking an index of 1500 securities is a broad market ETF, not a total market ETF. In my view any domestic ETF with fewer than 2000 holdings looks more like a broad market ETF than a total market ETF. Conclusion Overall this looks like a fairly good ETF. Since the ETF is going for a very low expense ratio and a passive style, there is not much to be done about adjusting the allocations. My preferred way to use an ETF like this would be to combine it with another more specialized ETF that placed a very high emphasis on my preferred sectors. When the investor combines the iShares Core S&P Total U.S. Stock Market ETF with another domestic equity fund they can look at the weighted average of the sector allocations which would be nice for building a very efficient portfolio.

YieldCo Index ETF: The YieldCo Model Breaks – It’s A Bigger Lesson Than You Think

YieldCos were supposed to do for utilities what LPs did for energy companies. The potential appeared huge, with increasing investment in renewable power. Only the model just broke, and Global X YieldCo Index ETF is the evidence. The postmortem here is more instructive than you may think. Investors appear to always be on the lookout for the next big thing that will make them rich. Wall Street, meanwhile, is always ready to sell investors something that appears to meet that desire. Only time and time again, the opportunity doesn’t pan out. YieldCos are the current asset melting down. The Global X YieldCo Index ETF (NASDAQ: YLCO ) is proof of it. What’s the bigger picture lesson? What’s a YieldCo? A YieldCo is basically a company created or spun off by another company with utility assets that it would like to sell, but not necessarily lose control of. The YieldCo raises capital in the markets by issuing shares and debt, and then buys the assets of its erstwhile parent. The assets usually come with long-term contracts, so the revenues are reasonably certain to materialize, and the parent normally has operational control. The allure for investors is a stated goal to pay out large, growing distribution streams backed by more acquisitions. If this sounds roughly similar to the model that pipeline owners have used in the limited partnership space for years, it should. That’s basically the building block on which YieldCos have been created. It sounds like a win for everyone involved. Only, there’s one small catch. Access to capital markets. Talk about timing Wall Street’s financial alchemists have a habit of pushing things too far. And YieldCos now appear to be falling into that category. The best example I can provide is YLCO, an ETF that came public in late May of this year. Its shares have fallen by nearly a third since that point. YLCO stands as a warning to investors to not get caught up in the hot new thing. That can be hard to do, I know. Hot new things always seem to come with really compelling stories about how they are a “can’t lose” investment. Which is why you should always ask yourself why something you are looking at could blow up on you. In the case of YLCO, the answer to that is pretty clear: the fund would tank if the YieldCo space in which it invests doesn’t hold the promise that Wall Street believes it does. However, that’s not a deep enough answer, and it would be too easy to glass over the issue and stop there. After all, YLCO is buying a basket of YieldCos, which reduces risk through diversification. That’s why you need to go further and ask: What would kill a YieldCo’s potential? And could that happen across the YieldCo space? We know the answer now Looking at these questions in reverse order, we know that the chances of a broad YieldCo meltdown was pretty high. But what was the problem on the individual company level? The answer is access to capital. For a company that pays out most of its revenues to investors via distributions, growth has to come from acquisitions. But acquisitions can only happen if the company can sell more debt and equity at decent prices. If investors aren’t willing to provide that capital at desirable rates, the YieldCo loses its ability to grow. That will likely lead to a stagnant distribution and even fewer reasons for investors to buy its shares. The parent company, meanwhile, is stuck with a child that isn’t nearly as desirable to have around. And more or less everybody winds up a loser. For evidence of this take a look at the current troubles of NRG Energy (NYSE: NRG ) and NRG Yield (NYSE: NYLD ). NRG Yield makes up around 7.5% of YLCO, by the way. Commenting on NRG Yield, credit watcher Moody’s is taking a dim view of the future. Moody’s vice president Toby Shea noted, “The review for downgrade is prompted by NYLD’s lack of access to the equity markets due to the large, approximate 30 percent fall in its stock price in recent months. The ongoing inability to access the equity market creates uncertainty regarding the company’s financial strategy going forward.” Basically, the model is broken. Don’t stop there But what are the real takeaways? First, Wall Street’s hot new products are often better for Wall Street than main street and shareholders. I don’t want to be cynical, but this is as true today as it has always been in the past. And I find it hard to believe the future will be any different. It’s difficult, but try to keep this in mind whenever you see something new offered up as the next big thing. Second, YieldCos are probably not worth owning right now. And clearly, neither is YLCO. The risks far outweigh the rewards for all but the most aggressive investors. Third – and this is the one you really need to think about – what about other companies that have business models built on accessing the capital markets for growth? Limited partnerships are the most salient example, since they are facing their own demons right now. But they aren’t the only ones. For example, Student Transportation Inc. (NASDAQ: STB ) is rolling up the school bus space. But if it couldn’t access capital markets, its growth prospects would quickly fade. Then there are real estate investment trusts, or REITs. As a whole, I wouldn’t be too concerned about REITs. But not all REITs are created equal. I doubt that an industry leader like AvalonBay Communities (NYSE: AVB ) will be completely shut out of the capital markets. But what about apartment competitor NexPoint Residential Trust (NYSE: NXRT ), which is a relatively new entrant buying up second-tier assets with the intent of sprucing them up? It’s already leaning hard on the debt markets, if it can’t do that anymore, what does it do for growth capital? These two companies obviously sit at opposite ends of the spectrum, but there are variations all along the way. It’s worth taking a moment to ask the question for both new companies like NXRT, and also more established names – just in case. Stapled Shares One of the reasons why I brought up Student Transportation is because it came to market in a very different form. At the IPO, it was a stapled share, essentially pairing a share of stock with a piece of debt. The distribution was a combination of dividend and bond interest. It was a hot Wall Street idea not too long ago, meant to sate investors’ desire for income. Only, it didn’t work out as planned. And now most, if not all, of the handful of companies that came out as stapled shares have either gone away or converted their shares to plain old regular stock. The end result was usually a dividend cut for shareholders on top of capital losses. I watched stapled shares come and go. I owned a few. I got burned. It’s one of the reasons why I’ve been sitting on the sidelines with YieldCos. And why I’m watching single family home REITs with extreme interest, but I’m not buying any. Too new, too much of a fad, and the model could break down. It’s better to give Wall Street’s big ideas time to prove themselves. You certainly could miss out on gains, but you’ll also protect yourself from ideas that end up enriching Wall Street at your expense. YLCO is a symptom of a bigger issue, but it offers up an important lesson. Could YieldCos work out in the long run? Sure. Could YLCO turn out to be a great income opportunity in the ETF space? Yes. But for anyone who bought into the YieldCo story early, things aren’t working out quite as planned right now and there’s real potential that the idea is fatally flawed. It’s hard to resist the temptations of Wall Street, but when it comes to new things (corporate forms, IPOs, new products like esoteric ETFs) you are far better off stepping back and waiting. At the very least, take the time to consider what happens if the rosy projections offered up don’t pan out. In other words, always look for a reason why you shouldn’t buy something as you are reveling in the reasons why you want to.

The SPDR Global Allocation ETF: A Comprehensive Fund Of Funds

Although it seems simple at first glance, it is a complex and comprehensive fund of funds. Generally, the fund is extremely well diversified with both domestic and international assets. An ideal fund which requires a minimum attention for investors with a long term view. Quite often investors shy away from a ‘fund of funds’. True, some individual investors have the experience, skill, knowledge and time to filter through and analyze the multitude of funds available. However, for those investors who are just starting out, whose time is consumed by careers and family, a ‘fund of funds’ might be the ideal solution for a foundational investment. These generalized investment vehicles require little attention during those ‘busy years’ and an automatic, disciplined investment routine can be set up with most retail/online brokers. There are plenty of ETFs to choose from, no doubt. The State Street Global Advisors’ Global Allocation ETF (NYSEARCA: GAL ), from State Street Corporation’s (NYSE: STT ) SPDR portfolio of ETFs, is one of the better performing funds in this asset class. The fund is relatively new, having launched in April of 2012 with a 5.38% return since then. However, over the past year the fund has return -2.59% and year to date, -4.60% . So is this an opportunity to buy a good fund at a low price? In order to make that determination, a closer inspection of the fund is necessary. The first important question the investor needs to ask is whether the fund is appropriate in terms of risk and time horizon. According to State Street, the fund “… seeks to provide capital appreciation …” In other words, the fund is more focused on the market ETF gains than only dividend returns or combined ‘total returns’. Next: …The Fund invests in exchange traded funds… …that seek to track the performance of a market index; exchange traded commodity trusts; and exchange traded notes … Another important factor is that the fund tracks the respective fund’s underlying index. Usually, when a fund of funds is actively managed, it indicates a high expense ratio: that means the annual percentage of assets the management charges shareholders for their efforts. This fund’s management fees are 0.35%, well below the industry average of 0.44%. The next important factor is the way the fund allocates its invested capital. Data from State Street Global The heaviest weighted allocation is in International Equities, followed by Fixed Income, Cash, U.S. Equities, High Yield Funds, U.S. REITs, U.S. Treasury “Inflation Protected Securities”, called TIPS, and lastly International REITS. Although a ‘fund of funds’ might seem simple enough, they can be quite complex. It seems that the best way to dig a little deeper into the fund is by asset sector: Equity, Fixed Income, High Yield and REITs. Interestingly, GAL is not comprised of exclusively State Street Global funds but also includes two WisdomTree (NASDAQ: WETF ) Hedged Equity Funds and SPDR-Barclays and SPDR-Dow Jones assets. Equity Funds Symbol GAL Weighting Type Gross Expense Ratio Return Since Inception Premium/ Discount Number of Holdings Trailing 12 Month Yield SPDR S&P World ex-US ETF GWL 14.42% International Equity 0.34% -0.53% 4/20/2007 Premium 0.90% 1406 2.78% WisdomTree Europe Hedged Equity ETF HEDJ 9.16% Europe Equity USD Hedged 0.58% 6.14% 12/31/2009 Premium 0.54% 129 0.21% WisdomTree Japan Hedged Equity ETF DXJ 8.67% Japan Equity USD Hedged 0.48% 2.27% 6/16/2006 Premium 1.68% 313 3.16% SPDR S&P 500 Trust ETF SPY 6.04% S&P 500 0.1098% with waiver 8.75% 1/22/1993 Premium 0.01% 507 2.01% SPDR S&P International Small Cap ETF GWX 3.03% International Equity Small cap 0.40% 0.58% 4/20/2007 Premium 1.06% 2238 1.07% Consumer Discretionary Select Sector SPDR ETF XLY 2.02 S&P US Consumer Cyclical 0.14% 8.05% 12/16/1998 0.00% 88 1.37% Industrial Select Sector SPDR ETF XLI 2.02% S&P 500 Industrials 0.14% 6.07% Premium 0.03% 66 2.08% Health Care Select Sect SPDR ETF XLV 1.97% S&P 500 HealthCare 0.14% 7.69% 12/16/1998 0.00% 57 1.46% Data From SPDR and WisdomTree Each of the international funds has diverse global allocations; the only ‘straight-forward’ one is the WisdomTree DXJ which is 100% Japan. The bar chart below summarizes the total national allocations of the international equity funds. (click to enlarge) Data From WisdomTree and SPDR Similarly, each of these international Equity Funds allocates capital differently among economic sectors as summarized in the chart below. (click to enlarge) Hence, what initially seemed like a simple fund of funds has so far proven itself to have an extraordinary amount of complexity. The international funds have over 4000 holdings in total, with capital distributed over 25 countries. It’s worth noting here that the average expense ratio of the international funds alone is 0.45% which is about the average ETF industry expense ratio. The average yield of the international funds is 1.805%. The US Equity based funds are not as straight forward as they seem, either. SPY is essentially the comprehensive and widely followed S&P 500 index [SPX]. However, GAL includes three SPDR select sector funds . Briefly, Select Sector SPDRs : …divide the S&P 500 into eleven index funds… …with the objective of matching the price and yield performance of their underlying sector indexes.. . The important factor here is the sector allocations. It’s important because each sector is already a component of the S&P 500 Trust! So the effect of the three SPDR Select Sector Funds along with SPY creates a ‘multiplier’ of the three included sectors: Consumer Discretionary , Industrials and Health Care . As it is SPY is allocated as in the chart below: Data From SPDR To see this visually, the pie chart slices in bright green are already sectors in the SPY fund and also separate SPDR Select Sector holdings XLV, XLY and XLI, (noted by the red lettering). The point being is that a change in one sector affects all four holdings, not by much, but pointing this out helps the investor understand the structure of a fund of funds. In this case, Health Care is a ‘defensive sector, while Consumer Discretionary and Industrials are more biased towards ‘capital appreciation’ which is the fund’s stated objective! Before going on to fixed income, a few definitions are necessary. From Investopedia, investment grade is: … A rating that indicates that a municipal or corporate bond has a relatively low risk of default. Bond Rating firms such as Standard & Poor’s, use different designations consisting of upper- and lower-case letters ‘A’ and ‘B’ to identify a bond’s credit quality rating ‘AAA’ and ‘AA’ (high credit quality) and ‘A’ and ‘BBB’ (medium credit quality) are considered investment grade. Credit Ratings for bonds below these designations (‘BB’, ‘B’, ‘CCC’, etc.) are considered low credit quality … Fixed Income Symbol GAL Weighting Type Gross Expense Ratio Return Since Inception Premium/ Discount Number of Holdings Average Yield ETF Hub 3 Year Return Position SPDR Barclays Capital High Yield Bond ETF JNK 9.91% 40% BB Grade, 40% B Grade 13.87% C 0.40% 5.07% 11/28/2007 Premium 0.27% 783 7.03% 12th of 109 Corporate High Yield SPDR Barclays Long Term Treasury ETF TLO 7.03% Avg 25 Years to Maturity UST 0.10% 7.97% 5/23/2007 Premium 0.06% 45 3.22% 10th of 18 US Long Term Treasuries SPDR Barclays Capital Long Term Corporate Bond ETF LWC 6.03% 5% Aa Grade 42% A Grade 49% Baa Grade 0.12% 9.59% 3/10/2009 Premium 0.58% 1768 5.10% 2nd of 3 long Duration Corporates SPDR Barclays Capital TIPS ETF IPE 3.94% Avg 9.18 Years to Maturity TIPs 0.15% 4.40% 5/25/2007 Premium 0.09% 36 0.86% 12th of 13 US Treasury TIPS SPDR Barclays Aggregate Bond ETF LAG 2.98% Mix of UST, MBS, ABS, CMBS, Corporates 0.10% 4.79 5/23/2007 Premium 0.22% 2438 2.83% 81st of 295 Fixed Income SPDR Barclays Capital Intermediate Term Corporate Bond ETF ITR 1.01% 8% Aa Grade 45% A Grade 45% Baa 0.12% 5.44% 2/10/2009 Premium 0.23% 2882 3.71% 2nd of 4 Intermediate Corporates SPDR Barclays Intermediate Term Treasury ETF ITE 0.99% Avg 4.02 Years to Maturity UST 0.10% 3.92% 5/23/2007 0.00% 207 1.78% 10th of 19 Intermediate US Treasuries Data From SPDR The fixed income funds comprise US Treasuries: long term, intermediate term and ‘inflation protected’ bonds; a ‘high yield’ fund consisting mostly of the lowest rated investment grade bonds; Long and Intermediate term corporates and an interesting ‘aggregate’ bond fund. All of the bond funds are pretty much straight forward; however the aggregate bond fund is worth a closer look. The SPDR-Barclays Aggregate bond fund contains a diversified mixed of fixed income securities, ranging from ultra-safe US Treasuries to more risky ‘Asset Backed Securities’. The chart below gives a quick visual of the LAG fund’s capital allocation. Again, it’s worth noting that since LAG holds US Treasuries, there’s an overlap with the US Treasury only funds, hence, there’s slightly more US Treasuries imbedded within the fund. Data from SPDR Also, it’s important to note the quality allocation: Data from SPDR The last significant type of holding is the Real Estate Investment Trusts, (REITS). The fund has two, one domestic and one international. Both REITS are from the SPDR-Dow Jones portfolio of funds. Some of the key metrics are summarized in the table below: REIT Symbol GAL Weighting Type Gross Expense Ratio Return Since Inception Premium/ Discount Number of Holdings Average Yield ETF Hub 3 Year Return Position SPDR Dow Jones REIT ETF RWR 4.06% Storage, Residential, Community, Groups and Trusts 0.25% 10.82% 4/22/2001 Discount -0.03 97 3.12% 6th out of 39 REITS SPDR Dow Jones International Real Estate ETF RWX 1.01% Groups, Shares, Companies, REITs, 0.59% -0.14% 12/15/2006 Premium 0.66% 134 2.99% 21st out of 39 REITS Without going into deep detail, it’s well worth taking a look at the returns over specific periods of time summarized in the next table. It should be pointed out that the poor performance of the international RWX over the past year coincides with the contracting economies in the Asia-Pacific region, indirectly affecting Europe, whereas the strong performance of the domestic RWR over this period coincides with a strengthening US economy. RWR outperforms RWX over 3 and 5 years, however, the RWX returns over 3 and 5 years are well positive, too. REIT Symbol 1 Month Quarter to Date Year to Date 1 Year 3 Year 5 Year 10 Year Since Inception SPDR Dow Jones REIT ETF RWR 3.38% 3.07% -3.02% 11.56% 9.66% 12.03% 6.55% 10.82% SPDR Dow Jones International Real Estate ETF RWX 0.44% -5.12% -3.15% -2.14% 4.87% 6.07% NA -0.10% The last notable difference between these two funds is the very different asset allocations: (click to enlarge) Data from SPDR; Getty Images To sum it all up, a fund of funds is an incredibly useful investment vehicle particularly for those who know the importance of having an investment plan, but perhaps do not have the time or knowledge to construct a well-diversified portfolio from scratch, nor perhaps, employ a personal investment advisor. A fund of funds, such as the SPDR Global Allocation ETF is an excellent starting point. As always, dollar cost averaging and distribution reinvestment over the long term is perhaps the most certain way to build a nest egg for retirement or college fund. (click to enlarge) There’s an even more subtle point to be gained from the foregoing narrative. Although a fund of funds is an excellent ‘starting point’ foundation investment which does not require a great deal of time and attention once it’s set up, it should not absolve the investor of occasionally taking the time to examine the funds one at a time, understand the terms and language, making comparisons and thus acquiring the knowledge to build upon a good foundation in coming years.