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ETF Trends For 2016: Part 1, Currency-Hedged Products

2015: A Quick Look Back Constant talk of interest rate hikes, the China market correction in August and the start of ‘chip’ credit cards in the U.S. – these are the things I believe will stand out in my mind if asked 10 years from now what happened in the world of finance in 2015. However, for Exchange Traded Funds (ETFs) 2015 was all about the continuing growth of Smart Beta strategies, the potential for Non-Transparent Exchange Traded Mutual Funds and new niche funds (like the iShares Exponential Technologies ETF (NYSEARCA: XT ) or the Restaurant ETF (NASDAQ: BITE )). According to ETF.com : As of Dec. 3, 2015, 270 ETFs had launched on U.S. exchanges. That is far beyond the roughly 200 funds that rolled out in 2014, and sets 2015 up to be a record-breaking year. You have to go back nearly a decade to find a year that achieved a similar number of launches. Click to enlarge As shown by the above image from the ICI 2015 Investment Company Fact Book , ETFs continue to grow in assets under management (AUM) and the number of fund offerings for investors. However, ETFs have yet to overtake mutual funds. But at current growth rates, ETFs will see parity soon enough. According to an article from Camilla de Villiers of Thomson Reuters: ETF assets today are expanding by 24% per annum – triple the rate of traditional mutual funds. Notwithstanding their popularity, ETFs have fallen well short of displacing the $16 trillion mutual fund industry. But over the long term, on current rates of growth, mutual funds and ETFs will reach parity at $50 trillion each by 2030. Earlier this year, Schwab commissioned an online study to gauge U.S. investor interest in ETFs (pdf download linked here ). The full report is a great read and full of useful data, but one key point especially stood out. As ETF interest continues to grow, we also see that the most avid users are the tech savvy first adaptors, millennials. Click to enlarge As of publication, we can see (using ETF.com’s Fund Flows tool ) investors in 2015 were not just interested in plain vanilla market cap-weighted funds, but their interest in specialized tools to conquer the market has continued to grow. However, old standbys like the Vanguard S&P 500 ETF (NYSEARCA: VOO ), the iShares Core U.S. Aggregate Bond ETF (NYSEARCA: AGG ) and the Vanguard Total Stock Market (NYSEARCA: VTI ) do continue to see investor appreciation. But the continuing impressive growth of ETF assets is to some extent old news in the investing world. What we’d like to focus on in the rest of this brief report are 3 key industry trends and their implications for the continued success of ETFs in the future. In this first part, we are going to cover currency-hedged products, while parts 2 and 3 will be on robo investors and expense ratios respectively. Currency-Hedged Products & Iterations On A Theme WisdomTree (NASDAQ: WETF ) launched its first currency-hedged fund in 2006, the Japan Hedged Equity Fund (NYSEARCA: DXJ ), and it took three-and-a-half years for them to launch a second, the Europe Hedged Equity Fund (NYSEARCA: HEDJ ). Clearly the idea didn’t catch fire right away, but it is growing rapidly now. There are now over 50 ETFs with a mandate to not only invest in equities from a region, but also neutralize exposure to fluctuations between that region’s currency and another (often the U.S. dollar). HEDJ and the Deutsche X-trackers MSCI EAFE Hedged Equity ETF (NYSEARCA: DBEF ) even led fund creations for 2015, with $15.77 and $12.67 billion respectively, as concerns around a weakening euro hit investors. This slight change in mandate from your average international-focused index fund can have a dramatic effect on returns. For example, see DXJ and HEDJ’s 5-year returns against two popular non-hedged funds tracking Japan and Europe as well, the iShares MSCI Japan ETF (NYSEARCA: EWJ ) and the Vanguard FTSE Europe ETF (NYSEARCA: VGK ). Click to enlarge To be fair, a currency hedge can be a negative thing for investors as well. When the dollar starts to fall against a foreign currency, currency-hedged investors lose out on the gain from this relationship. As stated by Chris Dieterich of Barron’s : For now, WisdomTree’s stock looks likely to behave as a leveraged play on the dollar. The higher the greenback goes, the more traders will clamor for currency-hedged ETFs. When wondering where the push for these funds came from finally and where they will go from here, we turn to a quote from Greg McFarlane of Investopedia : The upsurge in currency-hedged ETFs is a recent phenomenon spurred by an unmistakable cause – national banking authorities obsessed with inexpensive money. Players are entering the market at an alarming rate. With more such ETFs available to the individual investor, and firms thus forced to compete on price (which is to say, expense ratios), there’s never been a better time to not only expose yourself to international markets, but reduce price movement risks while doing so. Deutsche Bank (NYSE: DB ), iShares and WisdomTree lead the fund creation march now, but IndexIQ is the first to look outside the standard currency-hedged product box in the quest for differentiation and further investor assets. Its recently launched lineup of 50% currency-hedged ETFs each hedge approximately 50% of its foreign currency exposure to mitigate the effect of currency fluctuation on USD index returns rather than the traditional 100% hedge. These kinds of iterations on a theme will only offer investors further options when considering a currency-hedged strategy. Stay tuned for part 2 next week, which will focus on the rise of robo investors and how this industry will affect ETF investors and continue to grow in 2016.

ETF Update: 4 New Launches And 2 Closures

Welcome back to the SA ETF Update. My goal is to keep Seeking Alpha readers up to date on the ETF universe and to gain some visibility, both for the ETF community, and for me as its editor (so users know who to approach with issues, article ideas, to become a contributor, etc.) Every weekend, or every other weekend (depending on the reader response and submission volumes), we will highlight fund launches and closures for the week, as well as any news items that could impact ETF investors. So far January has not been the best month for buy and hold investing. As a long term investor I know stock dips are really opportunities to buy into strong companies that will not just recover but bloom again. However, even having studied behavioral portfolio management, I still get that flight response that all investors will feel at some time. As you can see in the fund flows YTD tables below, I am not the only person feeling this way. Top Redemptions Fund Name Net Flows in USD Millions SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) -4,073.29 iShares Russell 2000 ETF (NYSEARCA: IWM ) -2,108.65 PowerShares QQQ Trust ETF (NASDAQ: QQQ ) -1,996.87 iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) -1,648.93 iShares MSCI Emerging Markets ETF (NYSEARCA: EEM ) -1,349.74 Data Source: ETF.com Top Creations Fund Name Net Flows in USD Millions iShares Short Treasury Bond ETF (NYSEARCA: SHV ) -4,073.29 Vanguard S&P 500 ETF (NYSEARCA: VOO ) -2,108.65 iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) -1,996.87 iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) -1,648.93 iShares 1-3 Year Treasury Bond ETF (NYSEARCA: SHY ) -1,349.74 Data Source: ETF.com Inflows and outflows can be a great reflection of what investors and money managers actually think is happening in the markets. As I don’t offer investment advice, and none of my articles should be seen as advice, I will leave it to readers to decide what these data points mean in the comments section below. However, I do want to point out that most of the top new creations are Treasury ETFs, while the redemptions are funds tracking the popular U.S. equity indices. It is up to you to decide how (or if) this information from 3 weeks of market activity will affect your portfolio strategy. Even with the churning markets there were 4 new funds launched in the last 2 weeks, so let’s jump in: Fund launches for the week of January 11th, 2015 Van Eck launches the first generic pharmaceuticals ETF (1/13): The Market Vectors Generic Drugs ETF (NASDAQ: GNRX ) focuses on companies that make the majority of their revenues from generic medication. While there are other pharmaceutical ETFs avaliable to investors, the largest being the Dynamic Pharmaceuticals ETF (NYSEARCA: PJP ), GNRX is the first funds to highlight companies focused on the generic medication market. The fund currently holds 84 companies and the top holdings feature names biotech investors are likely already familiar with; Allergan Plc (NYSE: AGN ) (8.69%), Teva Pharmaceutical (NYSE: TEVA ) (8.60%) and Baxalta Inc (NYSE: BXLT ) (5.83%). Reality Shares launches 2 more DIVCON ETFs (1/14): Last week saw the launch of the Reality Shares DIVCON Leaders Dividend ETF (BATS: LEAD ) and the company already has two more out of the gate. However, the Reality Shares DIVCON Dividend Defender ETF (BATS: DFND ) and the Reality Shares DIVCON Dividend Guardian ETF (BATS: GARD ) are both long/short portfolios, which is new for the firm. As a refresher, the DIVCON methodology “rates companies’ dividend health based on seven weighted factors our research shows are correlated with dividend growth.” According to each ETFs homepage, DFND seeks to provide long-term capital appreciation through the use of a hedged equity portfolio, while GARD provides exposure to large-cap U.S. companies with the highest probability of increasing their dividends, as measured by their DIVCON Scores. However, GARD has some twists as well. It dynamically adjusts its market exposure based on the firm’s Guard Indicator market strength gauge, making it a much more complex fund. State Street (NYSE: STT ) rolls out its innovation ETF (1/14): The SPDR FactSet Innovative Technology ETF (NYSEARCA: XITK ) tracks an index of companies selected by FactSet meant to represent the most innovative segments of the technology and electronic media industries. As described on the fund homepage, “the Index Provider considers the most innovative segments of the Technology sector and Electronic Media sub-sector to be those with the highest revenue growth and believes that these companies are often involved in cutting edge research, innovative product and service development, disruptive business models, or a combination of these activities.” Top holdings include Rovi Corporation (NASDAQ: ROVI ) (2.22%), Super Micro Computer Inc. (NASDAQ: SMCI ) (1.49%) and CyberArk Software Ltd. (NASDAQ: CYBR ) (1.42%). There were no fund launches for the week of January 18th, 2015 There were no fund closures for the week of January 11th, 2015 Fund closures for the week of January 18th, 2015 ETRACS 2xMonthly Leveraged S&P MLP Index ETN (NYSEARCA: MLPV ) UBS ETRACS 2x Leveraged Long Alerian MLP Infrastructure Index ETN (NYSEARCA: MLPL ) Have any other questions on ETFs or ETNs? Please comment below and I will try to clear things up. As an author and editor I have found that constructive feedback is the best way to grow. What you would like to see discussed in the future? How can I improve this series to meet reader needs? Please share your thoughts on this first edition of the ETF Update series in the comments section below. Have a view on something that’s coming up or a new fund? Submit an article.

Gundlach: Buy Closed-End Bond Funds And Mortgage REITs

It seems that bond king Jeffrey Gundlach and I are reading from the same playbook. In the Barron’s Roundtable (registration required), he made his case for deeply-discounted closed-end bond funds and mortgage REITs. I’ve been bullish on both for over a year… and I’ve taken my lumps for it. But the values are there, and I’m collecting outsized payouts while I wait. Some of Gundlach’s comments are worth passing on: A portion of the credit market has a safety cushion large enough to absorb another 200- or 300-basis-point widening in junk-bond spreads versus Treasuries. I’m referring to closed-end bond funds, which trade on the New York Stock Exchange. Closed-ends are one of the best plays on the Fed not raising interest rates… Closed-end funds are leveraged, and investors have been afraid to own them because they fear that the Fed has launched a tightening cycle. Also, based on daily data going back 20 years, they have traded at a 2% discount, on average, to net asset value. Recently, however, the sector traded at a 10% to 12% discount to NAV. It has traded at such a steep discount only 5% of the time. In the past 20 years, the discount has been wider than that only during the financial crisis in 2008-’09… If history is any guide, discounts would widen further only in a 2008-type scenario, which is possible, although doubtful so soon after the prior crisis. Under current circumstances, you have about two percentage points of downside, and 10 points of upside to return to the historical discount. That makes a basket of closed-ends attractive. If you bought a junk-bond-oriented closed-end trading at a 12% discount to NAV, some of the bonds would be trading at a 15% discount. This isn’t a bad idea, but I prefer Brookfield Total Return (HTR). It is trading just as poorly as some other closed-ends, but is vastly safer. Gundlach’s firm, DoubleLine, is far too big to buy closed-end funds in any meaningful size. He’d end up single-handedly moving the market. But for individual investors, these may be the best option available these days. As Gundlach puts it, “If the S&P rises 10%, closed-ends could return 20%. If the stock market falls 30%, a decline is already priced into these funds. I look at closed-end funds as a good place to put your risk money.” I agree. Given the yawning discounts among closed-end bond funds, we have that all-important margin of safety in this space. Moving on, Gundlach had some interesting things to say about mortgage REITs: Fears that the Fed will raise rates significantly are overblown. This brings me to Annaly Capital Management (NYSE: NLY ), one of the largest mortgage REITs [real-estate investment trust]. It has an $8 billion market cap and has been trading at a 25% discount to book value for some time… It is selling for $9.41. A few years back, it sold for $18. These sorts of stocks have step-function moves. They don’t move by a few percent; they go from $18 to $12 and from $12 to $9, and if the yield curve is inverted, and they have to cut their dividends, things get really bad. But a discount of 30% to book value is the widest ever for Annaly, and historically very wide for a mortgage REIT. Annaly is paying a dividend of 30 cents per quarter. It yields 12.75%. The environment for Annaly has improved… At today’s discount, a lot of bad things are priced in. If the Fed doesn’t raise interest rates much, the stock should go higher. I’m not currently long Annaly. Rather than bet on a single mortgage REIT, I opted to buy a broader basket via an ETF. But my rationale was much the same. Across the sector, you have quality names trading at enormous discounts to their underlying portfolio values. The sector is worth more dead than alive. The rationale move here would be for mortgage REITs to plow the proceeds from maturing and prepaid mortgage securities into buying back their own stock. An m-REIT yielding 10% and trading at 80 cents on the dollar is going to deliver a better return than the mortgage securities they’re currently buying. Annaly, for one, has done exactly that, announcing over the summer that they intended to buy back about $1 billion in shares . At today’s prices, that amounts to about 12% of Annaly’s market cap. Expect more of their peers to follow suit. Disclaimer : This article is for informational purposes only and should not be considered specific investment advice or as a solicitation to buy or sell any securities. Sizemore Capital personnel and clients will often have an interest in the securities mentioned. There is risk in any investment in traded securities, and all Sizemore Capital investment strategies have the possibility of loss. Past performance is no guarantee of future results. Original Post