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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.

What Happened To Natural Gas ETFs In October?

This year has been bad for commodities, and natural gas is no exception. China-led global economic slowdown, supply glut and stronger dollar ahead of an impending Fed rate hike have been battering the performance of the energy sector. However, October was a balanced month for natural gas as it faced both the odds and advantages. Natural gas kicked off the month with an amazing performance. There were a number of factors that led to the bullish trend in their prices despite oversupply concerns. After hitting its three-year low, natural gas prices began to rise due to short covering and bottom fishing by traders. This was complemented by rebounding optimism in crude oil as many oil producing companies are also engaged in the production of natural gas. Oil price crossed its $50 per barrel mark on October 8 for the first time since July. The rally extended when consensus of a chilly winter across the eastern parts of the U.S. began to build up. Cold weather boosts demand for natural gas, which is used by around 50% of the U.S. households as the main source of heating fuel. November through March is generally considered as a peak season for natural gas when heating demand is at a high. This led natural gas futures for November contract to settle at the highest level of $2.535 per MMBtu (million British thermal units) on October 12 since September 29. However, natural gas prices retreated in the second half of October when forecast of a warmer-than-normal winter in the U.S., partly due to the El Niño phenomenon, became pronounced for the coming weeks. In the last week of the month, MDA Weather Services had predicted that heating degree days (measurement reflecting the demand for energy required to heat a building) will be 178 over the next two weeks in contrast to 199 in the same period last year. The lower heating degree days indicates warmer weather in the lower 48 states of the U.S.. The forecast of a mild weather pushed natural gas prices to its three-year low of $1.948 per MMBtu on October 27, their lowest since April 2012. This intensified concerns of a supply glut as a mild winter means lower demand for natural gas. However, the supply situation didn’t turn to be as bad as expected when the U.S. Energy Information Administration (“EIA”) released its October 29 update on natural gas inventories for the week ended October 23. The EIA report revealed a less-than-expected rise in natural gas inventories in storage, which increased 63 Bcf (billion cubic feet) to 3,877 Bcf compared to the expected rise of 69 Bcf. This led to some respite in the natural gas market as its price surged 11% from the previous day to $2.257 per MMBtu on October 29. However, concerns about a mild winter loomed yet again, beginning to dampen prices at the start of November. ETFs that follow the natural gas futures witnessed the same swings during October. Below we highlight three of them that were strongly influenced by the topsy-turvy movements of the natural gas futures during the month. United States Natural Gas Fund (NYSEARCA: UNG ) UNG tracks the movements of the price of natural gas as delivered at the Henry Hub, Louisiana. The ETF has been able to manage $487 million in its asset base and is actively traded with about 5.6 million shares per day. It charges 60 bps in annual fees and expenses. The product gained 1.3% in the first half of October but retreated 13.3% in the second half of the month. United States 12 Month Natural Gas Fund (NYSEARCA: UNL ) This fund is designed to track, in percentage terms, the movements of natural gas prices. It has garnered nearly $13 million in assets and trades in an average volume of 23,000 shares a day. It charges 75 bps in investor fees and returned 2.3% in the first half of October but lost 8.8% in the latter half of the month. iPath Dow Jones-UBS Natural Gas Subindex Total Return ETN (NYSEARCA: GAZ ) GAZ follows the Dow Jones-UBS Natural Gas Subindex Total Return Index, measuring the returns that are available through an investment in the futures contracts of the Henry Hub Natural Gas futures traded on the NYMEX as well as the rate of interest from an investment in U.S. Treasury Bills. The note is quite overlooked as it has amassed just about $7 million in its asset base while it sees average volume of roughly 27,000 shares a day. It has an expense ratio of 0.75% and returned 4.5% in the October first half but retreated as much as 25% in the latter. Original Post