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EFA: How Do You Make A Mediocre ETF Sound Exciting?

Summary EFA is a mediocre ETF. The sector allocation is mediocre, the geographic diversification is mediocre and the expense ratio is mediocre. The top holdings make sense, but they don’t reflect the total portfolio. Despite having a heavy portfolio weight towards financials, there is only one in the top ten. There is nothing bad about the ETF to warrant taking a capital gains tax on sale, but if a loss could be taken with proceeds reallocated… that would be nice. There isn’t much to say to make this ETF sound exciting. There are so many international ETFs it can be difficult for investors to choose one. Hopefully I can help with that problem by highlighting some of them and shining a light inside their portfolio. One of the funds that I’m considering is the iShares MSCI EAFE ETF (NYSEARCA: EFA ). 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 on the iShares MSCI EAFE ETF is .33%. I’d really prefer to see lower, but that isn’t high enough to remove the ETF from being worthy of further consideration. Geography The map above shows the top 10 countries by the market value of their allocations. This is certainly an international ETF, but the holdings seem more diversified from the list on the left side than from the list on the right side. I’d like to see even more diversification, but at least they have not assigned any single country a weighting higher than 25%. Sector Looking at the sector allocation is fairly interesting. Fortunately this is a fairly diversified group of sectors, but I think I would prefer a smaller allocation to financials. Perhaps I’m being too picky, but I’d rather see more consumer staples and foreign utilities mixed into the portfolio. I’d like to have the benefits of international diversification while overweighting the sectors that I expect to be less volatile. Largest Holdings (click to enlarge) Looking at the individual holdings, you wouldn’t expect that “Financials” would be so overweight. Only one financial company is in the top 10. The concern for me is that a heavy focus on financials in the lower parts of the portfolio suggests to me that the ETF may have a heavier weight on the companies that are easier to research or buy if markets are not sufficiently liquid in some countries. Building the Portfolio The sample portfolio I ran for this assessment is one that came out feeling a bit awkward. I’ve had some requests to include biotechnology ETFs and I decided it would be wise to also include a the related field of health care for a comparison. Since I wanted to create quite a bit of diversification, I put in 9 ETFs plus the S&P 500. The resulting portfolio is one that I think turned out to be too risky for most investors and certainly too risky for older investors. Despite that weakness, I opted to go with highlighting these ETFs in this manner because I think it is useful to show investors what it looks like when the allocations result in a suboptimal allocation. The weightings for each ETF in the portfolio are a simple 10% which results in 20% of the portfolio going to the combined Health Care and Biotechnology sectors. Outside of that we have one spot each for REITs, high yield bonds, TIPS, emerging market consumer staples, domestic consumer staples, foreign large capitalization firms, and long term bonds. The first thing I want to point out about these allocations are that for any older investor, running only 30% in bonds with 10% of that being high yield bonds is putting yourself in a fairly dangerous position. I will be highlighting the individual ETFs, but I would not endorse this portfolio as a whole. 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. Because a substantial portion of the yield from this portfolio comes from REITs and interest, I would favor this portfolio as a tax exempt strategy even if the investor was frequently rebalancing by adding new capital. The portfolio allocations can be seen below along with the dividend yields from each investment. Name Ticker Portfolio Weight Yield SPDR S&P 500 Trust ETF SPY 10.00% 2.11% Health Care Select Sect SPDR ETF XLV 10.00% 1.40% SPDR Biotech ETF XBI 10.00% 1.54% iShares U.S. Real Estate ETF IYR 10.00% 3.83% PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB 10.00% 4.51% FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT 10.00% 0.16% EGShares Emerging Markets Consumer ETF ECON 10.00% 1.34% Fidelity MSCI Consumer Staples Index ETF FSTA 10.00% 2.99% iShares MSCI EAFE ETF EFA 10.00% 2.89% Vanguard Long-Term Bond ETF BLV 10.00% 4.02% Portfolio 100.00% 2.48% The next chart shows the annualized volatility and beta of the portfolio since October of 2013. (click to enlarge) Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. You can see immediately since this is a simple “equal weight” portfolio that XBI is by far the most risky ETF from the perspective of what it does to the portfolio’s volatility. You can also see that BLV has a negative total risk impact on the portfolio. When you see negative risk contributions in this kind of assessment it generally means that there will be significantly negative correlations with other asset classes in the portfolio. The position in TDTT is also unique for having a risk contribution of almost nothing. Unfortunately, it also provides a weak yield and weak return with little opportunity for that to change unless yields on TIPS improve substantially. If that happened, it would create a significant loss before the position would start generating meaningful levels of income. A quick rundown of the portfolio I put together the following chart that really simplifies the role of each investment: Name Ticker Role in Portfolio SPDR S&P 500 Trust ETF SPY Core of Portfolio Health Care Select Sect SPDR ETF XLV Hedge Risk of Higher Costs SPDR Biotech ETF XBI Increase Expected Return iShares U.S. Real Estate ETF IYR Diversify Domestic Risk PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB Strong Yields on Bond Investments FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT Very Low Volatility EGShares Emerging Markets Consumer ETF ECON Enhance Foreign Exposure Fidelity MSCI Consumer Staples Index ETF FSTA Reduce Portfolio Risk iShares MSCI EAFE ETF EFA Enhance Foreign Exposure Vanguard Long-Term Bond ETF BLV Negative Correlation, Strong Yield Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio. 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. (click to enlarge) Conclusion EFA certainly has some volatility, but the correlation over longer time periods has been significantly lower than the correlation levels created by measuring on a daily basis. All around, this is a decent but not spectacular ETF. The ETF has a respectable but not incredible diversification among countries. The holdings are concentrated on the financial sector, but only one financial firm was able to warrant a large enough allocation to end up in the top 10. When it comes down to the sheer volume of holdings, there are 934 companies in the portfolio. Of course, that could change at any point. I love having extreme levels of diversification like that in international equity allocations, but such high diversification indicates a passive indexing strategy. As you might imagine, I’d rather not pay the .33% expense ratio for a passive index fund. The problems within the ETF aren’t bad enough for investors to have any cause to sell it and incur a capital gains tax, but I’d rather place international equity allocations in other ETFs. If an investor is able to harvest a tax loss on selling, that would be a very solid reason to reallocate to a more appealing ETF. If you’re looking for more appealing options, I put together an article with three of them .

Vietnam Steps Into Emerging Markets Spotlight

By Tim Maverick These days, when investors hear the words “emerging market,” they immediately run in the opposite direction. The Institute of International Finance reports that investors pulled $40 billion out of emerging markets in the third quarter alone. That’s the fastest pace since the height of the financial crisis and the largest outflow of funds since the fourth quarter of 2008. But as a contrarian investor, I’m intrigued. These outflows made me wonder if, in the panic for the exits, someone may have overlooked a gem. And sure enough, shining like a beacon in the dark, was Vietnam. According to researchers at Capital Economics, Vietnam is one of just five emerging nations, as well as the only nation in Asia, whose economy is growing above its average growth rate since 2010. Economists forecast that Vietnam’s $186-billion economy will grow at 6.1% this year and 6.2% in 2016. This follows growth of 5.2% in 2012, 5.3% in 2013, and 6% in 2014. Capital Flowing to Vietnam Vietnam has been able to attract productive capital inflows recently. In fact, it ranks seventh among all countries, including the United States and China, in foreign direct investment (FDI). Most of that money is going into manufacturing. Vietnam is highly competitive in low-tech industries like textiles and footwear. But importantly, it’s also competitive in high-tech manufacturing. Vietnam has become a major exporter of smartphones, for example, and Samsung has one of its largest global smartphone facilities there. Thanks to the Vietnamese government, the economy’s momentum should continue. The government lifted the 49% ownership cap at a number of listed companies, which will allow foreign companies to invest heavily – or even take over – some Vietnamese firms. In addition, the government has tamed inflation. In 1988, inflation was at an incredible 774%! Four years ago, it was still at 22%. Two years ago, it was down to only 6%. And today, inflation is negligible. Vietnam’s Emerging Consumer Class The growth of manufacturing jobs in Vietnam is changing the face of the country. Here are just a few examples: The country has one of Asia’s fastest urbanization rates, which is creating a consumer middle class. According to the CIA World Fact Book, about a third of the population is now urban. The annual urbanization rate from 2010-15 is just under 3%. Vietnam is now the fastest-growing auto market in Southeast Asia. Through August, year-on-year car sales were up a whopping 62%. Vietnam’s internet penetration rate is rising faster than anywhere else in the world. With more than 40 million people connected to the internet, Vietnam has more users than any other country in Southeast Asia. Not surprisingly, Vietnam has been Asia’s top performer in 2015. Its gain is only about 3.5%, but that looks fantastic compared to other stock markets: It’s still relatively cheap, too, at just 12.5 times estimated earnings. And what really caught my eye is that the market is still trading about 50% below the peak level hit in 2007. The only easy way for U.S. investors to play Vietnam is through an exchange-traded fund – the Market Vectors Vietnam Fund (NYSEARCA: VNM ). This ETF’s portfolio consists of 30 stocks, and it has about 75% of its assets invested directly into locally listed Vietnamese stocks. VNM has a very reasonable expense ratio of 0.7%. The big drawback is that VNM has underperformed Vietnam’s index, showing a year-to-date loss of about 19%. This is likely due to the fund’s over-weighting in the most liquid, financial stocks, as well as energy stocks. You can get much better performance with closed-end funds focused on Vietnam, which are traded in the over-the-counter market. The most liquid of these is the Vietnam Opportunity Fund ( OTCPK:VCVOF ). But even this one is very thinly traded. The advantage is that it’s trading 18% below its net asset value, so you’re buying assets at a discount in an already cheap market. Finally, when – not if – emerging market sentiment turns, the upside could be substantial. Original Post

The V20 Portfolio: Introduction

Summary The V20 Portfolio aims to generate annual returns of over 20% over the long term. This portfolio is highly volatile due to concentration. If you have a long-term horizon, the V20 portfolio may be for you. After multiple requests from readers and much deliberation, I’ve decided to reveal a portion of my portfolio which I’ve dubbed “V20.” A rather uncreative name, but I’ll get to that later. This sub-portfolio represents the core holdings (~70%) of my entire portfolio. If you are interested in the performance of my entire portfolio, you can view it at any time using the link beside my name. The main reason why I hesitated to disclose my holdings was because I do not want readers to blindly follow them without understanding the associated risks and goals. But with the recent market downturn, I believe that analyzing my portfolio right now could provide a lot of value. That being said, I must reiterate that you must understand the goals and risks of this portfolio and judge them yourself before taking any positions. Thus far I’ve been analyzing specific companies. With this series, I hope to shine a light on my portfolio construction strategies, as well as analyzing performance from a top-down perspective (looking at the portfolio as a whole). The weekly updates will identify whether there have been any significant events that could have impacted the portfolio and whether our original thesis remains intact. New or closed positions (if any) will also be announced. What Is The V20 Portfolio? The V20 Portfolio consists of stocks that I believe to have asymmetrical returns. In aggregate, the goal of the portfolio is to generate 20%+ return per year over the long term. The V stands for value, the style of investing that I abide by personally. What’s so special about the V20 portfolio? How does it differentiate itself from many other funds/portfolios that you see out there? I would say that one of the major differences is the return expectation. I am not aware of any mutual fund that aims for a return of 20% per year. These type of returns are typically only expected of alternative investment vehicles such as hedge funds and private equity funds. However, I believe that this performance goal is very achievable as a retail investor, if you can stomach the following risks. Risks First there is the volatility. To maximize expected returns of the portfolio, the holdings are not diversified (in the traditional sense anyways). There are typically 5 to 15 stocks at any given time, with skewed weights. Stocks with the largest upside will typically get the biggest share of the portfolio. Because of this set-up, volatility (defined as standard deviation of returns) will likely be much higher than an index such as the S&P 500 over any period of time. You must also accept price risk in the short and medium term. Price risk is the risk that holdings may be undervalued for an extended period of time even though there is still substantial upside. Because the portfolio holds many stocks that are out of favor, you must be willing to grit your teeth while the stock awaits a recovery. Risk In Action (click to enlarge) Here we have a graph illustrating the performance of the S&P 500 and the V20 Portfolio. As you can see, the portfolio has significantly outperformed the index this year. However, it wasn’t rosy all the time. At the beginning of the year, you can see that the portfolio drastically underperformed the index, almost losing 20% in a matter of weeks. To tie this back to the aforementioned risks, had you sold the portfolio then, you would’ve missed out on all of the subsequent gains. This is why I cannot stress enough that you must hold a long-term view if you want to invest in this portfolio. Who Is This Portfolio Suitable For? That answer to that question is ultimately for you to decide, but I do have a few suggestions. There are two general categories: investors who are building towards retirement and retirees who wish to pass on assets to family members. They may look different to you, but they are united by a common factor: a long-term investment horizon. In my mind, this is the critical success factor. By holding a long-term view, the aforementioned risks become irrelevant. To be invested in this portfolio, you must have no plans to withdraw the funds over the next five years at a minimum. This means that if you want to turn $40,000 into $50,000 by next year for a down payment on a house, this portfolio is not for you. If your child is going to college next year and needs tuition, then this portfolio is not for you. On the other hand, if you have excess income every month that you stow away at the bank earning 1% a year, then this portfolio may be suitable for you to create wealth over the long term. Portfolio Overview (click to enlarge) ACCO Brands (NYSE: ACCO ) You can read my previous analysis here . This company makes office supplies. Although there has been a shift away from paper-based products due to technological advancement and green initiatives, the company has delivered good results over the past couple of quarters. I admit that society is becoming increasingly reliant on electronics, however, I believe that things like binders (one of the products that the company makes) will remain prevalent in school and offices. To protect myself from a potential secular decline, I’ve allocated only a modest portion of the total portfolio to this stock. magicJack (NASDAQ: CALL ) As you can see, magicJack constitutes a significant portion of the current portfolio. You can read my analysis on the company here . Since I wrote the article in April, the stock has appreciated by around 25%. I think most people would be happy with a 25% return in less than six months, and may even sell the stock after a nice run. However, I believe that there remains substantial upside to this company, so I will keep the current allocation until fair value is reached or close to being reached. Due to the large amount of cash on the company’s balance sheet (which cushions its downside), I believe that the stock is relatively safe; hence, I’ve allocated a significant portion of assets to this stock. Conn’s (NASDAQ: CONN ) You can read my latest analysis here . Conn’s is one of my high conviction ideas. The company is a consumer retail company with a spin. Its primary customers are credit constrained (i.e. low credit) consumers. I think after the last financial crisis, investors have become automatically fearful when credit-related companies report increasing delinquencies. What they miss is that this is something that the management can easily control. Over the past couple of quarters, the management has significantly tightened credit policy in an attempt to decrease bad debt expense, all the while increasing sales. After the recent decline, I believe that there is once again significant upside for this stock, which is why I’ve put a large chunk of the portfolio in Conn’s. Dex Media (NASDAQ: DXM ) This is one of my more interesting holdings. There is a big chance that the company may go bankrupt. So why am I holding this you ask? Despite a declining business, the company is still generating a significant amount of cash ($136 million of cash form operation in H1). Given the low capex requirement ($4 million in H1), it is literally a cash cow. The only problem is that the company is saddled with debt, which stood at $2.2 billion at the end of the second quarter. Almost all of it will be due by the end of next year. There is absolutely no way that the company can afford to pay all of it out of pocket, so its future depends on whether the lenders will refinance. At the current price, the market is essentially betting that the equity holders will be completely wiped out. I, on the other hand, remain hopeful that the restructuring process will extend the bond maturities. Of course, this is a highly risky investment, as I could lose everything. For that reason, I’ve allocated only an extremely small portion of my portfolio to this stock. Intelsat (NYSE: I ) This is a satellite company. Similar to Dex Media, the company has a significant amount of debt. The difference is that the company remains profitable. There are significant barriers to entry, so I believe that the company can maintain its profitability. The problem is that it is fairly sensitive to rate increases. If the Fed raises interest rates, then it would cost more for the company to roll over its bonds. As it stands, however, I see substantial upside for this stock given the current financial profile. Nevertheless, the debt is a concern, so I’ve allocated only a modest portion of the portfolio to the stock. Perion Network (NASDAQ: PERI ) Perion Network is a technology company. Through its products, the company provides ways for software publishers to earn revenue by linking search results from major search providers such as Google and Microsoft. The products themselves are a bit dubious, with some critics calling them adwares. While the company is profitable, the stock was hit hard when Google decided to upgrade Chrome to enhance security, which prevented many of Perion’s products from being installed. However, I believe that the company’s products will continue to provide its partners (e.g. Microsoft) with search volume and are still a unique way for software publishers to monetize their content. Similar to magicJack, the company also has a large cash balance, which will protect losses in the short term. For the above reasons, I’ve decided to make it my third largest holding. How The Holdings Fit Together There is always systematic risk. This is the type of risk that I have no control over (e.g. a sector decline). However, I’ve tried to minimize this risk by diversifying my holdings into uncorrelated sectors. I believe that none of my holdings are tied to a single common factor that could influence their values. ACCO Brands manufactures office supplies, magicJack is a niche communication company, Conn’s is a sub-prime retailer, Dex Media is an advertising company, Intelsat is a satellite company, and Perion Network is a niche technology company. As you can see, none of the holdings have a clear overlap. However, I must admit that every stock will be influenced by an economic downturn. This goes back to the idea of systematic risk. Unfortunately, pretty much everything is tied to the economy, so I’ve decided to accept this risk for now. The second risk I want to talk about is a bit more elusive. I’m talking about the idea of permanent capital loss. Buffett supposedly said the following words: Over the years, a number of very smart people have learned the hard way that a long stream of impressive numbers multiplied by a single zero always equals zero. How do I apply this to my portfolio? Well, I believe that there are stocks whose potential upside is exceeding large; however, they are highly risky in the sense that it would be possible to lose everything. One such example in my portfolio is Dex Media. As mentioned earlier, there is no doubt in my mind that the company may go bankrupt over the next couple of years, which is why the company is trading at a depressed valuation in the first place. Nevertheless, I believe that the upside is extremely attractive should restructuring yield favorable results. There are a variety of factors in play here, but I will save those for another time. The bottom line is that I may lose the entire invested amount in Dex Media. Going back to Buffett’s quote, an easy way to get “impressive numbers” would be to invest your entire portfolio, so that should events transpire in your favor, you could achieve returns that would be out of this world. However, by doing so, you would be setting yourself up for the possibility of permanent capital loss if things don’t turn out the way you expect them to, and this is what I strive to eliminate from my portfolio. In the V20 Portfolio, you can see that DXM only constitutes a very minute (1.1%) portion. This means that I’ve limited my upside, but the portfolio will still enjoy a nice boost should the stock appreciate significantly, and I can sleep soundly even if the company goes bust. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.