Tag Archives: author

FFTWX: Want To Retire In 2025? Build A More Efficient Portfolio

Summary FFTWX offers investors a high expense ratio to go with a needlessly complex portfolio. By incorporating an enormous volume of other mutual funds the target date fund incorporates a higher expense ratio. If the fund needs exposure to the total U.S. market, they can ditch the complicated combination of funds and just use FSTVX. Lately I have been doing some research on target date retirement funds. Despite the concept of a target date retirement fund being fairly simple, the investment options appear to vary quite dramatically in quality. Some of the funds have dramatically more complex holdings consisting with a high volume of various funds while others use only a few funds and yet achieve excellent diversification. My goal is help investors recognize which funds are the most useful tools for planning for retirement. In this article I’m focusing on the Fidelity Freedom® 2025 Fund (MUTF: FFTWX ). What do funds like FFTWX do? They establish a portfolio based on a hypothetical start to retirement period. The portfolios are generally going to be designed under Modern Portfolio Theory so the goal is to maximize the expected return relative to the amount of risk the portfolio takes on. As investors are approaching retirement it is assumed that their risk tolerance will be decreasing and thus the holdings of the fund should become more conservative over time. That won’t be the case for every investor, but it is a reasonable starting place for creating a retirement option when each investor cannot be surveyed about their own unique risk tolerances. Therefore, the holdings of FFTWX should be more aggressive now than they would be 3 years from now, but at all points we would expect the fund to be more conservative than a fund designed for investors that are expected to retire 5 years later. What Must Investors Know? The most important things to know about the funds are the expenses and either the individual holdings or the volatility of the portfolio as a whole. Regardless of the planned retirement date, high expense ratios are a problem. Depending on the individual, they may wish to modify their portfolio to be more or less aggressive than the holdings of FFTWX. Expense Ratio The expense ratio of Fidelity Freedom® 2025 is .70%. That expense ratio is simply too high. Investors using a target date fund need to keep an eye on those expenses. It is possible to create a very efficient portfolio using only a few funds. Ideally the funds selected for building the portfolio would be selected for offering excellent diversified exposure at very low expense ratios. At the most simplistic level, an investor is looking for domestic equity, international equity, domestic bonds, and international bonds. If any of those had to be left out, the international bond allocation is the least important. In my opinion, there is no need to use both growth and value indexes. There is no need to individually use large, medium, and small-cap allocations. For instance, the Fidelity Spartan® Total Market Index Fund (MUTF: FSTVX ) has a net expense ratio of .05% and offers exposure to the vast majority of the U.S. market. If you were building a target date fund from Fidelity funds, you could simply use FSTVX and eliminate all other domestic equity funds. This method would provide investors with a low expense ratio on the underlying domestic equity position and excellent diversification. That is precisely why I am including FSTVX as a holding in my portfolio. The Vanguard Target Retirement 2025 fund has an expense ratio of .17%. Just so investors have a healthy comparison of how much it costs to run a very efficient target retirement fund, the Vanguard expense ratio gives a pretty clear indication. Holdings / Composition The following chart demonstrates the holdings of Fidelity Freedom® 2025: If you were making a target date fund, how many allocations would you need? Hopefully it wouldn’t be that many. Note that the holdings chart above simply showed the equity funds. There is another long list of funds for bond exposures. There is simply no need for a portfolio to be this complex. Volatility An investor may choose to use FFTWX in an employer sponsored account (if their employer has it on the approved list) while creating their own portfolio in separate accounts. Since I can’t predict what investors will choose to combine with the fund, I analyze it as being an entire portfolio. (click to enlarge) When we look at the volatility on FFTWX, it is dramatically lower than the volatility on the SPDR S&P 500 Trust ETF ( SPY). That shouldn’t be surprising since the portfolio has some large bond positions. Over the last five years it has significantly underperformed SPY, but that should be expected given the much lower beta and volatility of the fund. Investors should expect this fund to retain dramatically more value in a bear market and to fall behind in a prolonged bull market. Even adjusted for the beta, the returns on this portfolio were pretty weak. They were slightly over half the rate achieved by SPY. For comparison, one way an investor can achieve precisely half of the returns on SPY with precisely half the volatility is to buy SPY with half of their portfolio and leave the rest sitting in the account. That would have resulted in slightly lower returns, but it would also have resulted in a dramatically reduced max drawdown. For a fund designed for people that are retiring only a decade from now, having had a max drawdown that was almost as large as if the entire portfolio had been invested in SPY is a pretty poor performance. Opinions The first change I would want to make here is to see a lower expense ratio and a dramatically simplified portfolio of holdings. There is no need for a large complicated portfolio. To drive annualized volatility down while using Fidelity funds, I would favor using the Spartan ® Long-Term Treasury Bond Index Fund (MUTF: FLBAX ). The fund has a very high weighted average maturity (around 25 years), over 99% of the portfolio is in treasury securities (low credit risk), and an expense ratio of only .1%. That is a good solid mutual fund and using it in a target date portfolio fund with regular rebalancing allows investors to automatically take advantage of the negative correlation that long term treasuries have with the domestic equity market. Comparison Portfolio I used Invest Spy to put together a portfolio from Fidelity funds that I believe is dramatically superior to FFTWX. That portfolio is demonstrated below: (click to enlarge) This portfolio simply combines their total domestic market index (expense ratio .05%) with their long term treasury ETF (expense ratio .1%). The resulting expense ratio of the two underlying funds at a 50/50 weighting should be about .075%. This hypothetical portfolio had a max drawdown of only 7.3% and an annualized volatility of 7.2%, which is dramatically lower than the 10.4% reported for FFTWX. Of course, investors should not rely on historical results as predicting future results. The example is simply to demonstrate that a portfolio of domestic equities and long term treasuries has been capable of maintaining fairly low portfolio volatility due to the historical negative correlation of the two asset classes. Conclusion When an investor takes on an expense ratio that is even .3% higher and pays that ratio for 20 years, they are looking at losing 6% of the value of the portfolio without accounting for compounding. If investors account for the benefits of compounding and assume annual returns are positive, the potential value lost is even greater than 6%. FFTWX is an expensive option for investors looking for a simple “set it and forget it” retirement plan from their employer sponsored retirement accounts. The volatility of the fund is not a problem and the total exposures are not unreasonable. The problem comes down to two issues. One is that the fund has needlessly complicated the portfolio holdings and the other is that the expense ratio is simply too high when compared to similar products offered by competitors. There are some great funds offered by Fidelity and I have positions in a few of them. Unfortunately, this fund just falls short of the mark.

Consumer Staples Momo ETF Is A Winning Smart Beta Selection In A Defensive Sector

Investors looking for an ETF that is both defensive and has the potential for out performance should review PowerShares DWA Consumer Staples Momentum ETF. FINRA recently chimed in on Smart Beta ETFs with a Caveat Emptor opinion. As long as the US Dollar remains strong, this ETF should continue to excel. As with many previous market downturns, money has been flowing into the “safer” sectors of utilities, consumer staples, and telecom. If one looks at the recent high of the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) at $213.50 on May 21, the markets have fallen -9.3% as of Sept 23. Popular ETFs for these sectors are the Utilities Select Sector SPDR ETF (NYSEARCA: XLU ), the Consumer Staples Select Sector SPDR ETF (NYSEARCA: XLP ) and the SPDR S&P Telecom ETF (NYSEARCA: XTL ). Since May 21, utility and consumer staples investors have been rewarded with better relative declines of -5.9% and -4.9%, respectively, while telecom lost about market average of -9.8%. However, if one looked at the declines of these sector ETFs from their most recent highs, the carnage is a bit worse. Utilities peaked on Jan 29 and has declined -15.1%, telecom peaked on June 18 and has fallen -11.9%. Consumer staples peaked on Aug 5 and has declined -7.2%. On a year to date base, SPY is down -2.9%, XLU -8.5%, XTL -3.3%, and XLP -1.2%. Within these popular defensive sectors, consumer staples would seem to be the best performer for relative performance against a backdrop of an overall market decline. There are 13 consumer staples ETFs listed on ETFdb.com . YTD performance ranges from 9.39% for the PowerShares DWA Consumer Staples Momentum Portfolio ETF (NYSEARCA: PSL ) to -46.1% for the Global X Brazil Consumer ETF (NYSEARCA: BRAQ ). The top three YTD US performers were: PSL, the PowerShares Dynamic Food & Beverage Portfolio ETF (NYSEARCA: PBJ ) at 5.3% and the Guggenheim S&P Equal Weight Consumer Staples ETF (NYSEARCA: RHS ) at 2.5%. On a 1-yr, 3-yr and 5-yr basis, PSL has outperformed both the SPY and XLP, with the majority of its relative strength clocking in since Oct 2014. Prior, PSL mirrored SPY and bested XLP and the recent outperformance has lifted overall returns. According to etfdb.com, during the past year, PSL has returned 18.5% vs 7.5% for XLP, on a 3-yr basis, PSL has returned 70.5% vs 41.9% for XLP, and on a 5-yr basis, PSL has returned 123.7% vs 93.9% for XLP. A 3-yr graph of PSL vs SPY and XLP is below. What is the investment strategy of PSL that creates the outperformance? As a “smart beta” ETF, the underlying portfolio shifts quarterly centered on individual stock’s technical performance relative to the sector. PSL is a PowerShares ETF offered by Invesco. From their website : “The PowerShares DWA Consumer Staples Momentum Portfolio ((Fund)) is based on the Dorsey Wright® Consumer Staples Technical Leaders Index (DWA Consumer Staples Technical Leaders Index). The Fund will normally invest at least 90% of its total assets in common stocks that comprise the Index. The Index is designed to identify companies that are showing relative strength (momentum), and is composed of at least 30 common stocks from the NASDAQ US Benchmark Index. The Fund and the Index are rebalanced and reconstituted quarterly.” Zack’s comments on PSL: “Consumer staples sector is on the rise as it is directly linked with improving economic fundamentals, in particular the spending power, which has increased owing to cheap fuel and rising income. As such, PSL has been able to withstand global worries, gaining 2.6% so far in the second half. The ETF provides exposure to 32 stocks having positive relative strength (momentum) characteristics by tracking the DWA Consumer Staples Technical Leaders Index. It has amassed $203.4 million in AUM and trades in lower volume of 56,000 shares a day on average. Expense ratio came in at 0.60%. The product is pretty spread out across securities, with each holding less than 4.9% of assets. It has a definite tilt toward mid cap stocks while the other two market cap levels take the remainder. Food products, beverages and household durables are the key industries in the ETF having double-digit exposure each.” Momentum investing, aka “momo”, is a strategy of buying stocks that have generated high returns over the past three to twelve months, and selling those that have experienced poor returns over the same period. The ETF seeks investment results that correspond to the price and yield of the DWA Consumer Staples Technical Leaders Index, which evaluates companies based on a variety of investment criteria, including fundamental growth, stock valuation, investment timeliness and risk, comparative to others in the sector. From DWA website concerning their relative strength and top-down approach: “Relative Strength: Relative Strength, the measurement of how one security performs in comparison to another, is a key concept within Dorsey Wright’s methodology. Before investing in UPS, one should understand its recent performance relative to FedEx, or the S&P 500. The same logic can be applied to sector analysis, asset class evaluation, mutual funds, ETFs, commodities, fixed income, and even foreign countries. A relative strength matrix is like a massive tournament, where a huge quantity of investment options can be compared to one another – and we see who is strongest. Relative strength is the basis for virtually all of our managed products, where we select the best investment options from within a large universe of options. Top-Down Approach: We use primary market indicators to get a measure of overall risk, and then analyze broad industry sectors to determine which are in favor. We want to invest in sectors that are controlled by demand. We then select investments that have positive relative strength and have a good probability of outperforming the market. We do not feel compelled to be fully invested in stocks when an alternative investment (cash reserves) offers a more attractive opportunity. In fact, it is our belief that avoiding severe losses is extremely important in achieving strong market performance over the course of an entire market cycle.” PSL is one of 14 momentum driven ETFs utilizing various Dorsey Wright Technical Leaders Indexes and a list of other Indexes is found here . DWA offers an in-depth White Paper on the Dorsey Wright Strategy titled ” Relative Strength and Portfolio Management ” pdf. PSL was rebalanced on June 30 and the most recent list of stocks is below: (click to enlarge) Due to its focus on owning the top momentum stocks with quarterly rebalancing, investors should not be surprised at a high 83% Annual Turnover Rate. According to Morningstar, of the companies listed above, one was purchased in 2012, three in 2013, nineteen in 2014 and nine in 2015. The ETF’s industry allocation is broad based within the consumer staples sector and is reported by Invesco as follow: As the strategy includes NASDAQ stocks, PSL’s portfolio will have higher exposure to mid-caps and small-caps than its large cap S&P ETF brethren. Not only are smaller companies known for higher earnings potential, but usually are focused on domestic US markets rather than an extensive international network. Recently, the strength of the US Dollar has weighted on revenue growth and exchange rates for large cap companies, and this concern is usually less with smaller companies. The strength in domestic markets and reduced currency risk exposure may be a factor in these specific company’s current individual outperformance. The outperformance of PSL compared to XLP coincides with the meteorically rise in the US Dollar starting in Aug 2014. The average market cap in the portfolio is $14.5 billion and 72% of the portfolio are mid-caps or smaller. Below is a table offered by Morningstar of PSL valuation and growth matrix compared to the Benchmark of S&P 1500 Consumer Staples and the Category of Morningstar Defensive. While the comparison indicates PSL is trading at a higher valuation than the Benchmark and Category, its growth profile is also quite a bit higher. With Cash-Flow Growth 25% above the benchmark and Book-Value Growth more than double the Benchmark, a higher valuation would seem appropriate. This week, FINRA issued an Investor Alert titled, “Smart Beta-What You Need to Know”. The bottom line of the alert is the old adage: Know what you are buying and what the strategy is of the specific ETF. There are about 840 products that fall into a smart beta category, representing almost half of all the exchange-traded products listed in the U.S. and investors should understand that any strategy that aims to beat the market carries its own risks. “Recently, there has been significant growth in the number of financial products, primarily ETFs, which are linked to and seek to track the performance of alternatively weighted indices. These indices are commonly referred to as “smart beta” indices. They are constructed using methodologies that rely on, for example, equal weighting of underlying component stocks, or measures such as volatility or earnings, rather than market-cap weighting. Investors need to understand there is no free lunch here. Any time you are deviating from the market, you’re taking some kind of tilt. Understand what is the fund doing that is different than the market. That is a risk.” Investors looking for an ETF that is both defensive and has the potential for outperformance should review PSL to evaluate how it may fit into their current portfolio construction. As long as the US dollar stays strong and the international economies remain in question, this ETF should continue to reward long term investors. However, FINRA is correct: Caveat Emptor. Author’s Note 1: NASDAQ OXM (NASDAQ: NDAQ ) agreed to acquire privately-held Dorsey Wright Associates in Jan for $225 million. This will push NASDAQ into the smart beta ETF market in an aggressive manner. Author’s Note 2: Please review disclosure in Author’s profile.

Is Leverage Really An Advantage In Equity Closed-End Funds?

Prevailing wisdom holds that bullish market conditions favor leveraged, equity closed-end funds. Similarly, declining or flat markets are seen as favoring the unleveraged, option-income equity closed end funds. I look at comparable funds of each type for the period 2006 through 2015YTD to see how well this premise holds up. Closed-end funds (or CEFs) are primarily about income, less so about beating the market. If I may generalize, it’s the rare equity closed-end fund that beats, or even matches, other investment vehicles in its individual arena over sustained periods of time; but nearly all of them provide high levels of distribution income to their investors. If you’re not interested in the high yield, for domestic equity, you’re almost always going to be ahead of the game in either individual holdings, wisely chosen, or a solid indexed ETF. Of course there are exceptions; every generalization has exceptions, and I welcome your examples if you want to share them (with evidence if you please). But, by and large, I think this view holds up to careful scrutiny. Of course, some have success trading funds as their discounts and premiums fluctuate, or rack up gains in odd arbitrage situations that occasionally come up for CEFs, but that’s more specialized than what I have in mind. For the purposes of this article, I’m considering equity CEFs held primarily for current income and capital appreciation. For equity CEFs, there are two paths to generating that high income with capital appreciation. First is by exploiting the power of leverage to drive gains, and second is by an aggressive use of option trading, especially covered calls. Each strategy has its upsides and downsides. The conventional wisdom is that option funds are more defensive and do better in down or sideways markets. By this view, leveraged equity funds are at their best in strongly bullish markets. Makes sense, but the subject has come up several times in comment streams and private messages questioning those assertions when I’ve repeated them. I’ve been looking for evidence to support (or negate) that particular set of generalizations. I’m sure such research exists, but I’ve not put my hands on it so I thought I’d take a quick look. What I’ll report on here is not a rigorous analysis. It has a limited number of data points, covers a brief period, and is hardly more than observational in the large scheme of things. But it is what I’ve been able to put it together without an excessive investment of time given the limited sets of data I have access to. I would encourage anyone so inclined to make a more detailed analysis. For the present, I think CEF investors will find even a cursory analysis interesting enough to generate discussion. I decided to look at CEFs from a single sponsor. I selected 6 Eaton Vance equity closed-end funds, 3 each leveraged and unleveraged. I picked Eaton Vance because I think a good case can be made that theirs are among the best-managed equity CEFs. That, plus I own several, so it was of interest to me on a personal portfolio level as well. Funds were chosen on the basis of having the best 3 yr returns on NAV, an arbitrary cut, but straightforward data to obtain for large numbers of funds – NAV returns for longer time periods is not readily available in formats that can be used as to filter the data. I compared total return (market) for each by calendar year using data from YCharts for each of the funds. The six funds and current values for effective leverage are: Effective Leverage EV Enhanced Equity Income II (NYSE: EOS ) 0.00% EV Tax-Managed Div Equity Inc (NYSE: ETY ) 0.00% EV Tax-Managed Buy-Write Opps (NYSE: ETV ) 0.00% EV Tax Advantaged Dividend Inc (NYSE: EVT ) 21.05% EV Tax Adv Global Dividend Inc (NYSE: ETG ) 23.25% EV Tax Adv Global Div Opps (NYSE: ETO ) 24.38% The earliest year with complete data for all 6 funds is 2007. The period from 2007 through 2015 YTD covers the deep downturn of the recession and the strong bull market of the past few years, so there is a complete and extreme cycle. Plotting the average, maximum and minimum returns from the three funds of each class produces these charts. It’s clear that the leveraged funds fared much more poorly in the 2008 bear market than did the unleveraged funds. But it is difficult to see a clear pattern over the other years. To bring some clarity, I calculated the excess return of leveraged funds vs. unleveraged funds for each year, and plotted those values against annual returns of the S&P500 index. (click to enlarge) In this plot the Y axis represents the level of relative performance by leveraged funds and unleveraged funds. Outperformance by leveraged funds is represented by the area above the 0 line. Differences between funds in the two categories are shown here in basis points, so these data include highly meaningful differences in return to an investor. The trend line is consistent with the predicted relationship: For down years the option-income funds outperform. The correlation is weak at best, however: r 2 for the relationship is only 0.188. The trend line we see in this chart is strongly influenced by the 2008 data where, as we have already seen, the unleveraged funds strongly outperformed (in the sense of being much less negative) the leveraged funds. What happens if we look at the chart with that heavy weight of 2008 omitted? A different picture, but not one that adds clarity, emerges. (click to enlarge) What we see here is a weak trend in the opposite direction. The trend is even weaker than when 2008 is included (r2 = -0.069). Unleveraged funds outperformed the leveraged funds during the two years of highest returns for the S&P 500 (2009, 2013). This result cuts against that predicted from conventional wisdom. The leveraged funds did, however, outperform in years with moderately high returns, but from the full set of results that can as easily be attributed to chance as any advantage derived from market conditions that those funds may have had. The best we can say here is that any outperformance by leveraged funds is essentially uncorrelated to broader market performance. So, how fares the prevailing dogma on the topic? There’s a bit here to support it, in the sense that for the disastrous 2008, leveraged funds suffered much deeper losses than the unleveraged funds. But beyond that extreme case, which is after all only a single data point, there is little to support (or negate) the prevailing view that strongly up markets favor the leveraged funds. Clearly, this is only a glimpse at the full situation but, to my mind, there is sufficient information here to call into question idea that there are advantages for leverage funds in relation to prevailing market up trends. Which leads to the question: If leveraged funds cannot consistently outperform in bullish markets, why invest in them at all? I think an evaluation of the advantages or disadvantages of investing in leveraged equity is particularly relevant to the current situation where rising interest rates will increase leverage costs, however modestly, thereby increasing the drag on those funds. I have been avoiding leveraged equity CEFs for some time, in part because of the widely held view that less bullish markets favor the option-income funds, and in part because of previous research ( Debunking the Myth of Leverage for Closed-End Funds ), which did not consider overall market conditions, that showed little advantage to leverage in closed-end funds of various categories. As readers know, I am a fan of CEFs for providing income with capital preservation — as bond substitutes if you will. It’s been my view, which this brief look at the issue supports, that option-income is a more effective strategy for accomplishing those objectives than simply throwing leverage at it. So, for those looking for an explicit conclusion: Leverage is unlikely to provide returns that justify its inherent risk, even under conditions that are assumed to favor leveraged investing.