Tag Archives: energy

It Is A Good Time To Invest In The YieldCo ETF

Summary The renewable energy market is growing and yieldcos are gaining traction. The Global X YieldCo ETF remains insulated from the Chinese stock market weakness. Better performance than peers. The Global X YieldCo Index ETF (NASDAQ: YLCO ) is an ETF investing in YieldCos. This ETF provides a good chance of increasing investor returns, since it invests in the high yielding yieldcos as their underlying asset. In addition to investing in yieldcos which are considered a less risky way of earning stable dividends, this ETF also provides the benefit of diversification. The renewable energy market is set to grow at a rapid pace and will account for the lion’s share of electricity capacity going forward. YLCO has been battered recently due to a sharp fall in the overall energy sector. This has led to a jump in their yields as prices have declined. After drawing strong investor interest, the situation has reversed with investors shunning these securities. SunEdison (NYSE: SUNE ) which runs 2 yieldcos has said that it will not drop further projects into its yieldcos, given the sharp price erosion. Other companies such as Trina Solar (NYSE: TSL ) have also halted their plans of listing a yieldco. However, my view is that this is a temporary hiccup due to a combination of high exuberance for yieldcos and an overall selloff in energy prices. YLCO is currently trading down 27% since its listing in May 2015. Given the current slump in yieldco prices, I think it should be a good time to build some position in this safe bet. Why you should invest in this YieldCo ETF Underlying assets are yieldcos, which are growing – YieldCos are considered a safe bet given their low risk profile and ability to generate stable and predictable cash flows. They are also less volatile than renewable energy stocks. Even when the entire energy market is going through a severe downturn, I believe yieldcos are a good bet as they should continue paying their dividends since their cash flows are relatively immune from recessions. The growth story is also strong as the renewable energy industry is set to continue over the long term. No exposure to the Chinese market – The Chinese market turmoil has strongly affected the global commodity industry, with many commodity producers trading at multi year lows. There is a fear that the Chinese economy may face a hard landing leading to global slowdown. The global YieldCo ETF does not have any exposure in the Chinese market. The ETF has its maximum exposure in the U.S. market followed by the U.K. These two economies are performing well relative to other regions, such as Japan and Europe. A better shield to downside risks than individual holdings – YLCO has lost 27% since inception. Given below is the YTD performance of some of its top holdings, suggesting the ETF’s performance was better than most of its constituents. % of Holding YieldCos YTD performance 12.45 Brookfield Renewable Energy Partners (NYSE: BEP ) -10% 8.32 Terraform Power (NASDAQ: TERP ) -38% 7.68 NRG Yield Inc (NYSE: NYLD ) -45% 7.36 Nextera Energy Partners (NYSE: NEP ) -27% 6.53 Abengoa Yield (NASDAQ: ABY ) -27% Data as on 13th October’15 closing The renewable Energy Market is booming – There is an increased awareness about the renewable energy usage and its benefits in reducing the effects of global warming. Countries like India have large power deficits and rely on coal for their energy needs. Now these countries are at the forefront of an energy revolution, shifting largely towards solar, wind and other renewable forms of energy for their power needs. The U.S. has also made its stand clear by passing its recent ‘Climate Action Plan’. All of this speaks of a booming renewable energy demand. It is estimated that renewable energy could account for almost 80% of the world’s energy supply within four decades. The market for yieldcos is growing – YieldCos have proven to be a success amongst the shareholders, primarily due to their stable dividend growth and relatively lower risk profile. With the growing renewable energy market, more yieldcos are coming into existence. After the success of SunEdison’s ( SUNE ) Terraform Power, the company has also listed another yieldco specializing in developing economies – Terraform Global (NASDAQ: GLBL ). There was also a joint yieldco by SunPower (NASDAQ: SPWR ) and First Solar (NASDAQ: FSLR ) called 8point3 Energy Partners (NASDAQ: CAFD ). Likewise, Canadian Solar (NASDAQ: CSIQ ) is also thinking of forming a yieldco before year end. Stock performance & Valuation YLCO gave better returns than some of its top holdings, as shown in the table above. The YTD performance was also better than solar ETFs like the Guggenheim Solar ETF (NYSEARCA: TAN ) and the Market Vectors Solar Energy ETF (NYSEARCA: KWT ). The stock is currently trading at ~$11 which is 26% low than its all-time high price. The ETF was listed in May 2015 with an expense ratio of 0.65%. (click to enlarge) Source: Google Finance What could go wrong The energy stocks have taken quite a beating in recent days and yieldcos have not been immune to this fall. The slowdown of the Chinese economy has not only hurt the Chinese energy demand growth, but also the growth in other countries due to secondary indirect effect as their exports to the Chinese economy has declined. As we can see from the graph above, the stock price decline has happened in line and is following the trend in the broader energy market. If conditions get worse, the ETF could also lose more value. The project business is a highly capital intensive business, where developers resort to large amount of debt. Any problems in the sponsor company to honor their debt might lead to a slowdown in the yieldco business. Some of the yieldcos are now adopting a more prudent growth strategy to take into account the market turmoil. Some of the solar companies have also put their plans to do yieldco in cold storage. This might help YLCO as the competition for renewable energy assets will reduce, thereby making existing yieldcos more attractive. Conclusion The current weakness in the energy sector has caused major downturn in the energy sector. I believe this will cause the weaker players to close shop and only good quality stocks would survive. The major advantage of YLCO is that it does not have any exposure in the Chinese market, which is experiencing a major slowdown. Though it will not be totally isolated from the Chinese slowdown effects, it will still not be very drastic. Also the investment case for renewable energy market continues to be strong and YLCO insulates its investors from the volatility of directly investing in this sector. I think this is a good time to build a position in this yieldco ETF. Share this article with a colleague

Dollar Weakens; Time For Large-Cap Value ETFs?

The economic outlook looks misted up yet again by undesirable global events. The Chinese economy is striving to ease a hard landing; Japan is also seeing deceleration in its growth pace; European markets are far from steady despite a QE policy; capitals are gushing out of emerging markets and most importantly, recent reports out of the lone star in the developed market pack, the U.S. economy, aren’t quite favorable thanks to a soft labor market. Added to this, heightened speculations about the Fed lift-off have taken a backseat. While muted inflation and global growth worries had held back the Fed from ratifying a rate hike in its September meeting, a slowdown in the labor market over the last three months have almost killed the possibility of a hike at the December Fed meeting, guarantying cheap money inflows throughout this year. As a result, equities jumped and the greenback dived. And the case for large-cap ETF investing had never been stronger than now. Investors should note that a subdued greenback sets the stage of large-cap stocks’ outperformance as this group of companies has considerable exposure in the international market. So, foreign profits are curtailed in a stronger dollar environment when repatriating back home. That being said, we would like to note that levels of uncertainty have flared up in the investing world. This is truer given the fact that the IMF recently slashed its global growth forecast for 2015 and 2016. Back home, the Fed also cut the expectation for 2016 real GDP growth to 2.1─2.8% from 2.3─3.0% though the same for 2015 was upgraded to 1.9─2.5% from 1.7─2.3% projected in June. The Fed also lowered its 2015 projection for personal consumer expenditure inflation to 0.3─1.0% from 0.6─1.0% guided in June. The earnings picture looks equally gloomy as the S&P 500 earnings and revenues are expected to decline 5.7% each in the third quarter. This does not leave the U.S. market without doubts and mean that some investors might want to look at large caps for the vast majority of their exposure, and especially so in the value space. While one can do this with individual securities, there are a number of value-focused large cap ETFs that can be better choices. Below, we highlight four of such large-cap value ETFs which delivered smart returns in the last one-month frame and could be intriguing choices ahead should the market forces remain the same. First Trust Morningstar Dividend Leaders Index ETF (NYSEARCA: FDL ) This fund follows the Morningstar Dividend Leaders Index with AUM of $810 million in its asset base. In total, the fund holds 99 stocks. From a sector look, consumer staples, utilities, telecom, energy and industrials each take a double-digit allocation in the basket (read: 5 Investor-Friendly Dow Dog ETFs for 2015 ). Expense ratio comes in at 0.45%. The fund added over 5.8% in the last one month (as of October 12, 2015) and has a dividend yield of 3.60% annually. The fund has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook. iShares Core High Dividend ETF (NYSEARCA: HDV ) This product provides exposure to 74 dividend stocks by tracking the Morningstar Dividend Yield Focus Index. From a sector look, the fund is well spread out with double-digit exposure to Energy, Consumer Staples, Health Care, Telecom and Information Technology. This Zacks Rank #3 fund is among the largest ETF in the large cap space with AUM of about $4.17 billion. It charges 12 bps in fees per year and gained over 5.1% in the last one year. The fund has an annual dividend yield of 3.86%. First Trust Value Line Dividend ETF (NYSEARCA: FVD ) This ETF tracks the Value Line Dividend Index, giving investors exposure to about 209 companies that have a Value Line Safety Ranking of #1 or #2. Value Line selects those companies that have higher-than-average dividend yield as compared with the indicated dividend yield of the Standard & Poor’s 500 Composite Stock Price Index. This results in an equal weight approach for individual securities. Utilities takes the top spot at 22.7% of assets, followed by Financials (18%), Industrials (14.9%) and Consumer Staples (12%) (read: 5 Smart Beta ETFs to Beat the Choppy Market ). The Zacks Rank #3-fund is a bit pricier than many other products in the dividend space, charging investors 70 bps a year in fees. It has accumulated $1.4 million in its asset base. SPDR Dividend ETF (NYSEARCA: SDY ) This ultra-popular fund provides exposure to the 101 U.S. stocks that have been consistently increasing their dividend every year for at least 25 years. It follows the S&P High Yield Dividend Aristocrats Index and has amassed $12.6 billion in AUM. Expense ratio comes in at 0.35%. The product is widely diversified across components as each security accounts for less than 2.82% of total assets. Financials is the top sector taking up one-fourth of the portfolio while consumer staples (15.1%), industrials (13.7%), utilities (11.6%) and materials (11.2%) round off the next four spots. The fund was up nearly 4.6% in the last one-month and has a Zacks ETF Rank of 3. Link to the original post on Zacks.com

Direxion Daily Emerging Markets Bear 3x: Long Run Expected Value Is Zero

Summary Since inception, the ETF has depreciated over 98%. Its long run expected value is zero due to the structural deficiencies of leveraged ETFs, combined with the positive expected return of emerging market equities. The ETF is easy to borrow, making this an actionable short candidate when sized prudently. Background on the Fund The Direxion Daily Emerging Markets Bear 3X ETF (NYSE: EDZ ) seeks daily investment results, before fees and expenses, of 300% of the inverse of the performance of the MSCI Emerging Markets Index. As summarized below, the MSCI Emerging Markets Index is diversified geographically across 23 countries and 837 individual stocks. Source: MSCI Emerging Markets Index Fact Sheet The Direxion fund attempts to create its leveraged exposure through investing at least 80% of its assets in a combination of instruments/derivatives including futures, options, indices, swaps, forwards, reverse repurchase agreements, ETFs, and equity caps, floors and collars. As shown below, the fund is down more than 98% since its inception in late 2008. (click to enlarge) In order to understand the reasons for this performance, as well as whether it’s likely to persist over the long run, it helps to break down the performance into its two key drivers: 1) the return of the underlying index, and 2) the construction of the ETF. Let’s go through each. Performance of Underlying Index Despite the recent turbulence in emerging markets, the MSCI Emerging Markets Index is up just over 8.5% annually since 2000. (click to enlarge) Source: MSCI Emerging Markets Index Fact Sheet As we look forward, predicting short term moves in the market is extremely difficult (or impossible, according to some academics). But we do know that the MSCI EM Index is trading at an average (12 month forward consensus) P/E ratio of about 11, which translates to an earnings yield of about 9% (higher if cyclically adjusted). This means that if we ignore growth and assume that valuation multiples stay constant, the annual return of the index would be in the very high single digits so long as the value created by the underlying companies ultimately accretes to shareholders. (click to enlarge) Source: Yardeni Research Global Index Briefing Construction of ETF The second (and likely more important) driver of returns for the Direxion ETF over longer periods of time is the methodology of its construction. There are numerous articles in the academic literature (such as this ) reviewing the tendency of leveraged ETFs to decay over time. I’ll go through a number of additional examples of this decay a little later on, but first let’s walk through the reasons why it occurs. Effectively short volatility / mean reversion: Since the ETF seeks to track the daily returns of the underlying index, it must rebalance on a daily basis. When the index goes down, the ETF must add short exposure to maintain its positioning, and vice versa when the index goes up. In other words, the ETF routinely needs to “buy high and sell low.” The result is that in volatile, but non-trending markets, the ETF decays. The fund’s prospectus provides an example that “this fund… would be expected to lose 31.3%… if its Index provided no return over a one year period during which the Index experienced annualized volatility of 25%.” Magnified transactions costs: ETFs incur transactions costs when investors move in and out of the funds. The impact of this can be magnified for leveraged ETFs like EDZ since a) a large portion of the underlying investors in these funds are short-term oriented, and b) the funds must rebalance daily based on market moves, as discussed above. Fund expenses: Though not unique to leveraged ETFs, fund expenses are another marginal drag on returns. Per the fund’s prospectus, its operating expense ratio is approximately 0.98%. Additional Examples Below we can see a summary of annualized returns for the various equity-related Direxion 3x leveraged ETF pairs that have track records of at least 2 years. Name Ticker Appx Annualized Return since Inception Daily Energy Bull 3x ERX 0% Daily Energy Bear 3x ERY -47% Daily Financial Bull 3x FAS 14% Daily Financial Bear 3x FAZ -68% Daily Gold Miners Index Bull 3x NUGT -70% Daily Gold Miners Index Bear 3x DUST -12% Daily Junior Gold Miners Index Bull 3x JNUG -81% Daily Junior Gold Miners Index Bear 3x JDST -71% Daily Real Estate Bull 3x DRN 45% Daily Real Estate Bear 3x DRV -59% Daily Semiconductor Bull 3x SOXL 19% Daily Semiconductor Bear 3x SOXS -53% Daily Technology Bull 3x TECL 38% Daily Technology Bear 3x TECS -53% Daily Mid Cap Bull 3x MIDU 25% Daily Mid Cap Bear 3x MIDZ -53% Daily Small Cap Bull 3x TNA 30% Daily Small Cap Bear 3x TZA -60% Daily FTSE China Bull 3x YINN -8% Daily FTSE China Bear 3x YANG -42% Daily Developed Markets Bull 3x DZK 1% Daily Developed Markets Bear 3x DPK -43% Daily Emerging Markets Bull 3x EDC -6% Daily Emerging Markets Bear 3x EDZ -47% Daily Russia Bull 3x RUSL -58% Daily Russia Bear 3x RUSS -30% Simple Average -27% Although all of these ETFs are vulnerable to the sources of decay outlined above, in this article I highlight the Direxion Daily Emerging Markets Bear 3X ETF for a few important reasons: This ETF is easy to borrow (with a cost under 3% through some retail brokers), which makes it worthy of consideration as a longer term short for those knowledgeable in these products. However, a critical caveat is that the position would need to be sized prudently, given that there have been occasions when some of these ETFs have moved more than 100% over relatively short periods of time. Emerging market equities are an especially volatile asset class, which I expect to exacerbate the leverage trap given that these ETFs tend to underperform during periods of volatility, as discussed above. Equities tend to be more mean-reverting (compared to commodities, which often trend). As again reviewed above, these ETFs tend to decay most in mean-reverting environments. Emerging market equities are likely to have one of the highest long run expected returns among asset classes (though not necessarily the highest Sharpe) given their elevated earnings yield noted previously. Conclusion As long as one believes that the long run performance of emerging market equities will be positive or that it will be flat but with non-zero volatility, the long run expected value of this ETF is zero. Those considering trading the ETF should be cognizant of this (and the implicit bet on volatility that they are making).