Tag Archives: etfs

Fixed Income Ain’t So ‘Fixed’

Summary Subclasses of Fixed Income has had highly unusual and varied performance over this market decline. Medium & Long Term Treasuries are two of the greatest sources of risk in the Fixed Income subclass. High Yield Corporate debt has not only had positive returns, but is reducing risk. We’ve convinced readers several times through our intuitive visualizations that the market decline currently underway can’t simply be explained by looking at historical norms. The current market dynamics are telling a unique story about the undercurrents of asset behavior. Take for instance, Fixed Income. It’s that canonical asset class that garners the second half of portfolio allocation parlance — 80/20, 70/30, 60/40… In all of these coptic number combinations, the second value indicates the amount an investor should allocate towards Fixed Income in an effort to reduce risk in the portfolio at large. And yet, as an asset class with such a refined mandate of risk reduction, investors have seen highly varied outcomes in the subclasses of Fixed Income over the past two weeks. Below, we use the following Fixed Income subclasses and related tickers for our analysis: Fixed Income Subclass Ticker Short Term Treasuries (1 – 3 Years) SHY Medium Term Treasuries (7 – 10 Years) IEF Long Term Treasuries (20+ Years) TLT US Inflation Protected Securities TIP Investment Grade Corporate Bonds LQD High Yield Corporate Bonds HYG USD Denominated Foreign Fixed Income EMB Local Currency Foreign Fixed Income BWX Cumulate Return Since the Decline Began The first market correction occurred on Friday, the 21st of August. Therefore, the chart below looks at cumulative return of the major sub-classes of Fixed Income from market close on the 20th of August to market close yesterday, the 1st of September. (click to enlarge) In fact, the return of Fixed Income subclasses has been anything but ” fixed” during this market decline. Usually, treasury bonds are the bastion of safety when it comes to market dislocations. For example the 10 year yield dropped to an all-time low of 1.695% during the 2011 September correction. Not this time. From the chart above, you can see the only subclass of treasuries that has not experienced decline is Short Term Treasuries (1 – 3 years). Medium Term Treasuries (7 – 10 years) and Long Term Treasuries (20+ years) have experienced declines of roughly 1/4 of one percent and nearly 3% respectively. For comparative purposes, the iShares Core Aggressive Allocation , ticker, AOA has dropped 4.5% since the correction began. In simpleton terms, the subclass of Long Term Treasuries has experienced a loss 65% as great as an aggressively allocated portfolio… take a minute, because that’s a big deal. Also surprisingly, low credit quality corporate bonds — also known as High Yield — have been one of the greatest sources of risk reduction in the current decline. The often-quoted dogma is that “high yield bonds act like stocks during market decline.” However, High Yield has not only accreted positive return over the past two weeks (albeit marginally), but also hedged risk most effectively (as can be seen in the final chart below). Risk Sources in Fixed Income Subclasses Our prior posts have demonstrated the value of intuitive visualization when considering sources of risk. Specifically, an investor shouldn’t just care about how risky an individual asset is, but should also analyze the risk of an asset using some measure of co-movement. Below we provide both of those measures — Expected Extreme Risk and Contribution to Portfolio Risk — for the Fixed Income subclasses. (click to enlarge) Expected Extreme Loss is calculated using today’s sample estimate of exponentially smoothed volatility to scale historical log returns. Those scaled historical returns are then used to create a non-parametric return distribution, for which we use the 99% CVaR as the Expected Extreme Loss. Note how the expected extreme loss of High Yield debt is only slightly higher than Medium Term Treasuries and Investment Grade Corporate debt. This chart is akin to showing, “if market dynamics were to change (i.e. the structure of covariation were to change), which subclasses might we expect to exhibit the most extreme risk given today’s volatility information.” In our upcoming post, we will go through a more comprehensive description of how we frame risk at Viziphi, and how our tools make those concepts easily accessible to users. However, it suffices to say that investors should not just be thinking about the information available in the market today, but what might happen should we see a shift in the co-movement structure. (click to enlarge) Contribution to Extreme Loss is used by simulating multivariate t-distributions whose volatility and covariance structure are determined using exponentially smoothed sample estimates of today’s information. The investor should take note that the two single greatest sources of risk in the Fixed Income subclass, given today’s market dynamics, are Long Term Treasuries and Medium Term Treasuries, and one of the greatest sources of diversification is High Yield Corporate Debt. If you’re still reading this post, you shouldn’t be… you should be checking your brokerage account to see how much exposure you’ve got to those two subclasses because this is a significant shift from the way that risk has been hedged using Fixed Income in past market environments. Summary Historical anecdote doesn’t suffice in understanding how investor’s portfolios are being impacted by the current market environment. Core tenets of asset allocation — like using Fixed Income to broadly reduce portfolio risk — can fail to provide the most effective guidance to hedging risk in different market environments. Measurements like Contribution to Extreme Loss and Expected Extreme Loss help investors quantify risk in ways to respectively understand how: The current market environment is driving asset subclass risk within the portfolio Aggregate risk could change given a shift in asset co-movement Both measures are vital in constructing a coherent picture of risk and should be leveraged when attempting to make prudent portfolio allocation decisions. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

PIMCO High Income Fund – Next Stop, NAV

$PHK is a closed-end fund that had historically habitually traded at a large NAV premium, with the irrational bull thesis predicated on an unsustainable dividend. We had correctly predicted a dividend cut would be forthcoming. Now that dividend has been cut, the next stop for $PHK is NAV using $PHT as an analog. Target price of $7.11, represents -18% downside from current $8.62 price. This thesis is very simple. For the reasons articulated in our previous PIMCO High Income Fund (NYSE: PHK ) article , the bull thesis for $PHK trading at a significant premium to NAV was highly misguided as the dividend level was unsustainable. On 9/1/15, Pimco announced the predicted dividend cut in the September dividend announcement , cutting the monthly dividend by 15% to $0.103 from $0.122. $PHK’s stock price has decreased significantly today given the announcement, -8.8% currently to $8.62 from yesterday’s close of $9.45. Investors in $PHK or potential short-sellers may believe that the selling pressure will subside given the observed price action. However, this is misguided, as we have an analog for another high yield closed-end fund that had historically traded at a premium and had its dividend cut. Pioneer High Income Trust (NYSE: PHT ), which launched in Apr-2002 and cut its dividend in Feb-15 to $0.115/month from $0.1375/month (-16% dividend cut). This caused the fund to trade down dramatically from a ~45% premium to a current -1.5% discount to NAV, causing significant capital loss for CEF investors. (click to enlarge) $PHK’s current NAV is $7.11 (see ” Daily Statistics “), meaning that the current $8.62 price still represents a 21% premium to NAV. Now that the “dividend consistency” bull argument for $PHK has been discredited, there is no “NAV premium” floor for the fund and we expect $PHK to follow a very similar trajectory to $PHT, with $PHK ultimately trading to NAV in the near future. Note: In addition, there is adequate borrow for short-sellers. Caveat emptor. Disclosure: I am/we are short PHK. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: The author and/or others he advises holds short a position in PHK at the time of publishing this article. The author may make trades in securities mentioned without notification. The information contained in this article is impersonal and not tailored to the investment needs of any specific person. You should consult with a professional where appropriate. The author shall not be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. The opinions expressed in this article are for informational purposes only and should not be construed as investment advice. The article is not a recommendation of, or an offer to sell or solicitation of an offer to buy, any particular security, strategy or investment product. The research for this article is based on public information that the author considers reliable, but the author does not represent that the research or the article is accurate or complete, and it should not be relied on as such. The views and opinions expressed herein are current as of the date of this article and are subject to change. Any projections, forecasts and estimates contained in this article are necessarily speculative in nature and are based upon certain assumptions. In addition, matters they describe are subject to known (and unknown) risks, uncertainties and other unpredictable factors, many of which are beyond the author’s control. No representations or warranties are made as to the accuracy of such forward-looking assumptions. It can be expected that some or all of such forward-looking assumptions will not materialize or will vary significantly from actual result.

3 Large Cap Value ETFs For Every Kind Of Investor

Large Cap Value ETFs offer great balance to go-go growth stocks. Patience is rewarded with value stocks. The market often beats down great companies to levels below intrinsic value. Most Large cap value ETFs offer familiar names trading at discounts. I am a value investor, meaning I look for stocks that the market hasn’t discovered yet or that are out of favor for some reason. The large-cap sector can provide outsized returns with reduced risk, by not buying stocks that are even close to being fairly valued. These value stocks require patience that is often rewarded, and comes without the handwringing that goes along with growth stocks. I’ve been hunting down 3 large-cap ETFs to share with aggressive investors, conservative investors, and the average investor. Why own a large-cap ETF? As mentioned, value stocks give you a hedge against taking on too much risk, and they are necessary to offset the increased risk that comes with investing in small-cap stocks that offer higher rewards but higher risk. Also you must have diversification in your portfolio. Sector outperformance occurs all the time, and the more diversification you have, the better. If you don’t have diversification, then you risk seeing your overall portfolio fall more in bad times by having your money overly concentrated. For conservative investors, have a look at the Vanguard Value ETF (NYSEARCA: VTV ). One of the cheapest ETFs in the category, it carries an expense ratio of 0.09%. Vanguard asserts that similar funds have a 1.11% expense ratio. That expense ratio is easily covered by its 2.52% yield, so you get a little spending money along with this ETF. With 318 holdings and a median market cap of $85.5 billion, you are getting the top-of-the-line companies in this ETF. The top 10 holdings only account for 25.8% of the total asset base, and they are safe and reliable investments with all the premier names you recognize. The sector diversity of the Vanguard Value ETF is impressive. It has 22% of assets invested in financials, 18% in consumer goods and services, 15% in health care, 11% in industrials, 10% in technology and 10% in energy. The rest is divided between basic materials, telecom and utilities. What I really like here is the fund has a beta of 0.98, meaning is to 2% less volatile than the broad market. However, with a Sharpe Ratio of 1.85, it has significantly enhanced risk-adjusted return compared to a risk-free investment. Here we find the kind of famous names you’d expect: ExxonMobil (NYSE: XOM ) , Microsoft (NASDAQ: MSFT ) , Johnson & Johnson (NYSE: JNJ ) , Berkshire Hathaway ( BRK ) , and Wells Fargo (NYSE: WFC ). This is a buy-and-hold fund, with only 5.5% of stocks turned over in the past year. That’s as it should be. The point is that value stocks require patience, not switching in and out of stocks. Its average price-earnings ratio is 17.9. It has a 96% total return over the past ten years. Aggressive investors should have a look at the First Trust Large Cap Value AlphaDEX ETF (NYSEARCA: FTA ) . It has 204 holdings, so it isn’t highly concentrated and therefore too risky, but it isn’t spread too thin, either. The top 10 stocks only make up 10% of the asset base, so you don’t have too much concentration risk, either. That’s why I like it – its more aggressive approach is tempered by these moves.. The expense ratio is a bit high at 0.64%, but still 47 bps below the average fund, if Vanguard is to be believed. Since inception, it has only returned 30%. However, coming off the low of the financial crisis, it is up almost 260%. The top holdings are from several different sectors. They include Tesoro (NYSE: TSO ), Edison International (NYSE: EIX ), PPL Corp. (NYSE: PPL ) and Traveler’s Companies (NYSE: TRV ). The fund has concentrated itself into six sectors: 18.5% utilities, 16% energy, 15% financials, 5% consumer discretionary, 14% industrials, and 11% IT. It carries a 3-year beta of 1.05, meaning it is only 5% more volatile than the market and comes with a Sharpe Ratio of 1.51 – meaning enhanced risk-adjusted returns compared to risk-free investments. A solid large-cap value ETF choice for the general investor is the Guggenheim S&P 500 Pure Value ETF (NYSEARCA: RPV ) . At 199 holdings, it’s a bit too concentrated that I would like, but that’s still a lot of stocks to give you diversification that you need. The top 10 stocks account for 19% of the asset base. Its expense ratio is only 0.35%. Looking at risk, its 3-year beta is 1.2, meaning it has 20% more volatility than the broad market. However, the reason I like it for average investors is that the additional volatility comes with a Sharpe Ratio of 1.92 – meaning it has an excellent risk-adjusted return. Diversification is pretty good, with 25% energy, 33% allocationin financials, 4% health care, 4% technology, 5% industrial and 16% consumer holdings. Top names include Assurant (NYSE: AIZ ), Velaro (NYSE: VLO ), Gamestop (NYSE: GME ) , and Phillips 66 (NYSE: PSX ). As with any article regarding investments, you should never rely on information you read without doing your own due diligence. My articles contain my honest, forthright and carefully considered personal opinion, and conclusions, containing information derived from my own research. This may include discussions with management. I do not repeat “talking points” but may quote management from an interview. I am never influenced by third parties in arriving at my conclusions. Do not solely rely on my articles or anyone else’s when making an investment decision. Always contact your financial advisor before investing in any security. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.