Tag Archives: etfs

Global X YieldCo ETF: Not Ready For Prime Time

YieldCos are a relatively new market entrant focused on paying dividends. Despite some popularity among income investors, they are, at best, untested. But that didn’t stop Global X from creating an ETF to track them. I have misgivings about exchange traded funds, or ETFs, in general. While a good idea on one level, Wall Street has a habit of turning good ideas into misused and abused ideas. Which is why Global X YieldCo Index ETF (NASDAQ: YLCO ) caught my attention. I’d say this ETF is a risky investment that most investors should avoid. Here’s why… What’s a YieldCo? So an ETF is a collection of stocks or bonds that trade on an exchange all day long. Sort of like a mutual fund, sort of like a closed-end fund. The ability to trade all day makes ETFs similar to closed end funds. But the market price for a closed-end fund can vary greatly from its net asset value. The structure of ETFs lead them to trade pretty close to net asset value, like a mutual fund. ETFs are also very cheap to own. There is, in fact, a lot to like about ETFs, so long as you stick to large, well diversified funds. But Wall Street, seeing a hot new product, has ramped up its marketing machine. How many S&P 500 ETFs do we need? Not many. Which is why ETFs have gotten more and more obscure, often targeting niche areas and risky investment approaches. Is there a place for these vehicles? Probably. Should average investors be putting their money in them? Probably not. Which is why a YieldCo ETF caught my eye. YieldCos are a relatively new business construct, dating back to around 2012. At this point, they are very similar to a limited partnership structure in which there is a sponsor company that sells its assets to the YieldCo. The YieldCo then spits out income to shareholders. The big difference is that the YieldCo is generally a regular company, so there’s fewer tax headaches than you would face with an LP which is structured as a partnership. On the surface this sounds great. The YieldCos in existence have generally owned electric generating assets with long-term contracts in place, so there’s even some ability to predict a reliable income stream. Investments in the renewable power space (solar and wind, for example) are most often highlighted, though YieldCos own other types of electric generation, too. Growth comes from buying more and more assets. Like LPs and REITs, however, YieldCos spit out so much income that they have to issue more shares to pay for additional assets. There’s nothing inherently wrong with this, since there are obvious precedents for the business model. However, that still doesn’t mean this relatively new business model will work out as planned. Moreover, the focus on renewable power projects means that YieldCos are tapping into a current investor interest. That’s great right now, but what if investors lose interest? So, by and large, I’d say that YieldCos have an interesting story behind them. But, and this is a big but, the long-term legs of the story remain untested. So investors should tread lightly in the YieldCo space, tempering a desire for income and income growth with a bit reality about the very short life most of these entities have lived. If you want proof of these risks, take a moment to look at the recent events around NRG Energy (NYSE: NRG ) and its YieldCo NRG Yield (NYSE: NYLD ). Diversify to reduce risk Of course, one way to offset the risk of owning just one or two YieldCos would be to buy a portfolio of them, right? And that’s where Global X’s YieldCo product comes in. It owns 20 of the largest YieldCos and provides a one-stop shop for getting diversified exposure to this potentially up and coming space. Wait… There’s some problems here. YLCO does own 20 stocks, but its prospectus explains a minor detail you’ll want to watch: “The components of the underlying index are YieldCos selected from the universe of global publicly listed equities, which have a minimum market capitalization of $500m and an Average Daily Value Traded (“ADVT”) over the last three months greater than $1 million. If less than 20 securities satisfy this criteria, the market capitalization and ADVT requirements are lowered. If there are still fewer than 20 securities, the parent companies of proposed YieldCos with the nearest anticipated listing dates will be included in the index until there are 20 index constituents.” In plain English that says, “We want to own 20 YieldCos but there aren’t that many of them right now. So we buy all that we can, even really tiny ones. Since that still may not lead to 20 holdings, we’ll buy companies that aren’t YieldCos but that have said they want to spin one off.” So YLCO has built a niche ETF in a sector that doesn’t have enough stocks in it to support a portfolio of 20 sufficiently sized companies. Think about that for one second. You are buying everything in the sector without any regard to whether or not it’s a good or bad company. With only little regard to size. All a company needs to be is a YieldCo, or a company that says it wants to spin a YieldCo off, to pass muster with Global X. Sure, you’ve got broad exposure to this relatively new niche, but is that really the way you want to get it? If the YieldCo sector continues to grow and manages not to implode, YLCO could become a useful way for investors to get diversified exposure to the space. So, on that level, it’s not a bad idea. However, the YieldCo space just isn’t mature enough at this point to support what YLCO wants to offer. And, in the end, conservative investors should avoid it. In fact, I’d go so far as to say that most investors should avoid it until the YieldCo space has grown some more and YLCO has been stress-tested by the market.

How Long Can You Stick With Failing Factor Investing?

Someone asked me the other day why I reject factor investing. My answer was simple. I said that factor investing is usually just a good marketing pitch to charge higher fees for something that will give you most of the correlation of a market cap weighted portfolio. For the uninitiated, factor investing is one of the hot buzz words in portfolio construction these days. Researchers found that “risk” doesn’t properly describe what drives returns over the long-term and several other factors were discovered that explain some of these outperforming anomalies. For instance, value stocks tend to outperform and momentum stocks often outperform. But this isn’t always the case. This is simply the case inside of the rather small data set that researchers have mined so far. And that brings us to a rather gigantic problem with factor investing: these factors can go through extremely long periods of underperformance. Eddy Elfenbein does the legwork over at Crossing Wall Street where he shows that value has underperformed the S&P 500 for 8 years. That’s an entire market cycle! I’m not sure there’s a single investor who would put up with that type of underperformance. And yet factor investing is more popular than ever. In fact, we keep coming up with new factors by the day. And when one fails we move on to some other fancier and more intricate sounding sales pitch. But here’s the really big problem for me. When you buy stocks you shouldn’t look for the absolute best portfolio. There are no holy grails. You are just looking for an adequate portfolio that reflects a very broadly diversified set of equity instruments. You don’t need the best return. You want most of the return. But most factor portfolios just increase tax and fee frictions while giving you a substantial amount of the equity correlation that you’re looking for in a portfolio. But what we find with all of these factor funds is that they’re still very highly correlated with their benchmark. If you can decide when that correlation shifts a tiny bit to give you some slice of outperformance then you’re much smarter than me and everyone else in this business. Here’s a simple example of what I mean here. If we look at growth relative to the market cap weighted portfolio we find that the two portfolios have a 96% correlation over the last 15 years: In the early 2000’s growth looked terrible relative to market cap weighting. And then it has dramatically outperformed since the financial crisis. But over the course of the entire cycle there’s no telling where you would have gotten on and off that roller coaster ride. All we know is that you got 96% of the equity market correlation. And if you jumped on the growth roller coaster you paid a higher fee and you MAYBE outperformed. So, when you start looking for that holy grail in the factor pool you really start doing two things that are cardinal sins in the world of indexing: You’re relying on being able to time when a factor will or won’t outperform. You’re increasing your fees in the pursuit of beating the market. Breaking those rules just don’t make a lot of sense to me. I prefer to keep things simple. So, maybe I am too hard on the factor investing crowd, but I just don’t see why we should pay extra for something that might give you better performance, will definitely give you most of the correlation and will definitely increase your fees. Share this article with a colleague

How Diversifying Can Help You Manage Market Mayhem

Summary Diversification is not simply about holding more assets. It is about paying attention to how the different parts of your portfolio work together. At its most basic, you have three components: stocks, bonds and cash. You may want to hold a blend of all three, depending on your goals. Four traits adding flavor to a balanced portfolio include quality, geography, sectors and styles and size. The recent market volatility, while not unexpected , has certainly been hard for any investor to digest. If you are feeling a tad queasy, you aren’t alone. It’s an apt moment to pause and remind ourselves of the importance of diversification to help your portfolio ride through market turmoil. What is Proper Diversification? While attempting to teach my youngest daughter about nutrition over the summer, I pulled up the nutrition wheel . As I showed her the various food groups, I was reminded of a diversified portfolio with all its asset classes. Arguably the most overused word in investment jargon, diversification is not simply about holding more assets. It is about paying attention to how the different parts of your portfolio work together. It’s part art and part science, like so many things in life, and takes some careful thought to make the right choices. Think of it like maintaining a balanced diet – one food isn’t going to give you all the nutrition you need. Asset Classes as Food Asset classes are your basic food groups – carbs, proteins and vegetables. As with food, each asset plays a different role. At its most basic, you have three components: stocks, bonds and cash. Stocks are generally riskier than bonds, but you can potentially see greater gains over time. When stocks decline, bonds have generally held up better and often delivered positive returns. And then there’s cash, which many investors use to preserve capital for a major expense, like college tuition. You may want to hold a blend of all three, depending on your goals. Simply a mix of individual company stocks and corporate and government bonds, however, may not give you everything you need to best manage risk and return. A balanced portfolio could also include a variety of nutrients and flavors. Four Traits of a Balanced Portfolio Quality For your bond portfolio, you’ll want to consider diversifying across credit quality – such as Treasuries, investment-grade and high yield – each of which has a unique risk/return profile. For stocks, you may want to focus on the quality of a company’s balance sheets and evaluate factors such as dividend growth, earnings or management. Geography It’s natural to have a home-country bias, and the U.S. is still one of the strongest markets in the world. But there’s no denying that we live in a global economy. There can be real benefits to expanding your geographic horizon to pursue opportunities in other regions and countries. Try to have a risk-balanced blend of investments across developed and emerging markets so you’re well positioned globally. Also, keep in mind that the value of the dollar against other currencies has become more important to your bottom line lately. So consider whether some currency-hedged exchange traded funds (ETFs) may help to protect your portfolio against sudden changes. Sectors And Styles Industries respond differently to different parts of the business cycle. For example, cyclical sectors, such as technology and discretionary consumer goods, generally benefit from economic upturns. On the other end, defensive sectors, such as food staples and utilities, are the last areas that people cut back on when times are tough. There are also certain styles of stocks to consider, such as value or momentum, and, for certain investors, some smart beta strategies may be an alternative to consider to help you access those styles. In short, cycles turn, so you probably want to make sure you’re not over-concentrated in one area. Size Everyone wishes they had invested in just the right tech company in the early 1980s, when the now-successful ones were just getting off the ground. But back then, who knew that personal computers would not only be in nearly every home like a TV, but might actually kick TVs to the curb? While it’s true that smaller companies can sometimes pay off big, they also carry higher risks. So you’ll want to consider a mix of small, medium and large companies. Many investors skew to the large side, unless you have the stomach for lots of ups and downs. Stay Diversified Until the End This may feel like a lot to manage, but it’s not as complicated as it seems. Many online resources and financial planners can break down your existing portfolio into a pie chart so you can see what slices you have. Then seek advice before making any changes. If you’re just getting started, internet tools can help you create a diversified core portfolio . Or consider a core allocation ETF , based upon your risk appetite and time horizon. As you approach your goals, you may need to reallocate your holdings. But that doesn’t mean that you should be less diversified. Make sure you always have an appropriately balanced diet of investments. This post originally appeared on the BlackRock Blog.