Tag Archives: function

When To Rebalance Your Portfolio

It’s that time of year again. Time to look at your portfolio and decide on your rebalancing strategy. Most investors know they should rebalance but many don’t do it or they get hung up on the detailed mechanics of rebalancing. In this post I’ll present a quick summary of rebalancing approaches and share my approach as well. We rebalance portfolios to improve risk adjusted returns over the long haul. In general, if portfolios are not rebalanced then the equity portion of the portfolio grows to dominate the overall portfolio and its risk. This is usually not something investors want especially as they age. After the decision to rebalance, the next question is how often. The frequency of rebalancing has to be traded off with the costs of rebalancing, transaction fees, commissions, etc… We also need to consider if we should rebalance if there is any difference at all in our target percentage allocations or wait until there is a significant enough difference to trigger an allocation decision. Say your target is 60% stocks and at the end the year you end up at 61% stocks. Does the benefit of rebalancing outweigh the costs? Probably not in this case. So, how does an investor choose the best approach? Fortunately, the great folks at Vanguard have done all the heavy lifting for us in this paper. Here is the summary table. (click to enlarge) As the above table shows basically there is not a big difference in rebalancing approaches, outside of never rebalancing. Even a monthly rebalance with a 0% threshold does not increase portfolio turnover and costs as much as you would expect. The last column also shows the results of never rebalancing – higher returns but with significantly higher volatility which leads to portfolio outcomes that most investors cannot stick with over time. These results also hold for quant portfolios. Whether implementing the IVY portfolios, the Permanent portfolios, Quant portfolios, the timing and threshold of the rebalance does not make a significant difference to long-term portfolio returns, e.g. see the IVY portfolio FAQ question #4. However, it is important to point out that there are periods where rebalancing does not work. Let me give you an example. The table below compares the returns of 60/40 stock bond and 70/30 stock bond portfolios with yearly rebalancing and no rebalancing over the last 5 years (2009 to 2013). (click to enlarge) As the table shows, yearly rebalancing increased returns for the 60/40 portfolio but yearly rebalancing actually decreased returns for the more aggressive 70/30 portfolio. This is typical in strong bull markets when stocks consistently outperform. This is maybe one of the reasons investors abandon rebalancing. But it is important to focus on the long term and more importantly on risk adjusted returns and stick to a rebalancing strategy. Personally, I rebalance once a year with a 1% threshold across all my portfolios regardless of strategy. But that is what I have found works for me. The best advice I can give anyone is to paraphrase the Vanguard advice – choose a regular periodic rebalancing approach that fits your investment style and that you can stick with over the long haul. This is most likely my last post for this year. Hope everyone has a Happy New Year! Here is to a great and prosperous 2015. At the beginning of the year I’ll be focusing on updating all the yearly returns for all the portfolios and strategies I track. I’m looking forward to sharing the results with everyone.

Entergy Corporation: A Derivative Play For The Gulf Coast Petchem Boom

Summary Entergy is building a new power plant and has plans to build new transmission infrastructure. Load demand, not price hikes, is driving earnings growth. Shares are up considerably but I believe they still have a ways to run. It’s difficult to like utilities these days. With interest rates so low, utilities typically yield under 4%. To make matters worse, most states now have ‘renewable energy mandates,’ which means that utility companies are effectively mandated to invest in new energy infrastructure even when load demand is static. This leaves utilities with little choice but to raise rates in the coming years merely to recoup the cost of investment. On August 15th I wrote an article on Entergy Corporation (NYSE: ETR ), a Louisiana-based utility which I thought was the best alternative to the renewable energy hurdle facing US utilities today. Unlike most other states, Louisiana has opted out of renewable energy mandates. Louisiana’s economy is also benefitting greatly from an unprecedented boom in the petrochemicals industry along the gulf coast. This building boom includes everything from chemical plants, NGL crackers, steel mills and LNG export facilities. Since August 15th, Entergy has soared along with the rest of the space. Entergy has leapt from $72 per share to $91, thanks largely to falling interest rates. Right now, most US utilities are trading somewhere above their average P/E multiples, Entergy included. Does that mean it’s time to sell the stock and call it a day? That is what this article will try to answer. Load growth (click to enlarge) Courtesy of Entergy Corp Investor Relations This graphic pretty well sums up what Entergy expects in the coming three years. Residential use is expected to rise modestly, but industrial use will increase by around 6.75% per year, which will drive overall retail load growth by around 3.5% year on year. Utilities love industrial load growth, because it often begets residential load growth, which in turn brings commercial and governmental load growth. The petrochemical boom along the Gulf Coast could bring a decade of good times for utilities such as Entergy, which has business all throughout Louisiana and also in the Texas Gulf Coast. Utility companies must always consider replacing old generation and transmission infrastructure, but it’s easiest to do so when load growth is increasing, because the costs to build more capacity can be spread out on a larger customer base. Entergy is constructing another plant in Louisiana, one which the company believes will support economic growth in the region with low energy prices for years to come. The new power plant, named Ninemile 6, is a gas turbine. Ninemile 6 is scheduled to be ready by the first of next year, and it is the earliest of a very robust construction plan from Amite Parish in southern Louisiana to the Texas Gulf Coast around Houston. Through 2021, Entergy will build transmission lines for the new Cameron LNG plant and a new steel plant. New transmission lines will go up along the Gulf Coast, and eventually the company will upgrade its southeast Louisiana terminal equipment too. Next year, Entergy will spend $665 million. All the while, load demand increases and a focus on the most economical generation sources will keep rates down. With a kilowatt per hour cost of just 7.7 cents, Louisiana has the fourth lowest electricity cost in the nation (behind Kentucky, West Virginia and Washington state). A list of industrial projects underway on the Gulf Coast. Projects range from steel mills to LNG export terminals, and include several world-class companies. Courtesy of Entergy Corporation Investor Relations Valuation As I mentioned earlier, shares of Entergy have jumped up with the rest of the sector. Shares were somewhat below fair value back in August, but they are now just slightly above. Let’s take a look at FAST Graphs for a bigger picture. Courtesy of FAST Graphs In August, shares were well below their fair value and average P/E ratio. Now, however, shares are 13.4% above average P/E and just about at the Graham-Dodd ‘Fair Value’ number. (FAST Graphs measures this by trailing twelve-month earnings.) While Entergy may not be a great deal right here, I would also say that it is way too early to sell shares. Entergy’s 3%-4% retail electricity demand growth makes the company a better choice than most other utility names. Entergy is a multi-year play and I believe this stock has way more room to run. At twenty times trailing earnings Entergy would trade at $120. Given the company’s solid growth prospects, I think twenty times earnings would be a place to consider hopping off. For now, however, I believe that Entergy should be allowed to run for awhile. Conclusion Entergy is in the right place at the right time, and it is one of the only utilities I would consider owning right now. (In fact, it is the only utility which I currently own shares in.) Unlike most other utilities, Entergy is largely unburdened with the need to supply more expensive renewable energy to its customers. The petrochemical boom is fueled by a supply of cheap input costs in natural gas and natural gas liquids. This gives US petrochemical companies an advantage over the rest of the world, and this input cost advantage does not look to be going away anytime soon. Entergy is a relatively low-risk ‘derivative play’ for the petrochemical boom, and I believe shares have a good bit more ways to run before an investor should even consider taking anything off the table.

ETFs To Hedge Treasuries As Traders Go Short

Summary U.S. Treasuries had a great year. Bond traders are now growing wary, increasing shorts against Treasuries. Aggressive traders who have a bearish outlook on Treasuries can consider inverse leveraged ETF options. Bond investors are growing increasingly bearish on Treasuries futures. Exchange traded fund traders can also hedge against a fall in the Treasuries market through inverse products. For instance, the ProShares UltraShort 20+ Year Treasury (NYSEARCA: TBT ) seeks to deliver twice the daily inverse performance of the Barclays Capital US Treasury 20+ Year Treasury Bond Index. TBT has increased 3.4% over the past week but is still down 39.5 year-to-date. TBT’s triple- leveraged cousin, the Direxion Daily 20-Year Treasury Bear 3X ETF (NYSEARCA: TMV ) , has increased 4.7% over the past week but declined 54.3% year-to-date. Bond investors are building on what some are calling the largest short position ever in Treasury futures, reports Patti Domm for CNBC . Specifically, George Goncalves, head of rate strategy at Nomura, estimates that there are some $29 billion in shorts across the Treasury futures complex, the highest post-financial crisis level. Adrian Miller, director of fixed income strategy at GMP Securities, also pointed out that there were 258,000 net short positions for 10-year futures on December 16, the second largest ever behind May 2010. In comparison, there were only 75,000 net shorts as of November 25. “We started rolling into better data, and then we had the employment report. That probably quickened the trade,” Miller said in the article. “We can debate all day long how much rates are going to rise… At the end of the day, it’s still going to be a rising rate environment.” Along with higher rate expectations in anticipation of the Federal Reserve eventually hiking rates, the market is also positioning for other events, like the European Central Bank easing. “We’ve got the ECB meeting Jan. 22. The first week of January we get all of the European inflation data. That’s going to really set the tone,” Goncalves said in the article, arguing that the market sees a chance that the ECB could reveal a quantitative easing program. ProShares UltraShort 20+ Year Treasury (click to enlarge) Max Chen contributed to this article .