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New ETF Takes A Sophisticated Approach To Equal Weighting

A different approach to equal-weight, index-based ETFs. Highlight the recently launched PowerShares Russell 1000 Equal Weight Portfolio. How the equal weight portfolio stacks up against traditional market-cap and equal weight methodologies. By Todd Shriber & Tom Lydon Equally-weighted exchange traded funds are the least complex and the oldest of the non-cap weighted ETF group. Investors have poured billions of dollars into various equal-weight ETFs over the years, but there can be more to equal-weight ETFs than merely assigning the same allocation to each of the fund’s holdings. The PowerShares Russell 1000 Equal Weight Portfolio ETF (NYSEArca: EQAL ) , which is less than a month old, offers investors an evolved approach to the prosaic equal-weight ETFs that currently populate the market. EQAL tracks the Russell 1000 Equal Weight Index, which applies an equal weight to nine sectors and then assigns an equal weight to each security from those sectors, according to PowerShares . As Russell Investments notes, the traditional equal-weight methodology, like cap-weighting has flaws and biases of its own. According to Russell : This simple approach can result in notable sector biases, since the weight of each sector is determined solely by the number of companies in the sector. For example, with a simple equal-weighted-constituent methodology, if the Technology sector has 100 stocks and the Health Care sector has 50, Technology’s weight would be twice that of Health Care, regardless of the relative size of the companies within each of the two sectors. By addressing sector weights first, EQAL and its Russell index mitigate the flaws found in other equal-weight funds . EQAL, which charges 0.2% per year, has sector weights ranging from 2.3% for telecom up to 13% for technology. Six other sectors – industrials, health care, consumer staples, consumer discretionary, financial services and energy – receive double-digit allocations in the new ETF. Russell’s pre-screening methodology, which includes a mandate that the share portion of a potential constituent in a notional $5 billion portfolio cannot exceed 5% of the company’s float, ensures liquidity and that the benchmark remains investable. EQAL’s top four sector weights combine for about 48% of the new ETF’s weight. By comparison, the iShares Russell 1000 ETF (NYSEArca: IWB ) , the cap-weighted ETF that tracks the Russell 1000, allocates a combined 50.6% to its top three sector weights. Adds Russell: Equal-weighted indexes, first introduced more than a decade ago, may be one of the earliest examples of a ‘smart beta index.’ Their straightforward methodology has at times resulted in performance superior to that of their market-cap-weighted counterparts, albeit with an uptick in volatility. Other ETFs tracking Russell equal-weight indexes include the Guggenheim Russell 1000 Equal Weight ETF (NYSEArca: EWRI ) and the Guggenheim Russell 2000 Equal Weight ETF (NYSEArca: EWRS ) .

Diversify With A Cheap, Broad Munis Bond ETF

Investors may be exposed to markups when buying individual muni debt securities. Diversify with a broad municipal bond ETF instead. A look at muni bond ETF options, including short-duration plays. Fixed-income investors may be paying more than necessary when purchasing individual municipal debt securities. On the other hand, people can use munis exchange traded funds for a cheap way to access the market. Three U.S. regulators have began scrutinizing municipal bond markup fees that could cut into investor returns, reports Aaron Kuriloff for the Wall Street Journal . The markup shows the difference between a muni debt security’s current offering price among dealers and the higher price a dealer charges a customer. The markup typically occurs when a dealer acts as a principal who buys and sells from a personal account as opposed to brokers who facilitate trades for a nominal fee. As an alternative, Allan Roth, founder of Wealth Logic, believes that investors should use low-fee bond funds instead, arguing that markups the funds pay are smaller since ETF providers purchase in bulk and are more acquainted with the market. Additionally, Roth points out that muni funds can instantly help investors diversify through one single investment since the bond funds hold hundreds if not thousands of individual debt securities. For instance, the iShares National AMT-Free Muni Bond ETF (NYSEArca: MUB ) has a 0.25% expense ratio and includes 2,470 component holdings. The SPDR Nuveen Barclays Municipal Bond ETF (NYSEArca: TFI ) has a 0.23% expense ratio and 535 holdings. The Market Vectors Intermediate Municipal Index ETF (NYSEArca: ITM ) has a 0.24% expense ratio and 985 components. “Even if I have $5 million to buy municipal bonds, I really can’t diversify enough by buying individual bonds,” Roth said in the article. “And if I have $500,000, then I really can’t diversify.” Moreover, while purchasing individual bonds from one’s home state provides additional tax breaks, an investor may be overexposed to their state, especially the bond is based off the economy that supports his or her job and home, Roth added. With muni ETFs, investors can also spread out risk with various state exposure. The three muni ETFs are market-cap weighted, so the states with the largest outstanding debt have the biggest weights, which include California, New York and Texas, respectively. Additionally, some analysts and advisors suggest sticking to short- or intermediate-term funds since long-term bond funds are more susceptible to interest rate risks. MUB has a 6.34 year duration, ITM has a 6.92 year duration and TFI has a 7.14 year duration. There are also a number of short-term municipal bond ETFs available, including the SPDR Nuveen Barclays Short Term Municipal Bond ETF (NYSEArca: SHM ) , which has a 2.89 year duration, Market Vectors-Short Municipal ETF (NYSEArca: SMB ) , which has a 3.1 year duration, and iShares Short Term National AMT-Free Muni Bond ETF (NYSEArca: SUB ) , which has a 2.06 year duration. The Vanguard Group is also planning its first foray into the muni bond ETF space with the Vanguard Tax-Exempt Bond Index Fund, which will track the S&P National AMT-Free Municipal Bond Index. Max Chen contributed to this article .

Leverage Can Kill

Back in 2011 I highlighted the three biggest risks to most portfolios: Leverage Concentration Illiquidity With the SNB shocker this is a perfect time to revisit that thinking because we’re seeing a lot of carnage out there as a result of these three factors. Leverage multiplies the moves in assets. Borrow 100% and you’ve increased your beta or volatility by 2X. In volatile asset markets or markets that allow extreme leverage this can be particularly dangerous. FX and futures markets often allow much more than 2X leverage. $10 can be leveraged into $100 which means 100% of your capital can be wiped out by just a 10% move. In a market like the FX markets where 10% moves are uncommon, but not unheard of, this is a crazy way to try to generate returns. You’re a gambler, not an investor. You have to understand how much more risk you’re taking by leveraging something up. This is further multiplied when it’s done in a concentrated portfolio position. You’re narrowing all your risk down to a few assets and then leveraging. And as we now know, the SNB move resulted in widespread illiquidity which made the market losses that much worse. I’ve talked about the dangers of trading leveraged ETFs in the past because they tend to result in volatility clusters and expose investors to tail risk. But this also extends to FX markets, futures markets as well as most other markets. You have to really know what you’re doing when you engage in such a market. Leverage itself doesn’t kill people, people kill people. And people who don’t understand leverage or abuse it will inevitably get killed by it. I think there’s a good rule of thumb that comes from all of this. Most of us really don’t need to use leverage in our portfolios. Yes, it can be a useful tool in the right hands, but what leverage does to most portfolios is increase the probability of a tail risk event thereby increasing the risk of permanent loss. So, when the SNB comes in and does something that no one expects then a 20% move turns into a 100% loss for a lot of leveraged asset holders. No one needs that sort of added risk in a portfolio. So, when in doubt, stick to the old Warren Buffet rule: “don’t invest in what you don’t understand.” Odds are, you don’t understand leverage and don’t need to. For most of us, investing is actually just the act of allocating our savings. Unfortunately, the allure of “market beating returns” and the myth that we’ll “get rich quick” in the markets is powerful and leads people to do things that are often irrational. When in doubt avoid leverage. Now that you’ve read this, are you Bullish or Bearish on ? Bullish Bearish Sentiment on ( ) Thanks for sharing your thoughts. Why are you ? Submit & View Results Skip to results » Share this article with a colleague