Tag Archives: handle

Hedged ETFs Provide Foreign Exposure Sans Currency Risk

By DailyAlts Staff A new whitepaper from Deutsche Asset & Wealth Management (Deutsche AWM) considers the benefits of using currency-hedged ETFs (exchange-traded funds) to gain foreign equity exposure. Written by Deutsche AWM ETF strategists Dodd Kittsley and Abby Woddham, the paper explores the growth of investor interest in foreign stocks and the ETFs that hold them, as well as considering the potential “currency risk” of holding unhedged foreign equities. Foreign Investment Difficulties Investing in foreign stocks has been difficult historically for a variety of reasons. First and foremost, most foreign stocks trade on foreign exchanges, and domestic investors inherently have reduced access to foreign exchanges. Furthermore, stocks trading on foreign exchanges are priced in foreign currencies, creating an intermediary requirement (and hassle) for U.S. investors to first exchange dollars for foreign currencies, and also creating the phenomenon of “currency risk” – the risk that exchange rates between the dollar and the foreign currency will change during the holding period of the foreign stock. Overcoming Those Difficulties Over time, these difficulties have been addressed one by one. First, the number of foreign stocks trading on U.S. exchanges has increased steadily over time, including Alibaba’s record-breaking IPO last year. Secondly, U.S. investor access to foreign exchange markets has increased – but even more significantly, the rise of ETFs that hold stocks trading on foreign exchanges has greatly expanded investor access to such stocks. Indeed, the low cost, tax efficiency, liquidity, and transparency of ETFs has made them perhaps the most popular means of gaining foreign equity exposure. But for “unhedged” foreign stock ETFs, the phenomenon of currency risk remains – and it can have a devastating impact on an investment’s results. An Example of Currency Risk Deutsche AWM’s whitepaper offers the following example as evidence: Imagine you wanted to buy $150,000 of a stock trading on a German exchange, with the stock’s shares priced in euros. Suppose the exchange rate at the time of the purchase was $1.50 to 1 euro, and therefore $150,000 would buy 100,000 euros worth. Now imagine that a year later, the stock price is flat, and you therefore still have 100,000 euros worth of shares – but unfortunately, the dollar has strengthened against the euro so that $1 equals 1 euro. In this case, your 100,000 euros worth of stock, that you paid $150,000 for a year earlier, would now be worth just $100,000. Due to currency risk, an investment that would have resulted in a breakeven return became a 33% loss. This is illustrated below: (click to enlarge) How Currency Hedging Works In response, ETF providers have developed “currency-hedged” products. These ETFs hold shares of stocks priced in foreign currencies, but they use forward currency contracts to “hedge” against currency risk. This is done by agreeing to sell the foreign currency at the current exchange rate sometime in the future – if, in the example above, you would have agreed to sell 100,000 euros for $150,000 one year in the future at the same moment you bought 100,000 euros worth of stock; then a year later, your stock would still be flat at 100,000 euros, but instead of losing 33% to currency fluctuations, your forward contract would offset that loss with a 33% gain. You could sell your shares for 100,000 euros, but instead of exchanging them for $100,000 at the current exchange rate, your forward contract would entitle you to sell them for $150,000. Conclusion The authors of Deutsche AWM’s paper point out that currency risk is a blade that can cut both ways: Japanese stocks were up 54.6% in 2013 when priced in yen, but only 27.2% when priced in dollars due to the dollar strengthening against the yen that year. But when Japanese stocks only gained 0.6% in 2010 priced in yen, they gained 15.4% that same year priced in dollars due to the yen’s strengthening against the dollar that year. Since exchange-rate changes can have either positive or negative impacts on an investment’s value, the whitepaper’s authors suggest strategically choosing “to hedge or not hedge” based on the outlook for the particular currencies involved. But with the dollar widely expected to strengthen in 2015 as the Federal Reserve begins raising interest rates, currency-hedged ETFs may be particularly worth the consideration of investors seeking exposure to foreign stocks. For more information, download a pdf copy of the whitepaper .

The 5 Funds – Q4 2014 Portfolio Review

Summary Reviews the performance of The 5 Funds Portfolios. The Vanguard REIT Index was the top performing ETF in the portfolios last quarter. Junk Bonds and International ETFs were the worst performers. Each quarter I plan to update my 3 portfolios: The Aggressive 5, The Moderate 5, and The Conservative 5 and show the performance from the previous quarter, as well as since inception. I’ll also give an update on why I’m making some of the changes and my quick market update. Hopefully this will be helpful for people either following my portfolios or creating their own ETF portfolio. The Conservative 5 Name Symbol Type Allocation Change Vanguard Total Stock Market Index ETF (NYSEARCA: VTI ) Large Cap Blend 25% +5% 1 iShares Select Dividend ETF (NYSEARCA: DVY ) Mid-Cap Value 16% +1% 3 Vanguard Total Bond Market ETF (NYSEARCA: BND ) Intermediate Term Bond Fund 35% None PowerShares Senior Loan ETF (NYSEARCA: BKLN ) Short Term Bond Fund 0% -10% 2 SPDR Barclay’s High Yield Bond ETF (NYSEARCA: JNK ) High Yield Bond Fund 9% -1% 3 iShares Floating Rate Bond (NYSEARCA: FLOT ) Short Term Bond Fund 10% +10% 1 Cash Cash 5% -5% 2 Updated 1/4/2015 Add Allocation Reduce Allocation Investment Drift (No New Trades Required) Conservative 5 Performance* Conservative 5 SPY (S&P 500) Last Month -0.6% -0.3% QTD 2.0% 4.9% YTD – – Since Inception (10/1/2014) 2.0% 4.9% Std Dev. compared to SPY .31 1.0 As of 12/31/2014 Performance by ETF January 2015 Update The biggest update to the Conservative 5 Portfolio is the removal of PowerShares Senior Loan ETF and replacing it with the iShares Floating Rate Bond. The reason for the change is that I’m concerned with the amount of volatility in BKLN. As we saw, it took a few large dips in the 4th quarter of 2014. BKLN consists of a lot of lower quality bonds which is the reason for the volatility, FLOT is a more conservative, less volatile ETF which allows us to increase our position in VTI without adding much additional volatility to the portfolio. We continue to favor equities over bonds in 2015 and feel as rates rise and bonds are hurt, the equity market should outperform. We have also reduced the cash position in the account to 5% and moved that money over to Vanguard Total Stock Market Index. This move will add slightly more risk to the portfolio, but the overall risk of the portfolio should not be increasing significantly. The Moderate 5 Name Symbol Type Allocation Change Vanguard Total Stock Market Index ETF VTI Large Cap Blend 60% +5% 1 Vanguard FTSE Developed Markets ETF (NYSEARCA: VEA ) Large Cap International 5% -5% 2 Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ) Emerging Markets 0% -5% 2 Vanguard Total Bond Market ETF BND Intermediate Bond 20% None Vanguard REIT ETF (NYSEARCA: VNQ ) REIT 5% None PowerShares QQQ ETF (NASDAQ: QQQ ) Large Cap Growth 5% +5% 1 Cash Cash 5% None Updated 1/4/2015 Add Allocation Reduce Allocation Investment Drift (No New Trades Required) Moderate 5 Performance* Moderate 5 SPY (S&P 500) Last Month -1.1% -0.3% QTD 3.3% 4.90 YTD – – Since Inception 3.3% 4.9% Std. Dev compared to SPY .63 1.0 As of 12/31/2014 Performance by ETF January 2015 Update We made 2 fairly large updates to The Moderate 5 portfolio during this reallocation, both of which focused on reducing our international exposure and increasing U.S. exposure. We have seen emerging markets really struggle lately because of the rising dollar and many EM countries, like Russia, are oil exporters, so the lower oil prices have weighed on their economy. We have replaced our Emerging Markets ETF with QQQ, which is a technology themed U.S. growth ETF. We believe that the tech sector will continue to grow in 2015 and this should be a good compliment to the Vanguard Total Stock Market ETF already in the portfolio. We also reduced the Vanguard FTSE Developed Markets ETF because we are still concerned with international exposure and would prefer to have that money in the U.S. for now. That being said, we are keeping a close eye on Europe and Japan as we think both could do well this year. Don’t be surprised if we add back to our international position later in the year as Europe, Japan, and even China have promised to keep interest rates low and money pumping into these economies as the U.S. looks to rise rates as QE is now completed. The Aggressive 5 Name Symbol Type Allocation Change Vanguard Total Stock Market Index ETF VTI Large Cap Blend 66% +1% 3 Vanguard FTSE Developed Markets ETF VEA Large Cap International 9% -1% 3 Vanguard FTSE Emerging Markets ETF VWO Emerging Markets 0% -5% 2 PowerShares QQQ ETF QQQ Large Cap Growth 10% None Vanguard REIT ETF VNQ REIT 5% None iShares Russell 2000 (NYSEARCA: IWM ) Small Cap Blend 5% +5% 1 Cash Cash 5% None Updated 1/4/2015 Add Allocation Reduce Allocation Investment Drift (No New Trades Required) Aggressive 5 Performance* Aggressive 5 SPY (S&P 500) Last Month -1.3% -0.3% QTD 4.2% 4.9% YTD – – Since Inception (10/1/2014) 4.2% 4.9% Std. Dev compared to SPY .92 1.0 Performance by ETF January 2015 Update Only 1 large change this quarter to The Aggressive 5 Portfolio which focuses on reducing our international exposure and increasing U.S. exposure. We have seen emerging markets really struggle lately because of the rising dollar and many EM countries, like Russia, are oil exporters, so the lower oil prices have weighed on their economy. We have replaced our Emerging Markets ETF with iShares Russell 2000 Index. We saw small cap companies struggle in 2014 and think that they could rebound in 2015 now that their valuations are more attractive than where they were a year ago. We believe 2015 will be a good year for the market and typically small company stocks outperform the S&P 500 in that type of environment. We didn’t make a change to the Vanguard FTSE Developed Markets ETF, but the allocation percentage dipped by 1% because of their under performance over the past quarter. As discussed above, we are keeping a close eye on Europe, Japan, and even China, as we think these economies could do well this year. *Performance is measure by Morningstar and assumes no trade commissions. Assumes trades were placed on 10/1/14 at the closing price on that day.

Lipper Closed-End Funds Summary: December 2014

By Tom Roseen In December the U.S. market took investors on a wild ride. Toward month-end the Dow Jones Industrial Average and the S&P 500 Index posted their thirty-eighth and fifty-second record closes for the year, respectively. A strong nonfarm payroll report at the beginning of the month pushed up U.S. equity markets, and the Dow flirted with the 18,000 mark for the first time. However, concerns about the health of the global economy the following week fueled one of the largest one-week drops in two and half years and sent the VIX to its highest level since October 17. Investors shrugged off a better-than-expected consumer sentiment report and focused on volatility in oil prices and the possibility of the global economy succumbing to deflation. Despite a Federal Reserve-fueled Santa Claus rally toward month-end, U.S. stocks finished the good year on a down note, with the Dow witnessing a triple-digit loss on the last trading day of the month. Both equity and fixed income CEFs posted negative NAV-based returns (-1.43% and -0.24% on average, respectively) for the first month in three, while market-based returns were also in the red for both equity CEFs (-2.51%) and fixed income CEFs (-0.02%). Treasury yields declined at all maturities ten-years or greater in December, with the twenty-year yield declining the most, 15 bps to 2.47% at month-end. The rising dollar and slowing growth overseas made U.S. Treasuries more attractive to foreign investors. The Treasury yield curve rose in most of the lower-dated maturities, with the three-year rising the most-22 bps to 1.10%-by month-end. The one-month yield witnessed a small decline, dropping 1 bp to 0.03%. For December the dollar once again gained against the euro (+2.69%), the pound (+0.32%), and the yen (+0.88%). Commodities prices were mixed, with near-month gold prices rising 0.73% to close the month at $1,184.10/ounce. Meanwhile, front-month crude oil prices plunged a whopping 19.60% to close the month at $53.27/barrel. That equated to a quarterly decline of 40.41% and a one-year decline of 45.87%. For the month 47% of all CEFs posted NAV-basis returns in the black, with 33% of equity CEFs and 58% of fixed income CEFs chalking up returns in the plus column. The slide in oil prices and concerns over Greece’s inability to elect a favored presidential candidate, rekindling fears of another European crisis, weighed on Lipper’s World Equity CEFs macro-classification (-2.43%), pushing it to the bottom of the equity CEF universe. On the equity side (for the fourth consecutive month) mixed-asset CEFs (-0.73%) mitigated losses better than the other macro-groups, followed by domestic equity CEFs (-1.15%). Once again, the municipal bond CEFs group (+1.13%) was the only fixed income macro-classification posting a return on the plus-side for the month, with all of its classifications experiencing returns in the black. The muni CEFs group was followed by domestic taxable bond CEFs (-1.47%) and world bond CEFs (-4.17%). For December the median discount of all CEFs widened just 19 bps to 9.28%-deeper than the 12-month moving average discount (8.55%). Equity CEFs’ median discount widened 115 bps to 9.46%, while fixed income CEFs’ median discount narrowed 53 bps to 9.13%. To read the complete Month in Closed-End Funds: December 2014 FundMarket Insight Report, which includes the month’s closed-end fund corporate events, please click here .