Tag Archives: health

FSTA: This Little Gem Of An ETF Is Beautiful When You Look Inside

Summary FSTA tracks one of my favorite sectors and there is nothing to hold against it. From the market capitalizations of the companies down to the top 10 holdings, everything looks intelligently designed. While many consumer staples ETFs would be scared to go overboard on tobacco, FSTA gets it. Consumer Staples funds should be loaded up on companies producing addictive products. I’m a little concerned about the sheer size of the allocations to Coca-Cola and Pepsi because of a movement towards healthier foods. I wouldn’t want to cut out those holdings because I think the distribution and branding systems give them moats for competing in healthy foods. One of the sectors I’ve come to like is the consumer staples sector. Unfortunately, many investors seem to be catching on to how desirable the sector allocation is when there are concerns of a new correction or recession. One of the funds that I’m considering is the Fidelity MSCI Consumer Staples Index ETF (NYSEARCA: FSTA ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. Expense Ratio The expense ratio on the Fidelity MSCI Consumer Staples Index ETF is only .12%. This fund gets my stamp of approval for giving investors consumer staples exposure at a very reasonable expense ratio. Market Cap The ETF has a focus on large capitalization companies, but investors should be worried if this chart looked different. The idea is to load up the portfolio on big companies that are designed to withstand negative events in the economy. I think large companies make more sense than smaller companies in that aspect because I want to see companies that are market leaders with strong pricing power in an established industry. Geography There really isn’t much to talk about here. This is all domestic equity. Sector This sector breakdown is excellent. Personally, I have a moral objection to companies that sell tobacco products because they cause cancer. On the other hand, I don’t have a moral objection to risk adjusted returns. The result of that conflict is that I have to admire the structure of this portfolio. I’d love to see a further breakdown in some categories such as beverages because I’d value having some alcohol in the portfolio as well. When I’m looking at consumer staples, I want companies that sell products that are absolutely addictive. This is just cold hard logic. Market leaders that can dictate pricing on addictive products are in the ideal position to survive recessions without a major drop in sales or earnings. Largest Holdings This is a solid batch of holdings. I don’t see a single company on the list that looks exposed to a recession. I’ll admit that having both Coca-Cola (NYSE: KO ) and Pepsi (NYSE: PEP ) at the top of the portfolio feels a little heavy. If I was going to tweak the portfolio a little, I might drop those two in favor of having a little more alcohol. My big concern about those companies is that I believe we are in a very long term shift towards healthier food and some of their branding value is going to be lost. The reason I would still want a significant allocation is because they are both masters of building brands and have established enormous distribution networks across the world. When (or if) that sustained shift to healthier foods does occur, I expect both Pepsi and Coke to be in position to buy up smaller companies with the right products and then run the products through their branding and distribution product. Simply put, even if they don’t have the right products yet, they have incredible economic moats that should help them acquire the right products and utilize those products better than smaller competitors could. As I’ve been going through consumer staples ETFs, I’ve noticed that Wal-Mart (NYSE: WMT ) is suspiciously absent from some of them. I think that is a mistake. I really like Wal-Mart as a dividend growth company and I think the employee wage issues are overblown . Building the Portfolio The sample portfolio I ran for this assessment is one that came out feeling a bit awkward. I’ve had some requests to include biotechnology ETFs and I decided it would be wise to also include in the related field of health care for a comparison. Since I wanted to create quite a bit of diversification, I put in 9 ETFs plus the S&P 500. The resulting portfolio is one that I think turned out to be too risky for most investors and certainly too risky for older investors. Despite that weakness, I opted to go with highlighting these ETFs in this manner because I think it is useful to show investors what it looks like when the allocations result in a suboptimal allocation. The weightings for each ETF in the portfolio are a simple 10% which results in 20% of the portfolio going to the combined Health Care and Biotechnology sectors. Outside of that we have one spot each for REITs, high yield bonds, TIPS, emerging market consumer staples, domestic consumer staples, foreign large capitalization firms, and long term bonds. The first thing I want to point out about these allocations are that for any older investor, running only 30% in bonds with 10% of that being high yield bonds is putting yourself in a fairly dangerous position. I will be highlighting the individual ETFs, but I would not endorse this portfolio as a whole. The portfolio assumes frequent rebalancing which would be a problem for short term trading outside of tax advantaged accounts unless the investor was going to rebalance by adding to their positions on a regular basis and allocating the majority of the capital towards whichever portions of the portfolio had been underperforming recently. Because a substantial portion of the yield from this portfolio comes from REITs and interest, I would favor this portfolio as a tax exempt strategy even if the investor was frequently rebalancing by adding new capital. The portfolio allocations can be seen below along with the dividend yields from each investment. Name Ticker Portfolio Weight Yield SPDR S&P 500 Trust ETF SPY 10.00% 2.11% Health Care Select Sect SPDR ETF XLV 10.00% 1.40% SPDR Biotech ETF XBI 10.00% 1.54% iShares U.S. Real Estate ETF IYR 10.00% 3.83% PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB 10.00% 4.51% FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT 10.00% 0.16% EGShares Emerging Markets Consumer ETF ECON 10.00% 1.34% Fidelity MSCI Consumer Staples Index ETF FSTA 10.00% 2.99% iShares MSCI EAFE ETF EFA 10.00% 2.89% Vanguard Long-Term Bond ETF BLV 10.00% 4.02% Portfolio 100.00% 2.48% The next chart shows the annualized volatility and beta of the portfolio since October of 2013. (click to enlarge) Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. You can see immediately since this is a simple “equal weight” portfolio that XBI is by far the most risky ETF from the perspective of what it does to the portfolio’s volatility. You can also see that BLV has a negative total risk impact on the portfolio. When you see negative risk contributions in this kind of assessment it generally means that there will be significantly negative correlations with other asset classes in the portfolio. The position in TDTT is also unique for having a risk contribution of almost nothing. Unfortunately, it also provides a weak yield and weak return with little opportunity for that to change unless yields on TIPS improve substantially. If that happened, it would create a significant loss before the position would start generating meaningful levels of income. A quick rundown of the portfolio I put together the following chart that really simplifies the role of each investment: Name Ticker Role in Portfolio SPDR S&P 500 Trust ETF SPY Core of Portfolio Health Care Select Sect SPDR ETF XLV Hedge Risk of Higher Costs SPDR Biotech ETF XBI Increase Expected Return iShares U.S. Real Estate ETF IYR Diversify Domestic Risk PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB Strong Yields on Bond Investments FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT Very Low Volatility EGShares Emerging Markets Consumer ETF ECON Enhance Foreign Exposure Fidelity MSCI Consumer Staples Index ETF FSTA Reduce Portfolio Risk iShares MSCI EAFE ETF EFA Enhance Foreign Exposure Vanguard Long-Term Bond ETF BLV Negative Correlation, Strong Yield Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio. Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. (click to enlarge) Conclusion FSTA has a great expense ratio, great sector, and great allocations within the sector. This ETF is a slam dunk for long term holdings. The only concern I have about the sector right now is that other investors have caught on and started bidding up the price. There is one other worrying factor for the ETF. The average volume on it is quite dreadful. There are two ways to look at that issue. One is to bemoan the weak trading volume increasing the bid-ask spread. The other option is to look for ways to trade the ETF without commissions and then to keep using limit orders to try to enter at an attractive price. The ETF has far more liquidity problems than the underlying securities and the low expense ratio is fairly attractive for investors looking for a long term holding. The biggest caution here is that investors should avoid using any “market” orders. Only trade this one with limit orders.

XBI: An Aggressive ETF That Keeps Capturing Massive Returns

Summary XBI is an almost pure play on the biotechnology sector. For investors that want to rely on modern portfolio theory rather than assessing biotechnology companies, this is a solid option. The ETF has shown stronger correlations with international equity than domestic equity which suggests investors may want to limit international exposure when going heavy XBI. The negative correlation for XBI with long term treasury bonds is only mediocre. Compared to the S&P 500, it is more difficult to diversify away the portfolio risk through treasuries. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. The biotechnology sector has been hot and despite being high risk it can be a very profitable area to invest. The challenge is that investors either need specialized knowledge to pick the companies they will hold or a simple strategy for buying into an ETF in the sector. As you might guess, I prefer the second method. My strengths are in analyzing ETFs and mREITs. I’d rather not be forced to figure out which biotechnology companies are most likely to patent the next breakthrough. That makes using an ETF a great way to get exposure. One of the biggest options for that exposure is the SPDR Biotech ETF (NYSEARCA: XBI ). Expense Ratio The expense ratio on XBI is .35%. Sector XBI is not confused about their role. The portfolio is very close to a pure play on the biotechnology sector. Largest Holdings The largest holdings are shown in the chart below: While I usually recognize all the companies within an ETF, this isn’t one of those cases. I know precisely zero of these companies, but I do appreciate that the fund has been designed to be relatively equal weight. For comparison, I also grabbed a chart of the holdings for the index. Index Holdings You may notice that the order of holdings is very materially different. XBI is not just passively tracking the index. Investors might think that means their returns would be very different from the index, but it turns out they actually track the index quite closely. Comparison The following chart shows the performance numbers for several time periods: (click to enlarge) Some investors may have a much easier time visualizing the returns with graphs, so I grabbed a bar chart as well: (click to enlarge) I think the bar chart really drives this home. Even though XBI is using a very different portfolio structure than their index, they have extremely similar returns over each time period. When I check an ETF against their index, I usually expect them to slightly underperform because of the expensive ratio. They have trailed their index, but only by around .05% on an annualized basis which is very good when you consider that the expense ratio is .35%. If they can continue to deliver that performance over the next decade it will be a testament to the management doing a solid job of deciding which companies deserve to be overweight in the portfolio. Building the Portfolio The sample portfolio I ran for this assessment is one that came out feeling a bit awkward. I’ve had some requests to include biotechnology ETFs and I decided it would be wise to also include a the related field of health care for a comparison. Since I wanted to create quite a bit of diversification, I put in 9 ETFs plus the S&P 500. The resulting portfolio is one that I think turned out to be too risky for most investors and certainly too risky for older investors. Despite that weakness, I opted to go with highlighting these ETFs in this manner because I think it is useful to show investors what it looks like when the allocations result in a suboptimal allocation. The weightings for each ETF in the portfolio are a simple 10% which results in 20% of the portfolio going to the combined Health Care and Biotechnology sectors. Outside of that we have one spot each for REITs, high yield bonds, TIPS, emerging market consumer staples, domestic consumer staples, foreign large capitalization firms, and long term bonds. The first thing I want to point out about these allocations are that for any older investor, running only 30% in bonds with 10% of that being high yield bonds is putting yourself in a fairly dangerous position. I will be highlighting the individual ETFs, but I would not endorse this portfolio as a whole. The portfolio assumes frequent rebalancing which would be a problem for short term trading outside of tax advantaged accounts unless the investor was going to rebalance by adding to their positions on a regular basis and allocating the majority of the capital towards whichever portions of the portfolio had been underperforming recently. Because a substantial portion of the yield from this portfolio comes from REITs and interest, I would favor this portfolio as a tax exempt strategy even if the investor was frequently rebalancing by adding new capital. The portfolio allocations can be seen below along with the dividend yields from each investment. Name Ticker Portfolio Weight Yield SPDR S&P 500 Trust ETF SPY 10.00% 2.11% Health Care Select Sect SPDR ETF XLV 10.00% 1.40% SPDR Biotech ETF XBI 10.00% 1.54% iShares U.S. Real Estate ETF IYR 10.00% 3.83% PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB 10.00% 4.51% FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT 10.00% 0.16% EGShares Emerging Markets Consumer ETF ECON 10.00% 1.34% Fidelity MSCI Consumer Staples Index ETF FSTA 10.00% 2.99% iShares MSCI EAFE ETF EFA 10.00% 2.89% Vanguard Long-Term Bond ETF BLV 10.00% 4.02% Portfolio 100.00% 2.48% The next chart shows the annualized volatility and beta of the portfolio since October of 2013. (click to enlarge) Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. You can see immediately since this is a simple “equal weight” portfolio that XBI is by far the most risky ETF from the perspective of what it does to the portfolio’s volatility. You can also see that BLV has a negative total risk impact on the portfolio. When you see negative risk contributions in this kind of assessment it generally means that there will be significantly negative correlations with other asset classes in the portfolio. The position in TDTT is also unique for having a risk contribution of almost nothing. Unfortunately, it also provides a weak yield and weak return with little opportunity for that to change unless yields on TIPS improve substantially. If that happened, it would create a significant loss before the position would start generating meaningful levels of income. A quick rundown of the portfolio I put together the following chart that really simplifies the role of each investment: Name Ticker Role in Portfolio SPDR S&P 500 Trust ETF SPY Core of Portfolio Health Care Select Sect SPDR ETF XLV Hedge Risk of Higher Costs SPDR Biotech ETF XBI Increase Expected Return iShares U.S. Real Estate ETF IYR Diversify Domestic Risk PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB Strong Yields on Bond Investments FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT Very Low Volatility EGShares Emerging Markets Consumer ETF ECON Enhance Foreign Exposure Fidelity MSCI Consumer Staples Index ETF FSTA Reduce Portfolio Risk iShares MSCI EAFE ETF EFA Enhance Foreign Exposure Vanguard Long-Term Bond ETF BLV Negative Correlation, Strong Yield Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio. Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. (click to enlarge) Conclusion XBI is an extremely aggressive allocation that easily brings in the heaviest level of risk in the portfolio. Despite being a major source of risk, the correlation with the S&P 500 is only .56% and the resulting beta is “only” 1.44 which is very good when you consider how volatile the ETF has been. The thing that may be even more interesting is what happens when investors run the regression over a longer period. When I extended the sample period back to February of 2006, the correlation goes up to .68 but the beta drops down to .91 because the ETF was dramatically less volatile in the earlier years. Lately the sector has been substantially more volatile. The strong performance of XBI also extends back quite a ways. Since February 2006 the ETF has returned over 400%. I also extended this sample by running another regression of returns on XBI against a long term government bond index. The negative correlation in that case came in at -.35 compared to the S&P 500 coming in at -.54. The risk that comes from the weaker negative correlation is that it makes it more difficult to really drive portfolio risk lower. However, for an investor that is willing to hold a portfolio that is already overweight on equities, it would seem perfectly reasonable to include XBI as an allocation. It is a highly aggressive allocation, but it has done very well. The one other interesting note that I would make in that regard is that it has shown a substantially higher correlation with international ETFs than with domestic equity. If you’re planning to run XBI as a large holding, you may want to consider reducing the international equity allocation.

SEC Proposals To Lower Liquidity Risk In Mutual Funds

Periods of large investor withdrawals may spell doom for both fund houses and investors. Many funds have piled up hard-to-sell assets, which are non effective during such periods of withdrawals. The five-member Securities and Exchange Commission (“SEC”) unanimously voted last week to recommend new rules to help the multitrillion asset-management industry with effective liquidity risk management. These additional safety measures will require mutual funds and ETFs to implement new plans to manage liquidity risks. The proposal calls for funds to keep a minimum amount of cash or cash equivalents that can be easily sold within three days (down from seven days currently required for mutual funds). Moreover, fund families may charge investors who redeem their holdings on days of increased withdrawals. The move comes as part of five initiatives framed by the SEC to minimize risks imbedded in such funds and adequately shield them from any financial shock. Since the financial crisis, the asset management sector has been under increasing regulatory scrutiny. The proposals came after the Fed and IMF warned that certain funds may be incapable of keeping up with investor redemptions if there is a market rout. Addressing the Redemption Challenges The challenge is to meet shareholder redemptions during periods of stress and ensure smooth functioning of the funds amid large withdrawals. The SEC targets lower overall systematic risks in the $60 trillion asset-management industry and protection of investors’ interests. “Promoting stronger liquidity risk management is essential to protecting the interests of the millions of Americans who invest in mutual funds and exchange-traded funds,” said SEC Chair Mary Jo White. “These significant reforms would require funds to better manage their liquidity risks, give them new tools to meet that requirement, and enhance the Commission’s oversight.” The Reforms Under the proposal, mutual funds and ETFs must implement liquidity risk management programs and enhance disclosure regarding fund liquidity and redemption practices. These would lead to timely redemption of shares and collection of assets by investors without hampering day-to-day running of the funds. Further, the open-end funds will have to allow the use of “swing pricing” in certain cases. Swing pricing is a liquidity management tool designed to reduce the dilution impact of subscriptions and redemptions on non-trading fund investors. This step would enable mutual funds to reveal the fund’s net asset value (NAV) costs related to shareholders’ trading activity. In addition, the proposed reforms would put a 15% cap on investments that can be made in hard-to-trade assets. As reported by The Wall Street Journal , some of the largest U.S. bond mutual funds have 15% or more of their money invested in such illiquid securities. Need for Covering Liquidity Risks Assets are deemed liquid when an investor can buy or sell large quantities rapidly at an expected price. During market rout, investors may engage in intense panic selling, for which funds must have adequate the liquidity or return cash to investors. For instance, there are fears of bond liquidity once the Fed decides to hike rates. There is a growing concern that a massive exit from bonds may freeze the markets as the number of sellers may not match the number of buyers. An ideal market would have the right level of liquidity at the right price. Redemption of bonds will increase the sell-off and then fund managers will have to sell the less liquid assets to match investors’ cash demands. However, if a mutual fund or an ETF holds illiquid bonds, the price swings will be rapid and would create a vicious cycle as price drops will again end up in selling pressure. Funds with High Liquidity & Low Redemption Fees In such scenario, investors may buy funds that offer high liquidity and low redemption costs. As for liquidity, substantial stock holdings would provide the edge during a debt market sell-off. While withdrawing money from mutual funds, there are certain charges or penalties that investors may have to bear. The charges may include sales load and 12-b1 fees. While selling a fund, investors may have to incur Deferred Sales Charge (Load). There may be funds that carry no sales load, but have 12-b1 fees, which are operational expenses between 0.25% and 1% of the fund’s net asset. Funds may also charge redemption fees. It is different from sales load since it is not paid to a broker but directly to the fund. The SEC has set a 2% maximum ceiling on redemption fees. 3 Funds to Buy Hence, funds carrying no sales load and low expense ratio stuffed with substantial stock holdings in its portfolio should be safe picks. We have narrowed our search based on favorable Zacks Mutual Fund Ranks. The following funds carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy) as we expect the funds to outperform its peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance. The minimum initial investment is within $5000. The funds have encouraging returns for each of the 1, 3 and 5-year periods. The Fidelity Small Cap Growth Fund (MUTF: FCPGX ) seeks long-term capital appreciation. Under normal circumstances, FCPGX invests at least 65% of its total assets in the common and preferred stocks of companies located in at least three countries in Europe, Australia and the Pacific Rim. FCPGX offers dividends, if any, and capital gains, if any, at least annually. Fidelity Small Cap Growth carries a Zacks Mutual Fund Rank #1. While the year-to-date and 1-year returns are 9% and 18%, respectively, the respective 3- and 5-year annualized return is 16.6% and 16.7%. Looking at asset allocation, over 97% is invested in stocks, while it holds 2.8% as cash. Annual expense ratio of 0.90% is lower than the category average of 1.34%. The VALIC Company I Health Sciences Fund (MUTF: VCHSX ) invests the majority of its assets in common stocks of healthcare products, medicine or life sciences related companies. VCHSX focuses mainly on investing in large and mid-cap companies. A maximum of 35% of VCHSX’s assets is invested foreign companies. VALIC Company I Health Sciences carries a Zacks Mutual Fund Rank #2. While the year-to-date and 1-year returns are 13.5% and 26.4%, respectively, the 3- and 5-year annualized returns are 29.9% and 29.7% respectively. Looking at asset allocation, nearly 94% is invested in stocks, while it holds 5.1% as cash. Annual expense ratio of 1.09% is lower than the category average of 1.35%. The Bridgeway Small-Cap Growth Fund (MUTF: BRSGX ) aims to provide total return on capital over the long term. BRSGX invests in a broad range of small cap growth stocks that must be listed on the New York Stock Exchange, NYSE MKT and NASDAQ. Bridgeway Small-Cap Growth carries a Zacks Mutual Fund Rank #1. While the year-to-date and 1-year returns are respectively 6.8% and 12.7%, the 3- and 5-year annualized returns are a respective 16.9% and 16.4%. Looking at asset allocation, 99.5% is invested in stocks. Annual expense ratio of 0.94% is lower than the category average of 1.34%. Link to the original article on Zacks.com