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Vanguard Set To Move Into Muni Bond ETF Space

Vanguard Group, known for its low cost offerings, plans to make inroads to the increasingly popular muni bond ETFs space. Vanguard’s entry appears well timed, as the muni bond ETFs space has been on a roll since last year. In fact, the overall muni category managed to secure the third best position in 2014 having added 8.7%, its three-year highest. It’s not that the issuer is entirely new to munis. Presently, there are 12 actively managed Vanguard muni-bond funds worth $140 billion. The issuer expects the fund to be up for sale by the end of June. The fund will trade under the name of Vanguard Tax-Exempt Bond Index Fund . The Proposed Fund in Focus As per the SEC filing , the fund looks to track the performance of the investment-grade U.S. municipal bond market. The goal will be achieved by tracking the S&P’s National AMT-Free Municipal Bond Index. The index includes bonds having a minimum term to maturity greater than or equal to one calendar month. The “investor” share class will have to spend 0.2% in annual fees to own the fund. How Does it Fit in a Portfolio? Municipal bonds are great picks for investors seeking a steady stream of tax free income. Usually the interest income from munis is exempt from federal tax and sometimes even state taxes, making it especially attractive to investors in the high tax bracket looking to reduce their tax liability. The proposed fund too looks to follow munis that have their interests excused by U.S. federal income taxes and the federal alternative minimum tax (AMT). However, investors should note that tax-free bonds yield lower than taxable bonds. With the increase in the U.S. taxes, demand for municipal bonds has grown by leaps and bounds among high earners. Can it Succeed? There are quite a number of choices in the municipal bond space with iShares National AMT Free-Muni Bond Fund (NYSEARCA: MUB ) being the highest grossing ETF with about $4.2 billion. MUB tracks the S&P National AMT-Free Municipal Bond Index to provide exposure to a basket of 2,458 investment grade securities. The average maturity for the fund stands at 5.51 years, while duration is 6.33 years. The fund has a 30-day SEC yield of 1.58% and charges 25 basis points as expenses per year. Interestingly, the newly filed fund also follows the same index that MUB tracks. So it goes without saying that the proposed fund will face tough competition from the largest ETF in the space, i.e. iShares’ MUB. While the lack of first-movers advantage will be a negative for Vanguard, its ability to roll out a product on an ultra low price should give it an edge over many others presently on offer. Going by fundamentals, intermediate term munis offer great opportunities right now especially with the improving fiscal health of the U.S. states and a plunge in intermediate-to-long term yields. The only bump in the road ahead for Vanguard is its late entry to this space. It’s hard to predict how Vanguard’s new product would perform, but a low expense ratio should be the key to a sizable asset base or greater market share than iShares’ ultra-popular product.

Finally A New Airline ETF Prepares To Take Off

The U.S. aviation industry has been on cloud nine since the oil price succumbed to gravity. Moreover, a pickup in the domestic economy, rising cargo demand, a boost to tourism and the subsiding Ebola scare put the industry in the top-performing category. The sentiment around the sector was so bullish that Airlines rocketed to the highest level since 2001 in late December, per Bloomberg . Investors should note that the ETF industry was largely unable to reap the return out of this booming industry as Guggenheim closed the last airline ETF Guggenheim Arca Airline ETF (NYSEARCA: FAA ) in 2013. Prior to that, Direxion Airline Shares ETF (NYSE: FLYX ) had also faced the same fate in 2011. However, to fill the void, a new airline ETF has been filed lately. The fund looks to trade under the name of U.S. Global Jets ETF (JETS) . The Proposed Fund in Detail The passively managed product intends to track the U.S. global Jets Index that considers worldwide airline companies, per the prospectus. The index attaches weight to the companies on the basis of the square root of their average daily volume seen in the trailing three months. The index looks to consider 25 to 40 airline stocks across the market. The product will charge 60 bps in fees. How Does it Fit in a Portfolio? The global aviation industry holds a steady outlook for 2015. The outlook is especially positive for the U.S. economy, with GDP growth gaining momentum. Consolidation benefits, growing travel demand and enhanced ancillary revenues also provide an impetus for growth. Other regions including the Middle East, Latin America & Africa and Asia-Pacific also hold promise. Several Gulf-based airlines continue to build up their positions within the global airline industry. Fleet development should improve over the coming years. Apart from the high demand from the oil rich Gulf nations, a major part of the fleet demand will be driven by China and India, and continuous expansion of low budget carriers around the world. If this was not enough, an unexpected plunge in oil prices turned out to be the real catalyst in propelling the industry. Airline profit outlook depends on fuel prices, the major variable component in the industry. The oil price drop of about 50% seen in 2014 is yet to turn around in 2015. In such a bullish backdrop, the upcoming airline ETF has every reason to be successful, if it gets approval. ETF Competition The road ahead for the proposed ETF is nothing but clear skies. The industry has long been waiting for such a product after the shutdown of the Guggenheim fund. While there are no direct competitors to the product, investors should note that two transportation ETFs, namely the iShares Transportation Average ETF (NYSEARCA: IYT ) and the SPDR S&P Transportation ETF (NYSEARCA: XTN ) have weight in the airlines industry. While IYT puts about 45% of its weight in the airlines, air freight & logistics sectors, XTN places about one-fourth of the fund in them. We expect the newly filed product to cash in on the underlying sector’s allure and find a solid following among investors. Nonetheless, the two transportation ETFs could eat into the proposed fund’s asset base because of the formers’ diversified approach to the transportation sector. Still, investors solely eyeing the global aviation industry would be satisfied by the proposed JETS ETF.

2 Weeks Later: Did Mean Reversion Of CEFs Take Place?

Summary Annual rebalancing in YYY/CEFL led to systematic inflation and suppression of CEF prices. A previous article suggested to sell the CEFs that were added to the index and to buy the CEFs that were removed, after the rebalancing date. Two weeks later, some evidence of mean reversion is observed, though most of these effects were not statistically significant. Introduction In a previous series of articles, we explored interesting events that happened to the YieldShares High Income ETF (NYSEARCA: YYY ), a CEF “fund-of-funds,” and the ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSEARCA: CEFL ), the 2X leveraged version of YYY, at the end of the year. Both funds are based on the ISE High Income Index [YLDA], which rebalances annually on the last trading day of each year. After ISE gave notice of the proposed changes that it planned to make to the index on 12/24/2014, we observed high-volume buying of CEFs that were to be added to YYY/CEFL, and high-volume selling of the CEFs that were to be removed. The latter acted to depress the prices of existing constituents in the fund, causing YYY to significantly underperform the PowerShares CEF Income Composite Portfolio ETF (NYSEARCA: PCEF ), a CEF fund-of-funds that tracks a different index. Moreover, we observed price “spikes” for the underlying CEFs at the close of 12/31/2014, suggesting that YYY/CEFL were forced to rebalance at unfavorable prices. On the next day, 1/2/2015, YYY fell 1.25% (and CEFL fell 2.96%) on a day where stocks, bonds and PCEF held relatively flat. YYY Total Return Price data by YCharts The second of the articles suggested a third possible way in which YYY/CEFL investors could lose money: reversion of premium/discount values of the CEFs that had been added to the index. The heavy buying of these CEFs had pushed the premium/discount values of those funds to higher (i.e. more expensive) levels, leaving investors in those funds susceptible to reversion in premium/discount values. Thus, the article suggested to sell the CEFs that were added to the index and to buy the CEFs that were removed from the index to take advantage of mean reversion. This article provides an update on whether that hypothesis played out. Results and discussion The second of the articles was published on 1/6/2015, as it took me a few days to piece together the events surrounding the rebalancing event. Nevertheless, I will be using 1/2/2015 as the starting point for the performance comparisons as this is the day after the rebalancing took place. CEFs that were added We first consider the 10 CEFs that had the highest increases in allocation upon YYY rebalancing. Those 10 CEFs had increases ranging from 3.52% for ISD to 4.59% for DSL. The following graph shows the total return performance for those 10 CEFs from 1/2/2015 to 1/16/2015 (just over two weeks). EDD Total Return Price data by YCharts Those 10 CEFs had an average performance of -1.26%. The following table shows the premium/discount values for those 10 CEFs two weeks ago (1/5/2015) and today. CEFs are arranged in order of increasing premium/discount on 1/5/2015. Two weeks ago Today Change EDD -10.51 -10.42 0.09 GLO -10.2 -11.39 -1.19 PCI -9.43 -9.64 -0.21 HYT -9.22 -9.02 0.20 MCR -8.47 -11.98 -3.51 DSL -7.9 -8.06 -0.16 GHY -7.51 -5.13 2.38 ISD -7.11 -6.88 0.23 AWP -7.04 -11.52 -4.48 FPF -6.68 -7.85 -1.17 Average -8.41 -9.19 -0.78 We can see that premium/discount value of these 10 CEFs decreased by an average of -0.78%. The following chart displays the change in premium/discount values graphically, with CEFs arranged from the largest change to the smallest. We can see that 4 of the CEFs saw an increase in premium/discount value, while 6 of the CEFs saw a decrease in premium/discount value. Notably, the four funds that had the greatest decrease in premium/discount values (FPF, GLO, MCR and AWP) were the exact same funds that had the greatest positive deviation from 1-year historical premium/discount value two weeks ago (the largest white bars in this chart linked from my previous article). Overall, these data appear to support the hypothesis that the CEFs that were added to the index saw an inflation of value before rebalancing, making them susceptible to losses (average performance = -1.26%) as their premium/discount values reverted (average change in premium/discount = -0.78%). However, neither the average performance or the average change in premium/discount values were found to be statistically significant. CEFs that were removed We next consider the 10 CEFs that underwent the largest decreases in allocation upon rebalancing. Those 10 CEFs had decreases ranging from -4.18% for BOE to -5.76% for BCX. The following graph shows the total return performance for those 10 CEFs from 1/2/2015 to 1/16/2015 (just over two weeks). BOE Total Return Price data by YCharts Those 10 CEFs had an average performance of -0.08%. The following table shows the premium/discount values for those 10 CEFs two weeks ago (1/5/2015) and today. CEFs are arranged in order of increasing premium/discount on 1/5/2015. Two weeks ago Today Change BCX -16.01 -15.23 0.78 BOE -13.30 -12.27 1.03 ETJ -10.19 -9.82 0.37 JGH -9.59 -12.62 -3.03 MIN -9.29 -8.01 1.28 ETW -9.04 -7.75 1.29 NFJ -7.61 -6.57 1.04 ETV -4.11 -3.54 0.57 GAB -3.85 -2.75 1.10 PHK 48.45 55.84 7.39 Average -3.45 -2.27 1.18 We can see that premium/discount value of these 10 CEFs increased by an average of 1.18%. The following chart displays the change in premium/discount values graphically, with CEFs arranged from the largest change to the smallest. We can see that 9 of the CEFs saw an increase in premium/discount value, while 1 of the CEFs saw a decrease in premium/discount value. Overall, these data appear to partially support the hypothesis that the CEFs that were removed from an index saw a suppression of value before rebalancing. While the majority of CEFs saw an increase in premium/discount value (average change = 1.18%), this did not translate into a higher performance (average performance = -0.08%). As before, neither the average performance or the average change in premium/discount values were found to be statistically significant. Personal trade I also described my personal trade in the previous article: At the open of 1/5/2015, I sold all but a token position in CEFL, and instead replaced the position with ETW, ETV, NFJ, PHK and PTY. All five CEFs were removed from the index, and the first four were among the top 10 funds undergoing the largest decreases in allocation. The following chart shows the total return performance for CEFL and those 5 CEFs from 1/2/2015 (the close of this day roughly corresponds to the open of 1/5/2015) to today (about two weeks). ETW Total Return Price data by YCharts Happily, my selection of CEFs that I purchased at the open of 1/5/2015 did much better than CEFL over the past two weeks. The average of the 5 CEFs was +0.59%, while CEFL fell -3.75%. Summary Two weeks after rebalancing, the 10 CEFs that were added to the index saw an average decline of -1.26%, while the 10 CEFs that were removed from the index saw an average decline of -0.08%. Meanwhile, 8 CEFs that were not substantially impacted by rebalancing exhibited an average gain of +0.35%. However, a statistical test showed that none of these average performances were significantly different from 0%, with the -1.26% decline for the 10 CEFs that were added being the closest to significance (p-value = 0.066). Moreover, we saw some evidence of mean reversion in premium/discount values taking place. The average change in premium/discount of the 10 CEFs that were added was -0.78%, while that for the 10 CEFs that were removed was +1.18%. However, these average changes were again not significantly difference from 0%. The difference between the average premium/discount change of -0.78% for the 10 CEFs added compared with +1.18% for the 10 CEFs removed was close to being significant (p-value = 0.069). Has mean reversion for these batch of CEFs been fully played out? For CEFs like AWP, the answer is probably yes, as its premium/discount dropped 4.48 percentage points (from -7.04% to -11.52%) over the course of two weeks, and is now once again close to its 1-year average of -11.21%. One must look at each CEF individually to evaluate its deviation from its historical premium/discount averages. Hopefully, we will have a chance to revisit this idea at the end of 2015 to see if the same phenomenon occurs or whether these artificial deviations, being now more well-known, will be arbitraged away.