Tag Archives: management

Is Time Ripe For The Convertible Bond ETF?

The economy is on the threshold of an interest rate hike, a decade after a rock-bottom interest rate environment. Naturally, investors apprehend a sea of change and are looking for a safe and higher level of income with lower downside risk. After all, a December rate hike is now an extremely ripe prospect following a solid U.S. job report for October and the Fed’s perception that the U.S. economy is ‘ performing well ‘. Yields on the benchmark 10-year Treasury notes were at 2.32% on November 10, up from 2.05% recorded on October 27. Futures show a 68% chance of a lift-off by year-end compared with a 50% bet at October end. No wonder, investors have started to position their portfolio according to the looming lift-off and demand a high-yield but a harmless bet. For those investors, convertible bonds appear lucrative bets as these provide some of the benefits of bonds as well as stocks. What are Convertible Bonds? Convertible bonds are those that can be exchanged if the holder chooses to, for a specific number of preferred or common shares if the company’s share price climbs past a said conversion price during the bond’s tenure. Like traditional bonds, convertible bonds are issued on par, pay fixed coupons and have fixed maturities. The main difference is that convertible bonds offer investors the right to convert their bond holdings into a company’s shares at the holder’s discretion. This allows investors the potential to play both sides of a company – debt and equity – in a single security, offering a lower risk choice. The lack in this arrangement is that investors are compelled to accept a far lower coupon payment than traditional bonds of the same company. On the other hand, these bonds are less risky than equities. In case of bankruptcy, convertible bond holders get paid out ahead of equity holders. The price of these bonds generally moves in line with the underlying shares. However, unlike shares, the convertible bonds have some coverage against downside risks as investors can redeem these on par upon maturity, if the issuer is in business. All in all, these bonds are great instruments to tap a towering stock market, minimize risks and enjoy strong current income. ETF Impact Choices are very few in this corner of the ETF world. There is only one pure-play in the convertible bonds section – SPDR Barclays Capital Convertible Securities ETF (NYSEARCA: CWB ). Quite expectedly, the macro backdrop led to some decent trading in CWB in the recent past. CWB in Focus This popular ETF seeks to provide investment results that correspond generally to the price and yield performance of the Barclays Capital U.S. Convertible Bond > $500MM Index. This benchmark tracks United States convertible bonds with outstanding issue sizes greater than $500 million, giving the product a tilt toward the large cap securities. In terms of sector exposure, the product is skewed toward the tech industry (44.4%), while consumer staples and financial companies comprise about 16.6% and 12.4% of the portfolio. For credit quality, over 38% of the portfolio has a less than Baa rating, and over 35% of the basket is not rated followed by 19.2% having a Baa rating. The fund is also spread out in terms of maturities, with close to half of the bonds maturing in less than five years. This $2.73 billion-fund holds 104 securities. The top three holdings include Watson Pharmaceuticals 5.5 12/31/2049 (4.65%), Wells Fargo & Company (NYSE: WFC ) 7.5 12/31/2049 (4.27%) and Fiat Chrysler Automobile (NYSE: FCAU ) 787.5 12/15/2016 (3.24%). The fund was up 0.5% in the last one month (as of November 11, 2015) and yields about 4.61% as of the same date. Original Post

Japan In Technical Recession: Time To Buy ETFs On The Cheap?

The Japanese economy is now officially in a technical recession having shrunk 0.2% sequentially in Q3 followed by a 0.3% contraction in Q2. On an annualized basis, GDP fell 0.8% in Q3 trailed by a 0.7% (which was in fact a revised up figure) decline in the second quarter. Economists had expected a 0.2% annualized and 0.1% sequential drop for the third quarter. Per Bloomberg, lower capital expenditure by Japanese companies that resulted in soft business investment and lower inventories in the wake of global growth worries led to this miss. Though the economy is expected to step up in the ongoing quarter as companies are likely to increase output on declining ‘ stockpiles in warehouses ‘, the weak GDP numbers also led to talks about further policy easing. Views that the economy ” might have hit the bottom” in Q3 is widespread now and most people are wagering on a more beefed-up fiscal and monetary policy. Even if the Japanese corporate profile looks steady, sluggish capital spending is now a big hindrance. As per analysts, the soft global and domestic economic backdrop is restraining them from investing aggressively. Not at all. Japanese companies under Nikkei 225 delivered record earnings recently but valuations have swollen only 2.3% from the end of last year, per Bloomberg . About 55% companies under the broader Topix index beat analysts’ estimates this season. Consumer prices in Japan halted year on year in September 2015, falling from a 0.2% rise in August. Inflation in Japan has now fallen back to the level never seen since May 2013 . This boosted hopes for further monetary easing. The BOJ has now delayed the deadline for achieving an inflation target of 2% by six months. If this was not enough, after a stellar run by the ongoing QE stimulus, Japanese equity ETFs are still attractively valued. The popular Japanese ETF iShares MSCI Japan (NYSEARCA: EWJ ) trades at a P/E of 13 times at the currency level. This calls for scope for more returns out of the Japan-based ETFs. However, since yen has devalued considerably thanks to the prevailing easy money policy and the Fed is preparing for a policy tightening, a currency-hedged ETF approach is desirable in Japan investing. Though the economy Minister of Japan recently commented that “at this point the government is still not considering ‘pure’ fiscal stimulus” and that the outcome of wage negotiations for fiscal year 2016 will be a more significant growth driver than fiscal stimulus, there is a clear indication that the economy will gather steam by either one way or the other. WisdomTree Japan Hedged Equity Fund (NYSEARCA: DXJ ) DXJ looks to offer investors a way to gain exposure to the Japanese shares devoid of currency risks. This is a liquid choice in the space with 7,000,000 shares in average trading volume a day. The large-cap oriented fund has a huge asset base of $17.2 billion and charges 48 bps in fees. Toyota Motor (NYSE: TM ) (4.80%), Mitsubishi ( OTCPK:MMTOF ) (4.76%) and Japan Tobacco ( OTCPK:JAPAF ) (4.34%) take the top three spots of the fund while consumer discretionary (24.6%) and industrials (23.2%) are top two sectors. The fund was up 6.5% in the last one month (as of November 16, 2015) and has a Zacks ETF Rank #2 with a Medium risk outlook. Japan Hedged Dividend Growth Fund (NYSEARCA: JHDG ) The ETF follows the WisdomTree Japan Hedged Dividend Growth Index. The fund consists of about 248 companies. The $25.3-million fund measures the performance of dividend-paying common stocks with growth characteristics selected from the WisdomTree DEFA Index while at the same time neutralizing exposure to fluctuations between the yen and the U.S. dollar. Consumer discretionary rules the fund with about 25% exposure. Industrials (23%), IT (13.8%), consumer staples (10.6%) and telecom (10%) also get double-digit weight each. NTT DoCoMo Inc (NYSE: DCM ) (5.5%), Japan Tobacco (4.59%) and Toyota Motor (4.4%) round out the top three spots of the ETF. JHDG charges 43 bps in fees and was up 6% in the last one month. WisdomTree Japan Hedged SmallCap Equity Fund (NASDAQ: DXJS ) DXJS offers exposure to the Japanese small cap stocks while at the same time provides hedge against any fall in the Japanese yen. This is easily done by tracking the WisdomTree Japan Hedged SmallCap Equity Index. The fund has accumulated $196.5 million in its asset base and charges 58 bps in fees per year from investors. Volume is moderate as it exchanges 80,000 shares in hand per day on average. The product holds 618 stocks in its basket with none accounting for more than 0.95% of assets. Industrials and consumer discretionary take the top two spots with around 24% share each, while materials, financial and information technology round off the top five. The ETF gained 4.9% in the last one month and has a Zacks ETF Rank #2. Original Post

VSCSX: High Quality Short Term Corporate Debt May Be On Sale In December

Summary The Vanguard Short-Term Corporate Bond Index mutual fund is everything I would hope for in a short-term corporate debt exposure. The mutual fund has low volatility and low correlation with other important investments. The Federal Reserve may push up yields and put high quality bond funds on sale in December. The Vanguard Short-Term Corporate Bond Index Admiral Shares (MUTF: VSCSX ) is simply a great fund. I wish I could start more articles out with comments that are this positive. This fund is simply great. The yields are severely limited since this is short term debt with respectable credit quality, but the ETF on the whole is just exceptional when it comes to being part of an effective portfolio. Duration The following chart breaks down the duration of the funds. Holdings are almost all less than 5 years and usually more than 1 year. Again, this is a solid choice. If an investor wants to load up on even shorter term bonds, there are funds designed specifically for that. It is difficult to find a useful yield level on those ultra-short bonds so this is a reasonable portfolio composition. Credit The following chart shows the credit quality breakdown. When it comes to a corporate bond fund there are two ways that I like to see the weightings. Either I would want a junk bond fund or I would want one with a credit breakdown similar to this. Personally, favor combining a fund like this with quite a few other bond funds to create a more complex group of bond holdings. Sector The following chart breaks down the sector allocation: This sector allocation may seem absurd if an investor looks at numbers without reading the names. The names of the sectors indicate that rather than breaking down the market into all the corporate sectors, Vanguard is containing several other bond sectors that are not relevant to corporate debt. It wouldn’t make sense for this fund to have an allocation to foreign debt issues or MBS. Portfolio Usage When the mutual fund is placed within the context of a portfolio that is heavy on U.S. equities it looks like an intelligent way to reduce the overall risk of the portfolio. When it comes to generating alpha, I’ve often told investors that the secret to reaching alpha is to focus on reducing risk. (click to enlarge) Most other investors are already focused on trying to maximize their returns and many will take on more risk than they can handle. Focusing on risk reduction reduces the incentives for an investor to sell off after a big loss and makes it easier to generate alpha relative to the S&P 500 because it is easier to reduce risk through superior diversification. In this case we can see that the return on the fund was fairly weak over the last several years, but the annualized volatility has also been fairly low. When consider that the total risk contribution to the portfolio is negative due to the fund having a negative correlation with the S&P 500, the impact on risk adjusted returns is much more favorable than it would have appeared at first. These bonds do take on some credit risk as corporate debt, but the fund is not holding junk bonds so the credit risk is not material enough to outweigh the impact of a small amount of duration risk. As a result, investors end up with a negative correlation between this fund and most domestic equity funds. One Risk Factor The biggest risk factor for this portfolio right now is the potential for share prices to drop if the Federal Reserve is able to raise rates in December. I’m treating an increase in rates as a buying opportunity for any rate sensitive asset. That could mean bond funds, equity REITs, mREITs, or utilities. Regardless, I’d like to have a little cash available this December to see if the Federal Reserve is able to push some of the investments I want into the bargain bin. Another Use Investors that want to keep a fairly short amount of duration exposure in their portfolio while maintaining higher yield may consider this bond fund as part of an automatic allocation strategy within retirement portfolios. The yields aren’t going to be incredible, but for an investor that is feeling particularly risk averse this is a fairly nice fund. Since volatility is fairly low, it isn’t likely to move up or down very far, but it does offer some gains over time while making the portfolio less risky. Conclusion This mutual fund offers high quality corporate debt that will offer superior yields to treasuries but it still has a negative correlation with equity securities. The return is severely limited by short duration and high credit quality combining to create very low yields on the bonds, but it still makes sense for investors looking for some less volatile investments. If the Federal Reserve moves to raise rates it could put this fund on sale for a bit in December which would create a nice buying opportunity.