Tag Archives: management

TLT: Think Long Term

Many retail investors find it easier to access and buy bond funds or bond ETFs instead of going out andowning individual pieces of paper debt. It has been a dull few years for bond investors. As equity prices have risen higher since 2007 and 2008, bond performance has struggled. For the course of the long term, we remain very bullish on U.S. treasury bonds, and we recommend TLT – think long term. By Parke Shall Bonds can sometimes be tricky for the average retail investor. They are usually priced much higher than stocks, sometimes around $1000 if you want to buy individual bonds, sometimes higher. It’s for that reason that many retail investors find it easier to access and buy bond funds or bond ETFs instead of going out and owning individual pieces of paper debt. There are a growing number of bond ETFs that you can put your money into, but the most important thing to look at is always whether or not these ETFs are levered and what the fees are going to cost you. Bond instruments for the long term should not have leverage, and should simply track the yields of the type of bonds that you want to invest in, whether it is municipal bonds, corporate bonds, or our favorite; government bonds. Here is a list of some of the more popular treasury bond ETFs, from ETF Database , (click to enlarge) Our preference is the iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ). It has been a dull few years for bond investors. As equity prices have risen higher since 2007 and 2008, bond performance has struggled. This does not discourage us, however, as our bond investment strategy is to buy long term treasury bonds where we think there is eventually going to be some pricing support and some safety. Our investing strategy is one that always has some exposure to the consistent coupon of bonds. We try to keep some cash, we definitely keep equities, but we always do try and have varying amounts of exposure to bonds as well. Treasury bond prices have fallen, and the latest bit of news from the world of treasury bonds was that China was curbing the amount of money that they were pouring into U.S. government debt. Zerohedge said : As BNP’s Mole Hau put it on Monday, “whereas the daily fix was previously used to fix the spot rate, the PBoC now seemingly fixes the spot rate to determine the daily fix, [thus] the role of the market in determining the exchange rate has, if anything, been reduced in the short term. ” And a reduced role for the market means a larger role for the PBoC and that, in turn, means burning through more FX reserves to steady the yuan. Translation and quantification (with the latter coming courtesy of SocGen): as part of China’s devaluation and subsequent attempts to contain said devaluation, China has sold a gargantuan $106 (or more) billion in U.S. paper just as a result of the change in the currency regime. Notably, that means China has sold as much in Treasurys in the past 2 weeks – over $100 billion – as it has sold in the entire first half of the year. Today, we got what looks like confirmation late in the session when Bloomberg, citing fixed income desks, reported “substantial selling pressure in long end Treasuries coming from Far East.” We believe this move, on China’s part, is due to China needing to access the cash that it has in order to stabilize its stock market. When we look out over a broader term, we believe that Bond prices treasury bond prices will eventually study. Another interesting fact directing the bond market is the fact that inflation is seemingly nonexistent. This makes bond investing even more attractive, we believe. Short-term yields may stay at levels that they are at now for a little while to come. When the Federal Reserve finally gets around to raising rates,Will expect find pricing to begin stick up once again. However, for the course of the long term, we remain very bullish on U.S. treasury bonds, and we recommend TLT – think long term.

EFA: How Do You Make A Mediocre ETF Sound Exciting?

Summary EFA is a mediocre ETF. The sector allocation is mediocre, the geographic diversification is mediocre and the expense ratio is mediocre. The top holdings make sense, but they don’t reflect the total portfolio. Despite having a heavy portfolio weight towards financials, there is only one in the top ten. There is nothing bad about the ETF to warrant taking a capital gains tax on sale, but if a loss could be taken with proceeds reallocated… that would be nice. There isn’t much to say to make this ETF sound exciting. There are so many international ETFs it can be difficult for investors to choose one. Hopefully I can help with that problem by highlighting some of them and shining a light inside their portfolio. One of the funds that I’m considering is the iShares MSCI EAFE ETF (NYSEARCA: EFA ). 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 iShares MSCI EAFE ETF is .33%. I’d really prefer to see lower, but that isn’t high enough to remove the ETF from being worthy of further consideration. Geography The map above shows the top 10 countries by the market value of their allocations. This is certainly an international ETF, but the holdings seem more diversified from the list on the left side than from the list on the right side. I’d like to see even more diversification, but at least they have not assigned any single country a weighting higher than 25%. Sector Looking at the sector allocation is fairly interesting. Fortunately this is a fairly diversified group of sectors, but I think I would prefer a smaller allocation to financials. Perhaps I’m being too picky, but I’d rather see more consumer staples and foreign utilities mixed into the portfolio. I’d like to have the benefits of international diversification while overweighting the sectors that I expect to be less volatile. Largest Holdings (click to enlarge) Looking at the individual holdings, you wouldn’t expect that “Financials” would be so overweight. Only one financial company is in the top 10. The concern for me is that a heavy focus on financials in the lower parts of the portfolio suggests to me that the ETF may have a heavier weight on the companies that are easier to research or buy if markets are not sufficiently liquid in some countries. 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 EFA certainly has some volatility, but the correlation over longer time periods has been significantly lower than the correlation levels created by measuring on a daily basis. All around, this is a decent but not spectacular ETF. The ETF has a respectable but not incredible diversification among countries. The holdings are concentrated on the financial sector, but only one financial firm was able to warrant a large enough allocation to end up in the top 10. When it comes down to the sheer volume of holdings, there are 934 companies in the portfolio. Of course, that could change at any point. I love having extreme levels of diversification like that in international equity allocations, but such high diversification indicates a passive indexing strategy. As you might imagine, I’d rather not pay the .33% expense ratio for a passive index fund. The problems within the ETF aren’t bad enough for investors to have any cause to sell it and incur a capital gains tax, but I’d rather place international equity allocations in other ETFs. If an investor is able to harvest a tax loss on selling, that would be a very solid reason to reallocate to a more appealing ETF. If you’re looking for more appealing options, I put together an article with three of them .

Why Seeking Alpha Recommendations Outperform Mutual Funds And Brokerage Analysts

Summary Academic research indicates that, on average, Seeking Alpha recommendations outperform mutual funds and brokerage (sell-side) analysts by substantial margins. The SA coverage universe includes many small company stocks that are ignored by sell-side analysts, despite the longstanding and significant negative correlation between returns and market cap. SA contributors are far more likely than sell-side analysts to issue sell recommendations when circumstances warrant, thereby avoiding losses and exploiting opportunities to short. SA taps the “wisdom of crowds” via large numbers of highly trained contributors who are freer than brokerage analysts to develop and express individual stock ideas in great detail. Given the findings of academic studies at NYU and Purdue , there can be little doubt that Seeking Alpha (SA) recommendations, on average, actually do deliver substantial positive alpha. Nor can there be much doubt that actively managed equity mutual funds typically deliver negative alpha . With respect to sell-side analysts, a 2014 academic study of their performance found that only “about 50% of ‘buy’ recommendations issued by industry and market benchmarkers meet or beat their objective.” (Roughly as reliable, in other words, as basing one’s investment decisions on coin flips.) Fundamental Advantages of SA Research 1. Microcap and small cap stocks have a long history of outperforming large caps. As the NYU study noted, SA analysts often cover companies that are too small to attract coverage by brokerage analysts – or to be owned by mutual funds. When my Data Driven Investing co-author, Mitch Hardy, and I analyzed Compustat data for over 20,000 companies between 1951 and 2002, we found that an annually rebalanced portfolio of the 100 smallest stocks (with a minimum market cap of $10 million in 2002 dollars and assuming reinvestment of dividends at year end) would have grown from $1 to $4,418 ( 17.52% compounded annually ) during this 52-year period. This figure assumed that buys and sells were done for zero commission at year end closing prices, which is certainly an overly optimistic assumption. Nevertheless, it is a meaningful indicator of a powerful negative correlation between company size and investment returns when compared to the terminal values of $1 invested in similarly constructed portfolios with higher market cap minimums: $100 million minimum market cap – $1,293 terminal value (14.77% compounded annually) $250 million – $667 (13.32%) $500 million – $289 (11.51%) $1 billion – $303 (11.62%) S&P 500 – $254 (11.23%) 100 largest market caps – $148 (10.08%) From 1/1/03 through 10/2/15, this correlation has persisted. The Russell Mega Cap 50 has returned 139.9% (with dividends reinvested) vs. 199.9% for the Russell Microcap Index. 2. SA contributors are far more likely to issue sell recommendations when warranted than are sell-side analysts. Because brokerages have little to gain and much to lose from issuing negative reports, they make very few of them , thereby exposing their clients to avoidable losses, as well as causing clients to miss out on profitable short sale and put buying opportunities. Whereas almost all investors are potential buyers of the individual stocks that brokerage analysts recommend, relatively few are in a position to act upon sell recommendations. That is, unless an investor either owns a stock already or is inclined to short it (or buy puts), that investor will not act upon a sell recommendation. As a result, the potential commission revenue to be derived from making a negative call is relatively small. In addition, there are strong disincentives in play. Not only is the subject of a sell recommendation quite likely to look askance upon doing investment banking business with the brokerage that makes it, but it’s also possible for a single negative research piece to harm relationships with an entire industry . At the very least, going negative on a company can impede an analyst’s access to its management and the information needed to do his or her job. Moreover, these analysts have strong incentives to defend the stocks of companies that are either investment banking clients or prospects of their brokerages – even when short sellers put forth solid evidence of existential product liability problems and unsustainable business models. The next time Citron Research makes one of its “emperor has no clothes” calls, watch for one or more brokerage analysts to leap to the stock’s defense, however compelling the sell case might be. The more troubled the company, the more opportunity there may be to profitably pursue investment banking opportunities with it. Such companies may well be in the market for assistance from accommodative Wall Street firms in raising cash and/or dumping the stock owned by their managements upon unsuspecting investors. 3. SA contributors can focus far more attention than brokerage analysts on each opportunity they research. The SA posts of Citron provide us with prime examples of the thoroughness that brokerage analysts lack. (Click on the link in the preceding sentence to see what I mean.) The focus of sell-side analysts is necessarily diluted, due to the number of stocks they are assigned to cover, as well as their sales responsibilities. Academics have noted a negative correlation between analyst workload and accuracy (as well as a negative correlation between workload and research timeliness). Whereas it’s commonplace for a single sell-side analyst to have coverage responsibility for a dozen stocks or more (e.g. at Raymond James ), SA contributors have far more freedom to focus on developing one individual stock idea at a time. And when an important sell-side prospect or client needs handholding from an analyst, be it an institutional investor or investment banking-related, this may take precedence over research . 4. As the preeminent aggregator of crowdsourced investment research, SA is uniquely positioned to harness a large and growing pool of individuals with underutilized talent who are highly motivated to produce quality work. Many SA contributors (like yours truly , for instance) earn CFA designations with the hope of becoming an equity analyst or portfolio manager with an established firm. For those of us who will never realize this hope, SA provides an attractive means of pursuing our analytical passions, as well as a platform for sharing our analyses with, and receiving feedback from, thousands of viewers. Whether or not one has secured such a position, the rewards for writing insightful analyses can extend beyond the intellectual challenges, kudos from viewers, and penny per page view. There’s a reasonable chance that one’s audience will include someone impressed enough to make a suitable job offer or open a new account. The CFA charterholder population has roughly doubled during the past decade and now stands at over 123,000 – and there are more on the way, with more than 210,000 exam registrations received in 2014. Inevitably, this crop of CFA wannabees will ultimately yield a bounty of well-trained SA contributors. There are, of course, many highly competent SA contributors who do not hold CFA charters. Their numbers include underemployed MBAs, downsized financial services personnel, and those with no relevant formal training who have enough sense to know a good investment opportunity when they see one. In fact, when flooring contractors have something to say about Lumber Liquidators (NYSE: LL ), their observations carry more weight with me than whatever a desk-bound CFA/MBA type might have to offer. Whereas Wall Street firms offer no effective way for small investors to band together in challenging the assertions of their brokerage analysts, SA gives users the opportunity to publicly point out errors, unwarranted assumptions, and other shortcomings in the analyses submitted by its contributors. In addition, SA provides a convenient venue for critiquing the alleged wisdom of Wall Street. SA’s sharp-eyed editors constitute a first line of defense against the publication of factually incorrect or otherwise misleading submissions. And if significant deficiencies remain after publication, SA users’ multitude of eyeballs can generally be counted on to catch them. To the extent that the “wisdom of crowds” exists in the investment world – in contrast to the “madness of crowds” that is the Wall Street norm – it can be found at seekingalpha.com.