Tag Archives: management

IYR: This REIT ETF Has Some Great Holdings

Summary The portfolio construction of IYR is easy to admire. They took the risk of making the second heaviest weighting an equity REIT with extreme levels of operational leverage. They even incorporate a very small weighting to mREITs which further diversifies the portfolio. A heavy allocation to REITs makes more sense for investors that are weak on bond positions. 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. One of the funds that I’m considering is the iShares U.S. Real Estate ETF (NYSEARCA: IYR ). 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 IYR is .43%. Compared to other domestic equity funds like the Vanguard REIT Index ETF (NYSEARCA: VNQ ) or the Schwab U.S. REIT ETF (NYSEARCA: SCHH ), that is painfully high. VNQ charges .12% and SCHH charges .07%. Because I love diversification at low costs, I’m holding both VNQ and SCHH in my personal portfolio. Largest Holdings (click to enlarge) A large position to Simon Property Group (NYSE: SPG ) is a fairly normal starting point for most REIT ETFs. The very interesting thing about this portfolio is that they are using American Tower REIT Corp (NYSE: AMT ) as the second holding. For investors that are not familiar with AMT, they are a global telecommunications REIT. When you place a call from your cell phone, you may be using the services AMT provides as they contract with cellular companies to lease usage of their cell phone towers. The REIT has a very weak dividend yield and from most pricing metrics it looks absurdly expensive. The reason investors have kept shares of AMT so expensive is because their structure incorporates an enormous amount of operating leverage. When they go from having one client to two clients for a cell phone tower the variable costs are extremely low while the revenue scales up substantially. This is an interesting play because most holders of a REIT index would be looking to use the position to grab some dividends and AMT has fairly weak dividends. On the other hand, AMT is one of three major companies in their very small sector and there is the potential for excellent returns. This is a play with high risk and high potential returns. The best way to make those kinds of high risk plays is within the context of a diversified portfolio, so it makes sense that it would get a significant allocation within an ETF. Simply put, this strategy makes more sense from a diversification perspective than it does when we are considering why the investor might initially choose to buy a REIT ETF. Sector Exposure This breakdown of the sector exposure reinforces what I was seeing in the initial holdings chart. The heavy position in specialized REITs suggests a goal of using the ETF structure to create a portfolio that is substantially less volatile than the underlying holdings. Overall, I like the strategy in the portfolio construction. While I’d like to see more breakdowns on the “specialized” sector, I have to admit that I really admire seeing the ETF work to incorporate other types of holdings such as mREITs. That sector is highly complex and I spend a great deal of my time explaining it to investors. If investors get their exposure through a very small allocation within a REIT ETF, that would be a solid way to prevent the common investor mistakes of buying high and selling low which seems to be extremely common in the mREIT sector. 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 IYR has a great portfolio construction methodology for investors that want some diversified exposure to equity REITs. The dividend yield of 3.83% isn’t mind blowing, but it is higher than the yield on SCHH. Of course, investments in mREITs should help strengthen the dividend yield to make up for REITs like AMT that are priced based on expected future revenue growth combined with exceptional operational leverage. The only thing I really dislike in this ETF is that the expense ratio is just too high. I can’t justify paying that kind of expense ratio for a REIT ETF. If an investor is willing to put up with the huge expense ratio, they should take notice that the fund has a positive correlation with the long term bond portfolio in BLV. That can be difficult because investors would like to be able to use the negative correlations to hammer the portfolio volatility lower. On the other hand, the moderate correlation with the S&P 500 makes it a reasonable option for investors that intend to be running a portfolio that is very heavy on equities. I fall under that category. I run extremely heavy on equities and use a significantly higher allocation to equity REITs than I would if I were running a strong bond allocation.

Hedging For Disaster – Now, Are You Ready To Listen?

A follow-up to our September 4th post with new, actionable trade ideas. Our Options Opportunity Portfolio in now up 8.1% in week 7 – here’s how we did it. For those who can’t, or won’t, go to cash – we have some great hedging ideas. 3 weeks ago, we told you how to protect yourself from a market downturn . 21 days is not a lot of time to test an investing premise, but it’s good to take a look at our progress on this relatively small market dip (that we accurately predicted), so perhaps you’ll take the necessary precautions to avoid taking losses in the next leg of downturn. My biggest regret in 2008 was ” trying not to be so gloomy “, so now I’m going to keep reminding you to hedge (or better yet, get to cash!!!) – all the way down to the bottom. As you can see from Dave Fry’s S&P 500 chart, we’re barely down on the S&P from where we were on September 4th, so you’d think our bearish hedges wouldn’t pay off – but you’d be wrong! Why? Because, like our long market conditions, our bearish hedges follow our Be the House – Not the Gambler™ strategy, which allows you to make money in relatively flat markets too. Let’s take a look at the hedges we showed you that day (September 4th) from our Short-Term Portfolio: (click to enlarge) These are simple option trades called ” bull call spreads ” – something our PSW Members learn in their first week of trading stock options. This isn’t an educational post, so we’ll go right on to the results portion of the discussion: The ultra-short S&P (NYSEARCA: SDS ) September $21/24 bull call spread expired on 9/18 at $2.48 – up 50% from the $1.23 net we showed you on 9/4 (5th column from the right was that day’s prices). With 50 contracts, the position we showed you made $6,150 in 3 weeks. The ultra-short Nasdaq (NASDAQ: SQQQ ) September $21/24 bull call spread expired on 9/18 at $1.48 – up 169% from the 0.65 net we showed you on 9/4. With 50 contracts, the position we showed you made $4,150 in 3 weeks. The ultra-short Nasdaq January $18/30 bull call spread closed Friday at $4.50 – up 45% from the $3.10 net we showed you on 9/4. With 50 contracts, the position we showed you made $7,000 in 3 weeks. The ultra-short Russell (NYSEARCA: TZA ) October $11/14 bull call spread closed Friday at $1.28 – up 70% from the 0.75 net we showed you on 9/4. With 50 contracts, the position we showed you made $2,650 in 3 weeks. So that’s $50 less than $20,000 in gains from positions we showed you from our Short-Term Portfolio just 3 weeks ago (you’re welcome). At the time, our $100,000 portfolio was up 214.5% and $20%, added another 20% to bring us up to 234.5% all by itself; but we also wisely cashed in our longs right at the September highs, locking in gains on those positions as well (as noted in that post) – so our net is a bit better than that. I would tell you that you can learn all about hedging and options strategies at Philstockworld.com but wait, there’s more! That’s right, we also showed you our long trade ideas for our Option Opportunities Portfolio – a portfolio we have partnered with over at Seeking Alpha to help teach people basic option trading strategies following our virtual portfolio. At the time (same 9/4 post), the positions looked like this: With the full image, it’s easy to see what I meant by the current price. As with our Short-Term Portfolio at PSW, the Option Opportunities Portfolio practices a strategy of cashing in the winners and adjusting the losers (assuming we still like them) until they are also winners and we can profitably take them off the table. The performance of the above positions (and we detailed our logic for each one in the ” Hedging ” post) over the last 3 weeks has been: BID January $34 calls are now $1.95, down 28% for a loss of $1,500 in 3 weeks. We have rolled the position to the April $32 calls, now $3.80. DIA September $155/159 bull call spread expired at $4, up 207% for a gain of $5,400 in 3 weeks. RJET February $2.50/4 bull call spread is now net 0.45, up 350% for a gain of $350 in 3 weeks. IRBT January $25/Dec $32 bull call spread is now net $4.24, up 19% for a gain of $690 in 3 weeks. CCJ September $13 calls expired at 0.32, down 60% for a loss of $480 in 3 weeks. CCJ short December $14 calls are now 0.36, down 69% for a gain of $790 in 3 weeks (because we were short, not long). CCJ March $11/Jan $12 bull call spread is now net $1.05, down 58% for a loss of $1,450 in 3 weeks. TASR 2017 3-legged spread is now net $1, up 222% for a gain of $1,800 in 3 weeks. USO April/January 3-legged spread is now net $1.73, up 5,766% for a gain of $3,400 in 3 weeks. They weren’t all winners (can’t be, as we bet against ourselves to hedge our positions) but, as a group, the trades we showed you as a free sample just 23 days ago are now up $9,000, which is 9% of our $100,000 Portfolio. Of course it’s a live portfolio and we’ve added and subtracted positions since then, but our net return of 8.1% roughly reflects the gains we’ve managed to take off the table and now, hopefully, our new round of trades can do just as well in the next 3 weeks (sorry, no more freebies!). Would now be a good time to sell you on looking into our service? But wait – there’s more! In that same free post, I also laid our 3 brand-new trade ideas to prevent your portfolio from losing money in the rough markets we forecast ahead. As I noted above, we haven’t had much of a correction (yet) but, since we used our patented ” Be the House “™ strategy to lay out our trades – we still did pretty good. Buying 10 SQQQ October $22 calls for $4.20 ($4,200) Selling 10 SQQQ October $28 calls for $1.90 ($1,900) As you can see, ProShares UltraPro Short QQQ ETF ( SQQQ) can be extremely volatile and that’s why we were comfortable with such a wide spread (all the logic is laid out in the original post, which was more instructional). Now those October $22/28 bull call spreads are net $2.60 – up just 13% ($130) and still very playable as a hedge. We also suggested paying for the spread by selling the TASR 2017 $20 puts, which are now $3.60 (up $200) and we still like that combination but remember – you are obligating yourself to own 1,000 shares of TASR at $20 (now $23.58) – keep that in mind. Our second big hedge of that day was far more aggressive: Buying 20 TZA Oct $10 calls at $2.20 ($4,400) Selling 20 TZA Oct $13 calls at $1.00 ($2,000) Selling 10 TZA Jan $10 puts for $1.00 ($1,000) (click to enlarge) Another really volatile one but, as you can see, it’s well on track to our $13 goal and already the net on this 3-legged spread is $1.24, up 77% from the net 0.70 start and good for a $1,080 gain. It’s well on the way to a full $4,600 gain, so it’s still good as a new trade – just not as good as it was when we told you about it 3 weeks ago! Our final hedge from that day was our most aggressive as far as commitment. We felt very strongly the S&P would not hold 1,950 and we wanted some nice portfolio protection but, since that’s expensive, we offset the cost by promising to buy more of our Stock of the Year, Apple (NASDAQ: AAPL ): Buying 30 SDS March $23 calls at $3 ($9,000) Selling 30 SDS March $28 calls at $2 ($6,000) Selling 5 AAPL 2017 $70 puts for $4.35 ($2,175) (click to enlarge) (click to enlarge) As you can see from the chart, SDS is well short of our goal, but does show the tendency to show dramatic gains on a sell-off. At the moment, the March $23/28 bull call spread is up slightly (+33%) at net $1.33 (+$990) but the short 2017 Apple calls have already dropped to $2.73 for a very nice $810 gain on 5 contracts. That means our net $825 spread is already $1,800 and up 121% ($975) in just 3 weeks. The maximum return on that spread is $15,000, so another $13,200 to go means you didn’t miss much if you are coming in late to the party – it just seems that way, if you didn’t catch the entries we published for our members (and for you) back on September 4th: “As I mentioned, we’ve gotten mainly to cash, but that doesn’t mean we don’t find new opportunities for trades almost every day and that’s all the commercial you’re going to get in this post because I’m sure the performance of the picks we publish speaks for itself and we assume you’re an intelligent man (or woman) and can make your own decision as to whether you want to invest in learning our investing techniques.” “Learning how to use options (and Futures – but that’s another article) to hedge your portfolio gives you BALANCE that can steer you through the roughest market waters – keep that in mind next time your portfolio is heading for the rocks!” Enjoy your weekend, – Phil

NextEra Energy Still Not Worth Buying, More Questions Emerge In Hawaii

Summary Hawaii Electric looks less likely to close by the end of the year than in our previous analysis. NextEra still doesn’t appear worth more than the mid-$90s. NextEra is doing really well in Florida and profits are higher than expected. Today, we will to take a refreshed look at NextEra Energy (NYSE: NEE ). We first looked at the company in late February and followed that with an update in June . When we started our analysis in February, we argued for some correction. We then reiterated that valuation was too rich in June. YTD, the company is now down 5% and has not shown much ability to add more value. We noted we would be interested at the 90-level. Our main thesis was that, while the company’s health and catalysts were strong, valuations were pricing in a best-case scenario of 6% revenue growth and 22% operating margins consistently moving forward. In the June update, we continued to be worried about margin compression from the Hawaii Energy (NYSE: HE ) deal. Today, we want to revisit our catalysts in the wake of the last set of earnings as well as other developments that have occurred. Additionally, we will take another look at our pricing model to update that given this analysis. 2015 Catalysts Revisited Economic Moat Strength For me, the key strength for NEE has always been its economic moat that exists from non-competitive agreements that the company has with many municipalities. Non-comp agreements exist in many of the relationships the company has where it negotiates a “fair price” deal with a town/city/county that limits competition but keeps prices in check for citizens. As we noted before, NEE is very attractive because about 80% of its business is in the regulated arena, where profitability is strongest. This image from Market Realist tells the tale: (click to enlarge) (click to enlarge) The company benefits strongly from these regulated industries as it can establish infrastructure, keep consistent revenue/earnings flowing, and doesn’t have to worry about competition. As long as the company can maintain this strong mix, it will be attractive for income, long-term investors. To me, the real catalyst, though, is the company’s ability to have success in Hawaii. Hawaii – Another Regulated Market to Add Shareholder Value In 2014, NextEra bought Hawaiian Electric ( HE ) for north of $4B. The move was a chance to come into a new market that was in need of cost savings and be able to combine a regulated market with the company’s practice of making efficient utility deliveries. Further, NEE wanted to be able to bring its ability and knowledge of scaling renewable energy in an area that is burdened by extreme energy costs. Between the company’s initiatives in solar energy and knowledge of other sources, NEE stands to be able to generate a very strong value proposition for Hawaii while also continuing to promote its economic moat. So, how have things been moving since the last time we looked at the company… The last time we looked at the HE/NEE deal, the main aspect of the deal was just to get it done and approved. In April, HE’s CEO came out saying he was confident that the deal would be completed within a year, and the Hawaiian House of Representatives put a resolution in place to complete the deal by June 2016. Given the market is regulated, it is a major decision for Hawaii, consumers, etc. In the company’s latest earnings, here was the company’s comments on the HE deal: Steven Fleishman – Wolfe Research Yes, hi good morning and congrats. The couple things that I guess you didn’t mentioned, first is any kind of thoughts on the Hawaiian deal and just, there does seem to opposition in your ability to get that done? James L. Robo – Chairman and Chief Executive Officer Steve this is Jim, obviously the state filed a testimony ten days ago saying that they opposed the deal in its current form and the Governor held a press release where he, press conference where he said he opposed the deal in its current form. I think the key, the keywords there in its current form, they also, the state also listed several conditions that would be, I think just positive for them to think about changing their view. And we are in the process of responding to that testimony and we think we have a very strong case to put forward to the Commission around the benefits to customers, the benefits to customers were actually pretty compelling and I think we’re going be able to make that case as we go forward. So, this was not necessarily a surprise to me that the state filed a kind of testimony that they did and we are going to continued to move forward on laying out our arguments and we look forward to the hearings we’re going to have in December to make our case. As we can see, things aren’t progressing as well as the company has hoped. In the last report, the company had noted that they expected the deal to be done by the end of the year. Now, the company is not quite as positive. Waiting till December to answer testimony is much different than getting approval then. The state of Hawaii published testimony in July, and the Governor came out against the deal: Gov. David Ige said Tuesday he doesn’t support the sale of Hawaiian Electric to Florida-based NextEra Energy. The sale was approved by Hawaiian Electric’s shareholders in June but still needs approval from the state Public Utilities Commission. Ige said he supports capital investment in Hawaii, but he joined critics saying he’s concerned that NextEra may not be able to fulfill Hawaii’s goal that its utilities use 100 percent renewable energy by 2045. This news was not exactly the type of “positive” news that the company had hoped for. Since that comment in July, the Governor has said the process was still very early, and that he is looking forward to the company’s responses to testimony it presented. While we all expected some snags, the process continues to move quite slow and questions the long-term prospects of being able to have this deal work well for all parties. Overall, though, we believe this deal is very important to NextEra Energy. As we noted previously: The company brings the expertise of how to apply a mix of renewable energy and create consistent returns. With the prices that Hawaii is used to paying, the company should reduce costs for Hawaiians yet also make a strong profit. The company’s mix, though, of more green energy plays has not been as profitable. The company still makes its bread and butter in Florida where it uses a majority natural gas. So, the question will be if they can return the type of 20% operating margin in Hawaii? The nice thing that is baked into the cake for them is that Hawaiians are used to paying more than most Americans, so they will be able to invest more easily. We will continue to monitor this situation, but for now, the company is starting to look like they are getting off track. Current Pricing Next, we want to update our current pricing model for NextEra. The latest earnings for NEE were pretty solid in the latest quarter. EPS came in at 1.56 versus 1.50 expectations as well as a beat for revenue as well. The company’s strength continues to be seen in Florida, where revenues/earnings continue to rise. The company’s results were helped by an improving Florida economy that led to more additions as well as a lot of strength in NextEra Energy Resources, which saw a 21% increase in revenue. The NEER division is the renewable contracted part of the business, and that type of growth shows just how in demand renewable energy is becoming. In this section, we will want to take a look at our last pricing analysis, update it, and determine what we believe is a fair value price for NEE. In order to price the company, we need to make certain assumptions. In our last two articles, we modeled revenue growth to continue at a clip of 4-5% per year, and we believe that level will maintain for the next several years. The gains we noted in our last article were not sustainable in NEER, and the results have already seen a 50% reduction QoQ. Most analysts are only modeling for 1% growth still for this year, but we are using an annualized figure. Utility revenue is fairly consistent. The key to the company is definitely margins. Operating margins are key to our DCF analysis. The coming has forecast that they will come in at the 22-23% in 2015, but I imagine this number will dip some with the onslaught of Hawaiian Electric when it is approved. In Q2, the company’s operating margins came in strong at 26% after 28% in Q1. For 2015, we believe 22-23% is a bit light, and we will increase our expectation to 25%. As for the HE deal, it should add roughly $4.5B in sales in 2016, but the company operates with a 10% operating margin. The deal is really essentially to take what is a tough market for making money, revolutionize it, and improve it. This plan, though, will take several years. Therefore, margins will drop in 2016 but gradually improve again through 2020. Taxes have averaged roughly 25% for the past five years, and it’s likely this will stay around 28%-30% over the next several years. We may see it jump even a bit more beyond 2016 when more solar credits are expected to expire. Depreciation will continue to grow at about the same rate as revenue growth. Capex should come down in 2015 to around $6B and again in 2016 to $4B.The $4B rate, though, is pretty standard for the company. Our WACC rate is 5% for discounting. When we use this math in our five-year DCF analysis, we were looking at a low-90s number. We have made some positive adjustments, and here is our projections: PROJECTIONS 1 2 3 4 5 2015 2016 2017 2018 2019 Income from Operations 4350 3654 3990 4347.2 4726.73 Income Taxes 1218 1023.1 1117.2 1217.2 1323.48 Net Op. Profit After Taxes 3132 2630.9 2872.8 3130 3403.25 Plus: Depreciation 2600 2700 2800 2900 3000 Less: Capex -3600 -3900 -4000 -4100 -4200 Less: Increase in W/C -100 -100 -100 -100 -100 Available Cash Flow 2,232 1,531 1,773 2,030 2,303 We don’t see any major change from our last model, so we are keeping our price target at $96. Margin drops in HE and getting regulations approved are key to this model. Additionally, if Florida and NEER stay very strong, the company could outperform our expectation for the current FY. Conclusion NextEra has interesting catalysts to 2015, but after a tremendous run in 2014, the company looks like its upside may be limited in the near-term. Recent issues in Hawaii Electric ( HE ) make me nervous, but the rest of the company’s business is extremely intriguing and strong, which neutralizes my fears there. Yet, we still don’t see the reason to buy when we are at sitting at 2.5+ times sales and the company has question marks outstanding.