Tag Archives: management

Where Will China Financial ETFs Go From Here?

The Chinese economy has been grappling with liquidity crunch for more than two years now. But the problem recently reached an alarming level. While high bad loan in a waning economy made it hard for the borrowers to repay loans, the surprise devaluation of yuan in mid August worsened the crisis. This led to net foreign exchange outflows worth 723.8 billion of yuan in August that crumpled the Chinese banking system. Chinese banks are on their way to see the worst year in 13 years, per Wall Street Journal. Most of banking bellwethers reported lackluster first-half performances this year. Some analysts including those of Moody’s expect Chinese banks’ profits to weaken further in the second half of this year hurt by piled up non-performing loans and fall in net interest margins. A plunge in fee income from stock-related services will also hit banking services hard as Chinese investments fell out of investors’ favor lately. Is There Any Hope? While the operating backdrop looks outright grim for the Chinese banks, a few recent developments could favor the bunch. First, despite the record monthly decrease in forex reserves, China had the biggest hoard of foreign reserves of $ 3.56 trillion at the end of last month. Added to this, the percentage of bad debt in total loans, though high from the last quarter, remained low by global averages. Moreover, after the summer slowdown and a scorching sell-off in August, Chinese banks are now trading at bargain. The price/book value of Industrial and Commercial Bank of China’s Hong Kong-listed stock is 0.8 times, reflecting a 72.4% discount from the level seen in 2009, per Wall Street Journal. Several other big banks are also showing the same downtrend. Of course this valuation pointer reflects bearish sentiments on these banking stocks. But on a positive note, it also indicates dirt cheap valuation for the Chinese banks. If this was not enough, the Chinese central bank appears to be going all out to infuse liquidity into the economy and cut rates and reserve requirement ratios (RRR), as it has done several times this year, to boost lending. China also relaxed the methods for computing the reserve requirement ratios of banks. Per the 17-year old rule, banks were required to tally their RRR on a daily basis. “Under the changes, banks can report a daily RRR that is up to 100 basis points lower than the rate set by the PBOC, but their daily average RRR in the assessed period cannot fall under the required level,” per Reuters . Per a report by Barrons.com , Nomura Securities approximates that this easing can free up to 1.3 trillion yuan, or 1% of total banking deposit. All these stimuli should result in higher lending which in turn should boost profits. Also, in August, total social financing rose 13% to 1.08 trillion and corporate-bond issuances more than doubled to 287.5 billion indicating that present activities may not be as bleak as it looks. In a nutshell, relentless efforts by policymakers to boost loan growth and compelling valuation should stage the backdrop for China ETFs with heavy allocation to the financial sector, at least for the near term. Since no one knows what’s exactly cooking up behind the Great Wall and how long does it will take the country to return to top gear, caution needs to be practiced while playing these products. Investors should note that the core China financial ETF, the Global X China Financial ETF (NYSEARCA: CHIX ) was one of the best performers in the China equities ETFs space in the last one-week, four-week and one-year periods (as of September 15, 2015). So, we highlight two finance-heavy China ETFs which have bottomed out and could turn around in the coming days. After all, China shares have been trending higher in recent sessions after a bloodbath and financial ETFs could very well cash in on this rising trend: ETF Plays Global X China Financial ETF This ETF provides concentrated exposure to the financial segment of Chinese equity market by tracking the Solactive China Financials Index. In total, the fund holds over 40 securities in its basket with the top three firms – China Construction Bank ( OTCPK:CICHF ), and Industrial & Commercial Bank of China ( OTCPK:IDCBY ) and Bank Of China ( OTCPK:BACHY ) – dominating the fund’s returns at more than 9% share each. It is a large cap centric fund accounting for 85% of assets. The fund has amassed $54.1 million in its asset base while trades in moderate volume of 150,000 shares per day on average. It charges 65 bps in annual fees and expenses. The fund is presently trading at a P/E (ttm) of 7 times, suggesting an appealing valuation. The fund was up about 9% in the last one week (as of September 15, 2015) and has a Zacks ETF Rank of 3 or ‘Hold’ rating with a Medium risk outlook. iShares China Large-Cap ETF (NYSEARCA: FXI ) This is easily the most popular China ETF in the market, as over $5.7 billion is invested in the fund and average daily volume is over 30 million shares a day. The 51-stock product puts half of its weight in the financial sector. This means that any news out of the financial sector can have a huge impact on the overall return of this famous ETF. China Construction Bank Corp, Industrial & Commercial Bank of China and Bank of China Ltd. are among the top-five holdings. FXI charges 74 bps in fees and has P/E (ttm) of 9 times. The ETF added about 7.2% in the last five trading sessions and has a Zacks ETF Rank #3. Link to the original post on Zacks.com

FXG: Consumer Staples With Less Of The Consumer Staples

Summary The portfolio for FXG just doesn’t look right to me. The ETF uses fairly low allocations for some core consumer staple holdings. I’d like to see a heavier weighting for companies with massive market share or addictive products because those firms should be able to protect margins better. 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 First Trust Consumer Staples AlphaDEX ETF (NYSEARCA: FXG ). 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 for FXG is a fairly unappealing .67%, which leaves me feeling that there is some substantial room for improvement. Holdings I was able to grab a chart with all of the holdings for FXG: (click to enlarge) Is this really a consumer staples portfolio? Procter & Gamble (NYSE: PG ) is only 1.68% of the portfolio? Altria Group (NYSE: MO ) is less than 1% of the portfolio? Costco (NASDAQ: COST ) is entirely absent from the portfolio. Coca-Cola (NYSE: KO ) and Pepsi (NYSE: PEP ) are entirely absent. When I’m looking at an ETF of consumer staples, I want to see products that people are going to buy regardless of what is happening in the economy. I’m not a fan of smoking, but I wouldn’t mind a substantial allocation to tobacco. For that matter, I would prefer a portfolio built on companies that have enormous market share and sell addictive products. The fundamental goal of creating a consumer staples allocation in the portfolio is to provide the portfolio with more protection from weakness in the economy. Despite the challenges with firms missing, I do think a large allocation to Tyson Foods (NYSE: TSN ) and ConAgra Foods (NYSE: CAG ) does make sense. There has been enough concentration in this part of the industry that the major players are controlling a large part of the market and are unlikely to be forced to take major price cuts even if the market enters another recession. Building the Portfolio This hypothetical portfolio has a moderately aggressive allocation for the middle-aged investor. Only 25% of the total portfolio value is placed in bonds and a fifth of that bond allocation is given to high-yield bonds. If the investor wants to treat an investment in an mREIT index as an investment in the underlying bonds that the individual mREITs hold, then the total bond allocation would be 35%. Given how substantially mREITs can deviate from book value, I’d rather consider the allocation as an equity position designed to create a very high yield. This portfolio is probably taking on more risk than would be appropriate for many retiring investors since a major recession could still hit this pretty hard. If the investor wanted to modify the portfolio to be more appropriate for retirement, the first place to start would be increasing the bond exposure at the cost of equity. However, the diversification within the portfolio is fairly solid. Long-term treasuries work nicely with major market indexes, and I’ve designed this hypothetical portfolio without putting in the allocation I normally would for equity REITs. An allocation is created for the mortgage REITs, which can offer some fairly nice diversification relative to the rest of the portfolio and they are a major source of yield in this hypothetical portfolio. 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 35.00% 2.06% Consumer Discretionary Select Sector SPDR ETF XLY 10.00% 1.36% First Trust Consumer Staples AlphaDEX ETF FXG 10.00% 1.60% Vanguard FTSE Emerging Markets ETF VWO 5.00% 3.17% First Trust Utilities AlphaDEX ETF FXU 5.00% 3.77% SPDR Barclays Capital Short Term High Yield Bond ETF SJNK 5.00% 5.45% PowerShares 1-30 Laddered Treasury Portfolio ETF PLW 20.00% 2.22% iShares Mortgage Real Estate Capped ETF REM 10.00% 14.45% Portfolio 100.00% 3.53% The next chart shows the annualized volatility and beta of the portfolio since April of 2012: (click to enlarge) A Quick Rundown of the Portfolio Using SJNK offers investors better yields from using short-term exposure to credit-sensitive debt. The yield on this is fairly nice, and due to the short duration of the securities, the volatility isn’t too bad. PLW on the other hand does have some material volatility, but a negative correlation to other investments allows it to reduce the total risk of the portfolio. FXG is used to make the portfolio overweight on consumer staples with a goal of providing more stability to the equity portion of the portfolio. FXU is used to create a small utility allocation for the portfolio to give it a higher dividend yield and help it produce more income. I find the utility sector often has some desirable risk characteristics that make it worth at least considering for an overweight representation in a portfolio. VWO is simply there to provide more diversification from being an international equity portfolio. While giving investors exposure to emerging markets, it is also offering a very solid dividend yield that enhances the overall income level from the portfolio. XLY offers investors higher expected returns in a solid economy at the cost of higher risk. Using it as more than a small weighting would result in too much risk for the portfolio, but as a small weighting, the diversification it offers relative to the core holding of SPY is eliminating most of the additional risk. REM is primarily there to offer a substantial increase in the dividend yield which is otherwise not very strong. The mREIT sector can be subject to some pretty harsh movements, and dividends from mREITs should not be the core source of income for an investor. However, they can be used to enhance the level of dividend income while investors wait for their other equity investments to increase dividends over the coming decades. If you want a really quick version to refer back to, 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 Consumer Discretionary Select Sector SPDR ETF XLY Enhance Expected Returned First Trust Consumer Staples AlphaDEX ETF FXG Reduce Beta of Portfolio Vanguard FTSE Emerging Markets ETF VWO Exposure to Foreign Markets First Trust Utilities AlphaDEX ETF FXU Enhance Dividends, Lower Portfolio Risk SPDR Barclays Capital Short Term High Yield Bond ETF SJNK Low Volatility with over 5% Yield PowerShares 1-30 Laddered Treasury Portfolio ETF PLW Negative Beta Reduces Portfolio Risk iShares Mortgage Real Estate Capped ETF REM Enhance Current Income Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. Despite TLT being fairly volatile and tying SPY for the second highest volatility in the portfolio, it actually produces a negative risk contribution because it has a negative correlation with most of the portfolio. It is important to recognize that the “risk” on an investment needs to be considered in the context of the entire portfolio. To make it easier to analyze how risky each holding would be in the context of the portfolio, I have most of these holdings weighted at a simple 10%. Because of TLT’s heavy negative correlation, it receives a weighting of 20% and as the core of the portfolio SPY was weighted as 50%. 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 FXG has resisted weakness in the market as demonstrated by both the lower annual volatility and the lower max “drawdown” of -9.8% relative to the market’s worst performance of -11.9%. Despite that, the portfolio composition simply does not match the way I would want the consumer staples exposure constructed. Simply put, the portfolio does not offer strong enough allocations to some of the companies that have both enormous market share and addictive products. Heavy allocations to a few food companies look solid, but I’d rather see less of the convenience stores and more of the major retail low cost leaders such as Costco and Wal-Mart (NYSE: WMT ). Even if WMT is having a rough time lately, it is a long-lived dividend champion with a large market share and powerful economies of scale. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

We Have Heard This Message For A Long Time: Solomon, The Talmud, Diversification And Cash

Summary The investment community is divided on the importance of cash. This piece shows that it was very important for some ancient people. While there are references in the Bible regarding investing, there is scant advice on how to invest. The Talmud does offer investing advice, and this piece will show you how to use it, and how it performs. Biblical Diversification One of my passions has always been faith based investing, and using ancient texts to guide one’s money decisions. Jesus talked about money more than anything, except the kingdom of God. There are 101 verses in Proverbs about money, and there are many more in the Old Testamant. I have written about these topics before, but sometimes one should take another look at things to see if they still hold true. There is one, I specifically on which I want to focus. It is found in Ecclesiastes (11:1-6), and it comes from Solomon: “Ship your grain across the sea; after many days you may receive a return. Invest in seven ventures, yes, in eight; you do not know what disaster may come upon the land. If clouds are full of water, they pour rain on the earth. Whether a tree falls to the south or to the north, in the place where it falls, there it will lie. Whoever watches the wind will not plant; whoever looks at the clouds will not reap. As you do not know the path of the wind, or how the body is formed in a mother’s womb, so you cannot understand the work of God, the Maker of all things. Sow your seed in the morning, and at evening let your hands not be idle, for you do not know which will succeed, whether this or that, or whether both will do equally well.” Simply it means: Be involved in commercial enterprise. Invest in many things (seven is a special number). You simply cannot predict what will happen. Why should one diversify? As the English proverb says, “Don’t venture all your eggs in one basket.” If one concentrates all of their investments in one asset class, it is possible the entire investment could head straight to zero. Simply, diversification helps one to avoid unsystematic risks, those that are specific to particular investment or investment class. It goes beyond that, however. Brinson, Hood and Beebower conducted a landmark study, “Determinants of Portfolio Performance,” and presented in Financial Analysts Journal (May – June, 1992) there was an update in 1996. They showed that asset allocation decisions, far more than any other factor, affected the long-term performance of an investment portfolio. In fact, Brinson and his colleagues show that asset allocation effects over 90% of a portfolio’s performance. The results are illustrated in the chart below. (click to enlarge) Asset allocation is 15 times more influential than security selection and timing. Interestingly, the financial media spends the bulk of their market news in the latter. Of course, it is doubtful one would be able to sell much ad space if the media outlet spent the bulk of its time talking about asset allocation. When I see sites like the American Association of Individual Investors recommend seven asset classes for specific portfolios, I usually have a wry smile, and wonder if that was by accident or by design. Who knows? What is interesting is that Solomon did not specifically state how to invest. In fact there is no specific advice on how to invest in the bible. Talmudic Investing Now we look at the Talmud ; “…the body of Jewish civil and ceremonial law and legend comprising the Mishnah and the Gemara.” The Talmud evolved after the destruction of the second temple, and was the recordings of discussions and debates regarding the Torah. It was an attempt by Rabbinic Jews to write the oral law; an explanation of how to live under Biblical law. It was a guidebook on how to live. As for this piece, the focus is on the Tractate Baba Mezi’a folio 42a: R. Isaac also said: One’s money should always be ready to hand, for it is written, and thou shalt bind up the money in thy hand. R. Isaac also said: One should always divide his wealth into three parts: [investing] a third in land, a third in merchandise, and [keeping] a third ready to hand. Two parts of this investing strategy are pretty obvious. First, to invest in land simply means real estate. That is understood, and there are plenty of real estate investments one can make, some are in the form of real estate investment trusts (REITs) and are traded in the stock markets. Second, investing in merchandise means to invest in business; equity investing. It is the third part to this formula where there seems to be some disagreement. Where I see some debate is defining, “…and [keeping] a third ready to hand.” There are some who feel that means to invest in short-term securities which are safe. U.S. Government bonds would fit this quite well. Taken in context, though, the previous part of the discussion is pretty clear where it says, “One’s money should always be ready to hand…and thou shalt bind up the money in the hand.” The footnote to this passage states, “And not in another man’s keeping, so that advantage can immediately be taken of a trading bargain that is available.” To some, including me, this is a pretty clear conclusion that the Rabbi was talking about cash. The approach this is pretty simple. I used the following investments to track the value of a $1 investment since 1978: Wilshire US REIT Index Wilshire 5000 Total Market Index BlackRock Ready Assets Prime Money (MUTF: MRAXX ) The investments were divided in thirds, and rebalanced every calendar year. The chart shows the results: (click to enlarge) Someone who followed this strategy since 1978 would have realized an annual return of 10.25% (±10.44%). Compared to S&P 500 annual return of 11.58%, this is a strategy that holds up nicely, especially considering that 33% is invested in a Money Market Fund. What is more relevant is that it is less volatile than the S&P (±17.32%) for the same period. Why Should One Care? Let’s think about this. Solomon warns us of that we, “…do not know the path of the wind.” Rabbi Isaac says we should keep our money close in hand, which is similar to Deuteronomy 14:25, albeit that passage was referring to tithing. The key is that rabbinical texts suggest that one keep a certain amount in cash, and it is quite a bit of money. Why? The Bible is replete with verses about not knowing what tomorrow will bring. The Old Testament brings us: ” Do not congratulate yourself about tomorrow, since you do not know what today will bring forth. ” ~Proverbs 27:1 And let’s not forget that Solomon warns, “for you do not know which will succeed, whether this or that, or whether both will do equally well.” Was this a warning that we really do not know what will happen with our investments? I say, “Yes.” While the New Testament (albeit not part of the rabbinical text) tells us” ” You never know what will happen tomorrow: you are no more than a mist that appears for a little while and then disappears. ” ~James 14:4 This is just a theory, but I am willing to say that the Rabbi knew one should keep cash because of an uncertain future, and uncertain results. While the financial community is fairly split down in the middle when it comes to cash, it is important to keep a reserve so one can take advantage of opportunities. If one is fully invested, there is no way to buy new securities on the cheap without selling something; thus incurring a commissionable event. Remember the footnote, “so that advantage can immediately be taken of a trading bargain that is available.” One has to have cash on hand to take advantage of opportunities. During this downturn, one is unable to buy the stocks that just went on sale if all of their assets are otherwise invested already. Some proponents of modern asset allocation go as far as to suggest holding up to 15% in cash and its equivalents in a conservative portfolio. If 15% is considered conservative, then 33% would considered ultra conservative. Does this approach work? It depends on what one wants. If one wants to be fully invested in the stock market, that portfolio would yield a full 190% better result than the cash heavy Talmud portfolio over a 20 year period. One should remember, though, that same approach would have suffered a 37% loss in 2008 with no opportunity to respond. Meanwhile the Talmud portfolio would have only lost 24% in 2008, but still leave one with the ability to buy beaten down securities. It is really up to one’s personal psychology to decide. Conclusion I have often said that one should give up beating market averages . Investing is more about psychology, than one realizes. If sudden downturns force one to abandon a plan, then it is not a very good plan. If downside deviation keeps one awake at night, then one should consider a different approach; this is one that does work. It beats the two benchmarks that matter for most investors; zero and inflation. If one is looking for index funds for the Wilshire 5000 and REIT investments, consider BlackRock’s Total Stock Market Index (MUTF: BKTSX ) and BlackRock Real Estate Securities (MUTF: BCREX ) funds. Matching those with the previously mentioned money market fund, and one will have a nice three pack of mutual funds that will deliver over time. Happy Investing! Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.