Tag Archives: management

What You Don’t Own

By Andy Hyer What a year it’s been for Energy. Its rout can be seen in the chart of XLE shown below: Price return only, not inclusive of dividends. Updated through 12/8/15 However, it is not just 2015 where Energy has been weak. Consider the relative strength chart below of the Energy Sector SPDR ETF (NYSEARCA: XLE ) versus the S&P 500 (SPX): (click to enlarge) Price return only, not inclusive of dividends. Updated through 12/8/15 As shown above, Energy has been weaker than the S&P 500 for the majority of the time since June 2008 – although the worst of the relative performance has clearly come in the last year or so. When a sector is weak, a relative strength strategy seeks to underweight that sector. After all, what you don’t own is every bit as important as what you do own . Consider the chart below of the Energy exposure in the Dorsey Wright Technical Leaders Index (used for the PowerShares DWA Momentum Portfolio ETF (NYSEARCA: PDP )): As of 10/1/15 This index is constructed by taking a universe of approximately 1,000 U.S. mid- and large-cap stocks and ranking them by their PnF relative strength characteristics. The top 100 stocks make it into this index. Each quarter, the index is reconstituted to kick out any stocks that have lost sufficient momentum and to replace them with stronger names. One of the unique characteristics of this index is there are no sector constraints. If a sector is weak, it may have little or no exposure in the index. This quarter is now the 4th quarter in a row where PDP has had zero Energy exposure. Much is made of how momentum strategies seek to own the “hottest” stocks. Perhaps, more should be made of momentum strategies seeking to avoid the biggest losers. In the end, that matters every bit as much. The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. See www.powershares.com for a prospectus on PDP.

Employment Triggers A Green Light For A Fed Rate Hike, But…

By Jack Rivkin It’s still a slow-growth environment. Inflation is low. Investors can expect continued performance dispersion. Employment is off the table for the Fed As mentioned in our earlier video blog , the November employment gain of 211,000 combined with the upward revisions totaling 35,000 for September and October certainly took the employment issue off the table as a showstopper for a Fed Funds target rate hike this month. There are very few categories where the actual unemployment rate is above the 5.0% rate for the overall workforce: teenagers at 15.7%, blacks at 9.4%, Hispanics at 6.4%, those with less than a high school diploma at 6.9%, those with only a high school diploma at 5.4%, and I would highlight mining at 8.5% (versus 2.8% a year ago). I would posit that these levels are not the responsibility of the Federal Reserve to deal with. And, what is going on in the mining sector, which includes oil and gas extraction, may have added to the employment roles in other categories as lower energy prices increased both consumption and most companies’ (ex-energy’s) profit margins. The November beige book and the latest JOLTS report point to a tighter labor market with increased difficulty filling jobs and quit rates high, which point toward an increase in wage rates. The Fed does have to look at a tight labor market and make some judgments regarding this ultimate impact on inflation and the pace at which its 2% target is achieved. So what about inflation? The Fed’s preferred measure of inflation is the core personal consumption expenditure (PCE) index. That index is up only 1.3% year-over-year and was actually flat month-over-month in October. The general belief is that the US inflation rate may stay lower longer given the expected slow pace of global economic growth, the strong dollar and continued technological innovation. One cannot ignore the tragic events in Paris and San Bernardino as having an impact – on the margin, of patterns of consumer spending and, possibly, levels. This is likely to keep the Fed on a very slow path of target rate increases extending the runway for slow but steady real and nominal growth. I think this path will be followed until inflation actually picks up. I have some views on the timing of this, which I have been saving for this year’s Perspectives piece “What to Expect in 2016 (and Beyond),” but will provide a preview in a separate blog as a wild card to watch for. And what about the markets? In turn, these economic and financial results will likely produce slow growth – matching nominal GDP – in the US stock market if valuations stay close to current levels. The fixed income markets, on the surface, could also appear somewhat benign with a moderate increase in overall rates. No doubt, the slower pace of growth will produce specific credit issues – certainly in energy, but likely some other entities – but credit overall, may hold up reasonably well. The credit markets, at the moment, would appear to be pricing a broader disaster, particularly in the high yield markets. I think we will see some specific disasters – credit issues, but decent credit analysis can eliminate or reduce the impact. An actively-managed portfolio in high yield could be a logical allocation to a portfolio. Odds are some of the longer term trends in currency, commodities, and relative market performance will continue for a while with some bumps along the way when markets misread central bank actions or statements (à la Draghi) or geopolitical events cause temporary disruptions. So, how should one invest? In the table below, which looks at performance of the S&P 500 over the last several years, an interesting pattern emerges: When the market has been up or down double digits, all one really had to do was either own or sell the whole market. However, when we have experienced single-digit performance for the overall market, much as we are seeing this year, there has been significantly greater dispersion among stocks. This is an environment we expect to continue for some time-slow nominal growth in the economy and the equity markets, leading to dispersion of performance tied to active company management and active investment management. Why do we expect slow nominal growth to persist for several years making active management more important? There are at least four reasons (and I am sure some others): As Eric Peters of One River Asset Management recently reminded us, when the Fed takes action, which is typically designed to reduce the magnitude of an economic decline or surge, it has an effect on future patterns of growth. Easing pulls growth forward, while tightening pushes growth out, reducing the depth of the valleys and the height of the peaks and the distortions in employment and inflation those produce. We have been through an extraordinary pulling forward of future growth and it will take time for us to return to normal. The debt burden incurred by sovereign nations has been and continues to be enormous. If nothing else this will affect fiscal policy as the tool it could be to add to growth opportunities. China’s transition from a global engine for industrial production and consumption to a more internally-focused services economy, combined with the reversal of its own extraordinary steps to offset the impact of the western world recession – just look at the production and pricing of hard commodities beginning in 2009 – will be a damper on global growth for the foreseeable future. This bears watching to see how closely the yuan continues to track the dollar, or if it’s inclusion by the IMF as a reserve currency leads to a tracking of a basket of currencies and a different interest rate regime. Without putting too much weight on it, the “Buffett Rule” – future equity growth is problematic for a number of years when the total market value of equities exceeds the value of GDP – is operative. I discussed this anecdotally in a recent post . In a slower growth environment the likely dispersion of equity returns would push one away from index-hugging strategies toward active managers both long only and long/short managers. We have been suggesting this for a while. We would include private equity allocations in the active long only category if immediate liquidity is less of a need and the attractiveness of a potential illiquidity premium in a lower growth environment is magnified. We have these more active managers in our stable of funds, but others do as well. The key message is to adjust allocations to include more of these active strategies in the portfolio as one looks at the environment ahead. In the fixed income space, while there is risk of rate volatility affecting all debt classes, as big a risk would appear to be more specific credit issues. Does that mean one should be moving up the credit curve? I think the answer is in part, “yes.” But, the preferred way to do that would be similar to the approach on equities: Look for active managers – not benchmark huggers – who are analyzing specific credits and taking advantage of the homogenization of yields that comes from index buying and selling. The high yield index is offering a fairly significant yield spread over treasuries – very tempting as a category. But, just remember that around 18% of that index is in energy and hard commodity bonds. As shown below, the rest of the index, while at lower yields, is at spreads we haven’t seen for almost three and a half years. Historically, in a different energy regime, the rest of the index used to trade at higher spreads than oil and metals. At this stage, I would rather have someone looking at individual securities making up a diversified portfolio where the detailed analyses show relatively lower credit risks in the environment we foresee. Who knows? There may even be some energy credits that are worth holding but have been tarred by association. We see that in our own portfolios. There are certainly some credits in both high yield and investment grade where the credit default swaps don’t fully reflect the degree of risk at this stage. I want managers who are running portfolios where they can tell me the precise nature of the balance sheets of their individual holdings and the risks associated with the businesses. This is different from what has been required previously. One should not ignore the uncorrelated strategies, particularly systematic trend following. There are some long-term trends in place. While there are likely to be occasional reversals – some of which could turn into more permanent moves, I would rather use these managers to recognize the patterns and determine which foreign exchange, commodity, equity and fixed income indices should be included, negatively or positively, in the portfolio at any given moment in time given the environment we are facing. Allocations need to change It is hard to determine in isolation what the allocations in a specific portfolio should be. That requires a discussion. I know the allocations to active strategies should be higher. As I have been saying, past performance may not be the best guide for the future as opposed to a realization of a different pattern of future returns and an understanding of the volatilities and risks that exist in the environment we foresee. It is a less easy environment, with lower overall returns, but possibly a broader set of opportunities to meet one’s specific goals.

FBT Was +47.55% In 2014 And +10.00% YTD. Will The Returns Continue In 2016?

Summary This established Biotech ETF has an interesting structure but also is quite volatile. With $3.28BLN in assets, will the institutions continue to invest in 2016? We answer these questions and provide our recommendation on this top performer. The First Trust NYSE Arca Biotechnology Index ETF (NYSEARCA: FBT ) is an equal weighted passively managed fund with an established track record, (inception 06/19/2006). The fund seeks to replicate as close possible, before fees and expenses, the price and yield of the NYSE Arca Biotechnology Index, (previously the Amex Biotechnology Index). The interesting structure of the ETF is the 30 components, (previously 20 components prior to October 20, 2014). What is challenging for shareholders is the quarterly rebalancings that occur in late January, April, July and October. Due to the equal weighting objective of the Fund and the underlying Index and the general small to mid-cap nature of the sector, these rebalancings and the ETF, in general, can be volatile. We will analyze the structure of the ETF, its holdings, performance and fees and provide our recommendation. 100% of the ETF is in common equity holdings. Our Market Cap is quite simple, with most of our sources agreeing: FBT Market Capitalization Market Cap Weight Mid cap 34.98% Small cap 33.10% Large cap 31.98% These numbers were courtesy of Fidelity, with xtf.com extremely close in agreement. Morningstar, as we previously noted uses a slightly difference nomenclature. Their breakdown is: Medium at 40.56%, Small at 27.19%, Large at 23.12%, and Giant at 9.12%. Categorically we can state that the majority of the firms in this ETF are small to mid-cap firms with limited products presently, if any, in the marketplace. In terms of the style of the underlying components, it is quite clear to investors who have participated in this space. FBT Ownership Style Style Weight Growth 59.80% Pure Growth 30.00% Blend 7.10% Value 3.10% Without a doubt this ETF is a growth vehicle and not intended for those seeking value investments. Morningstar states that the ownership style is mid or medium and is considered high growth. In terms of currency and countries of the holdings it is somewhat interesting. FBT Country and Currency Exposure Country Weight Currency Weight United States 89.90% United States dollar 89.90% Ireland 3.68% Euro 10.10% Spain 3.23% NA NA Netherlands 3.19% NA NA Our country and currency exposure here is clearly US geographically focused with some Eurozone exposure as noted. The 10.10% euro weighting will not adversely impact this ETF even with the euro possibly moving below dollar-euro parity. As such, we have no issues with the underlying geographical or currency weightings. It is quite clear that the overall sector is 100% healthcare in FPT. The industry exposure is informative. Industry Weight Biotechnology 79.27% Life Sciences Tools & Services 16.29% Pharmaceuticals 4.47% While this is in no way diversified, it does show that there are companies within the ETF which are not pure biotech, but are grouped within the fund. Some of them we do recognize from previous research and there is one firm that we previously analyzed and recommended. We will discuss this firm when we review the holdings. In terms of the holdings, as usual we will analyze the top 15 components, their symbols, ratings, (Moody’s and S&P), if any, and their weight within the ETF and the underlying index {BTK}. In this fund’s case we will also show their individual year to date and 12 month performance. FBT top 15 holdings Name/Symbol YTD perf/ 12 month Ratings, (Moody’s/S&P) Weight-BTF Weight- Index, {BTK} Nektar Therapeutics (NASDAQ: NKTR ) 0.71%/-3.27% NR/NR 4.47% 3.33% Dyax Corp. (NASDAQ: DYAX ) 165.50%/168.18% NR/NR 4.10% 3.33% Isis Pharmaceuticals, Inc. (NASDAQ: ISIS ) -7.92%/-0.25% NR/NR 4.09% 3.33% Alnylam Pharmaceuticals, Inc. (NASDAQ: ALNY ) 0.74%/-8.18% NR/NR 3.93% 3.33% United Therapeutics Corp. (NASDAQ: UTHR ) 20.08%/16.21% NR/NR 3.78% 3.33% Celldex Therapeutics Inc. (NASDAQ: CLDX ) -16.33%/-17.19% NR/NR 3.70% 3.33% Alkermes, PLC (NASDAQ: ALKS ) 22.49%/22.62% Ba3/BB 3.68% 3.33% Illumina, Inc. (NASDAQ: ILMN ) -4.60%/-7.27% NR/BBB 3.64% 3.33% Charles River Laboratories International, Inc. (NYSE: CRL ) 18.73%/18.41% Ba2/BBB- 3.57% 3.33% Novavax, Inc. (NASDAQ: NVAX ) 36.09%/46.99% NR/NR 3.48% 3.33% Alexion Pharmaceuticals, Inc. (NASDAQ: ALXN ) -3.18%/-9.12% NR/NR 3.35% 3.33% Myriad Genetics, Inc. (NASDAQ: MYGN ) 25.54%/21.89% NR/NR 3.35% 3.33% Vertex Pharmaceuticals Inc. (NASDAQ: VRTX ) 2.52%/2.02% NR/NR 3.35% 3.33% Regeneron Pharmaceuticals, Inc. (NASDAQ: REGN ) 33.24%/25.67% Baa1/NR 3.32% 3.33% Amgen Inc. (NASDAQ: AMGN ) -0.62%/-5.91% Baa1/A 3.24% 3.33% The top 15 holdings represent 55.05% with an average of 3.67%, with the bottom 15 totaling 44.96%. This was expected with the equal weighting of the ETF. Unlike the index which is even at 3.33% or 1/30 for each holding, the ETF is adjusted for share price and an equal value. Based upon the individual performance of the top 15 holdings, it is fairly obvious that returns are not reasonably predictable without extensive analysis of each company, their future products and FDA approval developments. The equal weightings here do provide an opportunity of participating in one of the top performers, such as Dyax Corporation with a 165.50% return YTD. Obviously, the return on Dyax far outweighs the negative return of a firm such as Celldex Therapeutics at -16.33% YTD. The benefit of the ETF allows participation in a sector where returns can be quite diverse from one firm to another. In terms of credit ratings, only 14.13% (S&P) of the top 15 have ratings and only 25.66% of these 15 holdings. It is quite apparent that with the rapid growth and negative balance sheets of these firms, the majority of the firms are mostly lower grade credits, if rated at all. Only Illumina, Inc., Charles River Laboratories International, Inc and the well known Amgen Inc. are investment grade, as per S&P. One of the firms in the ETF with a weighting of 2.91% is our personal favorite, Quintiles Transnational Holdings, Inc (NYSE: Q ), a company we had previously analyzed and recommended. Quintiles is the leader in {CRO} services or a Contract Research Organization. The company basically performs many of the services that large pharmaceuticals and Biotech firms require to bring their product to market and to continue to develop new and existing products. This would include Consulting Services, Portfolio and Strategy Planning, Clinical Trial Execution, Laboratories, Real-World and Late Stage Trials, Technology Solutions, Patient and Provider Engagement, Product Marketing and Sales. We are a little surprised to see it in this ETF. It is a profitable and quite a large capitalized firm, yet it will continue to grow and profit as long as there is a need for their services from the healthcare sector. As such, we think it is a great way to participate in the overall growth of the firm (14.51% YTD/18.26% 12 month) balanced with the performance of the other holdings in the ETF. Based upon the components and structure we analyzed the overall performance of the ETF and the index. FBT’s Performance, Fees and Recommendation Category FBR {ETF} BTK {Index} Net Expense Ratio .58% NA Turnover Ratio 58.00% NA YTD Return 9.94% (11/30/15) 5.99% (12/07/15) 10.66% (11/30/15) 5.48% (12/07/15) 1-Year Total Return 10.08% (11/30/15) 5.56% (12/07/15) 10.79% (11/30/15) 5.58% (12/07/15) Dividend Yield/SEC Yield 0.17%/-0.43% NA Beta (Shares/Holdings) 1.13/.70 NA P/E Ratio FY1/current 29.60/26.93 NA Price/Book Ratio FY1/current 8.00/7.06 NA Our expense ratio is in-line with the asset class median of 0.53% and is quite acceptable. Our turnover ratio is only slightly surprising here. With an asset class median or 18.00%, we expected much higher. One of the reasons is the general nature of the sector and the rules of the ETF and the underlying index that cause firms to be replaced. According to the NYSE Arca: Components will be removed from the index during the quarterly review if they fail any of the criteria below: (1) Current Market Capitalization is lower than $900 million (2) The Average Daily Traded Value for the past 3 Months is lower than $900,000 (3) The Current Last Traded Price is less than $1.00 In addition, various corporate actions may cause the stocks in the index to be substituted. As there has been M&A activity and various other corporate actions in the sector over the past year, the high turnover ratio is to be expected here. In terms of the ownership of the ETF, it is readily apparent that institutions and funds hold large holdings. While Wells Fargo (NYSE: WFC ) holds 6.31% and Morgan Stanley Smith Barney LLC (NYSE: MS ) holds 8.81%, the big surprise holding is another ETF that we previously analyzed and recommended. The First Trust Dorsey Wright Focus 5 ETF (NASDAQ: FV ), holds 33.99% of the total shares in its ETF or 24.20% of the total assets. The ETF has performed well due to its allocation in FBT, among others. FBT will continue to attract institutional shareholders and advisory clientele who seek allocation to the Biotech sector, regardless of economic conditions. In terms of economic conditions, many consider Biotech as being within the Pharmaceutical and medical space and defensive. We tend to agree, yet the cost of capital for the industry is always a concern. With interest rates set to rise this may be an issue for those firms which tend to borrow heavily to fund R&D. As such, though we are impressed with the performance over the past year the ETF is not for the squeamish. It is noted above that the YTD performance has dropped 4.00% since the end of November. The sector and its holdings are not for investors who are looking for the short term. A dollar cost strategy may be appropriate for investors who are familiar (or not familiar) with the frequent market routs. In terms of FBT the year high on July 20,2015 was $132.21 representing at that time a 28.96% YTD return, while the year low of $64.08 set on August 24,2015, after the Asia sell off, represented a loss of -37.49% YTD at that time. Overall, the volatility of the sector has not dissuaded institutional investors, (or speculators for that matter) from participating in this ETF or the sector. As the second largest biotech ETF, after the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB ) it continues to represent an attractive vehicle to participate in a sector that will continue to produce new drugs and redevelop existing treatments. We are a strong buy on this ETF into 2016 and beyond.