Tag Archives: nasdaq

A Distinctly Canadian View Of Emerging Markets

Figuring out whether developed equity markets will outperform emerging market stocks has been no easy task, even if the choices couldn’t be any starker. By now, we are all familiar with the potential benefits of emerging markets: They have grown at a faster pace than developed economies, their population is younger , and they will soon be expected to aspire to consume many of the things people in the developed world take for granted. Sounds pretty good, right? Not so fast. These seeming positives have been in place for many years, and yet emerging markets have pretty consistently underperformed most developed markets since 2011. A combination of falling commodity prices, heightened political risk, slower (but still relatively brisk) economic growth, rampant corruption, a stalled reform agenda and limited earnings growth have all weighed on performance to one degree or another across the emerging world over this time period. So while emerging markets appear inexpensive, they are not unambiguously cheap. For Canadian investors, it’s even less clear if emerging markets will prove to be a winning destination for investment capital. As I’ll show, the loonie has tended to move with EM currencies, correlations between EM and Canadian equities have been high, and the sector composition was reasonably similar for a long time. That said, some of these factors are changing and even boosting the allure of holding EM equities in a portfolio. Currency Since the January lows, emerging market stocks have posted sizeable returns in US dollars, but the results are much less impressive in Canadian dollar terms, thanks to strength in the loonie. Some of the same factors lifting emerging market stocks, bonds and currencies also support the Canadian dollar and Canadian stocks: a rebound in commodity prices, a more patient Federal Reserve and less dire news about the global economy, especially out of China. This result shouldn’t seem all that surprising; the Canadian dollar has closely tracked emerging market currencies since 2010 (see the chart below). Consequently, Canadian investors don’t get as much of a boost to performance from appreciating EM currencies when risk appetites are growing and the global economy is accelerating, because the Canadian dollar is typically rising too. That said, EM currencies could potentially appreciate against the loonie given how far they’ve fallen. Click to enlarge Correlation Assets that exhibit a high positive correlation have more muted diversification benefits. If emerging market currencies and the Canadian dollar tend to appreciate together, then what about the correlation between EM and Canadian stocks? Here again, there’s another tight fit and another reason for Canadians to be apprehensive about the diversification benefits of owning emerging market equities. Looking at the chart below, Canadian equities have been much more positively correlated to EM equities since 2005 than to US or other international developed stock markets (represented by MSCI EAFE). That said, we should note that the high positive correlation of EM and Canadian equities have declined in recent years, boosting the diversification benefit. Click to enlarge Composition One reason correlations were this high – and the diversification benefits for Canadian investors this low – may have something to do with the similarity of industry exposures: the energy, materials and financials sectors made up more than half of the market cap of both Canadian and emerging market stocks. In the past five years, however, something interesting has happened. Thanks to the initial public offerings of many high-tech companies, the information technology sector has grown to more than a fifth of the emerging market equity index (see the chart below), whereas it’s less than 3% of the MSCI Canada index. As a result, EM may begin to deviate more from Canadian equities because of shifting sector exposures. The expansion of the tech sector is both a sign of, and offers investors exposure to, the convergence of emerging markets to developed economies. Click to enlarge Although not without risks, we’re warming up to emerging market equities and continue to believe in the possibility of improved investment returns based on better demography, faster growth and pent-up consumer demand. For Canadian investors, we see room for EM currency appreciation versus the loonie and better portfolio diversification benefits over time than has historically been the case. Source: BlackRock Investment Institute and Bloomberg. This post originally appeared on the BlackRock Blog.

Best And Worst Q2’16: Industrials ETFs, Mutual Funds And Key Holdings

The Industrials sector ranks first out of the ten sectors as detailed in our Q2’16 Sector Ratings for ETFs and Mutual Funds report. Last quarter , the Industrials sector ranked second. It gets our Neutral rating, which is based on aggregation of ratings of 20 ETFs and 17 mutual funds in the Industrials sector. See a recap of our Q1’16 Sector Ratings here . Figures 1 and 2 show the five best and worst rated ETFs and mutual funds in the sector. Not all Industrials sector ETFs and mutual funds are created the same. The number of holdings varies widely (from 20 to 343). This variation creates drastically different investment implications and, therefore, ratings. Investors seeking exposure to the Industrials sector should buy one of the Attractive-or-better rated ETFs or mutual funds from Figures 1 and 2. Figure 1: ETFs with the Best & Worst Ratings – Top 5 Click to enlarge * Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings U.S. Global Jets ETF (NYSEARCA: JETS ) and EcoLogical Strategy ETF (NYSEARCA: HECO ), and Guggenheim S&P 500 Equal Weight Industrials (NYSEARCA: RGI ) are excluded from Figure 1 because their total net assets are below $100 million and do not meet our liquidity minimums. Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5 Click to enlarge * Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings Five mutual funds are excluded from Figure 2 because their total net assets are below $100 million and do not meet our liquidity minimums. iShares US Industrials ETF (NYSEARCA: IYJ ) is the top-rated Industrials ETF and Fidelity Select Transportation Portfolio (MUTF: FSRFX ) is the top-rated Industrials mutual fund. IYJ earns a Very Attractive rating and FSRFX earns an Attractive rating. Market Vectors Environmental Services ETF (NYSEARCA: EVX ) is the worst rated Industrials ETF and ICON Industrials Fund (MUTF: ICIAX ) is the worst rated Industrials mutual fund. Both earn a Dangerous rating. 403 stocks of the 3000+ we cover are classified as Industrials stocks. JetBlue Airways (NASDAQ: JBLU ) is one of our favorite stocks held by FSRFX and earns an Attractive rating. Over the past decade, JetBlue has grown after-tax profit ( NOPAT ) by an impressive 30% compounded annually. The company has improved its return on invested capital ( ROIC ) from 2% in 2005 to 11% in 2015. The company has also quadrupled its NOPAT margin from 3% to 12% over this same timeframe. Despite the strong fundamentals, JBLU is undervalued. At its current price of $21/share, JBLU has a price-to-economic book value ( PEBV ) ratio of 1.0. This ratio means that the market expects JetBlue’s NOPAT to never increase from current levels. If JetBlue can grow NOPAT by just 12% compounded annually for the next decade , the stock is worth $47/share today – a 123% upside. Clean Harbors (NYSE: CLH ) is one of our least favorite stocks held by ICIAX and earns a Very Dangerous rating. Over the past five years, Clean Harbors’ NOPAT has declined by 1% compounded annually. Its ROIC has fallen from a once impressive 13% in 2010 to a bottom-quintile 4% in 2015. However, in a disconnect with the business fundamentals, the stock is up 26% over the past three months and shares are largely overvalued. To justify its current price of $50/share, CLH must grow NOPAT by 13% compounded annually for the next 18 years . Such lofty expectations make it clear why CLH in on this month’s most dangerous stocks list and should be avoided. Figures 3 and 4 show the rating landscape of all Industrials ETFs and mutual funds. Figure 3: Separating the Best ETFs From the Worst ETFs Click to enlarge Sources: New Constructs, LLC and company filings Figure 4: Separating the Best Mutual Funds From the Worst Mutual Funds Click to enlarge Sources: New Constructs, LLC and company filings D isclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

The Appropriate Portfolio Vs. The Optimal Portfolio

Perfect is the enemy of the good” – Adapted Italian Proverb We all want the perfect portfolio, the portfolio that achieves the highest amount of return for the lowest degree of risk. But one of the inconveniences of a system as dynamic as a financial market is that it’s impossible to consistently maintain the perfect portfolio. This pursuit, unfortunately, causes more damage than good since it leads to increased activity, higher fees, higher taxes and usually lower returns. I have argued in my new paper, Understanding Modern Portfolio Construction , that this pursuit of alpha is misguided and that we should seek the appropriate portfolio as opposed to the optimal portfolio. Here’s my basic thinking: There is an abundance of data supporting the fact that more active investors do not consistently generate alpha or excess return.¹ Alpha is elusive because it doesn’t exist in the aggregate and because we all generate the after tax and fee return of the aggregate financial markets. So, the diversified low fee indexer must ask themselves – if I want to be properly diversified and alpha is impossible to achieve in the aggregate, then is this a pursuit I should bother engaging in? For most people, the answer should be no. For most people, the generation of “alpha” is not a necessary financial goal. Asset allocators should be concerned with generating the appropriate return as opposed to the optimal return. This means building a portfolio that is consistent with your risk profile and managing it across time so that you maintain that profile while maintaining an appropriately low fee, tax efficient and diversified approach. The pursuit of alpha generation not only reduces returns by increasing taxes and fees, but also misaligns the way the portfolio manager perceives risk with the way the client sees risk. Since the portfolio manager is benchmarked to a passive portfolio they likely cannot outperform they will often exacerbate many of the frictions that degrade portfolio returns all the while increasing the risk that the client will not achieve their financial goals. Of course, the “optimal” portfolio might not seem so different from the “appropriate” portfolio, but I would argue that there’s a substantive difference. For instance, let’s look at an example of a 40-year-old man with $500,000 to allocate. Let’s assume he uses the simple “age in bonds” approach and comes to a 60/40 stock/bond portfolio. Every year this asset allocator should rebalance his portfolio so that he owns approximately 1% more in bonds. In all likelihood, the stock piece of the portfolio will outperform the bonds over long periods of time so he will consistently be tilting further away from stocks and into bonds. But why does he rebalance? He rebalances to maintain an appropriate risk profile, not to optimize returns and generate alpha. He is accepting the high probability of a good return and foregoing the risks associated with pursuing the perfect return. This should be the approach taken by most asset allocators seeking to build a proper savings portfolio. Countercyclical Indexing takes this process of risk profile based rebalancing a step further.¹ Since a 60/40 portfolio derives 85%+ of its risk from the equity market piece (and even more late in a market cycle) it is prudent to try to achieve some degree of risk parity across the market cycle. But we should be clear about the process of this rebalancing – we are not rebalancing to achieve alpha. We are rebalancing to better balance our exposure to asset risk across time. Said differently, we don’t implement this rebalancing to capture the best portfolio, but to capture an appropriate portfolio. In doing so, we are accepting that our portfolio might merely be “good,” but by pursuing the appropriate portfolio we are avoiding many of the pitfalls involved in pursuing the perfect portfolio. If more asset allocators abandoned the false pursuit of the optimal portfolio, I suspect they would perform better. Instead, they’ve let perfect become the enemy of the good. ¹ – See the annual SPIVA reports. ² See, What is Countercyclical Indexing ?