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Best And Worst Bond ETFs Of 2014

The U.S. stock markets delivered a somewhat muted performance this year (at least when compared to 2013) with the S&P returning about 12% YTD gains. The towering market of last year turned into a market that saw fears about a global slowdown and its effect on U.S. corporate earnings, plummeting oil prices, sluggish growth in Japan, concerns of a triple dip recession in Europe and the outbreak of the Ebola virus that forced many investors to look for safety and shun risky assets. Needless to say, the above threats kept bond yields at the lower side throughout the year causing investors to hunt for income bets. While long-term bond ETFs were weak last year due to taper threats, short-term bond ETFs hit the brakes this year due to rising rate concerns. Despite the Fed’s repeated assertion of keeping the rates low for longer, the recent strength in economic data has led to concerns that the Fed could start raising rates after the first quarter of 2015 instead of the initial June or September 2015 timelines. This in turn has lowered the appeal for short-term bond ETFs giving leeway for long-term bond ETFs to score higher in the face of dwindling global growth and an oil price rout. Flight from risk has caused the yield on the benchmark 10-year Treasury note to hover around 2%. Amid such a situation, it would be interesting to note which ETFs were the leaders and laggards in the bond space during 2014: Winners Two bond ETFs – the PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (NYSEARCA: ZROZ ) and the Vanguard Extended Duration Treasury ETF (NYSEARCA: EDV ) – soared this year having returned more-or-less 45%. ZROZ tracks the BofA Merrill Lynch Long U.S. Treasury Principal STRIPS index with effective maturity and effective duration of the fund being 28.99 years. On the other hand, EDV follows the Barclays U.S. Treasury STRIPS 20-30 Year Equal Par Bond Index. The fund has average maturity of 25.3 years and average duration of 25.0 years. The next best performers in the space comes in the form of the iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) , SPDR Barclays Capital Long Term Treasury ETF (NYSEARCA: TLO ) and iPath US Treasury Long Bond Bull Exchange Traded Note (NASDAQ: DLBL ) . These long-term bond ETFs have returned about 25% each this year. SPDR Nuveen Barclays Build America Bond ETF (NYSEARCA: BABS ) – a long-term muni bond ETF too returned smartly (up 21.6%) in 2014. To beat the potential rise in U.S. inflation and rack up gains on the real return, long-term TIPS bond ETF, the 15+ Year U.S. TIPS Index Fund ( LTPZ), was in demand in 2014 and has added about 19.3%. In short, the trend clearly indicates the inclination toward long-term bond ETFs. Beyond the border, PowerShares DB Italian Treasury Bond ETN (NYSEARCA: ITLY ) added about 19% this year thanks to the extremely easy monetary policy. Losers Thanks to the flattening of the yield curve, the U.S. Treasury Steepener ETN (NASDAQ: STPP ) turned out as an acute loser in this space. The product tracks the returns of a notional investment in a weighted “long” position in relation to 2-year Treasury futures contracts and a weighted “short” position in relation to 10-year Treasury futures contracts. Bullish stance on 2-year Treasury made the product a loser. The product was down 18%. Apart from this, junk bond ETFs like Peritus High Yield ETF (NYSEARCA: HYLD ) lost about 13% as returns were great in the safe government bonds space. Needless to say, short-term bond ETFs like the S&P/Citi 1-3 Yr Intl Treasury Bond ETF (NASDAQ: ISHG ) were defeated in the race. The fund is down 10% this year. The fate was similar for the WisdomTree Barclays U.S. Aggregate Bond Negative Duration Fund (NASDAQ: AGND ) with a loss of about 8.5%. Road Ahead Having presented the scorecard of the year, we would like to note that the trend will be quite similar in the year ahead. However, like 2014, TIPS ETFs should be out of the betting list courtesy of a tepid inflationary outlook across the globe. Apart from the long-term government bonds, investors having a stomach for risk can also have a look at the long-term investment grade corporate bond ETFs to earn some regular income along with securing the portfolio. To do so, investors might tap the Long-Term Corporate Bond Index Fund (NASDAQ: VCLT ) , SPDR Barclays Capital Long Term Corporate Bond ETF (NYSEARCA: LWC ) and iShares 10+ Year Credit Bond ETF (NYSEARCA: CLY ) .

Are Rate-Sensitive ETFs Suggesting Economic Weakness Ahead?

I am baffled by the economic acceleration certainty that nearly every respected voice has endorsed. In spite of the rosiest government data on jobs and GDP, which ETF asset classes proved most resilient in a month of volatile price movement? Utilities and REITs. The more the public is being told about the inevitability of rate increases, the greater the momentum for proxies like XLU and VNQ. Lost in the bull market euphoria is the reality that economists have been dead wrong about the direction of asset prices, particularly bond prices. Last December, when 55 of the most prestigious economists across a wide range of institutions had been polled by Bloomberg about where the 10-year yield (3.0%) would end the year, each of the 55 professionals anticipated higher rates. The average of those estimates? 3.41%. And yet, the 10-year will finish the year closer to 2.25%. That is one heck of an astonishing miss for the entire professional community. This December, polling of economists has produced an average forecast for the 10-year yield at 3.0% by the close of 2015. In other words, they expect intermediate term rates will climb in 2015, and yet, the projections merely approximate where 2013 ended. Even if the recent crop of poll respondents are correct this time around, what does this “non-normalization” of rates tell us about the highly touted strength of the U.S. economy? For all the hoopla, I am baffled by the economic acceleration certainty that nearly every respected voice has endorsed. Will Q4 gross domestic product (GDP) be as robust as the 5% in Q3? Not likely. Will Q1 2015 be better than the average of 2.1% sub-par growth that has existed each year since the Great Recession ended? Probably not. For one thing, lower bond yields have been warning U.S. investors that the world’s stagnation alongside regional recessions will eventually weigh down the U.S. It is one thing to pretend that the U.S. is a self-contained economic island, yet quite another thing to ignore the reality that close to 50% of corporate profits come from overseas. Moreover, there are a variety of potential crises that could sap the world (and yes, the U.S.) of economic demand, from a disorderly slowdown in China to an emerging market credit collapse to a second iteration of a euro-zone break-up scare. Need proof that scores of investors remain unconvinced by the notion that all is perfect in stock-land? In spite of the rosiest government data on jobs and GDP – in spite of strong retail sales as well as consumer confidence readings – which ETF asset classes proved most resilient in a month of volatile price movement? Utilities and REITs. Are The Bets On Lower Rates Still Continuing? MOM% SPDR Select Sector Utilities (NYSEARCA: XLU ) 9.0% iShares DJ Utilities (NYSEARCA: IDU ) 8.7% Vanguard Utilities (NYSEARCA: VPU ) 8.6% iShares Cohen Steers Realty Majors (NYSEARCA: ICF ) 4.2% Vanguard REIT (NYSEARCA: VNQ ) 4.2% SPDR DJ REIT (NYSEARCA: RWR ) 4.1% iShares DJ Total Market (NYSEARCA: IYY ) 1.0% If an investor is looking for modest growth in an area less tied to the economy, he/she may journey to the consumer staples segment or the health care sector. They are frequently identified as “non-cyclicals” since they represent things we need in good times and bad. And if an investor is looking for more total return in areas less tethered to economic well-being, he/she often travels to utilities and REITs. The exception to that rule? If rates are expected to rapidly rise across the yield curve, an investor would tend to shy away from the rate sensitivity associated with utilities and REITs. That’s not happening. In fact, the more the public is being told about the inevitability of rate increases, the greater the momentum for proxies like XLU and VNQ. The price-ratios for XLU:IYY as well as VNQ:IYY are at or near their highest points of 2014. I am not advocating that investors abandon economically sensitive stock assets let alone chase yield-sensitive stock segments. On the other hand, just as I recommended throughout 2014, I believe it makes sense to remain committed to longer-term bonds in funds like iShares 10-20 Year Treasury (NYSEARCA: TLH ) as well as lower volatility stocks across the sector spectrum. One of my largest client holdings, iShares USA Minimum Volatility (NYSEARCA: USMV ), is diversified across all of the economic sectors; the top 3 segments are health care, financials and information technology. What makes USMV particularly attractive in the current environment? The equities have lower volatility properties relative to the U.S. market at large, offering the possibility that losses during declining markets will be less dramatic. Similarly, gains in rising markets will emanate from exposure to strong economy stock sectors as well as weaker economy stock sectors. Click here for Gary’s latest podcast. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

I Like The Risk Level On The PowerShares S&P 500 Low Volatility Portfolio ETF SPLV, But The Expense Ratio Is Only Mediocre

Summary I’m taking a look at SPLV as a candidate for inclusion in my ETF portfolio. I’m not huge on the expense ratio, but I like the other aspects of the ETF. The ETF is incredibly well diversified which is favorably impact the standard deviation of returns. In the context of Modern Portfolio the correlation and standard deviation of returns are very important. The ETF looks favorable in those regards. I’m not assessing any tax impacts. Investors should check their own situation for tax exposure. 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. I’m working on building a new portfolio and I’m going to be analyzing several of the ETFs that I am considering for my personal portfolio. One of the funds that I’m considering is the PowerShares S&P 500 Low Volatility Portfolio (NYSEARCA: SPLV ). 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. What does SPLV do? SPLV attempts to track the total return of the S&P 500® Low Volatility Index. At least 90% of funds are invested in companies that are part of the index. SPLV falls under the category of “Large Value”. Does SPLV provide diversification benefits to a portfolio? Each investor may hold a different portfolio, but I use (NYSEARCA: SPY ) as the basis for my analysis. I believe SPY, or another large cap U.S. fund with similar properties, represents the reasonable first step for many investors designing an ETF portfolio. Therefore, I start my diversification analysis by seeing how it works with SPY. I start with an ANOVA table: (click to enlarge) The correlation is about 74.5%. This is pretty great for making the ETF fit under modern portfolio theory. The low correlation means it should be possible to use the ETF without raising the standard deviation of returns unless the risk ETF has a very high standard of deviation of returns. Standard deviation of daily returns (dividend adjusted, measured since January 2012) The standard deviation is phenomenal. For SPLV it is .5978%. For SPY, it is 0.7300% for the same period. SPY usually beats other ETFs in this regard, so the combination of relatively low correlation and lower standard deviation than SPY is giving this ETF a real chance at being selected for my portfolio. Mixing it with SPY I also run comparisons on the standard deviation of daily returns for the portfolio assuming that the portfolio is combined with the S&P 500. For research, I assume daily rebalancing because it dramatically simplifies the math. With a 50/50 weighting in a portfolio holding only SPY and SPLV, the standard deviation of daily returns across the entire portfolio is 0.6410%. If we drop the position to 20% the standard deviation goes to .6899%. Once we drop it down to a 5% position the standard deviation is .7195%. I haven’t decided what exposure level I would use yet, but probably 5% to 10%. I really like the combination of low volatility and moderate to low correlation. If it wasn’t for the higher expense ratio, I’d consider making this a core holding. Why I use standard deviation of daily returns I don’t believe historical returns have predictive power for future returns, but I do believe historical values for standard deviations of returns relative to other ETFs have some predictive power on future risks and correlations. Yield & Taxes The distribution yield is 2.21%. The yield seems strong enough that it could be included in a retirees portfolio to bring some diversification benefits and a moderate dividend yield. I’m not a CPA or CFP, so I’m not assessing any tax impacts. If I were using SPLV, I would want it to be in a tax exempt account to remove any headaches associated with frequent rebalancing. Expense Ratio The ETF is posting .25% for an expense ratio. I want diversification, I want stability, and I don’t want to pay for them. In my opinion, a .25% expense ratio is higher than I want to pay for equity investments. It’s still low relative to many other methods of investing, but I’m looking for long term holdings and I don’t want to give my investments away. I haven’t decided if it’s worth paying the higher expense ratio to include SPLV. If the expense ratio was under .10%, this ETF would have a very strong case for being included. Market to NAV The ETF is at a .05% premium to NAV currently. In my opinion, that’s not worth worrying about. It is practically trading right on top of NAV. However, premiums or discounts to NAV can change very quickly so investors should check prior to putting in an order. Largest Holdings The portfolio is extremely well diversified. The largest position is around 1.25% of the portfolio. That is solid diversification. The intense diversification is part of the reason the volatility of the ETF is so low. Check out the chart below: (click to enlarge) Conclusion I’m currently screening a large volume of ETFs for my own portfolio. The portfolio I’m building is through Schwab, so I’m able to trade SPLV with no commissions. I have a strong preference for researching ETFs that are free to trade in my account, so most of my research will be on ETFs that fall under the “ETF OneSource” program. SPLV is a difficult ETF to make a decision on. For equity investments, the expense ratio is a bit high, but the relatively low correlation and standard deviation of returns make a pretty good argument for using at least a small position such as 5% in a long term portfolio. I could go either way on this one. I won’t consider it as a core holding (20%+) because of the higher expense ratio.