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REM: A Supplement To Give Your Portfolio More Yield

Summary REM has a high expense ratio, but it is superior to new investors picking mREITs simply on trailing dividend yield. The top holdings are fairly similar, but as we move down to the third holding we see some great diversification benefits. When REM “goes on sale” after a period of intense interest rate volatility, it is not really “on sale”. The mREITs within the portfolio suffer severe losses from volatility. Investors should use allocations like REM in a conservative manner to boost the total income on the portfolio. One option many yield starved investors might miss out on is the iShares Mortgage Real Estate Capped ETF (NYSEARCA: REM ). The ETF isn’t perfect, but it does quite a few things right and in my opinion it may be a substantially superior option to investors picking their own mortgage REITs if they do not understand the mortgage REIT business. An enormous portion of my coverage on Seeking Alpha is in the mortgage REIT sector and I’ve seen quite a few investors lose large chunks of money to being heavily invested in individual mREITs without understanding the accounting implications of management’s decisions. If an investor is willing to put in the time to learn the mREITs, I find that superior to the ETF option. If that seems like too much work, REM is an option with a massive 14.4% dividend yield. Expense Ratio The expense ratio on REM is .48%. Largest Holdings (click to enlarge) The holdings are not ideal in my opinion, but they aren’t bad. For the expense ratio, I would expect more investigation of which small cap mREITs are going to be underpriced and which mREITs will excel in the opposite scenarios. Annaly Capital Management (NYSE: NLY ) is a fairly huge Agency mREIT and their portfolio is fairly similar to the second holding, American Capital Agency Corp. (NASDAQ: AGNC ). The biggest difference in these two mREITs at the present time is the structure of their swap portfolios. NLY is hedging farther out on the yield curve and AGNC is using hedges with shorter durations but a higher notional value. If you want to learn more about either, I’ve covered both quite a few times. The nice thing about this portfolio is that it uses Starwood Property Trust (NYSE: STWD ) as the third holding. Starwood Property Trust is a huge REIT with vastly different risk factors from the simple Agency RMBS portfolios of NLY and AGNC. You can see my introduction to STWD . Overall, the portfolio of mREITs will be prone to one major weakness which is volatility in the interest rate environment. Some of these mREITs will benefit more from low rates and some from high rates, but very few mREITs are designed to benefit from volatility in the interest rate environment. If we go into a sustained period of fairly stable interest rates, it would be very bullish for the sector. Dividend Difficulties If there is volatility in the interest rate environment, it can result in very serious damage to both book value and earnings for mREITs which could force them to cut their dividend payouts. If you’re using REM to supplement your retirement, be aware that the dividend could be reduced materially and share prices falling when interest rates are volatile does not necessarily mean that the sector is “on sale”. 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 REM offers investors exposure to a sector that has a fairly low correlation (less than .50) with the S&P 500. That low correlation combined with a strong dividend yield makes it an appealing option for many investors that do not understand mREIT accounting. When it comes to analyzing mREITs, the worst mistake I often see is investors buying on trailing dividend yield with only a cursory examination into whether the mREIT can sustain the dividend. It is a recipe for failure as share prices can drop sharply after an unsustainable dividend is cut. While the dividend yield is extremely strong, low prices are not necessarily indicative of “sales” because the damage to an mREIT portfolio from period of high volatility can be very material and the damage is generally permanent. When their assets are held at substantially more than par value due to favorable interest rates and the borrowers are paying off the loans at par value, the loss created is a real problem and does not simply correct itself in future periods. Limit the exposure, but using REM as a small part of a portfolio can work just fine. Compared to the presented portfolio, if an investor needed more yield I would contemplate dropping off FXG first and replacing it with more SJNK and then replacing some SPY with an ETF that emphasizes higher dividend yields and lower volatility.

XLV: Getting Your Dose Of Pharmaceuticals And Biotechnology In A Single Source

Summary XLV is a Health Care ETF with the heaviest allocations going to Pharmaceuticals and Biotechnology. The returns figures look fairly volatile in a regression analysis which makes it substantially more difficult to diversify away the excess risk. The nice thing for shareholders is that they would be holding the very companies that are establishing the prices for the medicine they may consume. 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 I am assessing is the Health Care Select Sect SPDR ETF (NYSEARCA: XLV ). 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 Health Care Select Sect SPDR ETF is .15%, which isn’t too bad at all. I’d love to see the expense ratio go under .10%, but .15% is within reason and not too bad for giving investors exposure to the Health Care sector. Remember that the Biotechnology sector is also within the Health Care sector which makes it more volatile. Largest Holdings (click to enlarge) I don’t see anything to complain about here. The top holdings for the ETF almost perfectly mirror the index so investors should expect the portfolio to have very similar returns. Given the low expense ratio, a fairly passive indexing strategy is usually the result. I’m fine with that. Passive indexing is a solid strategy over the long term. Looking at the individual companies, I like seeing Johnson & Johnson (NYSE: JNJ ) at the top of the holdings. This is a strong dividend company that offers investors some stability. Their product lineup is diverse enough that they are largely protecting from minor shifts in the economy and positioned to benefit from an aging population requiring more medicine. Sector The largest weighting by sector is clearly the pharmaceuticals rather than biotechnology stocks. As a result of this sector diversification the fund is dramatically more stable than peers that are heavily invested in biotechnology companies. On the other hand, the returns for it have also been materially weaker. 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 XLV is substantially less risky than the XBI. Since XBI is almost exclusively biotechnology companies, I’m not surprised that XLV is so much safer. Of course, it is still a fairly risky investment in its own right. The ETF has a beta higher than 1.00 so it will naturally be increasing the risk level on most traditional portfolios. The correlation with the S&P 500 stands at .88 which is high enough that it may be a concern. The bigger issue, in my opinion, is that XLV has a weaker negative correlation with the kind of long term bond holdings that investors would use to reduce portfolio volatility. In this case, that is demonstrated by having a negative correlation with BLV of only -.23 compared to -.29 for the S&P 500. I would treat XLV as a fairly aggressive allocation. If investors intend to bring their portfolio volatility significantly below the S&P 500, it will be more difficult if the allocations to XLV are significant. Despite the volatility, I do like the exposure within the portfolio. A heavy exposure to the pharmaceutical companies makes sense when an investor expects to be practically forced to buy their products in the future. While the portfolio has more volatility under modern portfolio theory, it does allow investors to benefit as shareholders if prices (and profits) from the pharmaceutical and biotechnology sector increase. 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.

Fed-Free Week Still Full Of Obstacles For ETFs

Summary A 2015 rate hike is off the table. In the near term, USDU might be the preferred option of the pair simply because it is short several emerging markets currencies, which have the potential to continue falling. As is often the case with weekly ETF previews, some familiar ETFs frequently re-emerge, and that is the case this week. By Todd Shriber, ETF Professor After a week spent worshiping at the altar of the Federal Reserve, financial markets will be spared the specter of a Fed meeting in the week ahead. However, that does not mean a 2015 rate hike is off the table. San Francisco Fed President John Williams told reporters last week that a rate hike this year could be appropriate. Richmond Federal Reserve President Jeffrey Lacker on Saturday said he dissented at a Fed policy meeting because he thought the economy was now strong enough to warrant higher interest rates, Reuters reported . Federal Reserve Bank of St. Louis President James Bullard said he argued against the continuation of the Fed’s zero interest rate policy. The ETF Situation The PowerShares DB USD Bull ETF (NYSEARCA: UUP ) and the actively managed WisdomTree Bloomberg U.S. Dollar Bullish ETF (NYSEARCA: USDU ) are the two primary exchange traded funds tracking greenback fluctuations, so suffice to say these ETFs would like 2015 rate hike momentum to reemerge and do so soon. In the near term, USDU might be the preferred option of the pair simply because it is short several emerging markets currencies, which have the potential to continue falling. UUP tracks the dollar against major developed market currencies, some of which could and should rally the longer the Fed puts off higher interest rates. There is some evidence to suggest some market participants were not reassured by the Fed’s no-hike call last week. For example, the Consumer Staples Select Sector SPDR ETF (NYSEARCA: XLP ) and the Utilities Select Sector SPDR ETF (NYSEARCA: XLU ) , each among the most rate-sensitive sector ETFs, lost a combined $382.3 million in assets last week. XLP posted a modest gain, while XLU climbed 1.6 percent – which could mean the latter is worth monitoring in the week ahead. Watch List As is often the case with weekly ETF previews, some familiar ETFs frequently re-emerge, and that is the case this week. It should be noted the Global X FTSE Greece 20 ETF (NYSEARCA: GREK ) merits a place on traders’ watch lists in the week ahead. In what feels like a monthly occurrence, Greece holds national elections again this weekend. Even with potential for increased volatility due to the election and news of a major index provider lowering Greece’s market classification , the Global X FTSE Greece 20 ETF climbed 3.8 percent last week and is up 6.3 percent over the past month. It could be a sign of a renewed risk appetite, though only time will tell, but the PowerShares QQQ Trust ETF (NASDAQ: QQQ ) , the NASDAQ-100 tracking ETF, hauled in over $1.2 billion in new assets last week despite suffering a modest drop. Remember what investors are doing by being long QQQ. They are making an ETF proxy bet on the likes of Apple, Microsoft and Amazon, as those stocks combine for over a quarter of QQQ’s weight. Disclaimer: Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation. 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. I have no business relationship with any company whose stock is mentioned in this article.