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Should You Make Chemical Enhancements To Your Portfolio?

By Todd Rosenbluth Most diversified index-based materials products have significant exposure to the chemicals industry, though the weightings can be different. For example, chemicals comprised approximately 70% of the S&P 500 Materials Index as of late June. Meanwhile, the S&P 500 Equal Weight Materials index had a 54% weighting in chemicals, with more exposure in containers & packaging companies. As such we think investors need to understand what drives the industry. S&P Capital IQ thinks cost saving efforts can spur the chemicals industry to higher earnings per share (EPS) growth levels in 2016, after expected growth of less than 10% in 2015. We see industry revenues growing slightly and at a slower pace over the next few years. Our profit and revenue growth forecasts are tied to the likelihood of a steadily improving U.S. macroeconomic environment, mostly offset by a stronger U.S. dollar, significantly lower oil prices, and slowing economic growth in China. The chemicals industry is comprised of five sub-industries: specialty chemicals, diversified chemicals, fertilizer & agricultural chemicals, industrial gases, and commodity chemicals. According to S&P Capital IQ equity analyst Christopher Muir, revenues of specialty chemicals companies are mostly influenced by volumes, while commodity chemicals companies face significant threats to revenue per share from changes in commodity prices for their products or raw materials. For fertilizer & agricultural chemicals companies, prices of the products will likely affect fertilizer revenue per share, while agricultural chemicals, including specialty seeds, are more-specialized products, which are driven by volumes. Industrial gas companies are likely to see a mix of volumes and prices driving revenues. In the fourth quarter of 2014 and first quarter of 2015, a rise in the value of the dollar versus other currencies had a negative effect on revenue per share, but a fall in the dollar index would be a positive in the second half of 2015 and in 2016. Specialty chemicals companies and divisions spend money and time developing new products. In most cases, Muir noted these new products are highly specialized to suit the end user, and as a result are often sold at much higher margins than their less specialized counterparts are, helping operating margin. S&P Capital IQ recently published an Industry Survey that reviews the drivers of the chemicals industry. This report along with S&P Capital IQ stock and ETF reports tied to materials sector can be found on MarketScope Advisor. Disclosure: © S&P Dow Jones Indices LLC 2015. Indexology® is a trademark of S&P Dow Jones Indices LLC (SPDJI). S&P® is a trademark of Standard & Poor’s Financial Services LLC and Dow Jones® is a trademark of Dow Jones Trademark Holdings LLC, and those marks have been licensed to S&P DJI. This material is reproduced with the prior written consent of S&P DJI. For more information on S&P DJI and to see our full disclaimer, visit www.spdji.com/terms-of-use .

Benchmarks May Have Their Uses But Gauging Portfolio Risk Is Not One Of Them

By Nick Kirrage Here on The Value Perspective, we have nothing against market indices in themselves but we do worry about how investors sometimes use them. Say you wanted to measure the relative returns on your investments over a suitably long time period, then please – benchmark away. But if you were planning to use an index as a way of gauging risk on your portfolio, here is why you should think again. People tend to see benchmarks as neutral entities and so, in some way, as an indication of safety – yet they are anything but. The classic example here – as so often – is the tech boom of the late 1990s. As technology stocks rose in value to become an ever greater part of market indices, so any ‘benchmark-aware’ funds had to buy more and more of the sector. As we know, this did not end well. Clearly, buying more tech in early 2000 as a means of reducing your risk relative to a benchmark index was a pretty flawed strategy but this is hardly a one-off example in the world of equities – or indeed in investment as a whole. In the fixed income sector, for example, index-relative global funds end up increasing their exposure to countries with the greatest amount of debt, regardless of the inherent risks. The reason we are revisiting the issue here is because of the recent decision by index provider MSCI not to include ‘A-Shares’ – those traded on China’s mainland stock exchanges of Shanghai and Shenzhen, as distinct from the ‘H-Shares’ traded on the Hong Kong exchange – within its principal global emerging markets benchmark. The last 18 months or so have seen an extraordinary bull run in Chinese equities and, while there have recently been some signs that has started to stall, China – by virtue of those H-Shares – now accounts for roughly 25% of the entire MSCI Global Emerging Markets Index. Had MSCI decided to include China’s A-Shares too, then that weighting would have jumped to around 45%. Presumably it is only a matter of time before MSCI deems all Chinese shares to be part of its emerging markets universe but, to our way of thinking, that is the rather farcical aspect of this debate – after all, regardless of whether MSCI or any other organizations reckons China to be an emerging market, it clearly is one. Where it becomes dangerous – and why we see MSCI’s decision as a near-miss (or perhaps a stay of execution) for benchmark-aware investors – is, the moment A-Shares are included in the index, these people will feel compelled to redirect yet larger quantities of money towards Chinese stocks because they apparently believe it would be a ‘risk’ to be so underweight China relative to their benchmark. But is that not perverse? It is not as if some huge new risk will have been revealed the day China’s weighting moves up from, say, 25% to 45%. Either it was always a risk to hold 25% in China or it was never one. The reality will not have changed, only some of the rules – but those rules can become hugely distorting. After all, if A-Shares had received the nod from MSCI and China now made up almost half the index, benchmark-aware investors would have had to scale back their exposures to other important emerging markets – for example, to 11% in Korea, 5.5% in Brazil and just 5% in India. This may not be quite as stark as our earlier tech boom example but it could have similarly unwanted consequences. Mind you, it could also throw up some similarly inviting possibilities for investors who prefer, as we do here on The Value Perspective, to think about risk in absolute as opposed to relative terms and for whom, in many ways, benchmark indices represent an opportunity more than they do a threat.

The Joy Of Portfolio Boredom

The word boring is worth exploring further as it is a very important building block of long-term investment success. Getting rich slowly or maybe the more modest goal of getting financially comfortable slowly means some pretty plain vanilla portfolio construction. The more exciting a portfolio is on the way up, the more “exciting’ it will be on the way down. Last week I stumbled across an article that favorably critiqued an alternative-strategy ETF for being boring which is its objective. “Boring” is not the stated objective in the prospectus but terms like market neutral, absolute return, low correlation to equities and some others really are about boredom. You can judge for yourself whether a given fund that is supposed to be boring is indeed boring, as not every fund will deliver on its stated objective. The word boring is worth exploring further as it is a very important building block of long-term investment success. Ten years ago I wrote a post called Getting Rich Slowly and while I have no idea whether the phrase was a Random Roger original, I think it captures the path that most people want to take in terms of realistic participation in capital markets. Getting rich slowly, or maybe the more modest goal of getting financially comfortable slowly, means some pretty plain vanilla portfolio construction. How you get to plain vanilla probably depends on the level of engagement you want to have in markets but from the top down it should start with blending together things like equities, fixed income and a small slice to alternatives (what for years I’ve been referring to as diversifiers) with relatively simple products and/or individual issues in such a way where all three sleeves avoid trading in lockstep, but over a long period of time gives a chance for having enough money when you need it, which presumably is at retirement. As we have discussed many times before, one of the biggest impediments to long-term financial success is succumbing to emotion at the worst possible times, which can mean panic selling your portfolio at a low or repeatedly panic buying hot stocks at their highs after a pundit just extrapolated past returns on stock market television. I had the opportunity to moderate a panel that included Dr. Richard Thaler about behavioral economics/finance, and one thing he talked about as a very common bias is loss aversion, which basically means that pound for pound people feel losses far more than they feel gains. Take that out a little further and it explains why people often react to large declines like they’ve never happened before; the tendency to think this one is different. The more exciting a portfolio is on the way up, the more “exciting’ it will be on the way down. Investors of course don’t mind excitement when it is resulting in gains, but the longer it goes on, the more complacent they become in terms of forgetting the last decline or using hindsight bias to explain away the last decline. Investors don’t want boring until the market peaks out, which of course is plenty guessable but not knowable. If there is no way to know when the market will peak and losses trigger twice the emotion that gains do, then right there is the argument for boring all of the time. Again, the context for boring is not no equities but if you can buy into the idea that an adequate savings rate, proper asset allocation and not panicking are the most important determinants to long-term portfolio success then the focus shifts more in line with the true long-term objective. You are very unlikely to remember what your portfolio did in the 3rd quarter of 2013 or what the market did that quarter, without looking, because it doesn’t matter in the context of your long-term financial plan. An exception would be if that was the quarter you retired. The only other way some random calendar quarter from your past is likely to matter is if you made some sort of catastrophic mistake like selling out in the first quarter of 2009. The conclusion for me is a diversified portfolio of equities that at the very least offers decent upside participation, fixed income exposure that offers some ballast to normal equity volatility and a little exposure to diversifiers, as I said above, that hopefully allows for managing volatility and correlation such that the potential for panic is at least partially mitigated. 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. Additional disclosure: To the extent that this content includes references to securities, those references do not constitute an offer or solicitation to buy, sell or hold such security. AdvisorShares is a sponsor of actively managed exchange-traded funds (ETFs) and holds positions in all of its ETFs. This document should not be considered investment advice and the information contain within should not be relied upon in assessing whether or not to invest in any products mentioned. Investment in securities carries a high degree of risk which may result in investors losing all of their invested capital. Please keep in mind that a company’s past financial performance, including the performance of its share price, does not guarantee future results. 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