Tag Archives: rem

First Fed Hike Puts These ETFs In Focus

Months of speculation and nail-biting hearsay about the timeline of the first rate hike in almost a decade finally ended yesterday thankfully, with neither shocks, nor surprises. The Fed pulled the trigger at long last, raising benchmark interest rates by a modest 25 bps to 0.25-0.50% for the first time since 2006, making it official that the U.S. economy is out of the woods; though still has miles to go. The step also sets the U.S. apart from other developed economies and had a great impact on the global currency market. The Fed believes that the possibility of further improvement in the labor market as well as in inflation is ripe at the current level. Muted inflation mainly due to stubbornly low oil prices has been an issue for long for the Fed. But in the 12 months through November, the core consumer price index grew 2% (matching the Fed’s target), the highest reading since May 2014 , followed by the 1.9% advancement in October. Unemployment rate fell to 5%, a more than seven-year low level. Average hourly earnings are rising of late. What’s more noteworthy was that the Fed did not move an inch from the ‘ gradual ‘ rate hike trajectory. Also, the central bank indicated that while the job market criteria is apparently accomplished, the Fed’s future focus would be on the inflation reading, which is yet to pick up at a sustained pace. Global growth worry is another factor, which is holding the Fed back from acting fast on tightening. Fed’s Projection The Fed lowered its 2015 projection for personal consumer expenditure inflation to 0.3-0.5% from 0.3-1.0% and 0.6-1.0% guided in September and June, respectively. The projections were also slashed for 2016 and 2017 from 1.5-2.4% to 1.2-2.1% and from 1.7-2.2% to 1.7-2.0%, respectively. The expectations for 2016 and 2017 real GDP growth have been ticked down to 2.0-2.7% from 2.1-2.8% guided in September (Fed’s June prediction for 2016 was 2.3-3.0%) and to 1.8-2.5% from 1.9-2.6%, respectively. However, the real GDP growth expectation for 2015 has been changed to 2.0-2.2% from 1.9-2.5% projected in September. As already discussed, unemployment was the true healer with its 2015 expectation being 5%, almost in line with the 4.9-5.2% expected in September. The coming two years will also see the same uptrend as estimates for 2016 were lowered from 4.5-5.0% to 4.3-4.9% while the same for 2017 remained unchanged at 4.5-5.0%. The notable changes were in the projection for the benchmark interest rate for 2015, 2016 and 2017. Fed’s funds rate for the longer run may be maintained at 3.0-4.0% but projection for 2015, 2016 and 2017 were changed from negative 0.1- positive 0.9% to 0.1-0.4%, from negative 0.1- positive 2.9% to 0.9-2.1% and from 1.0-3.9% to 1.9-3.4%, respectively. Market Impact However, the historic move did not mess up the market, as the investing world was prepared well ahead of the meeting. In fact, the Fed gave the global market enough time to digest the news when the central bank brought the December rate hike possibility back on to the table in October end. With no drama in the December meeting, the market is now focusing more on a sluggish rate hike, not just the hike itself. As a result, probability of a dovish rate hike trail ahead cheered equity investors almost across the globe. Even the highly vulnerable areas like emerging markets also tacked on gains during the Fed meeting. This produced a handful of surprise winners and losers post meeting. However, bonds obeyed the rule book and started diving as soon as the Fed enacted the lift-off. The two-year benchmark Treasury yield jumped 4 bps to 1.02% on December 16 – a five and a half year high. However, the yield on the 10-year Treasury note rose just 2 bps to 2.30% and yield on the long-term 30-year bonds saw a 2 bp nudge to 3.02%. All bond ETFs were in the red. Given this, we have highlighted ETF winners and losers from the Fed move: The PowerShares DB US Dollar Bullish Fund (NYSEARCA: UUP ) – Natural winner The U.S. dollar is a common winner following the lift-off. The U.S. dollar ETF UUP gained 0.04% after hours. The iShares MSCI Emerging Markets (NYSEARCA: EEM ) – Surprise Winner Emerging markets normally fall out of favor in a rising rate environment as investors dump these high-yielding, but risky, investing tools for higher yields at home. However, possibility of a gradual hike boosted the emerging market ETF EEM by about 2% on December 16. The fund added 0.2% after hours. The SPDR S&P Regional Banking ETF (NYSEARCA: KRE ) – Natural Winner The regional bank sector was pleased by the Fed decision and the resultant rise in yields, as it tends to benefit from the steepening of the yield curve. As a result, regional bank ETF KRE was up about 1% and added 0.1% after hours. The Market Vectors Gold Miners ETF (NYSEARCA: GDX ) – Surprise Winner but Potential Loser As soon as the greenback gains, commodity prices fall. Gold, one of the key precious metals, might have gained from the slower hike bet, but is likely to lose ahead. The SPDR Gold Trust (NYSEARCA: GLD ) tracking the gold bullion added over 1.2% while the largest big-cap gold mining ETF GDX added about 4% on the same day. The latter saw more gains as it often trades as a leveraged play on gold. But both lost over 0.3% and 0.6% in extended hours. The iShares Mortgage Real Estate Capped ETF (NYSEARCA: REM ) – Surprise Winner but Potential Loser Mortgage REITs perform better in a low interest rate environment. However, though high-yield REM added 3.2% yesterday, it might see a slump ahead. Original Post

REM Compared To Equal Weighted mREIT Portfolios

Summary REM holds up better than I would have expected. Market capitalization weighting is easy, but may be less than ideal for reducing risk. REM is compared over a two-year period and a one-year period against hypothetical mREIT portfolios built at equal weights. When I was taking a look at the iShares Mortgage Real Estate Capped ETF (NYSEARCA: REM ), one of my thoughts was that the portfolio would be more attractive with a different weighting scheme. My views on that have changed some since Annaly Capital Management (NYSE: NLY ) reported an excellent second quarter and its new strategy sounds much better . However, I still wondered from a risk-adjusted viewpoint how different an ETF might look if it held the same holdings, but applied an equal weight methodology rather than using market cap weights. The Benefits of Market Capitalization Weighting The biggest advantage to using market capitalization is that it is remarkably easy. The fund establishes the volume of assets and the total market cap of each company. They spend on the shares accordingly, and if they were not trying to grow assets in the ETF (to generate more fees), they would simply leave that same structure in place. The only modifications to be made would be to adjust for the new shares issued and old shares repurchased. In general, this is a very simple kind of ETF to run. The Problem When using market cap weighting, if a company becomes relatively overvalued, it is also likely to have a higher weight in the portfolio. Unless the overvalued status is coinciding with repurchasing shares to shrink the market cap, the weighting will grow. That is unfortunate. It also means a portfolio may have substantially less diversification if some holdings grow large enough to dominate a large chunk of the portfolio. Equal Weighting My theory was that even though smaller companies will on average be more volatile (as demonstrated in the charts I will provide), the benefit of better diversification could cancel out those effects. Equal weighting is rarely going to be the ideal method, but it provides a simple alternative to market capitalization. Findings I originally built a spreadsheet to run an analysis of correlations and simulate different portfolios, but I find the tools at InvestSpy.com were faster than running it through my spreadsheets. Therefore, I simulated the portfolios using its website. REM has a total of 39 holdings, but I ran my first comparison using only 20 mREITs. The names included several of the largest from the REM portfolio and some that I cover that are not given material weights in the portfolio. The analysis was based on comparing the last 2 years of returns. REM 2 Years (click to enlarge) The primary factor that I’m looking at here is that the annualized volatility of the portfolio is 12% and the beta is .42. I’m focused on testing for risk rather than testing for historical returns since using historical returns would create an enormous bias into the test, as I could simply avoid selecting mREITs that have cratered when designing my comparable 20 mREIT portfolio. Equal Weighted 20 The next table is going to be dramatically larger because it is showing the numbers for each individual mREIT. (click to enlarge) This portfolio made of 20 mREITs with equal weights shows a lower annualized volatility at 11.2%; however, it also shows a beta that is slightly higher at .43. I would say that given the sample size (only 2 years), the beta comparison is within the margin of error. Some other factors jump out when we look at this as well. The stock that generated the highest risk contribution was CYS Investments (NYSE: CYS ). It was not the highest volatility, it was not the highest beta, and yet it contributed the most to the portfolio. It also had one of the best return percentages. On the other hand, Blackstone Mortgage Trust (NYSE: BXMT ) delivered in every way. The risk contribution was low and the annualized volatility was the lowest within the group. Despite that, it had a total return of 31.2%, which should remind readers that not all risk and return tradeoffs are created equally. Both the highest-risk contributor and the lowest-risk contributor were near the top of the chart in their total return over the last 2 years. One-Year Comparisons The following chart has REM’s performance over the last year: (click to enlarge) For comparison, this time I wanted to replicate a larger portfolio, so I am only excluding one security from the portfolio. That security has a very short history and thus is not viable for the statistics. It should be noted that I have cropped the following image to make it substantially shorter since the site struggles with displaying longer charts. (click to enlarge) In this second comparison, there are about 37 mREITs all under equal weighting, but the annualized volatility for the portfolio is within a margin of error. In the context of a year, .1% is not reliable. Interesting Notes When I shifted to using 37 mREITs for the one-year measure, I was expecting it to result in a larger reduction in volatility, but it did not. It would seem the volatility of those smaller mREITs was enough to outweigh the benefits of more diversification. Investing in ETFs is generally relying on diversification within moderately efficient markets to be worth the costs. For the mREIT investor that has the best information, I don’t think the diversification is adding any advantages. However, for the mREIT investor who just wants to set it and forget it, the REM portfolio has done remarkably well. Comparison of Holdings The following chart shows the top 10 holdings of REM: (click to enlarge) As you can see Annaly Capital Management and American Capital Agency Corp. (NASDAQ: AGNC ) dominate the portfolio and combine to be over 26% of the portfolio value. Conclusion The way REM designs the portfolio is not perfect in my opinion; however, it is still done well enough to offer investors some fairly substantial reduction in risk. The expense ratio is high for my tastes at .48%, but at least investors are receiving a fairly substantial reduction in volatility, and when compared to other weighting methods, such as going equal weight, REM has done fairly well. If you are curious about the risk factors for REM, you’ll want to see my last piece on the ETF . Next time I cover REM I’m going to establish comparisons to the portfolio I would create if I were aiming to produce an ETF full of mREITs. Scroll up to the top of the article and hit the follow button so you don’t miss it. 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.

U.S. REIT ETFs: Correlations

REIT ETFs appear to offer an improvement to the overall portfolio performance. Correlations to the S&P 500 were in the low to mid 0.50s in the last 12 months. The largest U.S. REIT ETFs are fairly homogeneous with correlation coefficients of 0.98-1.00 between themselves. Real estate is often mentioned as a stand-alone asset class next to equities, fixed income and commodities. This notion prompts investors to allocate a portion of their portfolios to the real estate investment trusts (“REITs”) in pursuit of diversification benefits. In this article, I review how the U.S. REIT ETFs fit into the overall portfolio and whether they help to improve the performance. The analysis focuses on the five largest U.S. REIT ETFs that have been around for at least 5 years and manage over $1 billion of assets each (in descending order by size): Vanguard REIT Index ETF (NYSEARCA: VNQ ), iShares U.S. Real Estate ETF (NYSEARCA: IYR ), iShares Cohen & Steers REIT ETF (NYSEARCA: ICF ), SPDR DJ Wilshire Global REIT ETF (NYSEARCA: RWR ), and iShares Mortgage Real Estate Capped ETF (NYSEARCA: REM ). All the calculations were carried out on the freely available investor resource InvestSpy. To start with, let’s look at the correlation matrix of these ETFs plus the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ), utilizing 5 years of historical data: The table above presents us with two important insights. Firstly, all REIT ETFs had a correlation coefficient with the broad equity market no higher than 0.78. Although such a reading indicates a relatively close co-movement, it is low enough to offer diversification benefits. Secondly, the four largest REIT ETFs (VNQ, IYR, ICF, and RWR) had almost perfect correlation of 0.99-1.00 between themselves. This means that from an investor’s standpoint, these are pretty much identical securities, thus it is worthwhile paying more attention to expense ratios and bid-ask spread when making a selection. The only standout is REM, which demonstrates a lower correlation both with SPY and with the remaining REIT ETFs. This is due to the fact that REM is a mortgage REIT, thus it behaves somewhat differently from equity REITs. Five years is fairly long period of time and it is useful to investigate correlations in the more recent past. Below is the same correlation matrix, utilizing daily data for the last 12 months only: It appears that the close co-movement between the four equity REIT ETFs persisted to the same degree whilst REM deviated even further from the traditional REIT class with its correlation coefficients no higher than 0.70. Interestingly, correlations with the broad U.S. equity market dropped across the board to as low as 0.49 in the case of ICF. As all of these ETFs except for REM posted positive total returns similar to the S&P 500 over the last year, it is clear that investors that had allocation to REITs in this period achieved an improved risk/reward performance. Just to illustrate the difference a 20% allocation to REIT ETFs would have made, consider a standard 60% equities/40% bonds portfolio where 20% of equity allocation is replaced with a REIT ETF. A portfolio with 60% invested in the Vanguard Total Stock Market ETF (NYSEARCA: VTI ) and 40% in the iShares Core Total U.S. Bond Market ETF (NYSEARCA: AGG ) would have brought the following results in the last year: (click to enlarge) Meanwhile, with 20% allocated to VNQ, the dynamics change a little bit: (click to enlarge) The key metric I am looking at here is the annualized volatility. Note that even though we have replaced VTI with a riskier VNQI (12.1% vs. 14.4% volatility), the overall portfolio volatility has decreased from 7.0% to 6.8%. This is the diversification benefit in its purest sense. In addition to that, the total return and maximum drawdown figures are the same for both portfolios whilst the second one is substantially less dependent on the broad equity market with a beta below 0.50. It is also clear that risk contributions are largely skewed away from fixed income, but this a classical case in most of traditional portfolios as I have covered here , and this topic requires a separate discussion. Summing up, U.S. REIT ETFs appear to offer an improvement to the overall portfolio performance. The largest ETFs in this space are extremely highly correlated, thus an investor needs to look more closely at ETF features such as expense ratio and bid-ask spread to identify the most efficient option. Finally, correlations change over time and so does the diversification benefit. Therefore, one has to monitor periodically if their asset class allocation is delivering performance as anticipated. Please share your thoughts and feedback on the insights above. In the next article later this week, I will present a similar analysis for international REITs. 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.