Tag Archives: seeking-alpha

Comparing The Build Of BRIC ETFs

Summary BRIC ETFs have been around since 2006. Although returns tend to differ due to varying country weightings, risk profiles of BRIC ETFs are almost identical. There appear to be more efficient instruments to gain exposure to emerging markets rather than BRIC funds. The BRIC acronym has become a staple in the investment community. It was coined back in 2001 by Jim O’Neill from Goldman Sachs and refers to four countries: Brazil, Russia, India and China. These states are at the forefront of emerging markets although every single one of them has been going through its own struggles. Five years after the term BRIC came to existence, the first ETF targeting specifically this group of countries was launched. There are currently 3 main ETFs in this space and I would like to review and compare their risk characteristics and potential fit into investor’s portfolio. The largest BRIC ETF is the iShares MSCI BRIC ETF (NYSEARCA: BKF ), which was launched in 2007 and has over $200m in assets under management (‘AUM’). Its expense ratio stands at 0.68%. The second one by size is the Guggenheim BRIC ETF (NYSEARCA: EEB ) with $85m of AUM. EEB was the first BRIC ETF, launched in 2006, and comes with a net expense ratio of 0.64%. Despite its lowest expense ratio of 0.49%, the SPDR S&P BRIC 40 (NYSEARCA: BIK ) trails its competitors in terms of AUM with $82m. This fund came to existence in 2007. I would like to split the analysis into two parts: returns and risk. Returns Although all three ETFs posted negative substantially negative returns over the recent 5 year period, the extent of the decline was different. Whilst BIK declined 14.8% with 33.9% drawdown, EEB posted a whooping loss of 35.2% with 46.5% maximum drawdown. BKF stood somewhere in the middle with a 26.6% loss and 38.6% drawdown. This discrepancy between BRIC ETFs performance is easy to explain as each fund has distinctly different country weightings: Weightings as of October 9, 2015 Looking at single country ETFs in the same period, it is obvious that any fund that overweighed Brazil or Russia would have suffered most: This is exactly what happened in the case of EEB, which had by far the largest share of AUM invested in these two countries. Meanwhile, BIK was the least diversified in terms of country exposure but its focus on China delivered superior returns. It is important to note that the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) appreciated 61.5% in the same period, thus the performance of BRIC ETFs can be called dismal. However, one positive takeaway is that diversification across different regions appears to be working even when global stock markets are so closely linked together. Risk Even though the three BRIC ETFs were on different return trajectories, all of them had a strikingly similar risk profile. For the purpose of this analysis, I have used a simple online tool InvestSpy . Utilizing 5 years of historical data, the results are as follows: (click to enlarge) The two columns I would like to draw reader’s attention to are ‘Annualized Volatility’ and ‘Beta’. It is rather surprising to see that all three ETFs had almost identical volatilities and beta coefficients vs. SPY. Furthermore, they all had pretty much identical correlation to SPY: This illustrates that from the overall portfolio risk perspective, all three ETFs would have had the same impact to an average portfolio in terms of risk contribution, i.e. none of them was more or less risky. Alternatives Finally, given fairly high expense ratios for BRIC ETFs, I would like to explore potential alternatives. Utilizing the correlation tool on InvestSpy , it appears that there are 3 ETFs that have a correlation coefficient of at least 0.95 with BRICs: The Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ), the Schwab Emerging Markets Equity ETF (NYSEARCA: SCHE ) and the iShares MSCI Emerging Markets ETF (NYSEARCA: EEM ). Considering the fact that, for example, VWO is much more liquid, more widely diversified and significantly cheaper, it hard to make the case for investing in any of the BRIC ETFs.

Newest Additions To Our Friedrich Charts

In 1989 I was four years into working on building what would later be called Friedrich and back then I read a book called “The Money Masters” by John Train, which changed my life . In that book, one of the chapters was about the portfolio manager of Source Capital = Mr. George Michaelis, whom I consider one of the greatest investors in history. In the Appendix of that book, is part of the Source Capital annual report to investors for December 31, 1985. Here is what George wrote then. The ratio that you see in the first paragraph is actually one of the foundation stones of Friedrich and plays a major part in my creation of the final algorithm. The reason that ratio is so powerful is because it allows one to determine a company’s actual rate of growth on Main Street by incorporating its return on equity along with the company’s dividend payout policy, which both speak volumes about how well managed a company is. What I look for in using what I call the “Michaelis Ratio” is a return of at least 15% or higher. Here for example is our Friedrich chart for Accenture (NYSE: ACN ) that includes the Michaelis Ratio listed for the first time. As you can see Accenture’s Michaelis Ratio came in at 30%, which is twice what I look for as the ideal for this ratio. When you factor in my other original ratios like FROIC and CAPFLOW, you have quite impressive results for the company. But in that chart you will also see the Watson Ratio and the Sherlock Debt Divisor. Obviously, I am a big fan of Sir Arthur Conan Doyle’s work and have named these two powerful ratios after his greatest creations. Having said that, what is the Watson Ratio? The Watson Ratio is one of 30 original abstract ratios that I have created, which along with many others make up Friedrich. This particular ratio deals with the relationship between a company’s free cash flow and its diluted earnings per share. It uses the free cash flow methodology that Arnold Bernhard (the founder of Value Line) created, which is basically cash flow – capital spending and divides that result by the company’s diluted earnings per share. In theory most companies should have (what I call a Bernhard Free Cash Flow) result equal to its diluted earnings per share, so an average result should be 100%. When a company is well managed you will see a result greater than 100%, like Accenture’s result above of 110%, which obviously tells us that Accenture’s Bernhard Free Cash Flow is 10% better than then Accenture’s diluted earnings per share. Thus we end up with bonus points. A major concern that I have these days in analyzing companies is the amount of debt each company takes on relative to its operations and whether management is abusing our current Fed inspired low interest rate policy. Debt as anyone knows, when used wisely, allows for what is called leverage and leverage can be extremely beneficial within means. On the other side of the coin, the use of debt can also be excessive and put a company’s future in jeopardy. So what I have done to determine if a company’s debt policy is beneficial or abusive is create the Sherlock Debt Divisor, which allows us to investigate debt in a different abstract way. What the Divisor does is punish companies that use debt unwisely and rewards those who successfully use debt as leverage. How do I do this? Well I take a company’s working capital and subtract its long term debt. I then divide that result by the company’s diluted shares outstanding, then multiply that result by (-1). So if a company like Accenture has a lot more working capital than long term debt, I reward it and punish others whose long term debt exceeds its working capital. The final result for Accenture came in at $100.13 but the closing stock price was $104.78, so I am rewarding Accenture’s management for doing a great job using leverage. How do I reward them? Well I do so by using $100.13 as my numerator and not $104.78 in all my ratio calculations performed by Friedrich. So since the valuation in the Numerator is less, each ratio naturally generates a much more favorable result than it would have had I used $104.78. What does a company that is not doing very well look like? Well here is the Friedrich chart for Chevron (NYSE: CVX ). First of all, Chevron pays about a 5.09% dividend yield, so the growth for the company on a Main Street is only 1.91% on a Michaelis scale (7%-5.09%). It’s Watson Ratio ratio tells us to avoid it as its free cash flow is a disaster relative to its reported diluted earnings per share. Finally the large debt that Chevron has on its books punishes the company by adding $8.84 to the numerator in all ratio calculations performed by our Friedrich Algorithm. The Max Value you see below uses a different methodology to come up with its result and sometimes that result is skewed as it relies exclusively on what is called the “discounted owners earnings using a two stage dividend discount model’ found in Hagstrom’s great book “The Warren Buffett Way”. The final “Market Value of the Company” you see in the table below is what I call the Max Value. My work also incorporates different free cash flows than Mr. Hagstrom uses as I use the MFCF = Mycroft Free Cash Flow and since my Mycroft Free Cash Flow for Chevron comes in at $-785 million, you are obviously going to end up with a negative result for Max Value. My True Value and Buy Prices are based exclusively on my own ratios and that is why they are positive as they incorporate many more things than free cash flow in the analysis. As you can see if you used the Max Value in 2014 for Chevron you would have sold it then and avoided watching its stock price go down to $69.58, which is the 52 week low for this year. So when operating with abstract ratios sometimes you get such results where the buy price is higher than the Max Value, but what we are trying to do with Friedrich is find companies that are consistent year in and year out, so we do not need to sell. We are looking for just 50 stocks to put two percent in to become fully invested out of 3000 stocks that we analyze as part of our research. There is no such thing as a perfect system as perfection is an illusion that can only be found as a word in a dictionary. Once an investor understands that, she or he automatically matures and becomes a more seasoned investor. Plato once said “Experience is what man calls his mistakes”. Therefore, Friedrich is the culmination of what I have learned over the last 30 years in creating the Friedrich Algorithm, through trial and error and through my personal experiences in the stock market as a Professional Analyst.

Considerations For Building A Currency Hedged Strategy

By Jane Leung It’s been nearly impossible to ignore the news about the dollar, especially for those of us who are taking advantage of the upcoming vacation season to travel overseas. The greenback’s movement also has implications for investors. One of the things I’m hearing most from colleagues and clients is that investors know they need to have a view on the dollar – whether it will go up or down – and also be very aware of their investing time horizon. Unfortunately, they’re still unsure of how to implement a currency hedged strategy in their portfolio. Of course, predicting exact currency movements is impossible, especially in today’s environment. On one hand, you have the Federal Reserve angling to boost interest rates, while on the other, central banks in Europe and Japan continue efforts to lower rates, thus weakening their respective currencies. So let’s focus on the variable that’s easier to measure: time horizon. Why Time Matters Investors seeking to limit the effects of currency risk on their portfolios have a number of hedging strategies to consider, but what to do depends on the investment horizon. A quick review of the numbers shows that there is a big difference in the risk/return ratio of hedged and unhedged strategies depending on how long you remain invested. The chart below shows developed market return/risk ratios and reveals that results vary significantly over time. Of course, it’s important to remember that currency returns are generally viewed, over the long term, as a zero-sum game. And, as we can see, over a 15-year period, hedged and unhedged strategies, as measured by MSCI (daily index returns from April 1, 2005 to March 31, 2015) produced nearly the same results. However, applying some form of currency hedged strategy may help reduce volatility. In the example below, at 10 years, there was a higher return/risk ratio for a hedged v. unhedged index. The differences keep becoming more pronounced as you look at shorter time periods. Over a 1-year time period, a 100 percent hedged portfolio would have resulted in a 0.8 risk/return ratio while 100 percent unhedged would have resulted in a -0.6 risk/return ratio. EAFE HEDGING How to Build a Hedged Strategy When deciding how much of your portfolio should be hedged for currency risk, a good rule of thumb is to think about developing an asset allocation and hedging “policy” at the same time. To clarify my point, I’m including a simple risk-and-return illustration. Low risk/low return investments such as cash and U.S. bonds reside in the left corner and the potentially high risk/high return investments such as unhedged international equities in the upper right corner. The orange dot is where a hypothetical investor may indicate her risk tolerance. HYPOTHETICAL RISK TOLERANCE Considerations for Investing Overseas When you think about international investing, it is also important to recognize the distinct characteristics of each country that makes up a foreign region. Some of these features may or may not be correlated with the U.S., and this can affect the decision of whether or not to hedge and, if so, how much. Take a look at the annualized volatility over 10 years for a variety of single countries and international regions, as represented by MSCI: ANNUALIZED VOLATILITY: 10 YEARS We can see from the graph above that the annualized volatility over 10 years was consistently higher for unhedged positions than hedged positions and that different countries and regions had different levels of volatility relative to each other. In short, your asset allocation should depend on how much risk you’re willing to take on any given investment. If you have a portfolio that is heavily weighted toward international investments, has high currency volatility or high correlation between the currency and the underlying assets, a higher proportion of currency hedged investments might be appropriate. If you are more risk averse, and your portfolio is more heavily weighted towards U.S.-based investments, has lower currency volatility, or low correlation between the currency and the underlying asset return, you may consider having a lower proportion of currency hedged investments. Whatever your risk tolerance, you may want to consider a currency hedge as a way to help minimize the effects of volatility over the long term, regardless of short-term dollar movement. This post originally appeared on the BlackRock Blog.