Tag Archives: seeking-alpha

GAL Is An ETF Built From Other ETFs, Let’s Peer Inside

Summary I’m taking a look at GAL as a candidate for inclusion in my ETF portfolio. The description of GAL in the prospectus is a little weird, but I can provide a simpler one. The correlation to SPY is remarkably low for an ETF that holds 24% of the portfolio in shares of SPY. The ETF looks more appealing to investors that are constrained by commissions on trading ETFs. For investors that can build their own portfolio commission free, it is less appealing. 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 SPDR SSgA Global Allocation ETF (NYSEARCA: GAL ). 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 GAL do? GAL is a relatively weird ETF compared to most of the ETFs I have covered. Lacking a better option, I’m going to begin by quoting the prospectus: Under normal circumstances, the Fund invests substantially all of its assets in the SSgA Global Allocation Portfolio (the “Portfolio”), a separate series of the SSgA Master Trust with an identical investment objective as the Fund. As a result, the Fund invests indirectly through the Portfolio. As an analyst, I’m used to digging through complicated statements, but I’m no familiar with the incentives for this structure. I expect most readers won’t know what to make of that either, so I’m providing an alternate description based on my understanding of the ETF. In my estimation, GAL is an ETF that purchases shares in several other ETFs. That should be simple enough to understand, and it’ll make perfect sense when we get to the section on holdings. The category for GAL is “World Allocation.” Does GAL provide diversification benefits to a portfolio? Each investor may hold a different portfolio, but I use the SPDR S&P 500 Trust ETF (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 way better than I would expect. The correlation in this regression is 75%. I want to see low correlations on my international investments. Extremely low levels of correlation are wonderful for establishing a more stable portfolio. I consider anything under 50% to be extremely low. However, for equity securities an extremely low correlation is frequently only found when there are substantial issues with trading volumes that may distort the statistics. Standard deviation of daily returns (dividend adjusted, measured since July 2012) The standard deviation is incredible. For GAL it is .5495%. For SPY, it is 0.7063% for the same period. SPY usually beats other ETFs in this regard, so a lower volatility level is very impressive. Because the ETF has fairly low correlation for equity investments and a low standard deviation of returns, it should do fairly well under modern portfolio theory. Liquidity looks fine Average trading volume isn’t very high, a bit over 55,000, but that also isn’t low enough to be a major concern for me. This is extremely important to the analysis of GAL because the combination of low standard deviation and low correlation immediately set off red flags to watch for low levels of liquidity that might distort the statistics. 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 GAL, the standard deviation of daily returns across the entire portfolio is 0.5921%. With 80% in SPY and 20% in GAL, the standard deviation of the portfolio would have been .6539%. If an investor wanted to use GAL as a supplement to their portfolio, the standard deviation across the portfolio with 95% in SPY and 5% in GAL would have been .6925%. 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 2.65%. This ETF could be worth considering for retiring investors. I like to see strong yields for retiring portfolios because I don’t want to touch the principal. In my opinion, anything over 2% is high enough to warrant some consideration. Overall, a 2% yield on a portfolio wouldn’t be great for covering retirement costs, but I wouldn’t fill the portfolio with only high yield investments. By investing in ETFs I’m removing some of the human emotions, such as panic. Higher yields imply lower growth rates (without reinvestment) over the long term, but that is an acceptable trade off in my opinion. I’m not a CPA or CFP, so I’m not assessing any tax impacts. Expense Ratio The ETF is posting a .35% expense ratio. I want diversification, I want stability, and I don’t want to pay for them. The expense ratio on this fund is higher than I want to pay for equity securities, but not high enough to make me eliminate it from consideration. I view expense ratios as a very important part of the long term return picture because I want to hold the ETF for a time period measured in decades. Market to NAV The ETF is at a .27% premium to NAV currently. Premiums or discounts to NAV can change very quickly so investors should check prior to putting in an order. The ETF is large enough and liquid enough that I would expect the ETF to stay fairly close to NAV. Generally, I don’t trust deviations from NAV and I will have a strong resistance to paying a premium to NAV to enter into a position. Largest Holdings The diversification looks terrible if you are only looking at the percentage of the fund in each investment. However, since the investments are other ETFs, the actual diversification is phenomenal. This level of diversification is the reason the fund has such a low level of volatility. A chart of the holdings by market value is available 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 GAL 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. I’m having a difficult time deciding what to think on GAL. It’s the first ETF filled with ETFs that I’ve analyzed. I’m curious about the expense ratio. Before investing in GAL, I would want to know if the .35% expense ratio was strictly the amount that went to the managers of GAL, or if was including all fees charged at all levels of the portfolio. As investors, we already have to pay management of the company and the expense ratio of one ETF; I don’t want to pay the expense ratios twice. However, the correlation to SPY is remarkably low for an ETF that is already holding SPY as nearly a quarter of the portfolio. In my opinion, GAL looks like a better option for investors that are paying commissions on every trade. For those investors, a position in GAL could be combined with a position in SPY (or a similar ETF). If the investor was facing commissions on trades that encouraged them to hold a smaller number of ETFs directly, this could be a viable way of constructing the portfolio. For investors that are have access to a large volume of commission free ETFs, the appeal of GAL is much weaker. Despite the complications on the expenses, I may run more statistics on GAL in a diversified portfolio. It might still be worth a 2% to 5% allocation. The efficient frontier on portfolio structures doesn’t take into account the amount of time required to build very tiny positions in obscure securities. I would be willing to pay some additional expense ratio for that exposure. 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. The analyst holds a diversified portfolio including mutual funds or index funds which may include a small long exposure to the stock.

Stock Picking, Intricate As Love

The combination from creating a 20 stock portfolio is a number beyond this earth. A simpler indexing approach provides several benefits like low unsystematic risk and low cost. You can still be active and pursue a source of alpha while also retaining the benefits of index investing. In ABC’s ‘The Bachelor’, the road to love involves weeks of flirting, romance, cat fights, twist and turns, where one guy is introduced to 25 lovely girls. Picking 1 out of 25 girls must be a lot of work. Likewise, researching stocks is a lot of work and arguably not as fun as dating. But you have many choices. The S&P 500, often used as a proxy for the total US stock market, offers 500 choices. If one were trying to create a 20 stock portfolio, how much work would be appropriate and what are the possibilities? Instead of trying to quantify the workload necessary, an especially subjective matter, let’s gauge the implications of the variables involved in picking stocks by looking at all the resulting combinations that are possible. For our group of stocks, let’s take the S&P500, consisting of 500 individual stocks. To take out capitalization weighting effects, we will actually use the S&P 500 equal weighted index, which includes the same constituents as the capitalization weighted S&P 500. Picking a certain number of stocks out of 500 is a simple calculation using binomial coefficients, mathematics used since the 10th century in India. Binomial coefficients are a family of positive integers that occur as coefficients in the binomial theorem. The coefficients that appear in the expansion are usually written as: This method is applicable because selecting stocks from a group is essentially picking k objects from a population of n distinct objects without replacement and without regard to order. If we select 20 stocks for our portfolio, there are 266719851283743829654740530950952475 combinations of selecting 20 stocks out of a group of 500, calculated from simply applying binomial coefficients: To grasp the magnitude of this amount, if each combination was the height of a flat dollar bill, the stack of dollar bills would scale up from the earth to the sun about 195 quintillion times. (quintillion is a billion billions). Likewise, the stack of dollar bills would go from our Sun to its nearest star, Proxima Centauri 726 trillion times. Comparatively, if the Voyager 1 spacecraft (speed=38000mph) were to go to Proxima Centauri, it would take over 73 thousand years to arrive. The many different possible portfolios are staggering, even when limiting selection only within the S&P500. With so many, inevitably one combination, picked arbitrarily at random could beat a combination created by a professional. This sheds light on the often heard claim that a monkey can out-pick a mutual fund manager. But nobody should pick stocks, bonds, or other securities at random. You wouldn’t pick your next boyfriend, girlfriend, potential spouse at random. You would expect a better outcome if you are discerning in your selection. Accordingly, thousands of discerning mutual fund managers seek superior performance and some actually achieve it. Of course, magazines like Forbes report time and again that the majority of professional can’t beat the index. However, the Wall Street Journal ran an expert vs. random dart throwing simulation for 14 years, but declared no clear winner. No clear winner will ever be discovered in this holy war, because of the staggering number of possibilities. One way to simplify investing is to invest in the index. Indexing provides several benefits like low cost and low unsystematic risk, even lower than a 20 stock portfolio. You do not have to be entirely passive. Instead of being active in the securities selection layer, another approach is to be active at asset allocation layer, using index investing. (click to enlarge) When constructing your portfolio, consider where you should put most of your effort. One approach employed by many professionals focuses on a top-down investment strategy attempting to exploit opportunities among a set of assets, positioning a portfolio into assets or sectors that show the most potential for gains. The strategy focuses on the relative performance of asset classes rather than on the performance of individual securities. With more focus on the asset allocation layer, one can still seek a source of alpha while also retaining the benefits of index investing. Further, the derivative securities used to actively asset allocate are highly liquid and low cost to transact for example, (NYSEARCA: SPY ),(NYSEARCA: EFA ),(NYSEARCA: BND ). Additional disclosure: Article is for educational purposes only and does not constitute financial advice.

2 iShares ETFs To Participate In The NYSE Incentive Program

Summary As of Jan. 2, 2015, two iShares ETFs will start participating in the NYSE Arca ETP incentive program. What is the incentives program? How the incentives program will help provide liquidity and help investors execute more efficient trades. BlackRock (NYSE: BLK ), the world’s largest asset manager and parent company of iShares, the world’s largest issuer of exchange traded funds, said today that as of Jan. 2, 2015, two of its ETFs will start participating in the NYSE Arca ETP incentive program. The iShares Interest Rate Hedged High Yield Bond ETF (NYSEArca: HYGH ) and the iShares Asia/Pacific Dividend ETF (NYSEArca: DVYA ) are the two iShares ETFs that will participate in the program, which is “designed to incentivize Market Makers to undertake Lead Market Maker (“LMM”) assignment in exchange-traded products (“ETPs”) listed on NYSE Arca,” according to a statement issued by BlackRock: While the impact of participation in the NYSE Arca ETP Incentive Program, which is optional, cannot be fully understood until objective observations can be made in the context of the NYSE Arca ETP Incentive Program, potential impacts on the market quality of HYGH and DVYA may result, including with respect to the average spread and average quoted size for HYGH and DVYA. HYGH, which debuted in May and now has almost $47 million in assets under management, tries to reflect the performance of the Citi High Yield (Treasury Rate-Hedged) Index, which tracks a basket of high-yield bonds with a built-in hedge against rising interest rates. The fund tracks bond securities issued from the U.S. or Canada with at least one year remaining to maturity. The ETF has an effective duration of 0.36 years and a 30-day SEC yield of 5.67%. DVYA, which will celebrate its third anniversary in February, has almost $55 million in assets. The ETF has a trailing 12-month dividend yield of 6.29%. Australia accounts for 48% of DVYA’s weight while Hong Kong and Singapore combine for another 31%. According to the statement: As a participant in the NYSE Arca ETP Incentive Program, BlackRock will continue to pay the applicable NYSE Arca Listing and Annual fees in addition to an Option Incentive Fee, which would range from $10,000 to $40,000 per year and will in turn be paid by NYSE Arca to the LMM assigned to HYGH and DVYA. iShares Asia/Pacific Dividend ETF (click to enlarge) ETF Trends editorial team contributed to this post.