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FLOT Vs. FLRN: The Best Floating Rate ETF

The Fed rate hike may be just around the corner and investors have started probing every possible safe option in a likely rising rate environment. A barrage of solid economic data, including a more-than-seven-year low unemployment rate in August, an improving service sector, decent consumer confidence, and a pretty strong housing market raised speculations over the first rate hike in more than nine years. Investors should note that while fixed income investing underperforms in a rising rate environment, there are several plays, even in the bond market, that could ward off rising rate worries. A floating rate instrument is such an option. Floating rate notes are investment grade bonds that do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of the issuers. Since the coupons of these bonds are adjusted periodically, these are less sensitive to an increase in rates compared to traditional bonds. Unlike fixed coupon bonds, these do not lose value when the rates go up, making the notes ideal for protecting investors against capital erosion in a rising rate environment. Below we highlight two popular floating rate bond ETFs and try to figure out which one is a better bet at the current level: iShares Floating Rate Note ETF (NYSEARCA: FLOT ) This is the most popular fund in the floating rate securities market space that follows the Barclays US Floating Rate Note < 5 Years Index. Holding 458 securities, the fund has an average life of 1.78 years and effective duration of 0.14 years. The product has amassed over $3.60 billion in its asset base while trades in volume of 650,000 shares per day on average. Sector-wise, the fund invests over half of its assets in banking followed by 8.4% weight in areas with no guarantee. Companies like JPMorgan (NYSE: JPM ) (4.12%), Goldman (NYSE: GS ) (4.07%) and Citigroup (NYSE: C ) (3.49%) are top three holdings of the fund. Bonds with 1-2 years of maturity have the highest exposure of 33.17% in the fund while bonds with 0-1 years take the second position with 28.69% weight. Expense ratio comes in at 0.20%. The fund is off 0.02% so far this year (as of September 11, 2015) and yields about 0.48%. SPDR Barclays Capital Investment Grade Floating Rate ETF (NYSEARCA: FLRN ) This ETF tracks the Barclays U.S. Dollar Floating Rate Note < 5 Years Index with average maturity of 1.73 years and modified duration of 0.12 years. It holds 445 securities and has been able to accumulate $387 million in its total asset base. The fund charges 15 bps in annual fees while volume is moderate at under 30,000 shares. Sector-wise, the product is tilted toward the financial sector with 61% exposure followed by the industrial sector (25.43%). Individual holding-wise, no stock holds more than 1.60% in the fund. Goldman gets the top priority followed by Kommunalbanken (0.97%) and Toronto-Dominion Bank (NYSE: TD ) (0.91%). Here also, bonds with 0-1 years and 1-2 years of maturity hold top positions with 30.88% and 36.21%, respectively. It has lost 0.3% in the year-to-date timeframe and has a dividend yield of 0.59% (as of September 11, 2015). Which One is the Better Bet? While both options are pretty intriguing in a rising rate environment and quite similar in nature, there's a subtle difference between the two that might give one ETF an edge over the other in a rising rate environment. The chart below details the two bond ETFs: FLOT FLRN Effective Maturity 1.78 years 1.73 years Effective Duration 0.14 years 0.12 years Default Risks Slightly higher FLRN Slightly lower than FLOT Interest Rate Risks Slightly higher FLRN Slightly lower than FLOT Concentration Risks Slightly High Slightly Low Expense Ratio 0.20% 0.15% Yield 0.48% 0.59% To sum up, both FLOT and FLRN both have high exposure in the better-performing financial sector. Both handle around 450 bonds and certain international exposure, but are dollar-denominated in nature. Yet, FLRN appears a less risky product compared with FLOT going by various risk matrixes. FLRN is cheaper too. Link to the original article on Zacks.com

How To Avoid The Worst Style ETFs: Q3’15

Summary The large number of ETFs has little to do with serving your best interests. Below are three red flags you can use to avoid the worst ETFs. The following presents the least and most expensive style ETFs as well as the worst overall style ETFs per our Q3’15 Style ratings. Question: Why are there so many ETFs? Answer: ETF providers tend to make lots of money on each ETF so they create more products to sell. The large number of ETFs has little to do with serving your best interests. Below are three red flags you can use to avoid the worst ETFs: Inadequate Liquidity This issue is the easiest issue to avoid, and our advice is simple. Avoid all ETFs with less than $100 million in assets. Low levels of liquidity can lead to a discrepancy between the price of the ETF and the underlying value of the securities it holds. Plus, low asset levels tend to mean lower volume in the ETF and larger bid-ask spreads. High Fees ETFs should be cheap, but not all of them are. The first step here is to know what is cheap and expensive. To ensure you are paying at or below average fees, invest only in ETFs with total annual costs below 0.46%, which is the average total annual cost of the 281 U.S. equity style ETFs we cover. Figure 1 shows the most and least expensive Style ETFs. QuantShares provides 2 of the most expensive ETFs while Schwab ETFs are among the cheapest. Figure 1: 5 Least and Most Expensive Style ETFs (click to enlarge) Sources: New Constructs, LLC and company filings Investors need not pay high fees for quality holdings. The i Shares Enhanced U.S. Large-Cap ETF (NYSEARCA: IELG ) earns our Very Attractive rating and has low total annual costs of only 0.08%. On the other hand, the Schwab U.S. Small-Cap ETF (NYSEARCA: SCHA ) holds poor stocks. No matter how cheap an ETF, if it holds bad stocks, its performance will be bad. The quality of an ETFs holdings matters more than its price. Poor Holdings Avoiding poor holdings is by far the hardest part of avoiding bad ETFs, but it is also the most important because an ETFs performance is determined more by its holdings than its costs. Figure 2 shows the ETFs within each style with the worst holdings or portfolio management ratings . Note that there are no ETFs in the All Cap Growth and All Cap Value style under coverage. Figure 2: Style ETFs with the Worst Holdings (click to enlarge) Sources: New Constructs, LLC and company filings Ark, iShares, and Guggenheim appear more often than any other providers in Figure 2, which means that they offer the most ETFs with the worst holdings. Our overall ratings on ETFs are based primarily on our stock ratings of their holdings. The Danger Within Buying an ETF without analyzing its holdings is like buying a stock without analyzing its business and finances. Put another way, research on ETF holdings is necessary due diligence because an ETF’s performance is only as good as its holdings’ performance. PERFORMANCE OF ETF’s HOLDINGs = PERFORMANCE OF ETF Disclosure: David Trainer and Max Lee receive no compensation to write about any specific stock, style, or theme . 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.

Dual Momentum Model Recommends Move To Bonds Or Cash

The Dual Momentum model recommended selling equities as far back as August 10th. A slight modification of the Dual Momentum model recommends holding Cash or SHY. Look-back periods make a difference in recommendations. Three metrics, as described in the second table, improve returns and reduce annual draw-downs. Momentum investors following the Dual Momentum model are currently invested in either bonds or cash depending on how strict they follow the DM guidelines. In the following table the look-back period is one year or 365 days as recommended in Gary Antonacci’s book, Dual Momentum Investing . Exchange Traded Funds representing U.S. and International Equities markets are substituted for those securities suggested in Antonacci’s book. These ETFs are commission free securities available through several discount brokerage houses. VTI covers U.S. Equities while VEU represents International Equities. If neither VTI or VEU outperforms SHY , our cutoff ETF, we move to bonds. In this momentum model an intermediate bond BIV is selected as an obvious choice. One could also use BND as the bond representative. Using the 365-Day look-back period, the current recommendation is to invest 100% in bonds. Investors may wish to wait until after the FEDs settle on an interest rate rise before making this move. (click to enlarge) An alternative model to the above DM is shown in the following screen shot. After hours of research using a Monte Carlo model, a different look-back emerges. In the following model a 30% weight is assigned to the performance over the most recent 87 calendar days while a 50% weight is assigned to the most recent 145 calendar days. To hold down portfolio volatility and reduce risk, a 20% weight is assigned to a 14 calendar day mean-variance. Following these three metrics improves performance while reducing draw-down with respect to either the S&P 500 or VTSMX benchmarks. This can also be demonstrated using out-of-sample data. Numerous portfolios are now undergoing additional testing of this three-metric model. Using these three metrics, the recommendation varies slightly from the above DM model as investors are now advised to invest 100% in SHY, the “circuit breaker” ETF. Moving to SHY or Cash was recommended as far back as August 10th . One adjustment is advised when both VTI and VEA are out of favor as is now the situation. Instead of maintaining the 30% – 50% weights assigned to the 87- and 145-day periods, reverse those percentages. The reason is to place more weight on the most recent period so as to catch the upward swing when the market begins to rebound. As for the current situation, the Dual Momentum model recommends holding 100% in bonds while the revised DM model recommends holding 100% in Cash or SHY. Both are conservative portfolio positions. (click to enlarge) Disclosure: I am/we are long SHY. (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. Share this article with a colleague