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Summary I’m taking a look at PKW as a candidate for inclusion in my ETF portfolio. The risk level is reasonable and the correlation is high. The performance is surprisingly good. The liquidity is solid, so I expect the statistics to be reliable. Despite the higher expense ratio, the ETF has stacked up very well to SPY over the last several years. 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 PowerShares Buyback Achievers Portfolio (NYSEARCA: PKW ). 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 PKW do? PKW attempts to track the total return (before fees and expenses) of NASDAQ Buyback Achievers® Index. At least 90% of the assets are invested in funds included in this index. PKW falls under the category of “Large Blend”. Does PKW provide diversification benefits to a portfolio? Each investor may hold a different portfolio, but I use (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 just under 96%. That’s a very high level of correlation and relatively unattractive for investors hoping for diversification benefits. As an investor using modern portfolio theory, I would prefer to see lower levels of correlation. Of course, the low value correlation wouldn’t mean much if the values were being distorted by poor liquidity. The average volume of nearly 500,000 shares per day suggests that liquidity shouldn’t be a concern. That’s a good sign for investors wanting verification of the statistics or wanting to know that they can exit the position with less concern about it deviating from NAV. Standard deviation of daily returns (dividend adjusted, measured since November 2013) The standard deviation is fairly reasonable. For PKW, it is .787%. For SPY, it is 0.748% for the same period. The ETF is definitely showing a little more volatility than SPY when we compare returns on a daily basis. Mixing it with SPY I frequently run comparisons on the standard deviation of daily returns for the portfolio, assuming that the portfolio is combined with the S&P 500. However, for PKW, I don’t think that adds much value. The correlation being nearly 96% really destroys the benefits of diversification. 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 and Taxes The distribution yield is 1.06%. I like to see strong yields for retiring portfolios, because I don’t want to touch the principal. 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. This ETF doesn’t have a high yield, but I am far enough away from retirement to be willing to work with the weaker yields. Expense Ratio The ETF is posting an expense ratio of .68%. That’s high compared to most of the ETFs that are appealing to me, but the expense ratio may reflect the premium being charged for the trading methodology the ETF is using to determine the positions within the ETF. Market to NAV The ETF is at a .06% discount to NAV currently. Premiums or discounts to NAV can change very quickly, so investors should check prior to putting in an order. Generally speaking, that discount to NAV isn’t big enough to be a big deal. However, even a small discount to NAV is fairly attractive when we are talking about a high quality ETF. Largest Holdings The diversification in the holdings isn’t going to be a strong selling point. (click to enlarge) Conclusion PKW was one of the most difficult ETFs to make a decision about. The ETF posts a very high correlation to SPY and a high expense ratio. Some screeners don’t have a portfolio turnover ratio for the ETF, but the prospectus states that in the last fiscal year the turnover ratio was 92%. I expect that kind of turnover to require some costs, but I generally don’t want to pay higher turnover ratios because my use of ETFs involves relying on markets to be reasonably efficient. If the markets are thoroughly efficient, then creating a proprietary trading system to select which positions to enter and which ones to end should not result in any reliable excess returns. However, history is providing some support for the methodology PKW is using. I was suspicious about their outperformance of SPY in the test period, so I extended my sample to a five-year period and looked at the returns on a time line. The result is that PKW outperformed SPY meaningfully over that five-year period. Looking at the lines, it isn’t a single period where PKW outperformed either. The fund’s performance has been strong and steady, which makes it appear more repeatable. I wanted to eliminate the ETF for the high expense ratio and relative weakness in diversification, but I can’t do it. Maybe it is just chance that eventually an ETF had to deliver this kind of strong performance over an extended period, but I won’t toss out an ETF that makes a fairly impressive case for itself without digging deeper. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has 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. The analyst holds a diversified portfolio including mutual funds or index funds which may include a small long exposure to the stock.
Like most risky asset classes, oil exhibits short-term momentum. Investors seeking short-term gains from timing a bounce in oil prices should understand this phenomenon, which could be reversing. After seven monthly losses for oil, momentum might finally have turned the corner, giving traders with a shorter-term horizon impetus to add positions. While evolving supply and demand factors impacting oil prices favor a longer-term value investing approach, a simple momentum heuristic could point to potential near-term gains. This is a re-purposed version of an earlier article that cautioned potential investors to take a long-term value approach to falling prices. As I have written previously, the performance of oil exhibits short-term momentum. What does that mean? On average, falling oil prices continue to fall in the short term. Conversely, rising oil prices continue to rise in the short term. Like I have done previously in articles about momentum’s impact on the returns stocks and bonds , I can demonstrate this phenomenon empirically. Understanding the power of short-term momentum can help Seeking Alpha readers more ably position oil-related exposures. Oil prices have been falling for several months, dragging down energy-related investments. With oil prices stabilizing and beginning to rebound, the negative trend from momentum could also be reversing. Imagine a world with just two asset classes – oil and your mattress. Knowing that oil exhibits short-term momentum, you invest in oil when it has produced a positive return over the trailing one month. If oil is falling, you stick your money in your mattress, earning zero. The cumulative return profile of oil, mattress savings, and a momentum strategy that toggles between oil and mattress stuffing based on which had outperformed for the trailing one month and holds that leg forward for one month is diagrammed below for the trailing ten-year period (see full results at the end of the article). Over the last ten years, if you had stuffed your money in the mattress, you would have of course earned zero. If you had purchased oil, this recent downturn would have taken you to a negative ten-year cumulative return. If you would have properly understood the momentum phenomenon, you would have more than doubled your money. (Source: Bloomberg WTI Crude) This simple heuristic to knowing when not to invest in oil based solely on trailing returns delivers tremendous outperformance. Even before the recent downdraft in oil prices, the oil/mattress momentum strategy outperformed a long-only oil strategy materially. Why? First, the countries, companies, and cartels that are major players in the global market are very large, and the forces that shape oil prices are slow-moving. Even absent the game theory inherent in supplying oil, reducing supply to the market takes time. Conversely, there is a lag effect from higher demand and prices manifesting into increased exploration via the drill bit. Secondly, short-term momentum is a powerful market anomaly present in many markets. (See Erb and Harvey (2006) on momentum impacts in commodity markets, or a litany of sourced articles I have written on the subject in other asset classes with performance proof). This does not mean that beaten-down energy stocks are a bad investment today, just that picking a short-term bottom in oil prices to generate short-term gains is a difficult proposition. If you are underweight energy stocks, then you should examine an increased allocation. As demonstrated pictorially in the chart below, buying energy stocks after a correction tends to generate very strong long-term performance. This graph shows the S&P Energy Index, replicated by the Energy Select Sector SPDR Fund (NYSEARCA: XLE ), over the trailing 25 years graphed against oil. (Source: Bloomberg, Standard and Poor’s) When I first wrote a version of this article in early December, short-term momentum suggested that oil prices and energy stocks could weaken further. Oil has fell an additional 32% over the next two months through the end of January. With oil again producing a negative return in January, the momentum strategy would again suggest that investors stay out of energy-related investments this month. My momentum strategy uses monthly calendar returns, in part because it is easier to find monthly return information historically. One-to-three month momentum with one to three month lookbacks have been shown to produce alpha across asset classes, markets, and time. Using a one-month lookback from today until mid-January and oil prices have risen by 13%. Perhaps this turnaround signals reversing momentum and further gains ahead. I have added to energy-related investments with an eye towards long-term value. Short-term momentum helped me to avoid the deepening correction. These investments have included a factor tilt towards low-cost energy focused exchange-traded funds. Given my traditional tilt towards low volatility investments (NYSEARCA: SPLV ), I was underexposed to energy pre-correction. I added broadly to closed-end high yield bonds funds, w hich were disproportionately negatively impacted by the oil drawdown . I have also added closed-end funds like Clearbridge American Energy MLP Fund (NYSE: CBA ), a pipeline focused MLP which was trading at nearly a ten percent discount to net asset value and generating a nearly eight percent yield at the time of purchase. The midstream sector is less exposed to commodity prices, and the selloff appeared to be overdone with investors selling energy-related funds indiscriminately early in the correction. A more speculative play was my add to Memorial Energy Production Partners (NASDAQ: MEMP ), an energy and production-related MLP that had strongly hedged several years of forward production as part of its business strategy, but suffered in the downturn like it was fully exposed to the commodity price drawdown. MEMP still offers nearly a 13% distribution rate even after the recent bounceback. Another long-term value play in the Energy space was my purchase of busted business development company, OHA Investment Corporation (NASDAQ: OHAI ). The company, formerly known as NGP Capital Resources is heavily exposed to the oil and gas industry with seventy percent of investments in those sectors. The company has recently brought in leading distressed debt manager Oak Hill Advisors to manage the fund. The company is trading at over a forty percent discount to net asset value. While I expect further impairments on its energy loans and a likely dividend cut, the combination of the deep discount, strong manager, inside management purchases, low leverage, and healthy liquidity all make a long-term rebound and strong forward risk-adjusted returns appear likely. Of my energy adds, this has been the worst performer thus far, but I believe downside is limited with the market capitalization trading roughly equal to the value of cash, Treasury bills, and non-Energy investments on the balance sheet. Do not be distracted by the potential for short-term losses and heightened volatility. Successful investing in oil and oil-related stocks is as simple as expanding your investment horizon. Even if you trade with a shorter-term focus, momentum could be reversing in oil given the positive trailing one-month return. Disclaimer: My articles may contain statements and projections that are forward-looking in nature, and therefore inherently subject to numerous risks, uncertainties and assumptions. While my articles focus on generating long-term risk-adjusted returns, investment decisions necessarily involve the risk of loss of principal. Individual investor circumstances vary significantly, and information gleaned from my articles should be applied to your own unique investment situation, objectives, risk tolerance, and investment horizon. Appendix on Oil/Mattress Momentum: (click to enlarge) Disclosure: The author is long XLE, OHAI, MEMP, CBA, SPLV. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.