Tag Archives: stocks

Emerging Markets Vs. The S&P 500

By Jim Freeman, CFP ® The below chart shows how much emerging market equities have underperformed the S&P 500 (NYSEARCA: SPY ) since the financial crisis. It also shows how these stretches of underperformance and outperformance are not unusual. The key to success in investing in emerging markets is to rebalance and add to positions during periods of underperformance, and to rebalance and take profits during periods of outperformance. Having a dedicated allocation to emerging market equities and rebalancing back to this allocation systematically helps you accomplish this. See the graph below to see what would have happened to returns if an investor had held a 50/50 portfolio of emerging markets and the S&P 500 and rebalanced it back to 50/50 at the end of each year during this period. As you can see, the returns would have been 11.6%, or 1.5% better than those from the S&P 500. (click to enlarge) We normally allocate roughly 3-6% of a clients’ portfolio to emerging market equities. We use either the Vanguard Emerging Market fund or the DFA Emerging Market Core fund – both are highly diversified. The Vanguard fund holds 980 stocks, and the DFA fund holds 3,807 stocks. Many people believe emerging market equities will provide higher returns than the S&P 500 over the next market cycle, due to their recent underperformance. We would not be surprised to see this happen, since it is a well-established pattern, as the first graph illustrates. We plan to keep our clients’ allocation to emerging markets consistent, and we will also do tax swaps to lock in losses that can be used to offset gains in other areas of their portfolios. *The above graphs were taken from Ben Carlson’s blog, “A Wealth of Common Sense – Personal Finance, Investments & Markets”. Share this article with a colleague

2015 Q3 Value Performance Update And How I Value Markets

Summary Proof that you shouldn’t follow “smart money”, as it’s herd mentality. A list of my 2015 Q3 value strategy performances. A look at how I value the market to know whether it’s expensive. The final quarter. The home stretch. If you took advantage of the small market correction, great job, because the market has “recovered” about 6% already. The last thing you should do is take advice from what you hear on TV or the radio, because that’s where the peak of herd mentality exists. The talking heads don’t provide any deep insight or outside views, as it’s their job to provide simple outer-layer analysis that any average Joe can understand. You actually come out smarter if you ignore everything they say. Here’s a look at what I mean. This is the performance of the top 20 stocks held by hedge funds, according to novus.com . (click to enlarge) How does this look in a chart? (click to enlarge) Not impressive. Especially when people running these funds are supposed to be Ivy League top 0.1% brains. It’s quite easy to avoid these “top 20” names. Ignore news and headlines. Ignore popular stocks. Ignore complicated stocks you don’t understand. Investing doesn’t have to be complicated. Most of the investments above have complicated stories. If you’re looking for a simple business and investment thesis to understand, don’t look at hedge fund holdings. This is GREAT news for people like us. After all, the advantage that small investors and fund managers have is that we don’t have to play by their rules. It’s perfectly within the rules to resist the steady drumbeat of calls to activity. So, how does it look on the value side? Value Investment Strategy Performances 2015 Q3 YTD Even though on I’m on the value side, it’s not easy. It’s not supposed to be easy. Anyone who finds it easy is stupid. – Charlie Munger At the end of each quarter, I take some time to see what’s working and what isn’t working with a list of predefined value stock screens I follow. Here’s how it looks at the end of Q3. These are YTD performances. A lot can happen in one quarter, as you can see in the following image. The tables are organized so that the best-performing screen is at the top of each quarter. (click to enlarge) Don’t Blindly Follow High-Performance Screeners Last quarter, I mentioned how you should ignore the NCAV (Net Current Asset Value) and NNWC (Net Net Working Capital) performances this year. On paper, the results are mind-blowing, given the conditions this year, but in reality, it’s not so great and shows how difficult net net investing can be in a bull market. What do I mean? NCAV and NNWC produced only 8 and 12 stocks in the results respectively. They both include VLTC, which has done this. The problem is that at the beginning of the year, you wouldn’t have been able to purchase enough of it in your real-world portfolio due to low liquidity. It’s only after a spike that volume increases as traders and momentum seekers join the party. Plus, holding only 8 or 12 net nets in a bull market is not a strategy I want to employ. The 2015 NNWC stocks look like this: Thanks to one stock, the NNWC stock performance is up 30%. You may say that it’s the outcome that’s important, but I call this one more luck than skill. Why Bother Tracking Net Nets Or Underperforming Screeners? So why do I bother tracking this or other underperforming screens? The easy answer is to say that that one year doesn’t signal long-term performance, and then show you this table of results. (click to enlarge) (Source: Old School Value Stock Screener Performances ) But the better answer is that it’s a very simple and effective way for me to track how expensive the market is. I don’t refer to market P/E or Market-to-GDP, as it only looks at the entire market. I’m only interested in finding pockets in the market that provide value – mainly on the value investing side – and this is how I try to track and find those pockets of opportunity. Here are some more observations. When Mr. Market falls, it doesn’t care who you are. In fact, Mr. Market will take quality, growth and value all down with him. Risk management should be at the top of your list day in and day out. Boring value stocks fall less hard, but also don’t rise as quickly. Net Nets Are Awesome Indicators Let me revisit another reason why I like net nets. Using the number of net nets available as an indicator is a great way to expand Graham’s “net net” concept into a market valuation idea. In 2013, I made the claim that Ben Graham was a closet market timer, and drew up the following chart and table. Even without a table or chart like this, it’s obvious when the market is cheap. But it’s also most scary, which is why you need a table or chart like this where the facts smack you in the face. I haven’t updated this table in a while, but 2014 and 2015 are similar to the 2011 levels. Summing Up Investing is hard. “It’s not supposed to be easy. Anyone who finds it easy is stupid.” – Charlie Munger Ignore herd mentality. Ignore what the top funds are holding. Don’t play by the same rules as the big boys. Make use of your advantage, like buying smaller stocks, illiquid stocks, out-of-favor stuff. Net nets are awesome indicators. Recommended Reading

EFA: How Do You Make A Mediocre ETF Sound Exciting?

Summary EFA is a mediocre ETF. The sector allocation is mediocre, the geographic diversification is mediocre and the expense ratio is mediocre. The top holdings make sense, but they don’t reflect the total portfolio. Despite having a heavy portfolio weight towards financials, there is only one in the top ten. There is nothing bad about the ETF to warrant taking a capital gains tax on sale, but if a loss could be taken with proceeds reallocated… that would be nice. There isn’t much to say to make this ETF sound exciting. There are so many international ETFs it can be difficult for investors to choose one. Hopefully I can help with that problem by highlighting some of them and shining a light inside their portfolio. One of the funds that I’m considering is the iShares MSCI EAFE ETF (NYSEARCA: EFA ). 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. Expense Ratio The expense ratio on the iShares MSCI EAFE ETF is .33%. I’d really prefer to see lower, but that isn’t high enough to remove the ETF from being worthy of further consideration. Geography The map above shows the top 10 countries by the market value of their allocations. This is certainly an international ETF, but the holdings seem more diversified from the list on the left side than from the list on the right side. I’d like to see even more diversification, but at least they have not assigned any single country a weighting higher than 25%. Sector Looking at the sector allocation is fairly interesting. Fortunately this is a fairly diversified group of sectors, but I think I would prefer a smaller allocation to financials. Perhaps I’m being too picky, but I’d rather see more consumer staples and foreign utilities mixed into the portfolio. I’d like to have the benefits of international diversification while overweighting the sectors that I expect to be less volatile. Largest Holdings (click to enlarge) Looking at the individual holdings, you wouldn’t expect that “Financials” would be so overweight. Only one financial company is in the top 10. The concern for me is that a heavy focus on financials in the lower parts of the portfolio suggests to me that the ETF may have a heavier weight on the companies that are easier to research or buy if markets are not sufficiently liquid in some countries. Building the Portfolio The sample portfolio I ran for this assessment is one that came out feeling a bit awkward. I’ve had some requests to include biotechnology ETFs and I decided it would be wise to also include a the related field of health care for a comparison. Since I wanted to create quite a bit of diversification, I put in 9 ETFs plus the S&P 500. The resulting portfolio is one that I think turned out to be too risky for most investors and certainly too risky for older investors. Despite that weakness, I opted to go with highlighting these ETFs in this manner because I think it is useful to show investors what it looks like when the allocations result in a suboptimal allocation. The weightings for each ETF in the portfolio are a simple 10% which results in 20% of the portfolio going to the combined Health Care and Biotechnology sectors. Outside of that we have one spot each for REITs, high yield bonds, TIPS, emerging market consumer staples, domestic consumer staples, foreign large capitalization firms, and long term bonds. The first thing I want to point out about these allocations are that for any older investor, running only 30% in bonds with 10% of that being high yield bonds is putting yourself in a fairly dangerous position. I will be highlighting the individual ETFs, but I would not endorse this portfolio as a whole. The portfolio assumes frequent rebalancing which would be a problem for short term trading outside of tax advantaged accounts unless the investor was going to rebalance by adding to their positions on a regular basis and allocating the majority of the capital towards whichever portions of the portfolio had been underperforming recently. Because a substantial portion of the yield from this portfolio comes from REITs and interest, I would favor this portfolio as a tax exempt strategy even if the investor was frequently rebalancing by adding new capital. The portfolio allocations can be seen below along with the dividend yields from each investment. Name Ticker Portfolio Weight Yield SPDR S&P 500 Trust ETF SPY 10.00% 2.11% Health Care Select Sect SPDR ETF XLV 10.00% 1.40% SPDR Biotech ETF XBI 10.00% 1.54% iShares U.S. Real Estate ETF IYR 10.00% 3.83% PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB 10.00% 4.51% FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT 10.00% 0.16% EGShares Emerging Markets Consumer ETF ECON 10.00% 1.34% Fidelity MSCI Consumer Staples Index ETF FSTA 10.00% 2.99% iShares MSCI EAFE ETF EFA 10.00% 2.89% Vanguard Long-Term Bond ETF BLV 10.00% 4.02% Portfolio 100.00% 2.48% The next chart shows the annualized volatility and beta of the portfolio since October of 2013. (click to enlarge) Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. You can see immediately since this is a simple “equal weight” portfolio that XBI is by far the most risky ETF from the perspective of what it does to the portfolio’s volatility. You can also see that BLV has a negative total risk impact on the portfolio. When you see negative risk contributions in this kind of assessment it generally means that there will be significantly negative correlations with other asset classes in the portfolio. The position in TDTT is also unique for having a risk contribution of almost nothing. Unfortunately, it also provides a weak yield and weak return with little opportunity for that to change unless yields on TIPS improve substantially. If that happened, it would create a significant loss before the position would start generating meaningful levels of income. A quick rundown of the portfolio I put together the following chart that really simplifies the role of each investment: Name Ticker Role in Portfolio SPDR S&P 500 Trust ETF SPY Core of Portfolio Health Care Select Sect SPDR ETF XLV Hedge Risk of Higher Costs SPDR Biotech ETF XBI Increase Expected Return iShares U.S. Real Estate ETF IYR Diversify Domestic Risk PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB Strong Yields on Bond Investments FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT Very Low Volatility EGShares Emerging Markets Consumer ETF ECON Enhance Foreign Exposure Fidelity MSCI Consumer Staples Index ETF FSTA Reduce Portfolio Risk iShares MSCI EAFE ETF EFA Enhance Foreign Exposure Vanguard Long-Term Bond ETF BLV Negative Correlation, Strong Yield Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio. Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. (click to enlarge) Conclusion EFA certainly has some volatility, but the correlation over longer time periods has been significantly lower than the correlation levels created by measuring on a daily basis. All around, this is a decent but not spectacular ETF. The ETF has a respectable but not incredible diversification among countries. The holdings are concentrated on the financial sector, but only one financial firm was able to warrant a large enough allocation to end up in the top 10. When it comes down to the sheer volume of holdings, there are 934 companies in the portfolio. Of course, that could change at any point. I love having extreme levels of diversification like that in international equity allocations, but such high diversification indicates a passive indexing strategy. As you might imagine, I’d rather not pay the .33% expense ratio for a passive index fund. The problems within the ETF aren’t bad enough for investors to have any cause to sell it and incur a capital gains tax, but I’d rather place international equity allocations in other ETFs. If an investor is able to harvest a tax loss on selling, that would be a very solid reason to reallocate to a more appealing ETF. If you’re looking for more appealing options, I put together an article with three of them .