Tag Archives: stocks

The Benchmarks Lie, Here’s How

Many investors, new and experienced alike, are intent upon “beating the Dow” or “beating the S&P.”. A laudable goal except that… …those indices are always moving targets! The benchmarks lie. Many investors, new and experienced alike, are intent upon “beating the Dow” or “beating the S&P” rather than seeing their capital increase over time. It isn’t that difficult to beat the benchmarks. We’ve done it over 15 years from 1999-2014 and this year the markets, so far, are down 6% to our 1% so we ​hope to keep that trend alive. On the other hand, for investors ​who place their faith in buying only companies that are in the benchmarks often find ​it is difficult to beat the indexes. That’s because “the benchmarks lie.” Every time a company disappoints the keeper of these benchmarks, S&P Dow Jones Indices (a McGraw Hill Financial subsidiary) they boot it out of the index and replace it with something they consider more “representative.” I don’t believe it is a coincidence, however, that “representative” usually equates to rising relative momentum, making the index performance look considerably more attractive — although that index may have a completely different composition than the one you bought before all their changes. As for the companies booted out, they are still in business but, if you bought a mirrored portfolio of those 30 stocks, you own the same 30, but the index and its ETF​ clones own a very different index — and not because the​ component companies went out of business or failed to meet regulatory requirements. Assuming S&P Dow Jones Indices are correct in their momentum assessment, the results are regularly skewed upward. So if you obsess over, “why didn’t the 30 Dow stocks in my portfolio keep up with the Dow Jones Index?” well, in Nov 1999, did you toss Chevron (NYSE: CVX ), Goodyear (NASDAQ: GT ), Sears (NASDAQ: SHLD ), and Union Carbide out of your portfolio and replace them with Home Depot (NYSE: HD ), Intel (NASDAQ: INTC ), Microsoft (NASDAQ: MSFT ), and SBC Communications (which a few years later acquired/became AT&T?) S&P Dow Jones Indices​ did.​ In April 2004, did you sell AT&T (NYSE: T ) (after just 5 years in the index,) Eastman Kodak (out of bankruptcy ​now ​and again trading on the NYSE) and International Paper (NYSE: IP ) and instead buy AIG , Pfizer (NYSE: PFE ), and Verizon (NYSE: VZ )? Or in Sep 2008 sell Altria Group (NYSE: MO ) and Honeywell (NYSE: HON ) in order to buy Bank of America (NYSE: BAC ) and Chevron (which I suppose the indices gurus decided was worthy once again?) In 2009, when Citigroup (NYSE: C ) and General Motors (NYSE: GM ) stocks were plunging, did you switch to Cisco (NASDAQ: CSCO ) and Travelers (NYSE: TRV )? Or did you exchange AT&T for Apple (NASDAQ: AAPL ) this year? There are many other examples but you get the idea. “Representative” seems to mean “on its way up” — though it doesn’t always work out that way. A recent anomaly in the last couple years indicates some boot-ees do better than the new inductees, though it remains to be seen if this will continue. That brings us to an interesting example ​just today ​​of how trying to read too much into a benchmark can confuse or backfire. The S&P closed down 0.35% and the Nasdaq closed down 0.7% — but the Dow is up .08%. How come? Well, the Dow has only 30 components so if one of them soars or plunges on one day it can affect the index out of proportion to its long-term trend. Today it was DuPont that sent the Dow ahead (which will no doubt lead some feckless commentator to claim that, since the Dow means Blue Chips, that the “leadership of the Dow today proves” that the markets will rise.) But the reason ​the Dow rose as ​DuPont rose 10% today? The CEO said she would retire, giving rise to speculation the company may be broken up, hardly an event likely to be repeated every day. The bottom line is that I continue to believe that intelligent stock (and preferred, bond, ETF, CEF and mutual fund) selection remains key to market success, that indexes can be beaten by this approach, and that markets go up and down, meaning there are times to enter trailing stops, adjust your portfolio percentages to include more cash, bonds or hedges. In my next article, I will give some ​current ​examples. Disclaimer: As Registered Investment Advisors, we believe it is essential to advise that we do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as “personalized” investment advice. Past performance is no guarantee of future results, rather an obvious statement but clearly too often unheeded judging by the number of investors who buy the current #1 mutual fund one year only to watch it plummet the following year. We encourage you to do your own due diligence on issues we discuss to see if they might be of value in your own investing. We take our responsibility to offer intelligent commentary seriously, but it should not be assumed that investing in any securities we are investing in will always be profitable. We do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about. Best regards, Joseph L. Shaefer

Investors Should Avoid This New Fund-Of-Funds ETF

Summary The IQ Leaders GTAA Tracker ETF was just launched at the end of September. It’s designed as an “ETF of ETFs,” but its high expense ratio makes it less than an ideal choice for long-term investors. I offer two alternatives that would achieve a similar investment objective to this ETF at a much lower cost. I have a generally negative sentiment when it comes to “fund of funds” products whether they are mutual funds or ETFs. The main reason is that I think many of them layer on unnecessary fees for investors and can generally be replaced by an index mutual fund or ETF that charges a razor-thin expense ratio (the Vanguard funds, for example). I found myself feeling that way again when the IQ Leaders GTAA Tracker ETF (NYSEARCA: QGTA ) was launched at the end of September. This ETF is designed to be an “ETF of ETFs,” and looks to, according to the fact sheet , “track the performance and risk characteristics of the 10 leading global allocation mutual funds.” What it’s doing essentially is taking the most popular sector ETFs and investing in order to maximize the fund’s risk/return profile. The fund’s holdings are detailed below: (click to enlarge) There are a couple of things that immediately stand out to me when looking at this list. All of these products are managed by either State Street (NYSE: STT ), Vanguard or BlackRock (NYSE: BLK ). These companies are very low-cost providers generally speaking, and each of these ETFs have an expense ratio in the range of 0.07% to 0.20% (with the exception of the SPDR Barclays Capital Convertible Bond ETF (NYSEARCA: CWB ) that carries a 0.40% expense ratio and the iShares iBoxx USD High Yield Corporate Bond ETF (NYSEARCA: HYG ) with a 0.50% expense ratio). So individuals would be paying very little to invest in any of these funds. According to the fund’s fact sheet, this new ETF is charging a 0.60% annual expense ratio. Keep in mind that this fee is charged on top of the expenses that are already being charged by each ETF individually and that additional expense charge really adds up over time. Consider the two graphs below (courtesy of Vanguard’s website ): This examines how an expense ratio erodes the return of an investment over time. In this example, I use an estimated expense ratio of 0.20% (a close estimate of what someone would pay investing in each of these ETFs individually) and an average return of 6% annually. Over a 50-year time frame on a $10,000 investment, returns lost to expenses come to a total of $111,606. A large number to be sure, but take a look at what the GTAA Tracker ETF would do over time. With the same assumptions, except using an expense ratio of 0.80% (the 0.60% charge of the fund plus the individual ETF expense ratio already detailed above), the total lost to expenses jumps to $385,760. That’s over $250,000 (roughly a third of the fund’s returns) that is being paid over time to the fund managers instead of staying in your own pockets. That’s a lot of money sacrificed for not managing the ETFs one’s self. Which brings me to my second point. Most people, understandably, don’t want to manage a portfolio of ETFs and reallocate them regularly. That’s where the fund-of-funds concept holds its appeal. But investors can do better. If you look at the fund’s holdings, you’ll find that the total allocation works out to roughly 47% stocks and 53% bonds. I’ve written before about how the Vanguards Wellington Fund (MUTF: VWELX ) is one of the best mutual funds for retirement out there. It maintains an allocation of roughly 2/3 stocks and 1/3 bonds, so it doesn’t perfectly match this ETF’s allocation, but it’s still a good comparison. Wellington’s sister fund, the Vanguard Wellesley Income (MUTF: VWINX ) is another option for more conservative investors with its 1/3 stocks and 2/3 bond allocation. Both of these funds are rated 5 stars by Morningstar and carry expense ratios of just 0.25%, putting them closer to the low-cost category than the GTAA Tracker ETF. Conclusion While there’s nothing inherently wrong with the investment choices made within this ETF (in fact, most are among the lowest-cost choices within their chosen class), the high expense ratio of this fund makes it less than ideal for long-term investors. Trimming fund expenses is the easiest way to improve the long-term returns in one’s investment portfolio. I’ve offered two alternatives that combine both an excellent long-term performance record and low costs, leaving more of the investment return where it belongs. For the time being, investors should look for other alternatives to this ETF.

Cloud Computing ETF Aims For The SKYY, But Misses

Summary SKYY delivers exposure to companies in the cloud computing space. The definition of a cloud computing company includes everything from technology providers to game companies that use the technology. The result is a broad technology portfolio that lacks the pure exposure investors may be after. Cloud computing is transforming the information technology landscape. It offers companies numerous advantages, including enhanced agility and dynamic scalability as well as the potential for significant cost savings. This technology has been growing rapidly and that pace is expected to continue. Investments in key strategic areas like enterprise mobile, big data analytics and information security is expected to increase significantly over the next few years. Analysts at Market Research Media estimate that the global cloud computing market will grow 30 percent compounded annually over the next five years to reach $270 billion. This likely growth in the cloud-based computing sector offers investors an opportunity to reap tremendous rewards. First Trust ISE Cloud Computing Fund The First Trust ISE Cloud Computing Index ETF (NASDAQ: SKYY ) seeks to provide results that generally correspond with the price and yield of the ISE Cloud Computing Index. This exchange-traded fund normally invests at least 90 percent of assets in common shares or depository receipts issued by companies contained within the index. The ISE Cloud Computing Index is designed to provide a benchmark for investors tracking companies principally engaged in the cloud computing industry. To be included in the benchmark index, securities must be listed on a global exchange and be engaged in a business activity providing, supporting or utilizing cloud computing services. Securities are classified as pure cloud computing companies and non-pure play companies whose focus is outside the cloud computing space but still have a significant exposure to the industry. The sector also includes technology conglomerates that may indirectly utilize or support cloud computing technology. In addition to a 10 percent allocation in technology conglomerates, managers use a calculation based on the relationship between the market capitalizations of the pure and non-pure play companies to determine their respective allocations. The underlying index then uses a modified equal dollar-weighted average approach when balancing the portfolio semiannually. SKYY is a three-star Morningstar rated ETF with $468.24 million under management. As of October 4, the fund had a 94 percent exposure to domestic equities and a 6 percent allocation of foreign shares, mostly in developed Europe. Weighted heavily towards the technology space, SKYY also held a small position in consumer cyclical and communications services companies. The ETF had a 33 percent allocation to giant cap companies as well as a 22 percent and 35 percent exposure to large and mid-cap shares. There is also a 6 percent and 4 percent allocation to small- and micro-cap shares. The fund’s average market capitalization is $27.7 billion. The portfolio has a P/E ratio of 24 and a price-to-book of 3.8 according to the issuer’s website . The portfolio’s top 10 holdings comprise 43 percent of assets. Companies held in the fund include Amazon (NASDAQ: AMZN ), Google (NASDAQ: GOOG ), Netflix (NASDAQ: NFLX ), Facebook (NASDAQ: FB ) and Open Text (NASDAQ: OTEX ). As the top holding, Amazon has been a driving force behind the fund’s performance in 2015. While predominately known as an e-commerce site, Amazon generates more than $4.5 billion in revenue from its cloud-based services. Although cloud services account for less than 10 percent of Amazon’s total revenue, it is the fastest growing segment of the company’s overall business. The Amazon Web Services (AWS) business unit grew 49 percent in 2014 and 81 percent during the second quarter of 2015 on an annualized basis compared to the 26 percent growth in North American retail sales. While the company’s retail operation is losing money, AWS is very profitable. At 21 percent, it provides significantly higher profit margins when compared to other business units. The profit margin for AWS has continued to rise despite price competition from competitors like Google, IBM (NYSE: IBM ) and Microsoft (NASDAQ: MSFT ). One of the first to enter the cloud computing space, Amazon has a lead on its competitors. To stay ahead, it is expanding services to include tools for analyzing data stored on their servers, building new online software applications and increasing storage space. Based on a belief that the future is in the cloud, Amazon has been investing billions of dollars building and expanding centralized data storage centers. Eventually, Amazon’s cloud computing unit may become the largest business segment within the company. SKYY’s 1- and 3-year total returns are 6.29 percent and 13.27 percent respectively, as of October 4, which compares to the technology category returns of 4.92 percent and 14.93 percent over the same periods. SKYY has a 3-year beta and standard deviation of 1.08 and 14.09. The equivalent period ratings for the science and technology category are 0.98 and 13.87. The ETF’s net expense ratio of 0.60 percent is slightly higher than the category average of 0.57 percent. This chart shows the performance of SKYY and the Technology Select Sector SPDR ETF (NYSEARCA: XLK ). The two are highly correlated as one would expect, but the relative can be substantial. The second chart, the price ratio of SKYY versus XLK, shows that performance has swung between under- and outperformance, but without any consistent pattern. (click to enlarge) (click to enlarge) With a lot of big Internet names in the top holdings, it’s worth considering an Internet fund as well. Here’s the price ratio of SKYY versus the First Trust DJ Internet Index ETF (NYSEARCA: FDN ), which has substantial overlap in holdings. The funds track closely in terms of performance, tied as they are to the overall technology sector, but FDN has been a more consistent winner. (click to enlarge) Outlook As sometimes happens with sub-sector funds, the definition of a cloud computing company is stretched to create a full portfolio here, with several companies that are cloud users rather than backbone companies that provide the technology. With cloud services becoming a major part of the Internet business, it is also becoming difficult to separate out pure play companies. The result is a portfolio that looks a lot like an Internet or broader technology fund. Performance aside, the big strike against SKYY is the large weighting of familiar Internet companies found in most broad technology funds. SKYY isn’t offering the unique exposure that investors may think they’re getting. Investors looking for pure exposure to cloud computing would be better off holding individual stocks, and sticking with Internet or broad technology funds for the rest of their technology exposure.