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SCHA Looks Like A Nice Complimentary Holding To Enhance A Diversified Portfolio

Summary I’m taking a look at SCHA as a candidate for inclusion in my ETF portfolio. The expense ratio relative to the diversification is fantastic. The moderate level of correlation to major funds helps SCHA find a place. I wouldn’t consider SCHA as a core holding, but I may choose it for 5% to 10% of the portfolio. 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 Schwab U.S. Small-Cap ETF (NYSEARCA: SCHA ). 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 SCHA do? SCHA attempts to track the total return of the Dow Jones U.S. Small-Cap Total Stock Market Index. At least 90% of funds are invested in companies that are part of the index. SCHA falls under the category of “Small Blend”. Does SCHA 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 about 90%. This is a fairly moderate correlation. It’s low enough that we have a chance at lowering the risk level of a total portfolio so long as the standard deviation is not too high. Standard deviation of daily returns (dividend adjusted, measured since January 2012) The standard deviation isn’t great, but it is acceptable. For SCHA it is .9294%. For SPY, it is 0.7300% for the same period. SPY usually beats other ETFs in this regard, so that isn’t a major issue. 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 SCHA, the standard deviation of daily returns across the entire portfolio is 0.8094%. If we drop the position to 20% the standard deviation goes down to .7559%. In my opinion, that’s still too high. Once we drop it down to a 5% position the standard deviation is .7357%. If I include SCHA, I would probably seek to use an exposure level around 5%, but could potentially go as high as 10%. 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 1.43%. The SEC yield is 1.30%. In my opinion, these yields make the index less appealing for a retiring investor, but an argument could still be made for a position as large as 5% because of the correlation being down to almost 80%. I’m not a CPA or CFP, so I’m not assessing any tax impacts. If I were using SCHA, I would want it to be in a tax exempt account to remove any headaches associated with frequent rebalancing. Expense Ratio The ETF is posting .08% for an expense ratio. I want diversification, I want stability, and I don’t want to pay for them. The expense ratio on this fund is still within my comfort range. This expense ratio is lower than SPY, but higher than (NYSEARCA: SCHX ). SCHX is an alternative to SPY that I found more appealing. Market to NAV The ETF is at a .07% premium to NAV currently. I’m not thrilled about that, but it isn’t terrible. However, premiums or discounts to NAV can change very quickly so investors should check prior to putting in an order. Largest Holdings The portfolio is wonderfully diversified. The largest position is extremely short duration bonds at .67%. I suspect the ETF is using this as a method for storing dry powder rather than holding cash. That would be a fine solution in my book and I don’t mind seeing it in the portfolio as long as it is less than 1% of assets. I don’t want to be paying an expense ratio on a significant amount of funds that are not invested. For the real investments of the fund, the vast majority are under .30%. This is spectacular diversification and it is remarkable to find this with an expense ratio of only .08%. (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 SCHA 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. So far, I like SCHA for exposure to the smaller capitalization side of the market. The moderate correlation helps to mitigate the higher standard deviation of returns and makes this ETF look like a nice fit for a small portion of the portfolio. For me, that’s 5 to 10%. I’d be concerned about investors considering it a core asset and putting in 20% or more, but it looks like a nice piece for that small position in the portfolio. 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.

My New Years Resolution: Balance My Risky Portfolio

Summary As a young investor my portfolio is filled with risk. In 2015 I will be looking to limit my exposure to big risks. My portfolio was weighted heavily in oil and gas, which did not make for a pretty 2014. Thomas Jefferson once said “With great risk comes great reward.” This certainly is not always the case and my portfolio did most definitely did not agree with this statement in 2014. Since I’m quite young I can afford to have a large amount of risky plays in my portfolio which led to an interesting and ultimately dismal 2014. In 2015 I plan to, as best I can, de-risk my holdings, while still incorporating the right amount of risk for my age. A Few Current Positions For starters, in addition to covering the oil and gas sector heavily, my portfolio has been weighted toward the industry more than any other. You can imagine what this weight has done since the summer. One of my holdings in the industry is small cap Bakken producer Emerald Oil (NYSEMKT: EOX ). The company has operationally and financially improved dramatically since I first added shares but still remains an extremely risky play, especially with the current oil environment. I have averaged down on the name as the company has greatly scaled back its operations in this environment which should enable it to survive the downturn. On a different note, one of my other oil and gas names is a far less risky play. Gran Tierra Energy (NYSEMKT: GTE ) is a Canadian company with operations mainly in Colombia and Peru. The reason I say this is a significantly less risky play is the fact that at the end of Q3 the company continued to have no debt and $360M in cash. Its revised 2015 capex plan only calls for $310M. So while oil is at these depressed levels, Gran Tierra might just be in one of the best positions to ride it out. Along with that the company has several other catalysts. The company should announce soon, or with Q4/FY results, how the initial drilling in Peru is coming along. This will result in significant additions to the company’s reserves and ultimately will add a lot to its overall value. My only main concern with Gran Tierra while I have held it has been the ongoing conflict in Colombia. The FARC rebel group targets lots of infrastructure, including pipelines and rail lines which have in the past disrupted operations. This concern however has been quelled for the time being as the FARC announced a unilateral ceasefire that started December 20th. In 2015 I plan to maintain my current position in energy as I do not need to add more weight to my portfolio and to exit underwater positions would not make sense. Another risky portion of my portfolio includes a sizeable position in J.C. Penney (NYSE: JCP ). I’ve been playing the turnaround for some time now, and in the time I have held it the company has improved its quarterly results greatly. While I do believe in the turnaround working to some extent, depending on Q4 results, I may opt to close this position. Safer plays have become far more attractive than the troubled retailer, and I believe I’m ready to add more practical holdings. A position that I will most definitely be holding onto is Sirius XM (NASDAQ: SIRI ). I have held this position longer than any other, and it was in fact one of the first things I bought when I first began investing a few years ago. The company continues to perform well and I for one am a fan of the buybacks the company has been doing. Earlier in the year I was pleased that the deal with Liberty fell through because I see far greater upside without a buyout for a company with little comparable competition. One last higher risk name I also own is Synta Pharmaceuticals (NASDAQ: SNTA ). It is a small biotech that is engaged in many trials of various drugs, in particular its leading candidate, Ganetespib, which fights cancer. While obviously this further adds diversification to my holdings, Synta is only in trial stages of its drugs, and expects itself to have cash just through Q4 of 2015. This is worrisome because if the results from the trials in 2015 are poor it could see the shares free fall. Don’t get me wrong, I still believe in all of my current holdings. I’m just worried about how balanced I am between safer more reliable plays and high risk plays. In 2014 the market was quite good and that can be seen from the various indexes being up nicely. I’m sure you’ve heard the famous Warren Buffett quote a million times before but here it is once more: “Be fearful when others are greedy and greedy when others are fearful.” Now I can’t tell you where the market will go in 2015 and I’m not saying be fearful or greedy. I’m just highlighting the uncertainty and what my plans are for 2015. Positions I’m Considering When looking at my holdings going into 2015 I see one major problem that I want to fix: no companies I own pay dividends. I did for some time own Bank of America (NYSE: BAC ), but sold it part way through the year (a position in hindsight I wished I kept). My new strategy in 2015 will most definitely include a few and maybe many strong dividend payers. The first of which I am considering would be AT&T (NYSE: T ). With a 5.5% yield it is very enticing. The company continues to deliver some dividend growth announcing yet another increase a couple of weeks ago. I see the acquisition of DIRECTV (NASDAQ: DTV ), which is still pending, as a strong catalyst for further growth going forward. Another mega cap I’m considering is Pfizer (NYSE: PFE ). The company sports a 3.5% yield and also just announced that it was increasing its dividend yet again. In late October the company announced that it would buyback another $11 billion worth of its shares. A couple of other dividend paying names that I am considering adding include Flowers Foods (NYSE: FLO ), Ford (NYSE: F ), and Middlesex Water (NASDAQ: MSEX ). Some Risky Additions in 2015? Although I want to balance my holdings to safer plays that does not mean I won’t add some further risk to it. Over the past two weeks natural gas has been hammered and I see a possible very enticing risk vs. reward opportunity playing natural gas at these levels. This could turn out especially rewarding if we see bitter weather in late January or February. Henry Hub Natural Gas Spot Price data by YCharts Another position I may consider would be one in Twitter (NYSE: TWTR ). In 2015 the company is expected to become consistently profitable after many quarters of losses. The shares are trading 46% down from its 52 week high and the last time the shares were trading around this level they went on a 50% run. A short term catalyst for the shares may be the rumors that current CEO Dick Costolo may be canned. Costolo has lost investor confidence and replacing him could lead to a nice pop in the shares. Conclusion Being so young I can afford to have lots of risk and make mistakes (and learn from them). In 2015 I want to be more cautious and reasonable. Since beginning investing my holdings have always overwhelmingly been dominated by high risk names. To start 2015 I have saved enough to change this and will not only be adding more reliable and safe names, but will also be getting rid of some of the current risky names I hold. In particular I am going to add extremely financially sound companies that also pay dividends which should reward even if 2015 turns sour for the markets. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks. Additional disclosure: Always do your own research before investing. Keep in mind that everyone, especially by age group, has different investment goals and aims. Most of my investments remain long term but I also dabble in short term trading occasionally. I may initiate long positions in T, PFE, UGAZ, GASL, F, FLO, MSEX, TWTR.

The Case For Maintaining A Strategic Allocation To Real Assets

As investors continue to look for ways to diversify their portfolios away from traditional long-only stock and bond investments, real assets have become a popular alternative asset class. In fact institutional investors, such as leading endowments and foundations, have long used investments in real assets such as real estate, commodities, timber and energy as both a hedge against inflation and as a core diversifier. To provide more insight into this asset class and how institutional investors are using real assets, Michael Underhill, chief investment officer of Capital Innovations and a leading manager of multi-asset real return portfolios, answers a few questions for us on the topic. Given the increase in regional conflicts and greater overall geopolitical risks today, how is this influencing your respective portfolio positioning from both a macro and micro perspective? As geopolitical risks rise we would expect higher volatility in markets, increased risk of supply shocks to key commodities such as oil and food and a discounting of potential higher inflation and subsequent higher interest rates. As a hedge to these types of macro risks, exposure to real assets, and their relative inflation hedge qualities would become more attractive. Positioning on a more micro level we are incorporating these geopolitical risks and have been reducing our relative portfolio weighting in more interest rate sensitive groups such as electric utilities and telecomm and increasing more inflation hedge real assets such as energy, timber, agricultural commodities. What are the risks that investors should think about hedging or mitigating today and why? A common mistake investors make is to extrapolate current environment out too far and become complacent. The current environment of low interest rates, low inflation, and low volatility has afforded the opportunity to hedge the risk that this environment changes over the investment horizon. Do you want to bet that this backdrop we have had since the financial crisis does not change? The ideal time to add real asset exposure is when not many are thinking about it – buy an umbrella when the sun is shining. If we examine an allocation to real assets over the past 24 years, as shown in the chart below, we can see improved portfolio efficiency, with enhanced returns and lower volatility. Historical Effect of Allocating to Commodities (January 1980- July 2014) What are the opportunities investors should be seeking exposure to and why? In 2015, we expect improved global growth and a mid-year increase in US interest rates. The ECB and the BOJ remain in easing mode, and the policy outlook in the rest of the world varies considerably. The risk that global growth remains sluggish is high, and a lack of meaningful improvement could lead to a sharp increase in the dollar and a significant reorientation of capital flows. Most regions should see decreasing growth headwinds in 2015, although geopolitical uncertainties, volatile oil prices, and moderating Chinese growth remain concerns. It is for these reasons that we continue to advocate for a diversified, tactically managed, multi-asset portfolio that seeks to generate returns in excess of the actual rate of inflation and provides managed volatility rather than a single-asset-class solution. A broad range of real asset equity securities, including emerging markets and commodities, real estate investment trusts, and directly held positions in master limited partnerships. How does a global multi-asset real return strategy fit into a liability driven investing framework? The tangible properties of a real asset allow its price to fluctuate with overall market prices of physical assets. Real assets tend to be sensitive to inflation because of their tangible nature. Examples of real assets include direct investment in real estate, commodities, precious metals, timber, energy, farmland, precious metals, commodity-linked stocks, and commodity-linked hedge funds. Most investors are more familiar with investments in financial assets, which are contractual claims that do not generally have physical worth. In an LDI platform, real assets provide potential reductions in surplus volatility to the extent that real asset movements are not highly correlated to movements of financial assets. Returns from real assets may also boost returns since real assets are generally not as efficiently priced as the more competitively priced stocks and bonds. The return potential for real assets has become especially attractive in recent years since stocks and bonds have not performed well. From a risk management perspective, a key benefit from expanding asset classes to include real assets rests on correlations. A group of assets that have high correlations with each other but have low correlations with other groups of assets represent an asset class. There tends to be much less diversification potential from combining assets within an asset class than from combining assets from different asset classes. Real assets represent such a broad asset class that a wide range of correlations exist both within the asset class and with assets from other asset classes, allowing for attractive diversification. Our clients have found that the best performance comes from avoiding the large losses that markets often impose on passive investment portfolios. This tends to be especially important for real assets. As a first step we look behind the market consensus and identify where herding and overreaction phenomena may be at work. These phenomena occur both within and across asset classes. We perform extensive modeling with sensitivity analysis to find our best risk management strategy for an LDI structure. From there we model our best set of segments within an asset class and simulate the surplus volatility and return. This is not just simple quantitative analysis because we must also build in forward looking scenario planning. We track actual LDI performance against expected LDI performance. This type of tracking is revealing in that we can review what we were expecting when the allocations were set and identify where things developed differently. This type of learning over many years of experience is very helpful in building analysis skills.