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Best And Worst Bond ETFs Of 2014

The U.S. stock markets delivered a somewhat muted performance this year (at least when compared to 2013) with the S&P returning about 12% YTD gains. The towering market of last year turned into a market that saw fears about a global slowdown and its effect on U.S. corporate earnings, plummeting oil prices, sluggish growth in Japan, concerns of a triple dip recession in Europe and the outbreak of the Ebola virus that forced many investors to look for safety and shun risky assets. Needless to say, the above threats kept bond yields at the lower side throughout the year causing investors to hunt for income bets. While long-term bond ETFs were weak last year due to taper threats, short-term bond ETFs hit the brakes this year due to rising rate concerns. Despite the Fed’s repeated assertion of keeping the rates low for longer, the recent strength in economic data has led to concerns that the Fed could start raising rates after the first quarter of 2015 instead of the initial June or September 2015 timelines. This in turn has lowered the appeal for short-term bond ETFs giving leeway for long-term bond ETFs to score higher in the face of dwindling global growth and an oil price rout. Flight from risk has caused the yield on the benchmark 10-year Treasury note to hover around 2%. Amid such a situation, it would be interesting to note which ETFs were the leaders and laggards in the bond space during 2014: Winners Two bond ETFs – the PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (NYSEARCA: ZROZ ) and the Vanguard Extended Duration Treasury ETF (NYSEARCA: EDV ) – soared this year having returned more-or-less 45%. ZROZ tracks the BofA Merrill Lynch Long U.S. Treasury Principal STRIPS index with effective maturity and effective duration of the fund being 28.99 years. On the other hand, EDV follows the Barclays U.S. Treasury STRIPS 20-30 Year Equal Par Bond Index. The fund has average maturity of 25.3 years and average duration of 25.0 years. The next best performers in the space comes in the form of the iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) , SPDR Barclays Capital Long Term Treasury ETF (NYSEARCA: TLO ) and iPath US Treasury Long Bond Bull Exchange Traded Note (NASDAQ: DLBL ) . These long-term bond ETFs have returned about 25% each this year. SPDR Nuveen Barclays Build America Bond ETF (NYSEARCA: BABS ) – a long-term muni bond ETF too returned smartly (up 21.6%) in 2014. To beat the potential rise in U.S. inflation and rack up gains on the real return, long-term TIPS bond ETF, the 15+ Year U.S. TIPS Index Fund ( LTPZ), was in demand in 2014 and has added about 19.3%. In short, the trend clearly indicates the inclination toward long-term bond ETFs. Beyond the border, PowerShares DB Italian Treasury Bond ETN (NYSEARCA: ITLY ) added about 19% this year thanks to the extremely easy monetary policy. Losers Thanks to the flattening of the yield curve, the U.S. Treasury Steepener ETN (NASDAQ: STPP ) turned out as an acute loser in this space. The product tracks the returns of a notional investment in a weighted “long” position in relation to 2-year Treasury futures contracts and a weighted “short” position in relation to 10-year Treasury futures contracts. Bullish stance on 2-year Treasury made the product a loser. The product was down 18%. Apart from this, junk bond ETFs like Peritus High Yield ETF (NYSEARCA: HYLD ) lost about 13% as returns were great in the safe government bonds space. Needless to say, short-term bond ETFs like the S&P/Citi 1-3 Yr Intl Treasury Bond ETF (NASDAQ: ISHG ) were defeated in the race. The fund is down 10% this year. The fate was similar for the WisdomTree Barclays U.S. Aggregate Bond Negative Duration Fund (NASDAQ: AGND ) with a loss of about 8.5%. Road Ahead Having presented the scorecard of the year, we would like to note that the trend will be quite similar in the year ahead. However, like 2014, TIPS ETFs should be out of the betting list courtesy of a tepid inflationary outlook across the globe. Apart from the long-term government bonds, investors having a stomach for risk can also have a look at the long-term investment grade corporate bond ETFs to earn some regular income along with securing the portfolio. To do so, investors might tap the Long-Term Corporate Bond Index Fund (NASDAQ: VCLT ) , SPDR Barclays Capital Long Term Corporate Bond ETF (NYSEARCA: LWC ) and iShares 10+ Year Credit Bond ETF (NYSEARCA: CLY ) .

Latest Low Carbon ETF Sees Huge Popularity Out Of The Gate

The ETF world is becoming increasingly competitive as issuers continue to line up new products to entice investors. While most try to please investors by charging low expense ratios, others have even attempted product charging a zero percent management fee. In this cutthroat competitive world, iShares has recently launched a product based on the low carbon emission idea. The newly launched iShares MSCI ACWI Low Carbon Target ETF (NYSEARCA: CRBN ) comes close on the heels of the recently launched SPDR MSCI ACWI Low Carbon Target ETF (NYSEARCA: LOWC ) by State Street. Though the two new funds are hardly distinguishable from each other and both look to provide exposure to companies with lower carbon and greenhouse gas emissions, below we have highlighted some of the details of the latest product on the block. CRBN in Focus The newly launched ETF tracks the MSCI ACWI Low Carbon Target Index to provide exposure to developed and emerging market equities with a lower carbon exposure than that of the broad market. For this purpose, the index goes overweight in companies with low carbon emissions relative to sales and per dollar of market capitalization. Also, the index supports companies that are less dependent on fossil fuels. This strategy results in the fund holding a well-diversified basket of 956 stocks. Apple occupies the top position with 1.82% exposure, followed by Microsoft (NASDAQ: MSFT ) (1.04%) and Johnson and Johnson (NYSE: JNJ ) (0.87%). Sector-wise, Financials dominates the fund with a little less than one-fourth exposure, followed by Information Technology with 13.7% allocation and Industrials with 11.7% exposure. Geographically, the U.S. takes the biggest chunk with half of the assets invested in it. This is followed by Japan (7.5%), U.K. (6.6%) and Canada (3.5%). The fund charges 20 bps in fees, including waivers. How Does it Fit in a Portfolio? The fund is a great choice for long-term investors, especially institutions looking to invest in a way that can have a positive impact on the broader economy. The impact of climate change worldwide and the detrimental consequences of the presence of greenhouse gases in the environment have become an important topic of discussion lately. People these days are more focused on socially responsible investing and the new fund is a good platform for them to do so. ETF Competition Though the socially responsible investing space has a lot of funds focusing on companies that are socially accountable, the focus on funds targeting low carbon emission companies is still quite low. However, the iPath Global Carbon ETN (NYSEARCA: GRN ) is one such product which focuses on this space. The fund tracks the Barclays Capital Global Carbon Index Total Return, which measures the performance of the most highly traded carbon-related credit plans. The ETN is, however, quite unpopular and illiquid with an asset base of under $3 million and an average volume of 4,000 shares a day. The product is also quite expensive as compared with the newly launched product and charges 75 basis points as fees. Apart from GRN, the newly launched CRBN is likely to face competition from another recently launched fund by State Street’s LOWC, as it also tracks the same index and charges the same fees. With that being said, CRBN has already established its popularity in just a few days of its launch and is presently the most successful ETF launch, by assets, since October, as per research firm XTF . CRBN has gathered roughly $137.8 million in assets since its inception on December 8 this month, while LOWC has managed to garner $71.13 million after its launch on November 25. This clearly indicates that CRBN is already winning in terms of popularity and might have great days ahead as well.

Should You Look For Value In Cash Flows?

Most deep-value investors look at the balance sheet and P/E multiples when they are hunting for bargains, a strategy taught by the godfather of value investing, Benjamin Graham . However, what strategies like these fail to take into account is cash flow. Glen Greenberg and Donald Yacktman are two respected value investors, both of whom invest not just with asset value in mind but also cash flows. This strategy has yielded results. Greenberg’s fund, Chieftain Capital Management achieved a compounded annual growth rate of 25% from 1984 through 2000, the S&P 500 achieved a return over 16% over the same period. Annual returns through 2010 were 18%. Greenberg uses a DCF model to make his investments but rather than the traditional DCF method, in the style of Graham, Greenberg looks for a margin of safety before investing. This margin of safety is a hurdle/discount rate of 20% for all potential investments when computing the DCF. The rate was lowered to 15% in order to reflect the interest rate environment. (click to enlarge) Adjusted cash flows Meanwhile, Yacktman uses an adjusted cash flow figure to value securities. Yacktman equates the forward rate of return with a company’s free-cash yield . He calculates this yield by computing the FCF, then adds in the cash he believes the business can generate through growth and adjusts for the effect of inflation. That figure is then divided by the stock price. Using this adjusted cash flow figure, Yacktman compares the stock’s forward rate of return with yields on long-term Treasuries. The wider the spread, the deeper the discount and the more attractive the stock is to Yacktman. DCF valuations for forecasting free cash flows: Not clear cut The use of a DCF valuation places less reliance on current market valuations. Instead, it emphasizes the full-information forecasting of free cash flows over a multi-period finite horizon. In comparison, PE models are dependent upon the fact that current earnings measures are good proxies for value, placing emphasis on current, not future value. Moreover, DCF calculations allow for the choice of an appropriate finite horizon, estimation of growth beyond the horizon, and in its standard implementation, estimation of an appropriate WACC and of the value of non-equity claims on the firm. In other words, the valuation is more comprehensive and provides a long-term valuation of the company that it not dependent upon wider market valuations. That being said, there is some evidence to suggest that price targets calculated using a P/E multiple, are more accurate that price targets computed using a DCF analysis. A study entitled “ Does valuation model choice affect target price accuracy? ” found that DCF models are used to justify higher price targets by optimistic analysts. Additionally, a study entitled, Valuation Accuracy and Infinity Horizon Forecast: Empirical Evidence from Europe , published within the Journal of International Financial Management and Accounting 20:2 2009, found that when calculating a DCF forecast, analysis’ tend to factor in an “ideal” long-term growth rate, which is just above the WACC: …Therefore, using this ‘‘ideal’’ growth rate leads to the determination of ‘‘ideal’’ Target Corporation (NYSE: TGT ) prices that respect the long-term steady-state assumptions… Therefore, it’s easy to conclude that if a DCF figure is used to calculate a price target, or identify value opportunities , a suitable, conservative set of figures should be used to compute the DCF in order to prevent optimistic forecasting. Disclosure : None.