Tag Archives: utilities

VGSH: For The Investor That Wants Reduced Exposure To A Hot Equity Market

Summary The Vanguard Short-Term Government Bond Index ETF is an intelligent holding within a portfolio, especially when the equity market is hot. The ETF has low volatility and low correlation with other important investments. The credit quality is excellent and the expense ratio is reasonable. The big weakness is a very weak yield. The fund is relatively similar to simply holding cash within the account. Within a diversified portfolio almost all of the risk (volatility) attributed to VGSH is eliminated. The Vanguard Short-Term Government Bond Index ETF (NASDAQ: VGSH ) is a very solid choice for investors trying to limit volatility in an equity market that has been trading at fairly high levels over the summer. By many fundamental measures, such as P/E, the equity market is feeling expensive enough that investors may want to consider increasing their bond exposure. Unfortunately, the yields on debt have been very low, contributing to higher valuations in the equity market. For investors wanting to see their portfolio risk reduced, VGSH is a great tool to get there. Duration The following chart breaks down the duration of the funds. Holdings are all less than 3 years and usually more than 1 year. Again, this is a solid choice. It shouldn’t be surprising that such short-term debt is unlikely to have any meaningful volatility since this is high quality government debt and the short duration limits any volatility from shifts in the yield curve. Of course, there is one major weakness, which is the fund having a yield of .56%. That is a pretty severe weakness for the ETF, but it is a cost of acquiring such low volatility. Some investors may point out that they might as well just deposit their cash in the bank. If the investor has that as an option, that is a fine choice. However, if the investor is working with funds in retirement accounts, that may not be an option. If the account is a 401k and the exposure needs to be accomplished through mutual funds, VGSH also trades as a mutual fund under the ticker (MUTF: VSBSX ). A Hypothetical Portfolio I put together a very simple sample portfolio using Invest Spy. Due to some of the ETFs being newer, the sample period is limited to a little over two years. (click to enlarge) This hypothetical portfolio is weighted to 60% equity and 40% bonds. To break that down, the weights from the equity section are 30% total market index (NYSEARCA: VTI ), 10% equity REITs (NYSEARCA: VNQ ), 5% Utilities, 5% Consumer Staples (NYSEARCA: VDC ), 10% International Equity. The bond section is holding 10% in junk bonds (NYSEARCA: JNK ), 5% in extended duration treasuries (NYSEARCA: EDV ), 5% in emerging market government bonds (NASDAQ: VWOB ), 5% short term corporate debt (NASDAQ: VCSH ), 5% in short term government debt , 5% in mortgage backed securities (NASDAQ: VMBS ), and 5% in intermediate-term corporate bonds (NYSEARCA: BIV ). This portfolio won’t be perfect for hitting the efficient frontier, but it should beat the vast majority of real portfolios investors are using on a risk-adjusted basis. If long-term rates were higher, I would have used a higher weighting for long duration bonds due to their exceptional correlation to major equity classes. My disclosure already states it, but I’ll reiterate that I am long VTI and VNQ. Annualized Volatility When measuring risk-adjusted returns for a portfolio, the most efficient method is usually to use the Sharpe ratio. For that ratio, we are taking the total return annualized return and subtracting the risk free rate. Then we divide the resulting number by the annualized volatility. The problem is that this metric is only really known after the fact. Predicting the level of returns in advance is problematic, but correlations and relative volatility are more reliable over time than returns. Within the chart investors can see the annualized volatility of each holding as well as the resulting annualized volatility for the portfolio. While some holdings have higher annualized volatility scores, such as EDV, the ETF makes up for that by having negative correlation to a few of the equity holdings. As a result, the ETF only contributes .6% of the total risk in the portfolio. VGSH has an annualized volatility of .9%, which is extremely low. Once we adjust for correlation, the risk contribution to the portfolio is only .1% of the total. That means VGSH fits extremely well in this kind of hypothetical portfolio. This is fairly similar to using cash as part of the portfolio value except the returns over time here should be positive. I wouldn’t bother using VGSH outside of a retirement account, but it is a fine holding to use within the retirement account if the investor is concerned about the high valuations in the market. Correlation I want to dive a little deeper into the correlation statistics. The table below provides the correlation across each of those ETFs, which should make it very quick to see which ones are work very well together. When a correlation is shown in the tan color, it indicates a negative correlation which is very attractive for reaching the efficient frontier. You’ll notice that quite a few of the bond funds have negative correlations to VTI and the S&P 500 (NYSEARCA: SPY ). Since VTI and SPY have a correlation ranging between 99% and 99.9%, depending on the measurement period, it should not be surprising that those two funds have very similar correlations to other holdings. Here is the correlation table: (click to enlarge) Conclusion The expected returns on VGSH will regularly be weak when yields are already very low. On the other hand, with high valuations throughout the equity market, there is a solid argument for keeping part of the portfolio protected from the fluctuations in equity valuations. Disclosure: I am/we are long VTI,VNQ. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have 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.

Duke Energy Is A Good Play In This Volatile Market

Duke Energy is an electric power holding company whose stock is a low-risk investment. Despite its poor return on equity, Duke Energy has strengths that will continue to make it a reliable dividend stock. The company has performed poorly during the most recent quarter, but this is expected to improve. Duke Energy Corporation (NYSE: DUK ) is the largest electric power holding company in the United States and it is expected to stand firm in the electric utilities industry. Recently, the company has underperformed the industry average in many respects, causing its stock price to decrease from $89 to $70 within the past half year. However, an improvement in both company performance and market performance is anticipated. Duke Energy’s faults may currently overshadow its strengths, so it is important to dig deeper into the company’s operations and history before making a decision to buy. Insider Monkey shows that Luminus Management held onto about 1.68 million shares of DUK after decreasing its position by 22%. Seminole Capital’s position in DUK was slightly higher with 630,534 shares, while Highbridge Capital added a new position of 350,000 shares in DUK. We follow these funds because as Insider Monkey shows ( read the details here ), they have a penchant for making good long picks, but their short picks usually eat into their overall returns. In total, Insider Monkey showed five funds adding new positions in the shares of DUK and ten exiting their stakes. We think those funds staying long will not regret their decisions. Duke Energy has struggled with a YTD return of -12.19% even though its shares outstanding have decreased by 2.8% in the same time. The company’s gross margin of 42% exceeds the industry average, but its revenue has decreased over the past year, and in turn, DUK’s EPS has hit a recent low of $3.46. These disappointing statistics are troubling to investors, but there is plenty of reason to still consider DUK as a worthy investment. While many have lost faith in Duke Energy as of the most recent quarter, the company remains poised to reaffirm its reputation and generate a steady source of income for its shareholders. As the largest electric holding company in the country, Duke Energy has shown that its strengths will continue to make it an attractive opportunity for investors. With $120 billion or more in operating assets and nearly 8 million customer relationships , the company can ensure consistent operating cash flows and dividends. Its dividend yield is currently 4.49%. Slumping performance metrics are expected to improve in the near future as well. According to TheStreet , the market expects EPS to increase by $1.00 in the next year. With this may come a decrease in P/E ratio all else equal, meaning DUK may be undervalued considering its forecasted EPS. Additionally, NASDAQ shows DUK will realize earnings growth of 2.4% on a year-end basis and 5.28% by the end of 2016. DUK is known for its relatively consistent cash flows, but an improvement in performance may also be around the corner. Perhaps most important to investors, DUK is a low-risk stock, even compared to most other dividend stocks with an ultra-low beta of 0.35 on a 5-year basis. Its generally consistent performance is why the dividend has increased every year and the yield now stands at 4.5%. DUK remains an attractive option for risk-averse investors in that they have generated predictable cash flows through out their 150+ year existence, and its stock’s fortunes are not entirely tied to the market and the company’s fortunes are not entirely tied to the economy. Duke Energy’s two biggest direct competitors, American Electric Power Company (NYSE: AEP ) and CenterPoint Energy (NYSE: CNP ), have underperformed even more so than DUK. According to Yahoo Finance , AEP and CNP trail DUK in quarterly revenue growth, gross margins, operating margins, and EPS. The electric utilities industry in aggregate, however, has outperformed DUK in terms of quarterly revenue growth, perhaps due to the emergence of utility-scale solar developers. Otherwise, DUK seems to be in a far better position than its two largest direct competitors and the electric utilities industry as a whole. Duke Energy is a low-risk stock that may not offer grand price appreciation, but the company can provide shareholders with a steady source of income through dividends. Its position in the electric utilities industry, including its enormous portfolio of operating assets, allows cash flows to remain relatively predictable. Despite the disappointment surrounding recent performance metrics, DUK is still a reliable investment opportunity and can provide some stability in an increasingly volatile market. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Misguided, Flawed D.C. PSC Decision Will Not Derail The Exelon-Pepco Merger

Summary On August 25, the Public Service Commission of D.C., led by Chairwoman Kane, denied the Exelon-Pepco merger application; Pepco shares plunged 16.5%. The application review process lacked fairness, public interest factors misconstrued by the commission, and Chairwoman Kane failed to hold good faith negotiations. Exelon is likely to pursue legal action, and is in a good position to prevail. Public Service Commission of D.C. Denies The Exelon-Pepco Merger Application In what is being called one of the most misguided and inherently flawed decisions in the Public Service Commission of the District of Columbia’s 102-year history, the Commission denied the application for the proposed merger of Exelon (NYSE: EXC ) and Pepco (NYSE: POM ). The Commission, led by Chairwoman Betty Ann Kane, issued a press release and a summary of the decision suggesting the Commission held a thorough proceeding that began with the initial application on June 18, 2014. Over 14 months later, after reviewing submissions and comments and holding hearings, the Commission decided to deny the application and declared that “this decision is forever.” Unfortunately for Chairwoman Kane, such a bold statement is not based on fact, and exceeds the established authority of the Commission. (click to enlarge) (Source: Public Service Commission of D.C. website ) Since announcing the $6.8 billion transaction on April 30, 2014, Exelon and Pepco collectively have spent a tremendous amount of resources to secure all required regulatory approvals, and until August 25, had been successful in meeting the demands of all stakeholders in various jurisdictions. In order to close the transaction, Exelon has had to negotiate complex agreements with local regulatory agencies and commit to additional funding initiatives that total in the hundreds of millions, and has had to agree to other conditions. Through this lengthy process, Exelon and Pepco received regulatory approval from all of the following agencies: Virginia, New Jersey, Delaware, Maryland, and the Federal Energy Regulatory Commission. The only agency to deny the application was the District of Columbia, on August 25. (Source: Exelon Investor Presentation, April 30, 2014) Following the unusual and terse decision by the Commission, Exelon has announced that it is reviewing all of its options, and there are many options available to the company. The outcome of the Exelon-Pepco merger is far from over, and will likely lead to a lawsuit filed by Exelon against the Public Service Commission of D.C. A lawsuit by the company would have a very good chance of succeeding, which may lead to a negotiated settlement with the Commission. A negotiated settlement was always the option that was in the best interest of all parties, including the Commission, ratepayers and community activists. However, Chairwoman Kane’s unwavering political ideology and personal preference for dealing with the existing ownership and managerial structure of Pepco ultimately prevented the outcome that is in the public’s best interest. The very troubling aspects of the flawed decision by the Commission will likely be the center of attention over the next several weeks, and will be scrutinized in the Courts. Among the most egregious missteps by the Commission include: A Deeply Flawed Process in Reviewing the Application : The Commission decided early on that it did not favor the merger for reasons discussed at length here , and the proceedings held were merely a formality for a decision that had been made months ago. Rather than holding fair and objective proceedings, the Commission, working closely with the Office of People’s Counsel of D.C. , delayed as long as possible before issuing its final ruling that it had determined long ago with the hope that another jurisdiction or a legal action may unravel the transaction. This did not happen, so the Commission obscured their biased and subjective decision under a “public interest” theory. A deeper understanding of the public interest in the District of Columbia shows that the merger is a tremendous opportunity to help a vast number of poor and middle class inner city families. Commissioner Willie Phillips acknowledged this when he stated, “I am disappointed in the loss of many opportunities that could have achieved benefits for our local communities and across the region.” (click to enlarge) (Source: Public Service Commission of D.C. website) The Commission’s Reasoning to Support Decision is Inconsistent and Unsound, and Does Not Reflect the Economic Reality in the District of Columbia : The Commission refers to its statutory obligation and the seven public interest factors that must be considered and weighted to reach its decision, but it fails to acknowledge the economic reality of the District, which is essential in the first public interest factor. The District’s government, public officials, and regulators have continually failed to address the needs of inner city minorities, and the Commission’s August 25th decision is another example of this failure to serve in the public interest. Commissioner Willie Phillips would be the first to acknowledge this significant shortfall of the District’s government. We are surprised that Commissioner Joanne Doddy Fort does not also recognize the overwhelming lack of commitment by the Mayor and public officials to improving the lives of inner city minorities. Exelon’s commitment to local communities would provide substantial resources to those in need, and it is inexplicable that an activist Chairwoman Kane would allow her political ideology to prevail over the public interest. For example, in Maryland alone, the company agreed to spend “$66 million for residential rate credits, and $43.2 million for energy efficiency initiatives – 20 percent… dedicated to limited-income programs… $14.4 million in Green Sustainability Funds for Prince George’s and Montgomery Counties, and $4 million for sustainable energy workforce development programs.” The District has the ability to work with Exelon to provide similar initiatives for its citizens, but has thus far failed to make the commitment. The Commission’s Lack of Willingness to Negotiate in Good Faith and Failure to Act in the Public Interest : It is highly unusual for a single agency to outright deny an application for a transaction without holding significant negotiations with the applicants. The Commission merely dismisses the discussions and indicates “there was no settlement brought to the Commission that would have evidenced general agreement on those mitigating factors which would have satisfied the concerns of the parties.” Its stance on a settlement shows there was not a sincere attempt to engage Exelon and work together to the benefit of the public, ratepayers, and local communities. We believe that it is unlikely that the Commission’s decision will stand in a court of law, and in our view, Exelon will be successful in challenging the inherently flawed process of the Commission in reaching the erroneous decision. Shortly after the decision was announced, Exelon responded , “We continue to believe our proposal is in the public interest and provides direct immediate and long-term benefits to customers, enhances reliability and preserves our role as a community partner. We will review our options with respect to this decision and will respond once that process is complete.” It’s possible that the two sides will still reach a settlement prior to lengthy court proceedings, particularly since the Commission was deeply divided in its initial decision, and many of the flaws are now being exposed. Potential Outcomes for Shareholders of Pepco Pepco’s stock is now trading at $23.22 per share, and is up over 3% today. In our view, Exelon will file with the Commission within 30 days to reconsider its decision, and from there, if unable to reach a settlement with the Commission, the company will pursue legal action to have decision overturned. The best-case scenario is obviously a negotiated settlement, as the transaction would close relatively quickly, perhaps 30-45 days from now. But we think the probability of this outcome occurring is low (~10%). It is unknown how long a legal action would take, but we think Exelon has a strong case for the aforementioned reasons and would ultimately prevail, although this would likely happen in 2016. In our view, this scenario has an approximately 60% probability of occurring. (click to enlarge) (Source: Nasdaq) If Exelon were to suffer a defeat in the courts or decided to abandon the transaction if negotiations failed (30% probability), we would expect Pepco to trade anywhere from $19 to $21 per share. Given these potential scenarios, we will not add to our position at the current price. However, Pepco will continue to pay a dividend, and we will re-evaluate once Exelon decides on which option it will pursue to overcome this recent setback. Disclosure: I am/we are long POM. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.