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Summary This fund is designed with a target termination date at the end of 2015, but the holdings have been changing quite substantially. My expectation is that the fund will be gradually selling out of their longer positions and transitioning to treasuries and cash. BSJF is fairly low in volatility since there is little duration risk. The fund has been trading at a slight discount to NAV which is one source of return for investors since the fund should pay out NAV at termination. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. One of the funds I’m looking into is the Guggenheim BulletShares 2015 High Yield Corporate Bond ETF (NYSEARCA: BSJF ). 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. I’ll cover the holdings of the fund and then look at its performance in what I would consider a reasonable portfolio. Expense Ratio The expense ratio is .44%. Holdings Since this is a fairly interesting bond fund due to the presence of a termination date, I thought it would be useful to pull up their holdings a couple times before writing on them. Their holdings from early October are shown below: (click to enlarge) The first thing you should probably notice is that the ETF is the treasury bills being an ironic allocation for a junk bond fund. The situation is actually surprisingly simple. The bond ETF has an expected termination date of 12/31/2015. Most ETFs are long term investments, but BSJF appeared to be staying true to the name and expecting to simply terminate the ETF at the end of the year. The interesting thing is that when I went back to check on the fund in late October to see how much the Treasury allocation was increasing, I found it had disappeared instead. The most recent holdings are indicated below: (click to enlarge) As we get closer to the termination date I expect the percentage of assets coming from Treasury bill securities to increase materially. To be fair, the previous Treasury allocation did state that they were discount bills with a maturity of 10/22, which is two days ago. The irony for me at this point is the fact that the weighting for Kinetics has increased substantially from about 7% to roughly 10.8%. The par value of the position has not changed though, which suggests that the total assets have decreased substantially. The assets don’t appear to have been paid out, because the company makes their distributions very early in the month and the last distribution was $.03 per share on October 1st. Distributions The distribution is an area I really want to bring to investors. Have a look at the chart below (yeah, it is huge) and notice how the total distributions are paid out on a monthly basis but the size of the distributions has been shrinking lately as the fund is moving out of the higher yielding investments. (click to enlarge) The movement wasn’t really noticeably until the start of June, but now it is very clear that distributions are shrinking. Sectors The following chart breaks down the sector allocation of the underlying bonds. Finance is by far the heaviest weighting, but I’ve found that to be a trend when I’m examining these junk bond funds. If you’re going heavy on allocation to any junk bond fund with a strong exposure to a single industry, it would be wise to avoid overweighting the same sector in the equity part of your portfolio. Credit Credit risk is pretty significant here, but the bonds aren’t in default yet. Overall this is a fairly reasonable allocation for a junk bond portfolio. Building the Portfolio This hypothetical portfolio has an aggressive allocation for the middle aged investor, but should be fairly reasonable for a younger investor. Investors nearing retirement should aim for a significantly more conservative portfolio unless they have a high risk tolerance and a high ability to actually bear the risk. Retirees depending on the portfolio value should aim for something more conservative than this. A total of 40% of the portfolio value is placed in bonds. That makes it appear to be a fairly reasonable allocation for the middle aged investor. However the position in junk bonds is highly susceptible to losses at the same time as the equity positions because fear in the market will cause junk bonds to be sold off along with equity. You’ll also notice that emerging market bonds also have a positive correlation with domestic equity markets due to the influence of fear. 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 Vanguard High Dividend Yield ETF VYM 30.00% 3.16% iShares U.S. Real Estate ETF IYR 10.00% 3.82% Vanguard FTSE Developed Markets ETF VEA 10.00% 2.94% Vanguard FTSE Emerging Markets ETF VWO 10.00% 3.12% Vanguard Emerging Markets Government Bond Index ETF VWOB 10.00% 4.73% Vanguard Long-Term Corporate Bond Index ETF VCLT 10.00% 4.54% Vanguard Long-Term Government Bond Index ETF VGLT 10.00% 3.12% I include the yield from each investment to aid investors looking for a higher yielding portfolio. If nothing else, this should provide a very quick reference point for which other ETFs mentioned here might also be useful in constructing your own portfolio. I picked VYM as a replacement for SPY in this portfolio due to it having a significantly stronger dividend yield and the assumption that domestic equity would be the core of the portfolio. The next chart shows the annualized volatility and beta of the portfolio since October of 2013, courtesy of Investspy.com. (click to enlarge) Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. To make it easier to recognize the risk impact of the various positions, I’ve built this portfolio to be equal weight with the exception of the position in VYM. Since this is the core of the portfolio, I’ve allocated 30% to the ETF. You can also see that VGLT 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 VCLT is also very low in the impact on total portfolio risk. That is because these are very long duration high quality bonds. Even though they are not treasuries, they have a much higher correlation with treasury securities than with equity securities. Thinking of Modifications If an investor wanted to use something like this as a high yield portfolio while significantly reducing the risk, one way to do it would be to cut the allocations to VEA and VWO and to increase the allocations to VGLT and VCLT. That would create a lower risk portfolio overall and it would strengthen the yield on the portfolio. It should be noted that this modification would reduce the expected level of returns over the long term. A quick rundown of the portfolio I put together the following chart that really simplifies the role of each investment: Ticker Role in Portfolio VYM Core of Portfolio IYR Yield and exposure to equity REITs VEA International diversification VWO International diversification VWOB Strong Yield with International Diversification VCLT Moderate yield, moderate risk VGLT Strong Negative Correlation to Equity Correlation The chart below, created by Invest Spy 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 BSJF is an interesting junk bond fund because it has scheduled a termination date with the credit quality of the fund moving higher as it prepares for that date. Therefore, the correlation the fund has with other assets should be shifting over time. It is worth noting that the only negative correlation for BJSF is the correlation with long term treasury securities. Given that these are fairly short maturity instruments, I wouldn’t expect a strong correlation based on interest rate movements. You may notice that the correlation with VWOB is .40 which is much higher than the correlation with other bond funds. In that case the correlation is a combination of having some small amount of duration risk combined with substantial credit risk. Emerging market bonds tend to sell off in similar situations as domestic junk bonds which results in a higher correlation there. If you are interested in short duration bullet funds, this one would be a good one to keep an eye. Watch what happens with it over the next few months and see if it deviates materially from slightly longer duration bullet funds that won’t be expected to terminate. If nothing else, it should be interesting to watch the price movements. Investors interested in using the fund as a very short term holding should take note that the fund usually sells at a slight discount to NAV in the range of .1% to .2%. Since this is a short term holding, getting in with the discount is important to expected returns. I’ll be keeping an eye on how this fund does through the end of the year. If any readers are holding it, I’d love to hear from you in January about your experience with the liquidation of the fund so I can incorporate it into my analysis for other target date funds. Scalper1 News
Scalper1 News