I Own SCHF And Plan To Buy More; Here Is My Reasoning

By | November 16, 2015

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Summary My international allocation is currently underweight, but I expect stronger performance in international markets moving forward. The Federal Reserve is pursuing a policy of raising short term rates even though the United States has higher 10 year treasury rates than many developed countries. The top holdings in SCHF have materially lower interest rates than the United States. I expect the expansionary policies to result in stronger growth of GDP and earnings which should lead to higher valuations. The Schwab International Equity ETF (NYSEARCA: SCHF ) is one of my top choices for international diversification. The fund provides exposure to developed international markets with great diversification in the holdings. There are 1226 individual holdings in the fund and yet the expense ratio is only .08%. My criteria for picking top international funds are fairly. The top allocations are Japan and the United Kingdom which combine to be about 40% of the holdings. While I like to see some additional diversification, I can handle that by simply adding a couple other international ETFs to fill out the position. I’m already long on SCHF, but the position is only a very small part of my portfolio. I intend to change that over the winter as I want to shift my portfolio to have a larger allocation towards international equity at the cost of domestic equity. My preferred strategy for making these allocations is generally to leave active limit orders to buy more shares. If the market turns down in a hard way, that means I’ll find myself in before it gets very low. I counter that problem by allocating more cash away from my checking account and into my brokerage account whenever I’m seeing new 1 year lows. Why I want International Since I’m currently underweight on international, it would be reasonable to assume that I simply want to reach a more balanced allocation. However, my desire to raise the international allocation is based off a belief that international equity should be in position for some solid performance. As an mREIT analyst, watching the yield curves is a major part of my research. I’m also keeping an eye on actions by the Federal Reserve and some of the economic indicators. It is my opinion that the Federal Reserve is intent on raising short term rates even if raising the rates runs contrary to their dual mandate. They wish to remain relevant, but their constant talk of raising rates has only created uncertainty. Central Banks Around the World If investors look at central bank policies abroad, they are doing the exact opposite of the Federal Reserve. They are pushing to lower interest rates as far as possible. Some countries are already using NIRP, which is “Negative Interest Rate Policy”. For decades there has been a simple economic understanding that it is impossible to get investors to lock in negative nominal interest rates. It was also believed that investors would not accept negative real interest rates, but the yield on TIPS (treasury inflation protected securities) has clearly proven that negative real interest rates were readily accepted. In negative interest rate policy we see that negative rates can occur as well. The theory that rates could not turn negative was based off the idea that the owners of cash could simply stuff it in their mattress rather than accepting a negative rate. The banks have learned that stuffing billions into the mattress is not viable. There is a cost to protect cash. Because there is a cost, it is possible for the negative interest rates to be the cheapest option available. Resulting Yields Because central banks have taken very different policies in both their talk and their actions, the interest rates around the world are materially different. To demonstrate, I’d like to present charts showing the 10 year treasury yields in several countries. (click to enlarge) The rate on a 10 year treasury bond for the United States is 2.27%. The top two allocations in SCHF were Japan has a 10 year yield of .30% and the United Kingdom which has a yield of 2.01%. To make it simpler to see the relevant rates for the countries that are represented in SCHF’s portfolio, I built the following chart. The heaviest allocations are on the left and the smaller allocations are on the right. This list is not exhaustive, but it provides the top several countries: (click to enlarge) To put that in perspective, Australia is the only foreign country in the top 10 allocations for SCHF that has a materially higher 10 year rate than the United States. South Korea’s 10 year rate was very slightly higher, but the difference was small enough that it could easily flip back and forth in a day. Interpretation The Federal Reserve is intent on raising short term rates and their desire to raise short term rates combined with a positive employment report about a week ago resulted in domestic treasury rates moving significantly higher. The Federal Reserve has not even acted yet, but already our yields are materially higher than most developed markets. To be fair, there are many emerging markets with higher treasury yields. How many investors do you know that consider the United States to be an emerging market rather than a developed one? In my opinion, these other developed countries represent the best comparison of peers. Because I believe the central banks in international markets are doing a better job of handling economic policy, I believe those economies have an advantage for establishing stronger performance moving forward. I believe the expansionary policies will result in a faster growth rate of GDP and higher sales for companies in those locations should translate to stronger earnings and higher valuations. Conclusion SCHF is a diversified low fee index fund for gaining exposure to developed international markets. The top allocations in the fund are to countries that are showing materially lower treasury yields than the United States. The expansionary policies in those countries provide a tailwind to growth that should drive up their GDP. When those economies are expanding, I expect the strength in sales to lead to stronger earnings and higher valuations. Therefore, I will aim to increase my international allocations over the next few months. I may place some limit orders over the weekend to begin the process of acquiring more shares. Scalper1 News

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