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Summary I’m taking a look at PKW as a candidate for inclusion in my ETF portfolio. The risk level is reasonable and the correlation is high. The performance is surprisingly good. The liquidity is solid, so I expect the statistics to be reliable. Despite the higher expense ratio, the ETF has stacked up very well to SPY over the last several years. 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 PowerShares Buyback Achievers Portfolio (NYSEARCA: PKW ). 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 PKW do? PKW attempts to track the total return (before fees and expenses) of NASDAQ Buyback Achievers® Index. At least 90% of the assets are invested in funds included in this index. PKW falls under the category of “Large Blend”. Does PKW 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 just under 96%. That’s a very high level of correlation and relatively unattractive for investors hoping for diversification benefits. As an investor using modern portfolio theory, I would prefer to see lower levels of correlation. Of course, the low value correlation wouldn’t mean much if the values were being distorted by poor liquidity. The average volume of nearly 500,000 shares per day suggests that liquidity shouldn’t be a concern. That’s a good sign for investors wanting verification of the statistics or wanting to know that they can exit the position with less concern about it deviating from NAV. Standard deviation of daily returns (dividend adjusted, measured since November 2013) The standard deviation is fairly reasonable. For PKW, it is .787%. For SPY, it is 0.748% for the same period. The ETF is definitely showing a little more volatility than SPY when we compare returns on a daily basis. Mixing it with SPY I frequently run comparisons on the standard deviation of daily returns for the portfolio, assuming that the portfolio is combined with the S&P 500. However, for PKW, I don’t think that adds much value. The correlation being nearly 96% really destroys the benefits of diversification. 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 and Taxes The distribution yield is 1.06%. I like to see strong yields for retiring portfolios, because I don’t want to touch the principal. By investing in ETFs I’m removing some of the human emotions, such as panic. Higher yields imply lower growth rates (without reinvestment) over the long term, but that is an acceptable trade off in my opinion. This ETF doesn’t have a high yield, but I am far enough away from retirement to be willing to work with the weaker yields. Expense Ratio The ETF is posting an expense ratio of .68%. That’s high compared to most of the ETFs that are appealing to me, but the expense ratio may reflect the premium being charged for the trading methodology the ETF is using to determine the positions within the ETF. Market to NAV The ETF is at a .06% discount to NAV currently. Premiums or discounts to NAV can change very quickly, so investors should check prior to putting in an order. Generally speaking, that discount to NAV isn’t big enough to be a big deal. However, even a small discount to NAV is fairly attractive when we are talking about a high quality ETF. Largest Holdings The diversification in the holdings isn’t going to be a strong selling point. (click to enlarge) Conclusion PKW was one of the most difficult ETFs to make a decision about. The ETF posts a very high correlation to SPY and a high expense ratio. Some screeners don’t have a portfolio turnover ratio for the ETF, but the prospectus states that in the last fiscal year the turnover ratio was 92%. I expect that kind of turnover to require some costs, but I generally don’t want to pay higher turnover ratios because my use of ETFs involves relying on markets to be reasonably efficient. If the markets are thoroughly efficient, then creating a proprietary trading system to select which positions to enter and which ones to end should not result in any reliable excess returns. However, history is providing some support for the methodology PKW is using. I was suspicious about their outperformance of SPY in the test period, so I extended my sample to a five-year period and looked at the returns on a time line. The result is that PKW outperformed SPY meaningfully over that five-year period. Looking at the lines, it isn’t a single period where PKW outperformed either. The fund’s performance has been strong and steady, which makes it appear more repeatable. I wanted to eliminate the ETF for the high expense ratio and relative weakness in diversification, but I can’t do it. Maybe it is just chance that eventually an ETF had to deliver this kind of strong performance over an extended period, but I won’t toss out an ETF that makes a fairly impressive case for itself without digging deeper. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has 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. The analyst holds a diversified portfolio including mutual funds or index funds which may include a small long exposure to the stock. Scalper1 News
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