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Summary The fund follows through on “high yields” by offering investors greater than 5% yield from a junk bond portfolio. The allocations are primarily allocated to the 3-5 year range. The sector allocation is substantially higher for the industrial segment which should encourage investors to avoid buying equity exposure to the same sector. Despite being a debt instrument, the ETF has a negative correlation with treasuries. If investors are using SJNK to boost portfolio yields, it should replace part of the equity portfolio rather than part of the debt portfolio. The SPDR Barclays Capital Short Term High Yield Bond ETF (NYSEARCA: SJNK ) should be an interesting option for investors for one reason; it offers a fairly solid yield. When investors are looking for ways to enhance the income on their portfolio, a small allocation to junk bonds is one solid way to get the job done. I put together some analysis looking at both the holdings of SJNK and how it performs within a portfolio. Expense Ratio The expense ratio on SJNK is .40%, which is definitely higher than I want to see. Junk bonds can be a tricky part of the market because passive investing can be more difficult. Since it is more difficult to do passive investing, the expense ratios for the sector should be a bit higher. Quality I grabbed a chart to break down the credit ratings of the bonds in the portfolio: This certainly qualifies as a junk bond portfolio without being absurdly low ratings. Most of the securities are still BB or B, having over 17% of the portfolio below that rating shouldn’t go unnoticed. This is a very credit sensitive portfolio and as such investors should consider it as a mix of equity and debt since there will be some material correlation with the stock market. When markets are selling off, investors may also flee this credit sensitive debt. Maturities While the portfolio is certainly subject to credit risk, it is not subject to very much duration risk. The portfolio is heavily concentrated on the 3-5 year part of the yield curve, but there are some shorter allocations as well. It looks like the fund is selling off bonds as they get closer to maturity in favor of buying new longer dated securities that bring more risk and higher yields. Sector Allocation The fund appears to be very heavily invested in industrial debt. The logic here should be fairly simple. Since this credit sensitive debt will have positive correlations with equity and negative correlations with treasury debt, investors need to be wary of the sector. If they are going to buy into SJNK, they should not buy into any index funds that are heavily focused on industrial allocations. Doing so would result in having a higher concentration of risk. There just isn’t any reason to risk going heavily long on both the equity and the credit sensitive debt of a single sector. Building the Portfolio This hypothetical portfolio has a moderately aggressive allocation for the middle aged investor. Only 25% of the total portfolio value is placed in bonds and a fifth of that bond allocation is given to high yield bonds. If the investor wants to treat an investment in an mREIT index as an investment in the underlying bonds that the individual mREITs hold, then the total bond allocation would be 35%. Given how substantially mREITs can deviate from book value, I’d rather consider the allocation as an equity position designed to create a very high yield. This portfolio is probably taking on more risk than would be appropriate for many retiring investors since a major recession could still hit this pretty hard. If the investor wanted to modify the portfolio to be more appropriate for retirement, the first place to start would be increasing the bond exposure at the cost of equity. However, the diversification within the portfolio is fairly solid. Long term treasuries work nicely with major market indexes and I’ve designed this hypothetical portfolio without putting in the allocation I normally would for equity REITs. An allocation is created for the mortgage REITs, which can offer some fairly nice diversification relative to the rest of the portfolio and they are a major source of yield in this hypothetical portfolio. 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 SPDR S&P 500 Trust ETF SPY 35.00% 2.06% Consumer Discretionary Select Sector SPDR ETF XLY 10.00% 1.36% First Trust Consumer Staples AlphaDEX ETF FXG 10.00% 1.60% Vanguard FTSE Emerging Markets ETF VWO 5.00% 3.17% First Trust Utilities AlphaDEX ETF FXU 5.00% 3.77% SPDR Barclays Capital Short Term High Yield Bond ETF SJNK 5.00% 5.45% PowerShares 1-30 Laddered Treasury Portfolio ETF PLW 20.00% 2.22% iShares Mortgage Real Estate Capped ETF REM 10.00% 14.45% Portfolio 100.00% 3.53% The next chart shows the annualized volatility and beta of the portfolio since April of 2012. (click to enlarge) A quick rundown of the portfolio Using SJNK offers investors better yields from using short term exposure to credit sensitive debt. The yield on this is fairly nice and due to the short duration of the securities the volatility isn’t too bad. PLW on the other hand does have some material volatility, but a negative correlation to other investments allows it to reduce the total risk of the portfolio. FXG is used to make the portfolio overweight on consumer staples with a goal of providing more stability to the equity portion of the portfolio. FXU is used to create a small utility allocation for the portfolio to give it a higher dividend yield and help it produce more income. I find the utility sector often has some desirable risk characteristics that make it worth at least considering for an overweight representation in a portfolio. VWO is simply there to provide more diversification from being an international equity portfolio. While giving investors exposure to emerging markets, it is also offering a very solid dividend yield that enhances the overall income level from the portfolio. XLY offers investors higher expected returns in a solid economy at the cost of higher risk. Using it as more than a small weighting would result in too much risk for the portfolio, but as a small weighting the diversification it offers relative to the core holding of SPY is eliminating most of the additional risk. REM is primarily there to offer a substantial increase in the dividend yield which is otherwise not very strong. The mREIT sector can be subject to some pretty harsh movements and dividends from mREITs should not be the core source of income for an investor. However, they can be used to enhance the level of dividend income while investors wait for their other equity investments to increase dividends over the coming decades. If you want a really quick version to refer back to, I put together the following chart that really simplifies the role of each investment: Name Ticker Role in Portfolio SPDR S&P 500 Trust ETF SPY Core of Portfolio Consumer Discretionary Select Sector SPDR ETF XLY Enhance Expected Returned First Trust Consumer Staples AlphaDEX ETF FXG Reduce Beta of Portfolio Vanguard FTSE Emerging Markets ETF VWO Exposure to Foreign Markets First Trust Utilities AlphaDEX ETF FXU Enhance Dividends, Lower Portfolio Risk SPDR Barclays Capital Short Term High Yield Bond ETF SJNK Low Volatility with over 5% Yield PowerShares 1-30 Laddered Treasury Portfolio ETF PLW Negative Beta Reduces Portfolio Risk iShares Mortgage Real Estate Capped ETF REM Enhance Current Income Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. Despite TLT being fairly volatile and tying SPY for the second highest volatility in the portfolio, it actually produces a negative risk contribution because it has a negative correlation with most of the portfolio. It is important to recognize that the “risk” on an investment needs to be considered in the context of the entire portfolio. To make it easier to analyze how risky each holding would be in the context of the portfolio, I have most of these holdings weighted at a simple 10%. Because of TLT’s heavy negative correlation, it receives a weighting of 20% and as the core of the portfolio SPY was weighted as 50%. Correlation The chart below 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 SJNK offers investors a very attractive yield that can help their portfolio produce a higher level of income if they are in need of immediate income. Despite that benefit, the fund has some substantial correlation with the major equity indexes and should be treated as a bit of a mix of debt and equity due to the risk factors. Despite being a debt instrument, the correlation with PLW is negative. In an interesting twist, we see that SJNK is actually showing more of a negative correlation with treasuries than FXU, the utility ETF in this scenario. Since SJNK is so credit sensitive, investors using it in their portfolio to enhance income should consider it as a replacement for part of their equity allocation rather than using it to replace treasuries in an a bid to generate more current income from their portfolio. It is fine to use junk bonds to enhance income, just don’t pretend that they will offer the same negative correlation benefits that treasury bonds offer. Scalper1 News
Scalper1 News