Tag Archives: alternative

Floating Rate ETFs In Flux

This article originally appeared in the April issue of WealthManagement Magazine and online at Floating Rate ETFs in Flux . With fed rate hikes likely coming at a slower pace, investors flee some floating-rate notes. Nearly a year ago, as part of our survey of alternative income funds (” Alternative Alternative Income “), we picked through a number of floating-rate note (FRN) portfolios to find the potential best-of-class performance should interest rates rise. Well, since then rates have risen by 34 basis points in the three-month Libor and 26 basis points in the three-month T-bill yield. Curiosity compels us to revisit the floater funds to see how the asset class has fared. Not all these portfolios are alike, so one shouldn’t expect uniform results. The vast majority of the $9.8 billion held by exchange traded fund (ETF) versions are invested in corporate securities. And, among these, there’s further differentiation by credit ratings. Most investors are attracted to funds holding high-yield securities, though significant assets are committed to investment-grade paper. The junk/quality split is 54/40 with the remaining 6 percent in municipal and Treasury notes as well as a fund devoted to variable-rate preferred stock and hybrid securities. Money Flows Overall money has flowed out of the 12 ETFs plying the floater trade over the last 12 months. Net redemptions of $417 million reduced the category’s asset base by 4 percent. This wasn’t a wholesale dumping; it was more tactical. Some segments lost assets, some gained. And that’s a story in itself. Junk note funds lost nearly 16 percent, or $986 million, while ETFs invested in higher-grade corporate notes saw inflows of nearly 5 percent, or $183 million. At the same time, there was a $5 million, or 45 percent, boost in the newer (and smaller) Treasury segment. The single fund devoted to municipal notes bled assets, losing $27 million, or 28 percent, of its base while the other singleton, the variable preferred stock ETF, tripled in size with $408 million in net creations. Two trends are at work here. Some of the high-yield assets migrated to safer havens, namely bank-grade and Treasury paper. Mainly, that’s been an escape from duration risk. Money’s also being drawn to the equity side in response to more encouraging economic data. The second trend is a mercenary search for yield. Consider the inflow to the preferred stock ETF. Dividend yields for variable preferreds indexed in the Wells Fargo Hybrid and Preferred Securities Floating and Variable Rate Index exceed 5 percent, significantly higher than the rates earned by junk notes. Investors believe that stocks, common or preferred, are okay to buy again. Especially if they produce lip-smackin’ income. The insulation from duration risk is a boon. So, let’s take a closer look at the cash thrown off by these ETFs, along with their return characteristics. High-Yield Corporate Floaters The 600-lb. gorilla among high-yield floater ETFs is the $3.7 billion PowerShares Senior Loan Portfolio ETF (NYSEARCA: BKLN ) , which owns more than 70 percent of the segment. As BKLN goes, so goes the segment. Buoyed by a market-weighted 4.22 percent dividend yield, high-yield ETFs collectively earned a total return of -2.54 percent over the past 12 months. The segment’s discernible duration is 2.27 percent, making it the most rate-sensitive in the asset class. When benchmarked against the i Shares Core Total U.S. Bond Market ETF (NYSEARCA: AGG ) , a broad market bond index tracker with a duration of 5.53 percent, you can see the bargain made by FRN investors: Aiming for higher dividends and less rate sensitivity, they settled for lower overall returns. Despite its middling dividend yield, assets have flowed to the First Trust Senior Loan ETF (NASDAQ: FTSL ) in the past year. FTSL is actively managed with a mandate that allows the portfolio to be invested in non-U.S. paper and equities. Net creations have boosted the fund’s asset base by 87 percent. Investment-Grade Corporate Floaters Dividends are a lot lower in the bank-grade segment. With a collective “A” credit rating, the segment’s market-weighted yield is just 0.58 percent. Modified duration, at 0.12 percent, is very low as well. Like high-yield corporates, total returns have been negative, though at -0.40 percent, less so. The $3.5 billion iShares Floating Rate Bond ETF (NYSEARCA: FLOT ) sets the segment’s pace, though the fund to beat has been the SPDR Barclays Investment Grade Floating Rate ETF (NYSEARCA: FLRN ) . FLRN is the only corporate floater that produced a positive total return over the past year. Treasury Floaters Floating-rate Treasury paper, with its low yield and virtually nonexistent duration is really a cash substitute. Investors, wary of potential Fed rate hikes, have goosed up the segment’s small asset base in the last 12 months. It’s the only segment, too, that’s produced a positive, albeit small, total return. Nearly all the segment’s assets are held in the iShares Treasury Floating Rate Bond ETF ( TFLO) . Other Floaters There are a couple of ETFs at the corners of the floating-rate market. The PowerShares Variable Rate Preferred Portfolio ETF (NYSEARCA: VRP ) , claiming the highest dividend yield in the class, earns the variable moniker in more than one way. It’s been one of the category’s more volatile issues, and ended up losing money overall in the past 12 months. A stablemate, the PowerShares VRDO Tax-Free Weekly Portfolio ETF (NYSEARCA: PVI ) , owns municipal bonds, rated AA- on average, that can be redeemed weekly. Duration is negligible, which make the fund a cash substitute. With no dividend stream, however, the total return pretty much reflects its holding costs. No wonder the fund lost assets. An Overview The side-by-side comparison in Chart 1 shows how the category’s biggest funds behaved over the past 12 months. Three ETFs-FLOT, PVI and TFLO-varied little from their starting values, but BKLN and VRP wobbled significantly. Such volatility speaks to inherent risk. Floating-rate funds limit duration risk so they’re obliged to take on more credit risk to generate attractive returns. We seem to have reached a risk inflection point, though. By and large, investors are fleeing the risk in the high-yield corporate market. That exodus, in great part, reflects investor perceptions that Fed rate hikes may be coming at a slower pace than originally expected. The advantage of holding variable-rate securities, then, has diminished, making other assets more appealing.

GDX: Gold’s Resurgence Can Keep Rising

By Brenton Garen and Tom Lydon An obvious though still impressive beneficiary of gold’s resurgence this year is the gold mining industry and its corresponding exchange traded funds. That includes the Market Vectors Gold Miners ETF (NYSEArca: GDX ) , the largest and most heavily traded gold miners ETF. GDX is up 50% year-to-date. Not only is that good for one of the best performances among non-leveraged ETFs, it also puts GDX up nearly three times as much as ETFs that hold physical gold. That does not mean GDX and rival gold miners ETFs are perfect investments, not when the industry still faces headwinds. Strategists point out that costs keep rising, which has narrowed profit margins among gold miners. Recent mine closures have not improved margins. Current mining operations are also facing deteriorating ore grades. The recent decline in energy prices and depreciating currencies where local miners operate have also had minimal beneficial impact on cash costs. Gold is seeing greater support from safe-haven demand after currency devaluations across Asia added to investment demand for a better store of value than paper currencies or stocks and bonds. Gold assets look more attractive in a low interest rate environment as the precious metal is more competitive against assets that pay low interest, like bonds. Additionally, if the Fed holds off on further rate hikes, it would suggests the economy is not as strong, which would also help gold attract safe-haven demand. “I believe this could be due to the fact that the cash cost of mining the yellow metal has not only been constantly below the gold price, but also falling. For miners, any increase in the price of gold can push the income as well as profit margins even higher,” according to a Seeking Alpha analysis of GDX. Supporting miners and GDX is the dollar, which has quickly weakened. The greenback is being weighed down on speculation that ongoing uncertainty may force the Federal Reserve to refrain from hiking interest rates in the near future. Consequently, a weaker USD makes alternative assets like metals more attractive . Market Vectors Gold Miners ETF Click to enlarge Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Why Now May Be The Moment To Get In On Value

The market’s almost immediate plunge to start 2016 cast a pall over what might have been shiny prospects for a new year, just two weeks from the Fed’s “balanced” assessment of U.S. economic conditions and the first rate hike in nearly nine years. Often forgotten in the doom and gloom is that volatility means down… and up. What intrigues me as a 30+-year value investor is that value stocks have been among the most volatile. And that seemingly has sent investors packing. At the end of 2015, there was $2.7 trillion in growth mutual funds, almost double the $1.5 trillion invested in value mutual funds. This underallocation to value stocks could mean missed opportunity. Let’s look at a hypothetical $10,000 investment in growth, core and value segments over the last decade. We can see where an investor might have missed out in this case. Click to enlarge Opportunity in the making We believe the recent overallocation to and performance strength in momentum and growth sets the stage for investor rebalancing. While the long-term path to value outperformance is not a straight line, and may be marked by alternating spates of value and growth leadership, we fully expect that investors are going to want and need to re-allocate back to value in their portfolios. As shown below, some of the periods of greatest value underperformance are followed by some of the most significant periods of outperformance. While the timing is impossible to predict, it’s not too great a leap to suggest we may be setting up for a rotation in favor of value stocks. Click to enlarge Actively seeking value Beginning in August of last year, the market began to price in weakening global economic conditions. The bearishness tightened its grip in the fourth quarter and early 2016, and as a result, we saw defensive stocks bid up to very full prices as value stocks got cheaper. It seems clear to me that the heightened volatility over this period has created attractive valuations in certain areas of the market. Indeed, by producing dislocations in the market, volatility effectively separates the potential stock winners of the future from underperformers. As the chart below shows, the valuation spreads within sectors are wider than their long-term historic average in many areas of the market. The greater the controversy in the investment case, the greater the dispersion in valuation. That means some stocks are priced low and others high. We are seeing that most acutely in the energy sector. Click to enlarge But buyer beware: Determining which of those low-priced names are true bargains and which are priced low for good reason requires deep understanding of each industry and company. While we approach the market stock by stock, certain areas seem riper for the picking now: Banks. We see banks as less volatile than they have been in the not-too-distant past, characterized by stronger balance sheets and less volatile results. Yet, they are trading at lower valuations. Energy. The key questions here are: 1) when will oil prices bottom and 2) how high will oil prices go in a recovery? We lean to the optimistic side on both. We think oil prices could bottom in the second quarter and head up in the second half of 2016. And while the consensus sees oil recovering to $50-$60 a barrel, our year-end estimate is above $75. But selectivity is important. An investor grab for high-quality, low-risk stocks without regard for valuation or risk/reward has created some attractive long-term opportunities elsewhere in the sector, but a number of stocks in this sector will continue to underperform. Technology. By our analysis, large-cap tech stocks with high return on invested capital are trading at cheap valuations relative to both their history and the broader market, while also generating solid cash. The significant cash balances allow flexibility, and the recent price declines of fast-growing companies may create attractive merger and acquisition opportunities. Healthcare. Despite current market fears, we’ve found a number of interesting stocks that are attractively priced relative to history and compared to the broader market. Healthcare also exhibits better growth and is cheaper than other defensive sectors, such as consumer staples and utilities. The sector benefits from favorable demographic tailwinds (namely, the aging of the population) and continued innovation. Of course, this only scratches the surface. My colleagues and I are excited about the opportunity ahead. Our objective is to work from the bottom up (starting with the individual stocks) to find compelling investment opportunities that are mispriced by the market over a two- to three-year time horizon. We believe the current environment is wildly conducive to that. While we acknowledge China’s overcapacity and economic weakness, we believe the market was overzealous in pricing in the probability of a U.S. recession. In fact, February and early March have shown a reversal in pessimism… and in markets. This has created some attractive investment opportunities. In our assessment, the period of underperformance has produced some bargains and sets the stage for a rebalancing in favor of value. This post originally appeared on the BlackRock Blog.