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The PowerShares S&P 500 Low Volatility Portfolio ETF: Taming The Shrew?

An S&P tracking fund that ‘filters out’ volatile S&P issuers and tempers overall volatility. The fund has proven itself with consistent dividends and share appreciation. Incepted in May 2011, the fund has yet to be proven in a bear market. In the dialogue of ” The Taming of the Shrew” , Gremio famously asks , ” But will you woo this wild-cat? ” Gremio must have surely understood investing! You see, trying to tame portfolio volatility is like wooing a wildcat. However, as many an investor has discovered, there’s no attaining above average returns without taking higher volatility risks. According to Investopedia, “Alpha is one of five technical risk ratios; the others are beta, standard deviation, R-squared and Sharpe ratio” and that Alpha is, ” the excess return of the fund relative to the return of the benchmark index. ” Every passionate investor seeks Alpha through ” a course of learning and ingenious studies,… though time seem so adverse and means unfit .” Another technical risk ratio, ” Beta “, is the measure of volatility relative to the market. In brief, it’s a statistical relationship measuring the volatility of an asset relative to the market as a whole; i.e., to a benchmark. The benchmark is assigned a beta of 1. A beta of less than 1 means that the asset is less volatile than the market and a beta greater than 1 means that the asset is more volatile than the market. Beta is best thought of as the expected percentile change of an asset’s value relative to a benchmark change. After a little thought a prudent investor is certain to ask whether it’s possible, through careful selection of low volatility stocks, to produce above average results. In other words, can low beta produce high alpha? A passionate retail investor might even attempt to construct such a portfolio but generally speaking it would be quite a task. So it begs the question, whether there are ETF products available to satisfy this requirement. There are at least 20 volatility focused ETFs. These include those focused on the Russell 2000 and Russell 1000, S&P 500 enhanced volatility, rate-sensitive low volatility, Japanese, European, International Developed Market, Emerging Market and Global volatility focused funds. There’s one plain vanilla ETF that seems to focus simply S&P 500 low volatility. That is the PowerShares S&P 500 Low Volatility Portfolio ETF (NYSEARCA: SPLV ). According to Invesco: The PowerShares S&P 500 ® Low Volatility Portfolio is based on the S&P 500 ® Low Volatility Index… …The Index is compiled, maintained and calculated by Standard & Poor’s and consists of the 100 stocks from the S&P 500 ® Index with the lowest realized volatility over the past 12 months… The fund remains at least 90% invested at all times. Since the fund’s objective is to track low volatility, it’s a good idea to see how volatility is distributed throughout the fund. It’s said that a picture is worth a thousand words so the following table tells quite a story. The question becomes just how to describe the volatility by sector. To this end, a simplified version of beta is constructed by determining a simple average beta of the fund and it’s sectors and then comparing it with the entire S&P 500. This may be accomplished through the use of the corresponding individual Select Sector SPDR S&P ETFs. Average Beta Per Sector Sector Average Beta Consumer Discretionary 0.990 Sonsumer Staples 0.878 Financials 0.864 Health Care 0.858 Industrials 0.761 Technology* 0.670 Materials 0.893 Utilities 0.220 Energy 0.000 Average 0.682 According to Select Sector SPDR; … Each Select Sector Index is calculated using a modified “market capitalization” methodology. This formula ensures that each of the component stocks within a Select Sector Index is represented in a proportion consistent with its percentage of the total market cap of that particular index. However, all nine Select Sector SPDRs are diversified mutual funds with respect to the Internal Revenue Code. As a result, each Sector Index will be modified so that an individual security does not comprise more than 25% of the index… According to the Select Sector prospectus these are actively managed funds and are focused on tracking the entire sector regardless of volatility . It’s then becomes a simple matter to table and compare each sector’s beta. The S&P 500 is divided into 9 sectors. The fund is also divided into nine sectors but in a different way. The companies in the fund’s IT and Telecom sectors are included under the single heading of the S&P ‘technology sector’. Also, SPLV omits the energy sector completely. Hence, in order to create a 1-1 correspondence, the IT and Telecom sectors are combined and an entry of 0.00 is assigned to the energy sector. Beta Comparison Table Sector SPLV Weight SPLV Beta SPDR Beta Consumer Discretionary 6.504% 0.990 1.050 Consumer Staples 21.028% 0.878 0.610 Financials 35.413% 0.864 1.270 Health Care 11.195% 0.858 0.690 Industrials 14.083% 0.761 1.200 Technology* 6.355% 0.670 1.000 Materials 2.832% 0.893 1.290 Utilities 2.596% 0.220 0.250 Energy 0.000% 0.000 1.340 Average SPLV Beta 0.682 It is plain to see from the table that in some cases, the SPDR Sector Fund actually has a lower beta than does the SPLV sector. It is important to observe also, the Select Sector SPDR funds have far more holdings in each portfolio. For example, the SPLV financial sector includes 35 holdings and a beta of 0.864. On the other hand, the Select Sector SPDR Financial Sector fund, XLF has 88 holdings, essentially the entire S&P financial sector, with a beta of 1.27. What about SPLV’s performance when compared to the entire S&P 500? This is accomplished through the use of the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) which tracks the performance of the S&P 500. ETF Shares 1 Month YTD 1 Year 3 Year From 5-5-2011 SPY -2.17% 0.87% 5.09% 53.20% 54.86% SPLV -0.72% -2.19% 4.86% 34.53% 46.69% In the volatile month of June, SPLV did prove its mettle, losing a mere -0.72% versus a -2.17% loss for the unrestricted S&P tracking SPY. Year to date SPY was virtually unchanged with a 0.87% gain whereas the more defensive SPLV was down; -2.19%. This is more than should have been expected. Having an average 68% of the volatility of the S&P, SPLV should have returned at least a positive 0.59%. Over one year, it was nearly even with the unrestricted S&P tracking ETF. Over three years, the SPLV low volatility shares returned 34.53%, which works out to about 64.90% of the 53.20% return of the market tracking SPY shares. Hence, in the expectation ballpark. Lastly, from the inception date of May 11, 2011, SPLV outperformed its expectations with a 46.69 return vs. the unrestricted SPY’s 54.86%. Having an average of 68% of the S&P volatility, a 37.30% returned would have been expected. These are market price comparisons which do not include the $3.5381 total dividends distributed since the May 5, 2011 inception date. (click to enlarge) The question then becomes whether holding a low volatility S&P fund is worth the sacrifice of some of the upside gains vs. the unrestricted S&P 500? This is difficult to answer since SPLV came to market, as mentioned, in May of 2011 and has yet to prove itself in a real bear market. However, if the correlation of the fund to date is any indication, SPLV may well serve as an excellent ‘ defensive tool ‘ for an investor already in the market. There are many important questions the investor must consider. For example, is it worth the commission cost of reallocating? How much of the investor’s portfolio is really at risk? What will be the short or long term capital gains tax risk? Is there enough free capital at hand to ‘average down’ portfolio holdings in the event of a bear market? There are numerous good reasons to invest in the fund. For example, an investor might be too close to retirement to risk the full volatility of the equities market, but still has several years before the funds are needed, may consider it. Another is too use the fund to protect profits accumulated over the past several years and still participate in the market. It’s also important to note that the fund is marginable and that there are listed options for SPLV. Hence an experienced option investor may use SPLV as an underlying asset in combination with various options strategies. According to the summary prospectus the fund carries 100 holdings, matching the number of holdings in the S&P Low Volatility index and has 127.4 million shares outstanding adding up to a $4.742 billion market cap. However, it should be noted that the fund’s most recent P/E at 19.37% is higher than the unrestricted SPY P/E at 17.46. The fund is currently selling at a very low premium to its underlying NAV at 0.08%. SPLV has paid 43 dividends since inception totaling $3.5381 per share. That works out to 14.1978% of the fund’s closing price on its first day of trading 5/5/2011. Management fees are 0.25%. In summary, it seems that volatility can be indeed be tamed but it is done so at the expense of alpha. However, for those willing to devote themselves to a low volatility S&P fund, nested in a carefully diversified portfolio for the long term, well else can be said other than all’s well that ends well. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: CFDs, spread betting and FX can result in losses exceeding your initial deposit. They are not suitable for everyone, so please ensure you understand the risks. Seek independent financial advice if necessary. Nothing in this article should be considered a personal recommendation. It does not account for your personal circumstances or appetite for risk.

Raining On The All Seasons Portfolio

Investors are hungry for success stories, especially tales that include high returns with low risk. And the investment industry is always happy to stoke that appetite. One of the most popular stories today is the so-called All Seasons portfolio, whose virtues are trumpeted in the massive bestseller Money: Master the Game , by motivational speaker Tony Robbins. The book has been out since last November, and I thought the hype would blow over quickly, but I’m still getting inquiries about it, so I thought I’d take a closer look. The All Seasons portfolio was created by Ray Dalio of Bridgewater Associates , one of the largest hedge fund managers in the world. It’s based on Dalio’s similarly named All Weather fund , which reportedly has more than $80 billion USD in assets. The portfolio has the following asset mix: 30% Stocks 40% Long-term bonds 15% Intermediate bonds 7.5% Gold 7.5% Commodities In a backtest covering the 30 years from 1984 through 2013, the All Seasons portfolio had an annualized return of 9.7% (net of fees) and only four years with a loss. Its worst year was a modest -4% in 2008. With a risk-return profile like that, it’s no wonder so many investors have been attracted to the All Seasons portfolio. In fact, a service run by Robbins’ own advisor has been swamped with requests from investors who want a piece of this seemingly miraculous strategy. So, is the All Seasons portfolio really a recipe for stellar returns with minimal risk? Or is it just another example of investors chasing hypothetical past performance? The reasons for the seasons The All Seasons portfolio is based on the idea that asset prices move in response to four forces: rising economic growth, declining economic growth, inflation and deflation. In each of these economic “seasons,” some asset classes thrive and others suffer. For example, when growth is strong and inflation is low, stocks are likely to perform well, whereas commodities and gold benefit from rising growth and rising inflation. Bonds do well when economic growth and inflation are both falling. By including all of these asset classes in your portfolio, you’ll do well under all conditions. It’s like travelling with sunscreen, an umbrella, a swimsuit and a parka. There’s nothing wrong with this general idea: most investors understand that a portfolio should include asset classes with low (or even negative) correlation . Nor is it an original thesis: it’s very similar to what Harry Browne wrote in the early 1980s. Browne’s Permanent Portfolio was also based on the principle that you should hold asset classes that would thrive during four economic scenarios: stocks for prosperity, cash for recessions, gold for inflation protection, and long-term bonds for deflation. (If you’re interested in learning more, read Part 1 and Part 2 of my 2011 interview with Craig Rowland, co-author of The Permanent Portfolio .) Was the performance really remarkable? But while the premise of the All Seasons portfolio is reasonable, there’s nothing astonishing about its performance during the last 30 years. Moreover, anyone expecting it to deliver 9.7% with low risk in the future is likely to be disappointed. The returns were unremarkable. A 9.7% annualized return doesn’t mean much unless you compare it to the alternatives. The truth is that all diversified portfolios performed well during the last three decades. Despite the carnage of the dot-com bust at the turn of the millennium and the financial crisis of 2008-09, most of those 30 years were extremely kind to stocks. Late 1987 to the spring of 2000 saw the longest bull market in history, and the one we’re enjoying now ranks third all-time. From 1984 through 2013, the S&P 500 returned a whopping 11.1%. And what about bonds, which make up 55% of the All Seasons portfolio? In the US, long-term government bonds returned 9.4% during the period. In Canada, they did even better: the FTSE TMX Canada Long-Term Bond Index returned 10.3% over those 30 years. Once you consider the context, a 9.7% annualized return since 1984 isn’t remarkable at all. Anyone who stayed invested in a diversified portfolio would have seen similar results. The risk was not “extremely low.” OK, maybe the returns of the All Seasons portfolio were in line with a traditional balanced portfolio, but risk was much lower, right? In an article for Yahoo Finance , Robbins reports that the standard deviation of the portfolio during the 30-year period was 7.63%, which he declares is “extremely low risk and low volatility.” I’m not sure investors would agree with that assessment. If a portfolio has an average expected return of 9.7% and a standard deviation of 7.6%, that means in 19 years out of 20, its annual return can be expected to range between -6% and 25%. That’s not “extremely low volatility”: it’s about the same as that of a traditional balanced portfolio. In our white paper Great Expectations , my colleague Raymond Kerzhéro and I found that a portfolio of 40% bonds and 60% global stocks had a standard deviation of about 7.8% over a similar period (1988 to 2013). What about the fact that the All Seasons had only four negative years, all with only modest losses? Robbins and Dalio frequently compare the All Seasons portfolio to the S&P 500, which certainly saw much larger and more frequent drawdowns. But this is a totally inappropriate benchmark, as the All Seasons portfolio includes just 30% stocks. Dalio’s portfolio holds 55% bonds, which are far less volatile than stocks. More important, bonds only lose value when interest rates rise, and from 1984 to 2013, the yield on 30-year Treasuries fell from over 11% to about 3.5%. Any bond-heavy portfolio would have seen rare and modest drawdowns during that period. There were many disappointing periods. The long-term returns of almost any diversified portfolio look impressive, but unfortunately you can’t buy 30 years of performance in advance: you have to earn those returns by doggedly sticking to your plan even when it disappoints. And let’s be clear: the All Seasons portfolio would have tried your patience many times. While the portfolio never suffered huge losses, it would have significantly lagged a traditional balanced portfolio during the many periods when stocks delivered double-digit returns. That’s why this strategy – and the Permanent Portfolio, for that matter – had few followers during the 1980s and 1990s. A portfolio with just 30% stocks would have been met with derision during that long, giddy bull market. Gold would have been even harder to hold. Sure, it glittered during the most recent financial crisis, but during the 21 years from 1984 through 2004, the real return on gold in Canadian dollars was -2.3% annually. Would you have had the guts to hold it through two money-losing decades? Don’t make the mistake of thinking it’s easy to stick with a strategy when it underperforms during strong bull markets, as the All Seasons portfolio is almost certain to do. Bridgewater’s own All Weather fund returned -3.9% in 2013 , one of the best years for stocks in recent history (the MSCI World Index was up almost 34% in Canadian dollars). My guess is that Dalio’s clients took little comfort in the fact that strategy performed well in historical backtesting. Couldn’t stand the weather My goal here is not to beat up on the All Seasons portfolio specifically: on the contrary, I wanted to show that in many ways it’s not fundamentally different from other balanced portfolios. My concern is that the All Seasons portfolio is presented as a magic formula that will dramatically outperform a traditional stock-and-bond portfolio with far less risk. The very name implies that it will perform well during all market conditions. But that wasn’t true over the last 30-plus years, and it’s even less likely to be the case during a period of low interest rates. (No one knows where rates are headed, but it’s absurd to expect 9% or 10% returns on bonds when yields are 1% to 3%.) A well-diversified, low-cost portfolio executed with discipline offers your best chance of enjoying market returns with moderate volatility. But there’s no secret recipe, no optimal asset allocation, and no reward without risk. Be skeptical of anyone who suggests otherwise.

Will A Fidelity Select Funds Portfolio Perform Well In A Rising Interest Rates Environment?

Summary Old portfolio: FBMPX, FSCHX, FSELX, FSPHX, FGMNX. New portfolio: FBMPX, FSCHX, FSELX, FSPHX, FIBIX, FSBIX. The new portfolio significantly outperforms the old one. In a previous article , we presented the performance of a portfolio made up of five Fidelity select mutual funds. That portfolio had a stellar performance over the whole 27-year period from 1987 to 2015, but we are concerned about its performance in a stock bear market within a rising interest rate environment. To increase its robustness for such events, we decided to replace the GNMA fund (MUTF: FGMNX ) with two high-quality government bonds. The portfolio is made up of the following funds: Fidelity Select Multimedia Portfolio No Load (MUTF: FBMPX ) Fidelity Select Chemicals Portfolio No Load (MUTF: FSCHX ) Fidelity Select Electronics Portfolio No Load (MUTF: FSELX ) Fidelity Select Medical Delivery Portfolio No Load (MUTF: FSHCX ) Fidelity Spartan Intermediate Trust Bond Index Fund Inv (MUTF: FIBIX ) Fidelity Spartan Short Term Trust Bond Index Fund Inv (MUTF: FSBIX ) Our old portfolio performed very well during the two big bear markets of 2000-03 and 2008-09. During those markets, the portfolio was invested mostly in the GNMA fund that experienced growth due to declining interest rates associated with economic contraction. But if a stock bear market happens while interest rates are rising, the GNMA fund most likely would not offer protection. We expect that a short-term government bond would allow the portfolio capital to be preserved during such adverse market environments. Due to their low sensitivity to interest rates, the short-term Treasury bonds act mostly as cash. Basic information about the funds was extracted from Yahoo Finance and is shown in the table below. Table 1 Symbol Inception date Net assets Yield% Category FSELX 7/29/1985 2.32B 0.47% Technology FBMPX 6/30/1986 803M 0.24% Consumer Cyclical FSPHX 7/14/1981 10.75B 1.90% Health FSCHX 7/29/1985 1.47B 1.02% Natural Resources FIBIX 12/20/2005 1.35B 1.90% Intermediate Term Treasuries FSBIX 12/20/2005 863M 0.76% Short Term Treasuries Since the historical price data of the bond funds is available only from December 2005 on, and we need 65 trading days for estimating market parameters, we were able to simulate our optimal allocation strategy starting with April 2006. We performed an analysis of the difference in performance of the old and the new portfolios. The data for the study were downloaded from Yahoo Finance , using the Historical Prices menu for FGMNX, FBMPX, FSCHX, FSELX, FSPHX, FIBIX, and FSBIX, respectively. We use the daily price data adjusted for dividend payments. The portfolio is managed as dictated by a variance-return optimization algorithm developed on the Modern Portfolio Theory ( Markowitz ). The allocation is rebalanced monthly at market closing of the first trading day of the month. In table 2 below, we present the performance of the new portfolio for three levels of risk. Table 2. Portfolio performance from April 2006 to June 2015 TotRet% CAGR% No. of trades maxDD% VOL% Sharpe Sortino Low risk 247.96 14.41 112 -8.02 8.81 1.63 2.27 Medium risk 363.25 18 108 -9.86 12.35 1.46 2.01 High risk 457.9 20.39 94 -13.26 15.01 1.36 1.9 SPY 91.37 7.26 0 -55.18 20.98 0.35 0.41 In figure 1, we show the graphs of the portfolio equities. (click to enlarge) Figure 1. Equity curves for three portfolios adaptively optimized for low-, medium- and high-risk targets. Source: This chart is based on EXCEL calculations, using the adjusted monthly closing share prices of securities. In figure 2 below, we show the time variation of the percentage allocation of the funds for medium risk. (click to enlarge) Figure 2. Asset allocations for the new portfolio adaptively optimized for the medium risk target Source: This chart is based on EXCEL calculations, using the adjusted monthly closing share prices of securities. In figure 2, it can be observed that during the bear market of 2008-09, most money was allocated to the intermediate-term bond fund, FIBIX. During the market corrections of 2010 and 2011, most money was allocated to the short-term bond fund, FSBIX. The current fund allocations are shown in table 3. Table 3. Asset allocations for July 2015 FSELX FBMPX FSPHX FSCHX FIBIX FSBIX Low risk 30% 70% 0% 0% 0% 0% Medium risk 0% 100% 0% 0% 0% 0% High risk 0% 100% 0% 0% 0% 0% We also simulated the performance of the old portfolio over the same time period from April 2006 to June 2015 and for the same risk levels. Consistently over the whole simulation period, the new portfolio outperformed the old one by about a 40% increase in annual returns and a 20% or more decrease in maximum drawdown. We compared the returns of the portfolios over the bear market of 2008 and the market corrections of 2010 and 2011. The results are shown in table 4. Table 4. Total returns of the portfolios during market downturns Time Period SPY Old Portfolio New Portfolio 12/2007 – 3/2009 -48.92 -11.08% 9.74% 3/2010 – 7/2010 -10.95 -5.75% -0.30% 4/2011 – 9/2011 -16.22 -1.59% 15.51% From table 4, it is clear that the new portfolio performs better than the old one, and that it is very robust to market downturns. Unfortunately, there were no long enough periods of rising interest rates to allow us to make any judgment about the behavior of the portfolios during such times. It is our belief that in a long period of rising interest rates, the new portfolio will suffer only small losses by parking the money in the short-term bond fund. Conclusion The modified Fidelity portfolio performed significantly better than the old one. It even made gains during the 2008 bear market and the 2011 market correction. While there is no empirical data to prove it, we believe that the new portfolio is robust and will perform well even during a prolonged period of rising interest rates. Disclosure: I am/we are long FSELX, FSPHX. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.