Tag Archives: consumer

IYR: This REIT ETF Has Some Great Holdings

Summary The portfolio construction of IYR is easy to admire. They took the risk of making the second heaviest weighting an equity REIT with extreme levels of operational leverage. They even incorporate a very small weighting to mREITs which further diversifies the portfolio. A heavy allocation to REITs makes more sense for investors that are weak on bond positions. 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. One of the funds that I’m considering is the iShares U.S. Real Estate ETF (NYSEARCA: IYR ). 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. Expense Ratio The expense ratio on IYR is .43%. Compared to other domestic equity funds like the Vanguard REIT Index ETF (NYSEARCA: VNQ ) or the Schwab U.S. REIT ETF (NYSEARCA: SCHH ), that is painfully high. VNQ charges .12% and SCHH charges .07%. Because I love diversification at low costs, I’m holding both VNQ and SCHH in my personal portfolio. Largest Holdings (click to enlarge) A large position to Simon Property Group (NYSE: SPG ) is a fairly normal starting point for most REIT ETFs. The very interesting thing about this portfolio is that they are using American Tower REIT Corp (NYSE: AMT ) as the second holding. For investors that are not familiar with AMT, they are a global telecommunications REIT. When you place a call from your cell phone, you may be using the services AMT provides as they contract with cellular companies to lease usage of their cell phone towers. The REIT has a very weak dividend yield and from most pricing metrics it looks absurdly expensive. The reason investors have kept shares of AMT so expensive is because their structure incorporates an enormous amount of operating leverage. When they go from having one client to two clients for a cell phone tower the variable costs are extremely low while the revenue scales up substantially. This is an interesting play because most holders of a REIT index would be looking to use the position to grab some dividends and AMT has fairly weak dividends. On the other hand, AMT is one of three major companies in their very small sector and there is the potential for excellent returns. This is a play with high risk and high potential returns. The best way to make those kinds of high risk plays is within the context of a diversified portfolio, so it makes sense that it would get a significant allocation within an ETF. Simply put, this strategy makes more sense from a diversification perspective than it does when we are considering why the investor might initially choose to buy a REIT ETF. Sector Exposure This breakdown of the sector exposure reinforces what I was seeing in the initial holdings chart. The heavy position in specialized REITs suggests a goal of using the ETF structure to create a portfolio that is substantially less volatile than the underlying holdings. Overall, I like the strategy in the portfolio construction. While I’d like to see more breakdowns on the “specialized” sector, I have to admit that I really admire seeing the ETF work to incorporate other types of holdings such as mREITs. That sector is highly complex and I spend a great deal of my time explaining it to investors. If investors get their exposure through a very small allocation within a REIT ETF, that would be a solid way to prevent the common investor mistakes of buying high and selling low which seems to be extremely common in the mREIT sector. Building the Portfolio The sample portfolio I ran for this assessment is one that came out feeling a bit awkward. I’ve had some requests to include biotechnology ETFs and I decided it would be wise to also include a the related field of health care for a comparison. Since I wanted to create quite a bit of diversification, I put in 9 ETFs plus the S&P 500. The resulting portfolio is one that I think turned out to be too risky for most investors and certainly too risky for older investors. Despite that weakness, I opted to go with highlighting these ETFs in this manner because I think it is useful to show investors what it looks like when the allocations result in a suboptimal allocation. The weightings for each ETF in the portfolio are a simple 10% which results in 20% of the portfolio going to the combined Health Care and Biotechnology sectors. Outside of that we have one spot each for REITs, high yield bonds, TIPS, emerging market consumer staples, domestic consumer staples, foreign large capitalization firms, and long term bonds. The first thing I want to point out about these allocations are that for any older investor, running only 30% in bonds with 10% of that being high yield bonds is putting yourself in a fairly dangerous position. I will be highlighting the individual ETFs, but I would not endorse this portfolio as a whole. 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 10.00% 2.11% Health Care Select Sect SPDR ETF XLV 10.00% 1.40% SPDR Biotech ETF XBI 10.00% 1.54% iShares U.S. Real Estate ETF IYR 10.00% 3.83% PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB 10.00% 4.51% FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT 10.00% 0.16% EGShares Emerging Markets Consumer ETF ECON 10.00% 1.34% Fidelity MSCI Consumer Staples Index ETF FSTA 10.00% 2.99% iShares MSCI EAFE ETF EFA 10.00% 2.89% Vanguard Long-Term Bond ETF BLV 10.00% 4.02% Portfolio 100.00% 2.48% The next chart shows the annualized volatility and beta of the portfolio since October of 2013. (click to enlarge) Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. You can see immediately since this is a simple “equal weight” portfolio that XBI is by far the most risky ETF from the perspective of what it does to the portfolio’s volatility. You can also see that BLV has a negative total risk impact on the portfolio. When you see negative risk contributions in this kind of assessment it generally means that there will be significantly negative correlations with other asset classes in the portfolio. The position in TDTT is also unique for having a risk contribution of almost nothing. Unfortunately, it also provides a weak yield and weak return with little opportunity for that to change unless yields on TIPS improve substantially. If that happened, it would create a significant loss before the position would start generating meaningful levels of income. A quick rundown of the portfolio 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 Health Care Select Sect SPDR ETF XLV Hedge Risk of Higher Costs SPDR Biotech ETF XBI Increase Expected Return iShares U.S. Real Estate ETF IYR Diversify Domestic Risk PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB Strong Yields on Bond Investments FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT Very Low Volatility EGShares Emerging Markets Consumer ETF ECON Enhance Foreign Exposure Fidelity MSCI Consumer Staples Index ETF FSTA Reduce Portfolio Risk iShares MSCI EAFE ETF EFA Enhance Foreign Exposure Vanguard Long-Term Bond ETF BLV Negative Correlation, Strong Yield 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 IYR has a great portfolio construction methodology for investors that want some diversified exposure to equity REITs. The dividend yield of 3.83% isn’t mind blowing, but it is higher than the yield on SCHH. Of course, investments in mREITs should help strengthen the dividend yield to make up for REITs like AMT that are priced based on expected future revenue growth combined with exceptional operational leverage. The only thing I really dislike in this ETF is that the expense ratio is just too high. I can’t justify paying that kind of expense ratio for a REIT ETF. If an investor is willing to put up with the huge expense ratio, they should take notice that the fund has a positive correlation with the long term bond portfolio in BLV. That can be difficult because investors would like to be able to use the negative correlations to hammer the portfolio volatility lower. On the other hand, the moderate correlation with the S&P 500 makes it a reasonable option for investors that intend to be running a portfolio that is very heavy on equities. I fall under that category. I run extremely heavy on equities and use a significantly higher allocation to equity REITs than I would if I were running a strong bond allocation.

Consumer Staples Momo ETF Is A Winning Smart Beta Selection In A Defensive Sector

Investors looking for an ETF that is both defensive and has the potential for out performance should review PowerShares DWA Consumer Staples Momentum ETF. FINRA recently chimed in on Smart Beta ETFs with a Caveat Emptor opinion. As long as the US Dollar remains strong, this ETF should continue to excel. As with many previous market downturns, money has been flowing into the “safer” sectors of utilities, consumer staples, and telecom. If one looks at the recent high of the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) at $213.50 on May 21, the markets have fallen -9.3% as of Sept 23. Popular ETFs for these sectors are the Utilities Select Sector SPDR ETF (NYSEARCA: XLU ), the Consumer Staples Select Sector SPDR ETF (NYSEARCA: XLP ) and the SPDR S&P Telecom ETF (NYSEARCA: XTL ). Since May 21, utility and consumer staples investors have been rewarded with better relative declines of -5.9% and -4.9%, respectively, while telecom lost about market average of -9.8%. However, if one looked at the declines of these sector ETFs from their most recent highs, the carnage is a bit worse. Utilities peaked on Jan 29 and has declined -15.1%, telecom peaked on June 18 and has fallen -11.9%. Consumer staples peaked on Aug 5 and has declined -7.2%. On a year to date base, SPY is down -2.9%, XLU -8.5%, XTL -3.3%, and XLP -1.2%. Within these popular defensive sectors, consumer staples would seem to be the best performer for relative performance against a backdrop of an overall market decline. There are 13 consumer staples ETFs listed on ETFdb.com . YTD performance ranges from 9.39% for the PowerShares DWA Consumer Staples Momentum Portfolio ETF (NYSEARCA: PSL ) to -46.1% for the Global X Brazil Consumer ETF (NYSEARCA: BRAQ ). The top three YTD US performers were: PSL, the PowerShares Dynamic Food & Beverage Portfolio ETF (NYSEARCA: PBJ ) at 5.3% and the Guggenheim S&P Equal Weight Consumer Staples ETF (NYSEARCA: RHS ) at 2.5%. On a 1-yr, 3-yr and 5-yr basis, PSL has outperformed both the SPY and XLP, with the majority of its relative strength clocking in since Oct 2014. Prior, PSL mirrored SPY and bested XLP and the recent outperformance has lifted overall returns. According to etfdb.com, during the past year, PSL has returned 18.5% vs 7.5% for XLP, on a 3-yr basis, PSL has returned 70.5% vs 41.9% for XLP, and on a 5-yr basis, PSL has returned 123.7% vs 93.9% for XLP. A 3-yr graph of PSL vs SPY and XLP is below. What is the investment strategy of PSL that creates the outperformance? As a “smart beta” ETF, the underlying portfolio shifts quarterly centered on individual stock’s technical performance relative to the sector. PSL is a PowerShares ETF offered by Invesco. From their website : “The PowerShares DWA Consumer Staples Momentum Portfolio ((Fund)) is based on the Dorsey Wright® Consumer Staples Technical Leaders Index (DWA Consumer Staples Technical Leaders Index). The Fund will normally invest at least 90% of its total assets in common stocks that comprise the Index. The Index is designed to identify companies that are showing relative strength (momentum), and is composed of at least 30 common stocks from the NASDAQ US Benchmark Index. The Fund and the Index are rebalanced and reconstituted quarterly.” Zack’s comments on PSL: “Consumer staples sector is on the rise as it is directly linked with improving economic fundamentals, in particular the spending power, which has increased owing to cheap fuel and rising income. As such, PSL has been able to withstand global worries, gaining 2.6% so far in the second half. The ETF provides exposure to 32 stocks having positive relative strength (momentum) characteristics by tracking the DWA Consumer Staples Technical Leaders Index. It has amassed $203.4 million in AUM and trades in lower volume of 56,000 shares a day on average. Expense ratio came in at 0.60%. The product is pretty spread out across securities, with each holding less than 4.9% of assets. It has a definite tilt toward mid cap stocks while the other two market cap levels take the remainder. Food products, beverages and household durables are the key industries in the ETF having double-digit exposure each.” Momentum investing, aka “momo”, is a strategy of buying stocks that have generated high returns over the past three to twelve months, and selling those that have experienced poor returns over the same period. The ETF seeks investment results that correspond to the price and yield of the DWA Consumer Staples Technical Leaders Index, which evaluates companies based on a variety of investment criteria, including fundamental growth, stock valuation, investment timeliness and risk, comparative to others in the sector. From DWA website concerning their relative strength and top-down approach: “Relative Strength: Relative Strength, the measurement of how one security performs in comparison to another, is a key concept within Dorsey Wright’s methodology. Before investing in UPS, one should understand its recent performance relative to FedEx, or the S&P 500. The same logic can be applied to sector analysis, asset class evaluation, mutual funds, ETFs, commodities, fixed income, and even foreign countries. A relative strength matrix is like a massive tournament, where a huge quantity of investment options can be compared to one another – and we see who is strongest. Relative strength is the basis for virtually all of our managed products, where we select the best investment options from within a large universe of options. Top-Down Approach: We use primary market indicators to get a measure of overall risk, and then analyze broad industry sectors to determine which are in favor. We want to invest in sectors that are controlled by demand. We then select investments that have positive relative strength and have a good probability of outperforming the market. We do not feel compelled to be fully invested in stocks when an alternative investment (cash reserves) offers a more attractive opportunity. In fact, it is our belief that avoiding severe losses is extremely important in achieving strong market performance over the course of an entire market cycle.” PSL is one of 14 momentum driven ETFs utilizing various Dorsey Wright Technical Leaders Indexes and a list of other Indexes is found here . DWA offers an in-depth White Paper on the Dorsey Wright Strategy titled ” Relative Strength and Portfolio Management ” pdf. PSL was rebalanced on June 30 and the most recent list of stocks is below: (click to enlarge) Due to its focus on owning the top momentum stocks with quarterly rebalancing, investors should not be surprised at a high 83% Annual Turnover Rate. According to Morningstar, of the companies listed above, one was purchased in 2012, three in 2013, nineteen in 2014 and nine in 2015. The ETF’s industry allocation is broad based within the consumer staples sector and is reported by Invesco as follow: As the strategy includes NASDAQ stocks, PSL’s portfolio will have higher exposure to mid-caps and small-caps than its large cap S&P ETF brethren. Not only are smaller companies known for higher earnings potential, but usually are focused on domestic US markets rather than an extensive international network. Recently, the strength of the US Dollar has weighted on revenue growth and exchange rates for large cap companies, and this concern is usually less with smaller companies. The strength in domestic markets and reduced currency risk exposure may be a factor in these specific company’s current individual outperformance. The outperformance of PSL compared to XLP coincides with the meteorically rise in the US Dollar starting in Aug 2014. The average market cap in the portfolio is $14.5 billion and 72% of the portfolio are mid-caps or smaller. Below is a table offered by Morningstar of PSL valuation and growth matrix compared to the Benchmark of S&P 1500 Consumer Staples and the Category of Morningstar Defensive. While the comparison indicates PSL is trading at a higher valuation than the Benchmark and Category, its growth profile is also quite a bit higher. With Cash-Flow Growth 25% above the benchmark and Book-Value Growth more than double the Benchmark, a higher valuation would seem appropriate. This week, FINRA issued an Investor Alert titled, “Smart Beta-What You Need to Know”. The bottom line of the alert is the old adage: Know what you are buying and what the strategy is of the specific ETF. There are about 840 products that fall into a smart beta category, representing almost half of all the exchange-traded products listed in the U.S. and investors should understand that any strategy that aims to beat the market carries its own risks. “Recently, there has been significant growth in the number of financial products, primarily ETFs, which are linked to and seek to track the performance of alternatively weighted indices. These indices are commonly referred to as “smart beta” indices. They are constructed using methodologies that rely on, for example, equal weighting of underlying component stocks, or measures such as volatility or earnings, rather than market-cap weighting. Investors need to understand there is no free lunch here. Any time you are deviating from the market, you’re taking some kind of tilt. Understand what is the fund doing that is different than the market. That is a risk.” Investors looking for an ETF that is both defensive and has the potential for outperformance should review PSL to evaluate how it may fit into their current portfolio construction. As long as the US dollar stays strong and the international economies remain in question, this ETF should continue to reward long term investors. However, FINRA is correct: Caveat Emptor. Author’s Note 1: NASDAQ OXM (NASDAQ: NDAQ ) agreed to acquire privately-held Dorsey Wright Associates in Jan for $225 million. This will push NASDAQ into the smart beta ETF market in an aggressive manner. Author’s Note 2: Please review disclosure in Author’s profile.

This ETF Will Tell You A Lot About Inflation Expectations

Summary Inflation is a scary word, as it generally presages effects like rising interest rates, higher costs of living, and climbing commodity prices. Based on widely accepted measures such as the Consumer Price Index (CPI), inflation has been kept in check or steadily trending downward over the last several years. Another way to gauge inflation expectation is by taking the temperature of the fixed-income markets. Inflation is a scary word, as it generally presages effects like rising interest rates, higher costs of living, and climbing commodity prices. This has been one of the expected outcomes from the Fed’s implementation of quantitative easing during the course of the last half decade. Yet, despite their best efforts, inflation has been a non-event in the economic recovery from the 2009 lows. Based on widely accepted measures such as the Consumer Price Index ((NYSEARCA: CPI )), inflation has been kept in check or steadily trending downward over the last several years. Obviously the decline in traditional commodity and agriculture prices has helped keep input costs in check, which have in turn carried forward to products and services we consume. Another way to gauge inflation expectation is by taking the temperature of the fixed-income markets. One of my preferred methods for this task is monitoring the price trend of the iShares TIPS ETF (NYSEARCA: TIP ). This ETF has $13.5 billion dedicated to a portfolio of 39 Treasury Inflation Protected Securities. TIP has an expense ratio of 0.20% and an average duration of 7.71 years. Most investors incorrectly assume that something with “inflation protection” in the name must mean it works well in a rising interest rate environment. However, TIPs function by readjusting their coupon payments based on the movement in CPI. Essentially they offer an insurance component that makes them attractive to own when inflation measures are on the move higher. A look at the chart of TIP below shows how fixed-income investors perceive the likelihood of true inflationary pressures creeping up. Not only is the price of TIP trending lower, but the short and long-term moving averages are also sloping down as well. Of course, it’s important to consider the price trend of TIP in context of the wider bond market as well. When you compare this index against a basket of traditional intermediate-term Treasury bonds, it makes the divergence even more pronounced. Below is a 1-year performance comparison between TIP and the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ). The spread between these two indexes shows a big separation since mid-July, when the talk about the Fed raising interest rates really started to gain some traction. So what does this mean for your portfolio? The primary reason for owning TIPs is to gain a hedge against inflationary pressures. Right now there isn’t any evidence to support this thesis. One day that will probably change, but for the time being I am avoiding any significant ownership of this sector. It makes more sense to stay focused on areas of the bond market that offer higher yields, solid trends, or a compelling advantage for your specific portfolio . One such fund that I own for clients in my Strategic Income Portfolio is the SPDR DoubleLine Total Return Tactical ETF (NYSEARCA: TOTL ). This actively managed ETF owns a variety of quality and credit securities across multiple attractive sectors of the bond market. TOTL eschews any TIPs exposure for greater focus on mortgage backed securities, emerging market bonds, and a mix of corporates. This ETF has a 30-day SEC yield of 3.18%, average duration of 4.25 years, and charges an expense ratio of 0.55%. The Bottom Line TIP is a solid index to monitor for a sense of where the market perceives inflation to be headed over the short and intermediate-term time frames. However, I would prefer to own this ETF in the midst of a strong price trend and more supportive fundamentals for inflationary statistics.