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What Assets Should You Have In Your Moderate Portfolio?

With flat to slightly negative returns, one could make the case that the static Ibbotson model for diversification is working just fine. On the other hand, the more that one has minimized the downside risk of investment canaries in the financial mines, the more one has been able to relax. Based on the evidence, moderate growth investors who choose an allocation of 60% in large-cap U.S. stocks and 40% investment grade U.S. bonds are likely to outperform the static Ibbotson model in the near-term. If market internals continue to deteriorate and if the macro-economic backdrop continues to weaken, a tactical asset allocation decision to reduce the risk of exposure to extremely overpriced U.S. stocks may be called for. Ibbotson Associates provides asset allocation guidelines that span the risk spectrum from conservative to aggressive. The moderate portfolio consists of roughly 42% in U.S. Stock, 18% in Non-U.S. Stock, 35% Fixed Income and 5% in Cash. It follows that the static Ibbotson model might employ the following ETFs to achieve its moderate growth and income aim: With flat to slightly negative returns, one could make the case that diversification is working just fine. On the other hand, the more that one has minimized the downside risk of investment canaries in the financial mines – high yield credit, emerging markets and smaller corporations – the more one has been able to relax. An allocation of 60% in large-cap U.S. stocks (NYSEARCA: SPY ) and 40% investment grade U.S. bonds (NYSEARCA: BND ) improved performance to 1.6% – a swing of 240 basis points. An argument in favor of diversification across asset class segments is that, if one holds recommended percentages for the next 20 years, recent underperformers will provide value down the road. Moreover, the combination of the above-mentioned asset types performed better than an ethnocentric large-cap-only allocation (60% S&P 500, 40% Barclays Aggregate Bond Index) over the previous 20 years. Here’s the problem: There are times when the breakdown in an asset grouping and/or an influential sector(s) of an economy is symptomatic of larger issues for market-based securities. For instance, the collapse of the banking system in 2008 had been telegraphed by financial stock woes nearly a year beforehand. The Financial Select Sector SPDR ETF (NYSEARCA: XLF ):S&P 500 SPDR Trust ETF ( SPY ) price ratio had been highlighting the rapid-fire demise of financial stocks relative to the broader benchmark. (Note: Back in 2007, “ex Financials” was the popular excuse offered to dismiss S&P 500 overvaluation; in 2015, many are using “ex Energy” to justify S&P 500 overvaluation.) There’s more. Even as SPY notched new record highs in October of 2007, other asset groupings did not recapture highs set in July of 2007. Small companies via the iShares Russell 2000 ETF (NYSEARCA: IWM ) did not make it back. In the fixed income space, preferred shares via the iShares U.S. Preferred Stock ETF (NYSEARCA: PFF ) were weakening as well. In the last year of the previous bull market (2007), lightening up on smaller companies, higher-yielding preferred shares as well as the financial sector benefited investors. Here in 2015, lightening up on smaller company stock ( IWM ), foreign developed stock (NYSEARCA: EFA ), emerging markets (NYSEARCA: VWO ) and high yield bonds (NYSEARCA: HYG ) has also been beneficial. For one thing, each of these asset types sits below long-term 200-day averages – a bearish sign for these asset classifications. Secondly, even when one excludes energy from the high yield bond picture, “ex Energy” spreads have been diverging from the S&P 500 throughout the year. Based on the evidence, moderate growth investors who choose an allocation of 60% in large-cap U.S. stocks and 40% investment grade U.S. bonds are likely to outperform the static Ibbotson model in the near-term. One might consider spreading the large-cap exposure across several ETFs such as the iShares Core S&P 500 ETF (NYSEARCA: IVV ), the iShares S&P 100 ETF (NYSEARCA: OEF ), the Technology Select Sector SPDR ETF (NYSEARCA: XLK ), the iShares Russell 1000 Growth ETF (NYSEARCA: IWF ) and iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ). I have had virtually no allocation to small caps, high yield bonds or emerging market stocks during this late-stage bull market. All of those areas remain mired in long-term technical downtrends. In addition, I have only 25% allocated to investment grade bonds with another 15% in cash/cash equivalents. If market internals continue to deteriorate and if the macro-economic backdrop continues to weaken , a tactical asset allocation decision to reduce the risk of exposure to extremely overpriced U.S. stocks may be called for. Make no mistake about it… large-cap U.S. stocks are overpriced. Year-over-year, corporate earnings have fallen from a height of $106 on 9/30/2014 for the S&P 500 to the most recent estimate just shy of $91 (October 2015). That is a decline of approximately 14%. The earnings contraction over multiple quarters with the TTM P/E Ratio at 22.7 is well above the average since 1870 of 16.6. For those who would rather embrace Forward P/Es, Birinyi Associates at WSJ.com estimates a value of 17.4. This implies that $91 is going to be $121 in the next 12 months. Short of a miraculous revival in energy demand, 33% earnings growth is not particularly plausible. Even a forward P/E of 17.4 is 25% higher than the 35-year average forward P/E of 13. Overvaluation by itself is not a reason to reduce exposure to large caps. A late-stage bull market could continue for several more years; highly priced can become exorbitant. That said, if an economic slowdown becomes an economic standstill, and if the number of large company stocks holding up the market-cap weighted indexes further retrenches, reducing one’s overall equity profile and raising one’s cash level is sensible. Keep in mind, positions that haven’t been working (e.g., high yield bonds, small caps, emerging markets, etc.) will probably cause even greater pain when the market falls. It is critical to keep losses small. Similarly, it is constructive to exercise a methodical approach to raising cash as a late stage bull market carries on. Having some cash available is the way to purchase investments at a better price in the future. Indeed, there’s a reason that one of the premier rules for investing rule is “Sell High, Buy Low.” For Gary’s latest podcast, click here . Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

EQT Corporation – Strong Position In A Growing Natural Gas Field

Summary EQT Corporation has watched its stock price drop by more than 50% since the start of the oil crash. For an oil company, the company’s dividend is negligible dividend. At the same time, the company’s natural gas production is growing rapidly bringing increasing earnings. Introduction EQT Corporation (NYSE: EQT ) is one of the largest natural gas producers in the Appalachian Basin. The company is headquartered in Pennsylvania and operates throughout the Appalachian mounts. The company has significant stakes in the natural gas fields there. EQT Corporation – RMUS Entry Media EQT Corporation has had a difficult time recently. The company has seen its stock price drop from $110 per share before the oil crash in mid-2014 down to recent lows of just over $50. At the same time, the company has a negligible dividend yield of 0.23% compared to a dividend yield almost 7 times that in 2012. Investment Highlight s Now that we have talked about the company, let us now talk some about the company’s investment highlights. The company has 10.7 trillion cubic feet of proven reserves amounting to 22 years of production at the current rate. At the same time the company has 42.8 trillion cubic feet of 3P reserves amounting to more than 87 years. On top of that, the company has a proven ability to increase its reserves with a > 25% forecasted production volume sales growth for the year of 2015. At the same time, the company has a 90% interest in EQGP (NYSE: EQGP ) which has a $4.8 billion market cap and has dropped almost 40% since the start of the crash. Lastly the company has a strong equity position. The company has $1.7 billion in cash along with a $1.5 billion undrawn credit revolver. The company’s cash position amounts to approximately $10.6 per share, impressive for a company in such difficult times. (click to enlarge) EQT Resources – EQT Investor Presentation The above image shows the company’s resources along with its impressive acreage and midstream assets. The company’s 9100 pipeline miles and 3.4 million acres leave significant room for the company to explore. These explorations could significant increase the company’s reserves. Production Growth Now that we have talked about the company’s investment highlights, it is time to talk about the company’s production growth. (click to enlarge) Marcellus Shale Production – EQT Investor Presentation The above image shows the company’s Marcellus Shale play which has impressive growth potential. The company began horizontal drilling on the area in 2008 and has seen 32% year over year growth since then. That has resulted in production growing from 200 million cubic feet a day from 2008 up to 1800 million cubic feet per day in 2015. (click to enlarge) EQT Proven Reserves – EQT Investor Presentation The company’s proven reserves have also impressive grown as a result of the company’s Marcellus shale assets. The company’s reserves in the Marcellus have grown from 2.879 billion cubic feet in 2010 to 8.284 billion feet in 2014. The company’s Marcellus assets also make up more than 50% of its 3P reserves. (click to enlarge) EQT Development Area – EQT Investor Presentation The company is currently focused on developing its core Marcellus assets with much if it focused in a core development area. This area contains 600,000 acres along with an impressive 23.3 trillion cubic feet or 3P reserves of 31 trillion cubic feet of total resource potential. At the same time the company drilled 138 wells in 2015 and plans on continue drilling additional wells. (click to enlarge) EQT Production Costs – EQT Investor Presentation At the same time, the Marcellus plays, the company’s largest assets have impressive fundamentals even after taxes. The company’s current margins after tax at $2.5 natural gas are 22%. With current natural gas prices at $2.05 the company should barely be breaking even. (click to enlarge) EQT Operating Expenses – EQT Investor Presentation However, the company has been maintaining noticeably lower operating costs compared to the rest of its peers. The company’s per-unit operating expenses are the lowest among its peers while the company’s 3-year F&D costs are the fourth rank among its peer group. Conclusion EQT Corporation has had a difficult time recently watching its stock price drop more than 50% since the start of the original stock market crash. At the same time, the company offers a negligible dividend of roughly 0.23% per year. As a result, I do not recommend investors get involved for the dividend. However, the company has an impressive Marcellus asset play with millions of acres and tens of trillions of cubic feet worth of reserves. The company drilled over 150 wells in 2015 and plans to continue drilling a large number of additional wells that could increase its reserves. For investors interested in averaging into a strong position at a low prices, EQT Corporation is a strong corporation with huge potential. Those who get into now and average down should see impressive long term gains.

Backtesting Smarter Beta: Do We Have A Winner?

Summary The smarter-beta strategy uses three smart-beta ETFs as sources for an investable portfolio that provides exposure to three risk-premia factors. The factors are low volatility, momentum and quality. In this article I report on a backtest of the strategy using data from the inception of the youngest of the three ETFs. I started an exercise to mine three of iShares smart-beta ETFs for investment ideas. My idea was to use the portfolios of the funds, which are designed to provide broad exposure to one of the risk-premia factors, as a source for devising and investable portfolio that provides exposure to all three factors. The three ETFs I selected are: iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ) iShares MSCI USA Momentum Factor ETF (NYSEARCA: MTUM ) iShares MSCI USA Quality Factor ETF (NYSEARCA: QUAL ) These are, as the names tell us, focused on low-volatility, momentum and quality factors. I refer you to my first article on the topic where I describe the methods and concepts in detail ( A Quest For The Smartest Beta ). Briefly, I compare the portfolios of the funds and select the equity positions that are held by all three. This is illustrated in the Venn Diagram to the right. I combine the stocks that overlap the portfolio holdings of all three funds in an equal-weighted portfolio. Readers have pointed out that I’m neglecting at least two important factors, value and size, which are also cards in the iShares ETF smart-beta deck. I looked into this ( Expanding The Smart Beta Filter: Does It Help? ) and concluded they offered no advantage over the three I selected. This was based on a very limited data set as I’ll describe, however. With access to earlier cycles for the funds’ portfolios it may be worth the effort to revisit this question as well. One feature of these funds is that their indexes are rebalanced twice annually, on the last business days of May and November. Until today, I was unable to do any sort of backtest. So, when I first introduced the concept in November I used the portfolio that was put into effect in June 2015 and looked at returns over the five-month period. At the end of November, I published a rebalanced portfolio ( Momentum, Quality and Low Volatility: Continuing the Quest for Smarter Beta ) and results for the full six-months of the ETFs’ rebalancing cycle. Those results were highly encouraging. Each time I wrote on the topic, I lamented not having access to historical portfolios for the funds to further explore performance. Then a sharp-eyed reader added a comment pointing out where those data were available (thanks again, ipaul66 ). So, I’ve downloaded holdings data going back to end-of-November rebalance for the inception of QUAL, the youngest of the three funds, in August 2013. I’ve also shown that the three funds together in an equal-weighted portfolio turned in a solid performance record vs. the broader market represented by the S&P 500 TR index (^SPXTR). I’ve included that portfolio in this analysis as a comparison. The backtest covers two years, still woefully short, but a huge improvement on six months. There are four six-month cycles with complete results. The most recent cycle began on the last day of November, so we have nothing meaningful from that as yet. CAGR Let’s start with the big result: CAGRs for each of the strategies. This table shows CAGRs for each six-month cycle for the smarter-beta portfolio (MQLV), the S&P 500 TR index, and the equal-weighted ETFs (3ETFsEqWt). Both the MQLV and the three ETFs beat the S&P 500. Only for the Dec 2013 through May 2014 cycle does the broader market outperform. Commutative and Cycle Returns The next chart shows cumulative return on $100,000 invested in the three strategies on December 1, 2013 through the November 29, 2015. (click to enlarge) And, for $100,000 invested at the beginning of each semi-annual rebalancing cycle: (click to enlarge) Conclusions and Caveats These results do support and validate the earlier finding. The smarter-beta strategy appears to be an effective filter that can add meaningful alpha relative to the broader market, or to equal-weighting the three source ETFs. I caution, however, that this is based on only two years’ history, and for a quarter of that period the smarter-beta strategy sharply under performed. The model is equal-weighted which may not be optimal and weighting needs a closer look. Having this two-year data set will give me the opportunity to explore other weighting strategies. This analysis makes no allowance for trading costs. One can often buy an S&P 500 index fund in a commission-free ETF. The three-ETF portfolio requires at most twice-yearly rebalancings for modest cost. The MQLV portfolios comprised 12 to 19 positions over the two years, so trading costs are significant, especially for smaller portfolios. If I introduce a 0.25% slippage factor (which allows for trading costs but not spread costs) the CAGR falls to 15.46% for a $100,000 portfolio, still beating the S&P 500 handily, but it does illustrate the cost of turnover. For a smaller portfolio, a larger slippage factor is required. For a $10K initial investment, 32 annual trades at $8/trade would be 2.56% and that much friction drops the CAGR to $10.17%. Even assuming the best interpretation of these results, the strategy generates substantial turnover and is only suitable for reasonably large portfolios (or for those who have accounts that provide free trades). I mention this because I have had commenters suggest they might try the strategy with only a small number of shares for each position. For the investor who is not interested in the turnover and trading this strategy will require, the equal-weighted portfolio of the three ETFs is an attractive alternative. That strategy did not turn in a single negative cycle, more than can be said for either the smart-beta portfolio or the S&P 500. Trading costs are modest with a maximum of 12 trades a year for the semi-annual rebalance, but even that may not be necessary as the ETFs do not vary much from on another over the course of a year or two. Comparing the two-year CAGR of 11.68% to 9.58% for the broad market would seem to indicate that the strategies being used in the MSCI indexes do in fact capture alpha from exposure to the risk-premia factors.