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Vanguard Set To Move Into Muni Bond ETF Space

Vanguard Group, known for its low cost offerings, plans to make inroads to the increasingly popular muni bond ETFs space. Vanguard’s entry appears well timed, as the muni bond ETFs space has been on a roll since last year. In fact, the overall muni category managed to secure the third best position in 2014 having added 8.7%, its three-year highest. It’s not that the issuer is entirely new to munis. Presently, there are 12 actively managed Vanguard muni-bond funds worth $140 billion. The issuer expects the fund to be up for sale by the end of June. The fund will trade under the name of Vanguard Tax-Exempt Bond Index Fund . The Proposed Fund in Focus As per the SEC filing , the fund looks to track the performance of the investment-grade U.S. municipal bond market. The goal will be achieved by tracking the S&P’s National AMT-Free Municipal Bond Index. The index includes bonds having a minimum term to maturity greater than or equal to one calendar month. The “investor” share class will have to spend 0.2% in annual fees to own the fund. How Does it Fit in a Portfolio? Municipal bonds are great picks for investors seeking a steady stream of tax free income. Usually the interest income from munis is exempt from federal tax and sometimes even state taxes, making it especially attractive to investors in the high tax bracket looking to reduce their tax liability. The proposed fund too looks to follow munis that have their interests excused by U.S. federal income taxes and the federal alternative minimum tax (AMT). However, investors should note that tax-free bonds yield lower than taxable bonds. With the increase in the U.S. taxes, demand for municipal bonds has grown by leaps and bounds among high earners. Can it Succeed? There are quite a number of choices in the municipal bond space with iShares National AMT Free-Muni Bond Fund (NYSEARCA: MUB ) being the highest grossing ETF with about $4.2 billion. MUB tracks the S&P National AMT-Free Municipal Bond Index to provide exposure to a basket of 2,458 investment grade securities. The average maturity for the fund stands at 5.51 years, while duration is 6.33 years. The fund has a 30-day SEC yield of 1.58% and charges 25 basis points as expenses per year. Interestingly, the newly filed fund also follows the same index that MUB tracks. So it goes without saying that the proposed fund will face tough competition from the largest ETF in the space, i.e. iShares’ MUB. While the lack of first-movers advantage will be a negative for Vanguard, its ability to roll out a product on an ultra low price should give it an edge over many others presently on offer. Going by fundamentals, intermediate term munis offer great opportunities right now especially with the improving fiscal health of the U.S. states and a plunge in intermediate-to-long term yields. The only bump in the road ahead for Vanguard is its late entry to this space. It’s hard to predict how Vanguard’s new product would perform, but a low expense ratio should be the key to a sizable asset base or greater market share than iShares’ ultra-popular product.

Don’t Rely On Your Emotions To Trade The Oil Patch

An inflection point has been reached in oil’s valuation per barrel. The Oil/Gold ratio at this level has historically confirmed a trend change. The supply/demand news cycle is beginning to turn. (The Oil/Gold Ratio: click to enlarge) The first thing one sees in the chart (above) is an almost perfect symmetry, with each low point occurring early in Q1 on the red line (excepting 1986, 88, 89). It begs a question for the curious: Under what previous economic conditions did the oil/gold ratio reach today’s extremes? What is the correlation in barrels per oz. of gold?” “How far into this drop are we currently?” We are at Financial Crisis lows (2008-09); and the deep devaluations of the late-1980s are the only levels remaining to be pierced. The oil/gold ratio has been at this level three times in the last two decades, and each time it rallied. The current comparison clocks in at $45/bbl. How cheap is oil? Early this morning you could buy 28 barrels of oil with a single oz. of gold, the most in the modern era (excepting 1988). I am using the price of gold to value a barrel of crude because gold is a storage of value. Oil is a cultural commodity and the substrate of modern industrial society. In terms of financial comparisons, gold retains its value, oil we use ubiquitously. The ratio measures the cost of that use. Observe the parabolic surges in the chart below. Excepting the go-go years of impossibly cheap oil (1986 and 1989), each one of these telephone-pole tops flamed-out quickly. (click to enlarge) If zoomed-in for a closer look (below), you can see that the final weeks of the surge (red boxes) were composed of unsustainable, soaring price-gaps. For example, an ounce of gold this morning could buy you 33% more oil than on January 1, 2015, less than 3 weeks ago; or 60% more oil than in November, 2014! Is this any way to price a commodity that’s used 91ML bbl a day? In just the last week we have had several 5% up and down days close-by in sequence, resulting in single-session half-trillion dollar gains or losses for crude oil. This kind of price discovery only occurs near turning-points – when the market can’t figure out what something is worth – when all the news and analysis is clouded in total confusion – and hence the focus of this article. For ages, if you wanted to figure out what something was worth, you compared it to gold; and at this point, oil is as cheap as it gets. (click to enlarge) In my previous articles, I have used a pressure-cooker model to scale into positions through dollar-cost averaging, buying at gradual intervals over a few weeks time. This method sometimes takes weeks, even months, to fulfill, but in the end it works, because every tick down lowers the cost-basis before the eventual turn. The important thing is to begin near the extremes. Crude oil is selling for less than it takes to drill, ship and deliver it almost anywhere in the world. Some OPEC countries could actually default on their debts if crude oil remains in this state of devaluation. But there is hope on the horizon. An upcoming storm of lay-offs, falling rig counts, and production cuts is beginning to slash into the North American crude suppliers (the source of oversupply), and by 2Q’2015 this pullback should be in full swing. SA author Wolf Richter fully describes this retrenchment in his fiery articles . The trade here is to gradually buy into a crude oil ETF, for example, XLE , OIL , or USO , and hold until oil hits $70/bbl. For the more speculative investor, the leveraged ETFs – UCO (2x crude), or UWTI (3x crude) are also an option.

Which Junk Bond ETF Is Best For 2015? Part 1

Summary JNK has a higher yield and lower expenses. HYG has higher credit quality and lower volatility. JNK and HYG have near identical returns over the past 5 years. Both have seen their payouts decline along with interest rates. The two largest high yield bond funds are the iShares iBoxx $ High Yield Corporate Bond (NYSEARCA: HYG ) and the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ). These funds use very similar strategies that result in largely similar portfolios and performance, with a few small variations. Index & Strategy HYG tracks the Markit iBoxx USD Liquid High Yield Index , while JNK tracks the Barclays High Yield Very Liquid Index. These two funds are highly correlated, to the tune of 0.9985 since 2006. Since 2010, the correlation rises to 0.9995. This comparison of some key data points reveals the main differences between the funds. Through January 16, these ETFs had near identical 3-year and 5-year annualized returns. Investors can pocket a little more income with JNK, but total returns are very similar. Along with that slightly higher yield comes a slightly higher duration, making JNK a little more sensitive to changes in interest rates. HYG has more assets and higher average dollar trading volume. The number of shares traded is very similar, but HYG’s price is more than double that of JNK. JNK is cheaper than HYG, to the tune of 0.10 percent a year. Given the similarities between the funds, the difference in cost is a big advantage for JNK. Even though HYG is at disadvantage on cost and yield, it has managed to outperform JNK. In terms of credit quality, JNK has 40 percent in BB rates bonds; 43 percent in B; and 16 percent in CCC or lower. HYG has 48 percent in BB rated bonds; 39 percent in B; and 11 percent in CCC. Performance This price ratio chart of HYG versus JNK shows the funds move in tandem, except during the financial crisis. Over the past 5 years, the two funds have fluctuated within a range of 3 percent of each other. A rising line indicates HYG is outperforming. (click to enlarge) This price ratio chart compares the price performance of HYG and JNK over the past 5 years without adjusting for dividends. It shows that HYG has benefited more from price appreciation than from income, as would be expected given HYG yields less, yet returns the same in the long-run. (click to enlarge) This chart shows their returns since 2010. (click to enlarge) Income JNK has a higher yield than HYG, but both funds have seen their payout decline amid low interest rates (data from the provider websites). (click to enlarge) The chart below shows the trailing 12-month yields based on actual payouts. JNK was paying more at the start in part because shares did under perform during the financial crisis. The main takeaway is that yields were falling due to falling interest rates (rising bond prices) and if that trend continues, investors will continue to see shrinking payouts. (click to enlarge) Risk & Reward JNK has a 3-year beta of 1.17 versus HYG’s beta of 1.09., both versus the BofAML HY Master II Index. JNK has a 3-year standard deviation of 5.33 compared to HYG’s standard deviation of 5.01. This means JNK is slightly more volatile than HYG. Both funds have exposure to the energy sector, with HYG’s provider listing its exposure at 13.82 percent. JNK does not break out its exposure by sector, but given the volatility in that sector, if it had a meaningful difference in exposure, there would be a considerable difference in returns. JNK is down 1.15 percent in the past three months versus a 0.26 percent drop in HYG. High yield bonds are less sensitive to changes in interest rates due to their lower duration, but they are very sensitive to the economy. In 2008, JNK fell 25.67 percent and HYG lost 17.37 percent. The late 2014 plunge in oil prices weighed heavily on junk bond funds. Including dividends, HYG is down about 3 percent over the past seven months, versus the 4 percent decline in JNK. The most recent turnover data from Morningstar shows JNK had turnover of 30 percent as of June 30, 2014, while HYG had turnover of 11 percent as of February 28, 2014. If HYG has historically maintained this lower turnover, this makes the cost gap smaller than the expense ratio indicates, since HYG would face fewer transaction costs. Conclusion JNK and HYG are very similar funds, but they do have their differences. JNK charges less and has a higher yield, but that comes with higher volatility and lower credit quality. HYG manages to consistently deliver nearly the same total return as JNK though. Overall, this makes HYG the more attractive ETF, especially given our position in the economic cycle. A recession isn’t brewing yet, but it has been seven years since the last one began. With better credit quality, HYG is likely to hold up better again in the next recession. Investors will receive a smaller yield from HYG, but this extra bit of income isn’t worth the risk of under performing the next time the high yield bond market suffers a major sell-off. Short-Term High Yield While HYG is a better choice than JNK in 2015, there are more funds to consider. In part 2, we’ll look at the SPDR Barclays Capital Short Term High Yield Bond ETF (NYSEARCA: SJNK ) and the PIMCO 0-5 Year High Yield Corporate Bond Index ETF (NYSEARCA: HYS ).