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IDLV Deserves Consideration – The Low Correlation To SPY Is Beautiful

Summary I’m taking a look at IDLV as a candidate for inclusion in my ETF portfolio. The expense ratio is a little high relative to my cheap tastes, but certainly within reason. The correlation to SPY is low and based on reasonable trade volumes. Returns since inception have been fairly weak, but the measuring period is less than 3 years. The ETF might fit for my portfolio. I’m not assessing any tax impacts. Investors should check their own situation for tax exposure. 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. I’m working on building a new portfolio and I’m going to be analyzing several of the ETFs that I am considering for my personal portfolio. One of the funds that I’m considering is the PowerShares S&P International Developed Low Volatility Portfolio (NYSEARCA: IDLV ). 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. What does IDLV do? IDLV attempts to track the total return (before fees and expenses) of the S&P BMI International Developed Low Volatility Index. At least 90% of the assets are invested in funds included in this index. IDLV falls under the category of “Foreign Large Blend”. Does IDLV provide diversification benefits to a portfolio? Each investor may hold a different portfolio, but I use (NYSEARCA: SPY ) as the basis for my analysis. I believe SPY, or another large cap U.S. fund with similar properties, represents the reasonable first step for many investors designing an ETF portfolio. Therefore, I start my diversification analysis by seeing how it works with SPY. I start with an ANOVA table: (click to enlarge) The correlation is excellent at 71%. I want to see low correlations on my international investments. Extremely low levels of correlation are wonderful for establishing a more stable portfolio. I consider anything under 50% to be extremely low. However, for equity securities an extremely low correlation is frequently only found when there are substantial issues with trading volumes that may distort the statistics. Standard deviation of daily returns (dividend adjusted, measured since April 2012) The standard deviation is great. For IDLV it is .7265%. For SPY, it is 0.7420% for the same period. SPY usually beats other ETFs in this regard, so a lower volatility level is very impressive. Because the ETF has fairly low correlation for equity investments and a low standard deviation of returns, it should do fairly well under modern portfolio theory. Liquidity looks fine Average trading volume isn’t very high, a bit over 50,000, but that also isn’t low enough to be a major concern for me. Mixing it with SPY I also run comparisons on the standard deviation of daily returns for the portfolio assuming that the portfolio is combined with the S&P 500. For research, I assume daily rebalancing because it dramatically simplifies the math. With a 50/50 weighting in a portfolio holding only SPY and IDLV, the standard deviation of daily returns across the entire portfolio is 0.6794%. With 80% in SPY and 20% in IDLV, the standard deviation of the portfolio would have been .7045%. If an investor wanted to use IDLV as a supplement to their portfolio, the standard deviation across the portfolio with 95% in SPY and 5% in IDLV would have been .7312%. Why I use standard deviation of daily returns I don’t believe historical returns have predictive power for future returns, but I do believe historical values for standard deviations of returns relative to other ETFs have some predictive power on future risks and correlations. Yield & Taxes The distribution yield is 3.17%. That appears to be a respectable yield. This ETF could be worth considering for retiring investors. I like to see strong yields for retiring portfolios because I don’t want to touch the principal. By investing in ETFs I’m removing some of the human emotions, such as panic. Higher yields imply lower growth rates (without reinvestment) over the long term, but that is an acceptable trade off in my opinion. I’m not a CPA or CFP, so I’m not assessing any tax impacts. Expense Ratio The ETF is posting .35% for a gross expense ratio, and .25% for a net expense ratio. I want diversification, I want stability, and I don’t want to pay for them. The expense ratio on this fund is slightly higher than I want to pay for equity securities, but not high enough to make me eliminate it from consideration. I view expense ratios as a very important part of the long term return picture because I want to hold the ETF for a time period measured in decades. Market to NAV The ETF is at a .23% premium to NAV currently. Premiums or discounts to NAV can change very quickly so investors should check prior to putting in an order. The ETF is large enough and liquid enough that I would expect the ETF to stay fairly close to NAV. Generally, I don’t trust deviations from NAV and I will have a strong resistance to paying a premium to NAV to enter into a position. Largest Holdings The diversification is very good in this ETF. My favorite thing about the ETF is easily the diversification. If I’m going to be stuck with that expense ratio, I expect it to buy a fairly strong level of diversification and in this case it appears to do just that. (click to enlarge) Conclusion I’m currently screening a large volume of ETFs for my own portfolio. The portfolio I’m building is through Schwab, so I’m able to trade IDLV with no commissions. I have a strong preference for researching ETFs that are free to trade in my account, so most of my research will be on ETFs that fall under the “ETF OneSource” program. I like the correlation and the diversification in the holdings. Overall, the fund is looking pretty good. While I’m fairly cheap in regards to expense ratios, this one isn’t too bad. A few years ago I would have treated it as being very favorable, but I’m getting spoiled by seeing the ETFs with gross expense ratios under .10. I don’t place a large importance on historical returns (outside of risk), but the fund did underperform SPY by a fairly large amount over the holding period I used. The dividend adjusted close for SPY moved up by 49.11% and for IDLV it moved up 19.9%. I’m going to keep IDLV in my list of potential ETFs for international exposure, but if it makes the final round of challengers I’ll need to dig into the securities and make sure they are capable of producing higher levels of returns. Since it is an international equity fund, I’d be looking at a 5% to 10% allocation if it is selected. The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis. The analyst holds a diversified portfolio including mutual funds or index funds which may include a small long exposure to the stock.

QJPN Borders On Being Too Good To Be True

Summary I’m taking a look at QJPN as a candidate for inclusion in my ETF portfolio. The expense ratio is a bit high, but the diversification is moderate. The correlation with SPY appears low, and the overall risk level for a portfolio looks great. However, weak liquidity could be influence results. Despite the relatively short history on QJPN, I’ll keep it on my short list for international exposure. I’m not assessing any tax impacts. Investors should check their own situation for tax exposure. 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. I’m working on building a new portfolio and I’m going to be analyzing several of the ETFs that I am considering for my personal portfolio. One of the funds that I’m considering is the SPDR MSCI Japan Quality Mix ETF (NYSEARCA: QJPN ). 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. What does QJPN do? QJPN attempts to provide results which are comparable (before fees and expenses) to the total return of the MSCI Japan Quality Mix Index. QJPN falls under the category of “Japan Stock”. Does QJPN provide diversification benefits to a portfolio? Each investor may hold a different portfolio, but I use (NYSEARCA: SPY ) as the basis for my analysis. I believe SPY, or another large cap U.S. fund with similar properties, represents the reasonable first step for many investors designing an ETF portfolio. Therefore, I start my diversification analysis by seeing how it works with SPY. I start with an ANOVA table: (click to enlarge) The correlation is about 44%, which is phenomenal for Modern Portfolio Theory. The extremely low correlation makes it much easier to mix the ETF into a portfolio and take advantage of the benefits of diversification. My goal is risk adjusted returns, and my method is minimizing risk. Standard deviation of daily returns (dividend adjusted, measured since June 2014) The standard deviation is very reasonable. For QJPN it is .8159%. For SPY, it is 0.7232% for the same period. SPY usually beats other ETFs in this regard, and the low correlation with SPY makes the higher standard deviation acceptable. Short time frame Investors should be aware that this is a substantially shorter time frame than I usually use. I would like to have about 3 years of data on the ETF for running statistics and half of one year is short enough to introduce sampling errors. In statistics, the minimum sample size is generally 30 so over 130 days of trading returns may seem sufficient, but I would caution investors to take this with a grain of salt. Liquidity concern The average volume comes in at just under 2000 shares. That’s a potential problem for investors that need liquidity and for running correlation values. I checked the dividend adjusted closing values for each day and there were very few times that the change was 0.00%, which means the low volume of trades was not the only factor in the low standard deviation. For statistical validity, I’m more concerned about the relatively short time frame that I have available than the number of shares trading each day. For an investor concerned about spreads and liquidity, the low number of shares trading could be the bigger concern. Mixing it with SPY I also run comparisons on the standard deviation of daily returns for the portfolio assuming that the portfolio is combined with the S&P 500. For research, I assume daily rebalancing because it dramatically simplifies the math. With a 50/50 weighting in a portfolio holding only SPY and QJPN, the standard deviation of daily returns across the entire portfolio is 0.6553%. If an investor wanted to use QJPN as a supplement to their portfolio, the standard deviation across the portfolio with 95% in SPY and 5% in QJPN would have been .7063%. While the low correlation makes very large positions look quite appealing, I wouldn’t want to risk my money on those statistics holding. However, the low correlation and reasonable standard deviation make this a strong contender for a position in my portfolio, even if I have to limit the exposure to something much smaller than the statistics would have suggested. Due to the potential for the low trading volumes and short time frame to distort the statistics, I will want more data before making a final decision on the ETF. So far, I am definitely considering it. Why I use standard deviation of daily returns I don’t believe historical returns have predictive power for future returns, but I do believe historical values for standard deviations of returns relative to other ETFs have some predictive power on future risks and correlations. Yield & Taxes The SEC yield is 1.37%. That is too weak for a retiring investor to live off the yield, but the ETF still could merit a small position as part of a rebalancing plan to reduce the overall risk level in the portfolio is the investor was certain he or she would not have liquidity needs that would force them to sell. I’m not a CPA or CFP, so I’m not assessing any tax impacts. Expense Ratio The ETF is posting .30% for an expense ratio. I want diversification, I want stability, and I don’t want to pay for them. The expense ratio on this fund is slightly higher than I want to pay for an equity fund, but it isn’t enough to disqualify the ETF from consideration. Market to NAV The ETF is at a .29% premium to NAV currently. Premiums or discounts to NAV can change very quickly so investors should check prior to putting in an order. I wouldn’t want to pay a premium greater than .1% when investing in an ETF, unless I could find a solid accounting reason for the premium to exist. This premium looks small enough that I think I could enter into a position with a limit buy order that removed the premium. Largest Holdings The diversification within the ETF is moderate. Normally I want more diversification, but if the correlation and standard deviation hold up over a longer time period, I wouldn’t have any problem with the level of diversification in the ETF. (click to enlarge) Conclusion I’m currently screening a large volume of ETFs for my own portfolio. The portfolio I’m building is through Schwab, so I’m able to trade QJPN with no commissions. I have a strong preference for researching ETFs that are free to trade in my account, so most of my research will be on ETFs that fall under the “ETF OneSource” program. QJPN is going to be on my short list (for now) for potential inclusion in my portfolio as part of my international exposure. If QJPN continues to look better than other international ETFs under modern portfolio theory I will extend my analysis to look for other ETFs with similar holdings and a longer trading history so if the data on those ETFs support the statistics so far on QJPN.

Bad News Is Good News: A Contrarian View Of China Investing

A Healthy Balance Between Monetary and Fiscal Support. Government to Remain Accomodative. Oil Sinks, Airlines Take Flight. When China celebrates its new year next month, we will transition into the Year of the Ram, also known as the Year of the Goat or Sheep. If you believe in luck, this could be a good sign. The ram comes eighth in the 12-zodiac cycle, and in Mandarin, “eight” sounds very similar to the words meaning “prosper,” “wealth” or, in some dialects, “fortune.” As you might imagine, the Chinese consider the number to be very lucky. But of course successful investing involves so much more than luck. In a time when not only China but much of the rest of the world is trying to get its groove back, it’s important to be cognizant of the factors that shape the markets, including changing government policy. We often say that government policy is a precursor to change, so it’s important to follow the money. With that in mind, I asked portfolio manager Xian Liang to outline a few of the most compelling cases to remain bullish on the Asian giant. Below are some highlights from our discussion. A Healthy Balance Between Monetary and Fiscal Support Back in October, I pointed out that one of the main contributors to the European Union’s sluggish growth is its inability to balance its monetary and fiscal policies. It has been eager to tax everything and everyone who moves. Waiting for European Central Bank (ECB) President Mario Draghi to act often feels a little like waiting for Godot. Investors’ patience is wearing thin. China, on the other hand, is much more responsive and actively committed to making full use of both policies in its arsenal to spur its cooling economy. On the monetary side, according to Xian, are interest rate cuts and a loosening of reserve requirements for certain deposits. The goal is to ease access to loans for businesses and individuals seeking to purchase big-ticket items such as homes. As a result, Chinese entrepreneurs have increasingly been able to start more businesses. (click to enlarge) Jobs growth has been so robust, in fact, that the government has managed to attain its job creation target outlined in its current Five-Year period ahead of schedule and by a wide margin. The country has grown millions of jobs with great efficiency, even as GDP sags. Although the Chinese housing market has stagnated in recent months, these new monetary measures will help it pick up steam. Already we’re seeing some improvement, with home property stocks moving higher. Regulations are an indirect taxation of the economy, whereas deregulation unleashes entrepreneurial spirit. (click to enlarge) On the fiscal front, the government is reportedly planning to spend $1.6 trillion over the next two years on infrastructure projects in various industries-300 separate infrastructure programs, to be exact, according to BCA Research. As I pointed out last month, many of these projects will largely involve high-speed rail, both domestically and abroad. China has already secured multiple construction deals with countries ranging from Brazil, South Africa, Nigeria, India, Russia, the U.S. and others. Government to Remain Accommodative There are a couple of reasons the Chinese government has accelerated support to capital markets, according to Xian: One, a significant deflationary threat has been driven by slumping energy prices. And two, there are potentially lower exports to commodity producing nations. Indeed, sluggish global demand has contributed to China’s weak December purchasing manager’s index (PMI), which dropped to an 18-month low of 50.1. China has been quick to respond to lower PMI data with a drop in interest rates. (click to enlarge) But Where There’s Bad News, Good News Is Often Not Far Behind The silver lining to falling commodity prices is that since China is a net-importer of raw materials-crude oil especially-the country has been able to save tremendously on its oil and gas bills. Back in November, I reported that for every dollar the price of a barrel of oil drops, China’s economy saves about $2 billion annually. From its peak in June, crude has slipped close to $50-you do the math. This has served as a major wealth transfer from oil-producing countries into China’s coffers. Oil Sinks, Airlines Take Flight Speaking of crude, declining oil prices-they’re currently below $50 per barrel-have been good for airlines, Chinese companies included. As you can see, there’s been a clear inverse relationship between crude oil returns and airline stocks. (click to enlarge) China is the largest investor in U.S. government bonds. The country has accumulated close to $1.3 trillion, so a strong dollar and falling oil prices benefit its economic flexibility. More middle-class Chinese might be able to afford to travel abroad, specifically here to the U.S., where inevitably they will spend their money. (click to enlarge) According to Carl Weinberg, founder and chief economist of High Frequency Economics: Chinese President Xi Jinping has estimated that there will be more than a half-billion Chinese tourists traveling to the West in the next 10 years. You can work out the impact if all of them came to New York and spent $2,000 or $3,000 each. That would be enough to add a half-percentage point to U.S. GDP every year over the next decade. Reasonable Stock Valuation Chinese stocks are currently valued below their own historical averages as well as those among other global emerging markets, making them both attractive and competitive. “Odds favor mean reversion to continue,” Xian says. “The better the Chinese markets perform, the more global liquidity they might attract.” Chinese stocks, as expressed in the MSCI China Index, are currently a much better value than those in the S&P 500 Index, trading at 10 times earnings whereas the U.S. is trading at 18 times. (click to enlarge) A-Shares Still a Huge Draw Chinese A-Shares surprised the market by breaking out last summer, having delivered 66 percent for the 12-month period. It looks like a breakout from the long-term bear market. (click to enlarge) What’s more, the upside is unlikely to have been exhausted. Although they aren’t as stellar of a bargain as they once were, they’re not yet overvalued, and retail and institutional investors might accumulate on pullbacks. For the A-Shares market, we have recently added exposure to A-Shares in one of our funds to capture more attractive valuation. In today’s environment, we believe the safer bets are investable H-Shares, which are driven by A-Shares and, in 2014, returned 15.5 percent. H-Shares comprise the vast majority of the fund’s exposure to Chinese equities, with further exposure gained through A-Shares exchange-traded funds (ETFs). The Ram Is the New Bull As GARP (growth at a reasonable price) hunters, we’re prudently optimistic about the upcoming year and anticipate great things out of the world’s second-largest economy. China’s government and central bank are committed to jobs and manufacturing growth as well as policy easing. Its stocks are reasonably valued, and low commodity prices should continue to offset slowing global demand. As Xian eloquently put it last month: China’s leadership appears to be delivering on the promises it made in November 2013 at the Third Plenary Session, specifically the liberalization of the financial sector and reform of the role capital markets play in allocating resources. This leadership is determined and committed to putting China on the right path. Past performance does not guarantee future results. Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. By investing in a specific geographic region, a regional fund’s returns and share price may be more volatile than those of a less concentrated portfolio. The HSBC China Services PMI is based on data compiled from monthly replies to questionnaires sent to purchasing executives at more than 400 private service-sector companies. The MSCI China Free Index is a capitalization weighted index that monitors the performance of stocks from the country of China. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility. Fund portfolios are actively managed, and holdings may change daily. Holdings are reported as of the most recent quarter-end. Holdings in the China Region Fund as a percentage of net assets as of 9/30/2014: Air China Ltd. 0.00%, China Eastern Airlines 0.00%, China Southern Airlines Co. 0.00%. All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.