Tag Archives: fund

Beyond The Benchmark: Tracking Error Vs. Active Share

Summary We have reservations about using tracking error to gauge “active investing” because it relies on historical volatility data versus a benchmark to draw conclusions about risk. Active share, in our view, provides a clearer picture of how active a fund manager is as compared with drawing conclusions from standard deviation calculations. We believe the fund has to be meaningfully different to its benchmark to create an opportunity to deliver alpha. We believe active share more clearly shows how a fund and benchmark differ, a key to delivering alpha. By Rob Stabler, Product Director Active share, a tool for demonstrating how a fund’s portfolio differs from its respective benchmark, has been a common term among active investors over the last few years. Tracking error, which has a much longer history, is often regarded as another tool that does the same job. But the differences between the two measures affect how Invesco’s Global Opportunities investment team views their effectiveness and usefulness for investors. Tracking error: Useful from returns perspective Tracking error – the divergence between price behaviors of a portfolio and its benchmark – is a backward looking tool, using historical data to show the volatility of the fund’s returns versus that of its benchmark. It’s useful in demonstrating how closely a portfolio follows its benchmark from a returns perspective. However, it’s important to consider these two questions: What’s the benchmark? A fund with a low tracking error versus a volatile benchmark may not produce the return profile investors seek. Are upside and downside volatility equally important to investors? The most common method of assessing tracking error involves calculating the standard deviation of the fund and benchmark returns, which reflects both upside and downside volatility. In our experience, however, investors have been more concerned about the implications of downside volatility. More importantly, as active investors, our team’s main reservation about tracking error is acceptance of the benchmark as the right reference point for measuring volatility and, by implication, risk. In contrast, the investment world doesn’t revolve around the benchmark for our fund managers. We define risk as the potential for permanent loss of capital, using maximum drawdown and downside volatility as indicators. And we often view volatility – at least in the short term – as an opportunity to exploit valuation anomalies in the stock market. Active share: Looks at holdings and weightings Active share is a much simpler calculation that provides a snapshot in time. It measures how different a portfolio is from its benchmark by comparing the fund’s holdings and their weightings with those of the benchmark. We believe active share provides a clearer picture of how active a fund manager is than drawing conclusions from standard deviation calculations. In simple terms, a tracker fund that perfectly replicates its benchmark will have an active share of 0%, while an active fund that owns no constituents of its reference benchmark will have an active share of 100%. This measure is increasingly important, given the rise of passive investing and the need to differentiate between quasi-passive and genuinely active managers. Origin of active share The concept of active share was introduced in research by Martijn Cremers and Antti Petajisto, which indicated that portfolios with a high active share were, on average, likely to outperform their benchmarks, suggesting a positive correlation between performance and active share. 1 Additional research by Cremers and fellow economist Ankur Pareek 2 combined active share analysis with portfolio managers’ stock holding period, where long duration is defined as more than two years. The research shows clear outperformance, on average, of those strategies that combine high active share and long duration, or low turnover, of stocks. Of course, past performance does not guarantee future results. Earlier this year, Invesco published a white paper examining the historical outperformance of active management , using active share as the measuring stick for active management. Because high active share offers no performance guarantee, it’s possible to have a high active share portfolio that underperforms its benchmark. However, our team believes that to outperform a benchmark, portfolio construction needs to differ from the benchmark, and active share is a reliable, easy way of measuring this. So while active share doesn’t guarantee performance, we believe it’s a prerequisite – if you aren’t different, then you can’t hope to achieve a different result, good or bad. By-product of investment philosophy While we don’t explicitly target a high active share in the Invesco Global Opportunities strategy, it’s a by-product of our investment philosophy – concentrated and flexible investing that views risk as absolute, not relative. The result is an active share that is typically high, currently at 95%. Put simply, to create an opportunity to deliver alpha for our investors, we believe the fund has to be meaningfully different from its benchmark. In addition, we see no evidence to suggest a direct link between the strategy’s tracking error and performance. Sources “How active is your fund manager? A new measure that predicts performance,” Aug. 7, 2006. Patient Capital Outperformance: “The Investment Skill of High Active Share Managers Who Trade Infrequently,” Sept. 19, 2014. Important information Alpha refers to the excess returns of a fund relative to the return of a benchmark index. Standard deviation measures a portfolio’s range of total returns and identifies the spread of a portfolio’s short-term fluctuations. Drawdown is the largest cumulative percentage decline in net asset value as measured on a month-end basis. Absolute return refers to the return an asset achieves over a certain period of time, without comparison to another measure or benchmark. The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE All data provided by Invesco unless otherwise noted. Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd. ©2015 Invesco Ltd. All rights reserved. Beyond the benchmark: Tracking error versus active share by Invesco Blog

VWEHX: Giving You High Yields Since The ’70s

Summary High-yield bond fund that has shown good returns over the last decade. Junk bonds are in the top end of credit quality. Option to help with reducing risk and volatility in a portfolio. Mutual funds are a great way to improve risk adjusted returns for investors. There are many options when looking for high yield investments and recently I have been looking at high-yield bond funds. Vanguard High-Yield Corporate Fund Investor Shares (MUTF: VWEHX ) holds high rated “junk bonds” and aims for investors who are looking for consistent income. Since inception in 1978 the fund has had an average annual return of 8.48%. With how well the bonds are chosen and a high yield, this fund has the potential to fit into many portfolios. While it may not beat the market in overall return, there is going to be less risk and volatility to worry about. Expense Ratio The expense ratio is .23% for the minimum investment. This is a surprisingly low expense ratio for an actively managed fund seeking high-yield bonds. There is a minimum investment of $3,000 to invest in this mutual fund. The Lipper peer average expense ratio was 1.11% as of 12/31/2014. The management team had a turnover rate of 34.7% the last fiscal year and has performed well compared to similar funds. Yield VWEHX has a distribution yield of 5.58%, which is great for more current income in a portfolio. The combination of a high yield and a low expense ratio make this fund a definite option. While this fund is correlated on a short term basis to stocks, the high yield needs to be taken into consideration. During an extended down period for the market this high yield is going to greatly reduce the overall loss. However, when we are in a bull market a bond fund is not going to see a lot of growth. Here’s a comparison to the S&P: Even though you can definitely see the correlation, there is a massive difference in volatility. Over a long period of time VWEHX has performed very well on a returns basis because of the high yield. Because of how this fund functions, I wouldn’t have it in my portfolio unless I had a good utilization for the yield. Diversification Here’s a graph showing bond sector allocation: Along with 402 holdings, VWEHX has broad diversification. All the different sector and company exposure is a good first step in protecting against risk. Among the 402 holdings, there is a good balance of diversity without investing too much in a few companies. There is only one holding with over 1% and quickly shifts to the tenth being at .80%: On top of being well diversified, the management has shown over decades their process to choose bonds has worked. The fund uses a fundamental process when looking at credit quality. With how the bonds are chosen there is generally a higher credit quality and less volatility than competitors. The average annual returns over the past ten years has been 6.56% and over five years has been 6.33%. This has been a top performing high yield bond fund since its inception and continues to perform. I normally wouldn’t pay attention to one-year periods, but it makes a point of how this fund does during a bump. Over the last year the fund has had an annual return of .91%, which is in the top 10% for funds in this category. VWEHX’s high yield has saved the day again here. An interesting point to look at this fund is the yield and performance while selecting high-quality junk bonds as shown in the following chart: 90% of the holdings are B3 or above. Management has stated that they will never have more than 10% of the holdings below B quality. Over 85% is in the top end of non-investment grade bonds. There has been some speculation as to how management finds bonds, which can be found here . Whatever exact strategy is used, Wellington Management has done a good job choosing investments for this mutual fund. Conclusion VWEHX is broadly diversified and has had a high sustainable current income. VWEHX has higher credit quality bonds compared to the others junk bond funds. Management has used a credit selection process, which has shown a lower return volatility compared to competitors. High-yield bond funds will have a correlation to the market, but the lower risk and high income coming in from a high yield will get rid of massive bumps in volatility. I would want this fund around 5%-10% of my heavily indexed portfolio to help with income and reduce overall volatility.

The SPDR Global Allocation ETF: A Comprehensive Fund Of Funds

Although it seems simple at first glance, it is a complex and comprehensive fund of funds. Generally, the fund is extremely well diversified with both domestic and international assets. An ideal fund which requires a minimum attention for investors with a long term view. Quite often investors shy away from a ‘fund of funds’. True, some individual investors have the experience, skill, knowledge and time to filter through and analyze the multitude of funds available. However, for those investors who are just starting out, whose time is consumed by careers and family, a ‘fund of funds’ might be the ideal solution for a foundational investment. These generalized investment vehicles require little attention during those ‘busy years’ and an automatic, disciplined investment routine can be set up with most retail/online brokers. There are plenty of ETFs to choose from, no doubt. The State Street Global Advisors’ Global Allocation ETF (NYSEARCA: GAL ), from State Street Corporation’s (NYSE: STT ) SPDR portfolio of ETFs, is one of the better performing funds in this asset class. The fund is relatively new, having launched in April of 2012 with a 5.38% return since then. However, over the past year the fund has return -2.59% and year to date, -4.60% . So is this an opportunity to buy a good fund at a low price? In order to make that determination, a closer inspection of the fund is necessary. The first important question the investor needs to ask is whether the fund is appropriate in terms of risk and time horizon. According to State Street, the fund “… seeks to provide capital appreciation …” In other words, the fund is more focused on the market ETF gains than only dividend returns or combined ‘total returns’. Next: …The Fund invests in exchange traded funds… …that seek to track the performance of a market index; exchange traded commodity trusts; and exchange traded notes … Another important factor is that the fund tracks the respective fund’s underlying index. Usually, when a fund of funds is actively managed, it indicates a high expense ratio: that means the annual percentage of assets the management charges shareholders for their efforts. This fund’s management fees are 0.35%, well below the industry average of 0.44%. The next important factor is the way the fund allocates its invested capital. Data from State Street Global The heaviest weighted allocation is in International Equities, followed by Fixed Income, Cash, U.S. Equities, High Yield Funds, U.S. REITs, U.S. Treasury “Inflation Protected Securities”, called TIPS, and lastly International REITS. Although a ‘fund of funds’ might seem simple enough, they can be quite complex. It seems that the best way to dig a little deeper into the fund is by asset sector: Equity, Fixed Income, High Yield and REITs. Interestingly, GAL is not comprised of exclusively State Street Global funds but also includes two WisdomTree (NASDAQ: WETF ) Hedged Equity Funds and SPDR-Barclays and SPDR-Dow Jones assets. Equity Funds Symbol GAL Weighting Type Gross Expense Ratio Return Since Inception Premium/ Discount Number of Holdings Trailing 12 Month Yield SPDR S&P World ex-US ETF GWL 14.42% International Equity 0.34% -0.53% 4/20/2007 Premium 0.90% 1406 2.78% WisdomTree Europe Hedged Equity ETF HEDJ 9.16% Europe Equity USD Hedged 0.58% 6.14% 12/31/2009 Premium 0.54% 129 0.21% WisdomTree Japan Hedged Equity ETF DXJ 8.67% Japan Equity USD Hedged 0.48% 2.27% 6/16/2006 Premium 1.68% 313 3.16% SPDR S&P 500 Trust ETF SPY 6.04% S&P 500 0.1098% with waiver 8.75% 1/22/1993 Premium 0.01% 507 2.01% SPDR S&P International Small Cap ETF GWX 3.03% International Equity Small cap 0.40% 0.58% 4/20/2007 Premium 1.06% 2238 1.07% Consumer Discretionary Select Sector SPDR ETF XLY 2.02 S&P US Consumer Cyclical 0.14% 8.05% 12/16/1998 0.00% 88 1.37% Industrial Select Sector SPDR ETF XLI 2.02% S&P 500 Industrials 0.14% 6.07% Premium 0.03% 66 2.08% Health Care Select Sect SPDR ETF XLV 1.97% S&P 500 HealthCare 0.14% 7.69% 12/16/1998 0.00% 57 1.46% Data From SPDR and WisdomTree Each of the international funds has diverse global allocations; the only ‘straight-forward’ one is the WisdomTree DXJ which is 100% Japan. The bar chart below summarizes the total national allocations of the international equity funds. (click to enlarge) Data From WisdomTree and SPDR Similarly, each of these international Equity Funds allocates capital differently among economic sectors as summarized in the chart below. (click to enlarge) Hence, what initially seemed like a simple fund of funds has so far proven itself to have an extraordinary amount of complexity. The international funds have over 4000 holdings in total, with capital distributed over 25 countries. It’s worth noting here that the average expense ratio of the international funds alone is 0.45% which is about the average ETF industry expense ratio. The average yield of the international funds is 1.805%. The US Equity based funds are not as straight forward as they seem, either. SPY is essentially the comprehensive and widely followed S&P 500 index [SPX]. However, GAL includes three SPDR select sector funds . Briefly, Select Sector SPDRs : …divide the S&P 500 into eleven index funds… …with the objective of matching the price and yield performance of their underlying sector indexes.. . The important factor here is the sector allocations. It’s important because each sector is already a component of the S&P 500 Trust! So the effect of the three SPDR Select Sector Funds along with SPY creates a ‘multiplier’ of the three included sectors: Consumer Discretionary , Industrials and Health Care . As it is SPY is allocated as in the chart below: Data From SPDR To see this visually, the pie chart slices in bright green are already sectors in the SPY fund and also separate SPDR Select Sector holdings XLV, XLY and XLI, (noted by the red lettering). The point being is that a change in one sector affects all four holdings, not by much, but pointing this out helps the investor understand the structure of a fund of funds. In this case, Health Care is a ‘defensive sector, while Consumer Discretionary and Industrials are more biased towards ‘capital appreciation’ which is the fund’s stated objective! Before going on to fixed income, a few definitions are necessary. From Investopedia, investment grade is: … A rating that indicates that a municipal or corporate bond has a relatively low risk of default. Bond Rating firms such as Standard & Poor’s, use different designations consisting of upper- and lower-case letters ‘A’ and ‘B’ to identify a bond’s credit quality rating ‘AAA’ and ‘AA’ (high credit quality) and ‘A’ and ‘BBB’ (medium credit quality) are considered investment grade. Credit Ratings for bonds below these designations (‘BB’, ‘B’, ‘CCC’, etc.) are considered low credit quality … Fixed Income Symbol GAL Weighting Type Gross Expense Ratio Return Since Inception Premium/ Discount Number of Holdings Average Yield ETF Hub 3 Year Return Position SPDR Barclays Capital High Yield Bond ETF JNK 9.91% 40% BB Grade, 40% B Grade 13.87% C 0.40% 5.07% 11/28/2007 Premium 0.27% 783 7.03% 12th of 109 Corporate High Yield SPDR Barclays Long Term Treasury ETF TLO 7.03% Avg 25 Years to Maturity UST 0.10% 7.97% 5/23/2007 Premium 0.06% 45 3.22% 10th of 18 US Long Term Treasuries SPDR Barclays Capital Long Term Corporate Bond ETF LWC 6.03% 5% Aa Grade 42% A Grade 49% Baa Grade 0.12% 9.59% 3/10/2009 Premium 0.58% 1768 5.10% 2nd of 3 long Duration Corporates SPDR Barclays Capital TIPS ETF IPE 3.94% Avg 9.18 Years to Maturity TIPs 0.15% 4.40% 5/25/2007 Premium 0.09% 36 0.86% 12th of 13 US Treasury TIPS SPDR Barclays Aggregate Bond ETF LAG 2.98% Mix of UST, MBS, ABS, CMBS, Corporates 0.10% 4.79 5/23/2007 Premium 0.22% 2438 2.83% 81st of 295 Fixed Income SPDR Barclays Capital Intermediate Term Corporate Bond ETF ITR 1.01% 8% Aa Grade 45% A Grade 45% Baa 0.12% 5.44% 2/10/2009 Premium 0.23% 2882 3.71% 2nd of 4 Intermediate Corporates SPDR Barclays Intermediate Term Treasury ETF ITE 0.99% Avg 4.02 Years to Maturity UST 0.10% 3.92% 5/23/2007 0.00% 207 1.78% 10th of 19 Intermediate US Treasuries Data From SPDR The fixed income funds comprise US Treasuries: long term, intermediate term and ‘inflation protected’ bonds; a ‘high yield’ fund consisting mostly of the lowest rated investment grade bonds; Long and Intermediate term corporates and an interesting ‘aggregate’ bond fund. All of the bond funds are pretty much straight forward; however the aggregate bond fund is worth a closer look. The SPDR-Barclays Aggregate bond fund contains a diversified mixed of fixed income securities, ranging from ultra-safe US Treasuries to more risky ‘Asset Backed Securities’. The chart below gives a quick visual of the LAG fund’s capital allocation. Again, it’s worth noting that since LAG holds US Treasuries, there’s an overlap with the US Treasury only funds, hence, there’s slightly more US Treasuries imbedded within the fund. Data from SPDR Also, it’s important to note the quality allocation: Data from SPDR The last significant type of holding is the Real Estate Investment Trusts, (REITS). The fund has two, one domestic and one international. Both REITS are from the SPDR-Dow Jones portfolio of funds. Some of the key metrics are summarized in the table below: REIT Symbol GAL Weighting Type Gross Expense Ratio Return Since Inception Premium/ Discount Number of Holdings Average Yield ETF Hub 3 Year Return Position SPDR Dow Jones REIT ETF RWR 4.06% Storage, Residential, Community, Groups and Trusts 0.25% 10.82% 4/22/2001 Discount -0.03 97 3.12% 6th out of 39 REITS SPDR Dow Jones International Real Estate ETF RWX 1.01% Groups, Shares, Companies, REITs, 0.59% -0.14% 12/15/2006 Premium 0.66% 134 2.99% 21st out of 39 REITS Without going into deep detail, it’s well worth taking a look at the returns over specific periods of time summarized in the next table. It should be pointed out that the poor performance of the international RWX over the past year coincides with the contracting economies in the Asia-Pacific region, indirectly affecting Europe, whereas the strong performance of the domestic RWR over this period coincides with a strengthening US economy. RWR outperforms RWX over 3 and 5 years, however, the RWX returns over 3 and 5 years are well positive, too. REIT Symbol 1 Month Quarter to Date Year to Date 1 Year 3 Year 5 Year 10 Year Since Inception SPDR Dow Jones REIT ETF RWR 3.38% 3.07% -3.02% 11.56% 9.66% 12.03% 6.55% 10.82% SPDR Dow Jones International Real Estate ETF RWX 0.44% -5.12% -3.15% -2.14% 4.87% 6.07% NA -0.10% The last notable difference between these two funds is the very different asset allocations: (click to enlarge) Data from SPDR; Getty Images To sum it all up, a fund of funds is an incredibly useful investment vehicle particularly for those who know the importance of having an investment plan, but perhaps do not have the time or knowledge to construct a well-diversified portfolio from scratch, nor perhaps, employ a personal investment advisor. A fund of funds, such as the SPDR Global Allocation ETF is an excellent starting point. As always, dollar cost averaging and distribution reinvestment over the long term is perhaps the most certain way to build a nest egg for retirement or college fund. (click to enlarge) There’s an even more subtle point to be gained from the foregoing narrative. Although a fund of funds is an excellent ‘starting point’ foundation investment which does not require a great deal of time and attention once it’s set up, it should not absolve the investor of occasionally taking the time to examine the funds one at a time, understand the terms and language, making comparisons and thus acquiring the knowledge to build upon a good foundation in coming years.