Tag Archives: mutual-fund

VHDYX: Fantastic Equity Mutual Fund For Long Term Investing

Summary VHDYX has great sector exposure with a low expense ratio. Well created equity index for anyone planning for long term retirement. Fund is focused on a high dividend and invested in the large companies in the U.S. market. Saving for retirement can be a daunting task when choosing where to invest money. If the ability to save for the long haul is available use it to your advantage. Some portfolios may look too volatile and risky but time is often a great answer. The fund we will be looking at for long term investing is the Vanguard High Dividend Yield Index Fund Investor Shares (MUTF: VHDYX ). Expense Ratio The expense ratio for VHDYX is .18%, which looks great for a mutual fund. Diversification The following chart shows the top ten holdings and also gives a good idea of what we’re looking at in this fund: I would like to see an index with 436 stocks have less than 30% of its holdings in the top ten. That being said, I still like the broad range of sector exposure. The index does invest 98.94% into domestic companies. There are some global giants among the holdings so there will be some international exposure. I stress some because if international exposure is really important for a portfolio I don’t think this index will be enough. Great diversification here with no sector being over 15%. Technology and health care are the two equity sectors that I would look into investing more in. With the advancement and cost effectiveness of automating jobs I tend to favor having technology around 14%. Health care should be a strong sector with the rising age of the population for the next couple of decades. Beyond baby boomers, people are also living longer which is magnifying poor health habits. With a pure equity index I was glad to see telecommunications and basic materials so low. Telecommunications does have the ability for some serious upside but the problem is knowing where it will come from. Everyone wants to sell you their new phone. The competition is rising and causing the sector to really buckle down and intelligently decide what to do next. We have seen some major flops even by the telecommunication giants and now would be a bad time to fall behind. There are plenty of good arguments for who will come out on top but I’m sure we’re all in for a few surprises. With companies working on snazzy new features and trying to be the first one to market breaking technology it’s not a position I want to be heavily invested in. Risk Even though there are hundreds of stocks in this index it is still an equity fund. There is going to be quite a bit of volatility with the market and therefore a lot of risk on a short term basis and there is a chance that a handful of years could take rough swings. There is a high correlation between VHDYX and the S&P 500 and I would invest in them both the same way – long term. Below is a comparison with VHDYX and its benchmark: These returns do look good but I would not use this information to invest if I wanted to retire in five years and could not handle losses. There is the option of diversifying the risk to your liking but if it were me I would make sure I could invest for at least ten years. Yield The yield at 3.29% is what makes this index a winner for me. So many investors plan on a long term goal which involves taking some money out of their portfolio. Where many mistakes happen is watching an index drop and then deciding to pull their position. The high yield here allows you to invest and leave it alone for years while collecting dividends. Conclusion There is a lot to be positive about when looking at this mutual fund. There’s ten sectors to be diversified in and the amount allocated is well thought out. The high yield allows investors to put the money in the index and then leave it alone. The correlation to the S&P 500 should continue with the funds current holdings of only large U.S. companies. On the flip side there is some risk involved; especially if your goals aren’t long term. There is very little international exposure and almost 31% of the holdings in the top ten companies. I would like to see heavier weights for the smaller holdings while maintaining similar sector allocations. I’m heavily debating making it a part of my portfolio. I would want to invest with a long time horizon, such as 15 years, so that I could ride out any bumps in the economy while reinvesting dividends to grow the position

Using Leverage To Get More Out Of Your Bond Allocation

Summary A 50/50 stocks and bonds portfolio typically generates better risk-adjusted returns than a stocks-only portfolio. This is because bond funds generate positive alpha. For an S&P 500 index fund paired with an uncorrelated bond fund, the net beta is 0.5 and the net alpha is one-half the bond fund’s alpha. An easy way to improve raw and risk-adjusted returns is to allocate one-sixth to a 3x S&P 500 fund, and five-sixths to the bond fund. The portfolio beta is still 0.5, but portfolio alpha is five-sixths rather than one-half of the bond fund’s alpha. The strategy generalizes to asset allocations other than 50/50 and allows for non-zero correlation between the bond fund and the S&P 500. Fixed Stock/Bond Portfolios Personal investors typically increase exposure to bonds as they get closer to retirement, reducing risk and drawdown potential while also sacrificing raw returns. Consider a 50% stocks, 50% bonds portfolio based on a simple S&P 500 index fund and a total bond mutual fund or ETF. The beta for such a portfolio is simply the average beta of the two funds. If there is no correlation between the two funds, the portfolio beta is 0.5. That means it tends to move 0.5% for every 1% the S&P 500 moves, which of course reduces both growth potential and drawdown potential. The portfolio alpha for a 50/50 strategy is one-half the bond fund’s alpha. So if the bond fund has positive alpha due to maturing bonds and/or falling interest rates, the portfolio will have positive alpha. This is unlike a 100% S&P 500 portfolio, which by definition has zero alpha. Notably, net positive alpha is the reason that portfolios with both stocks and bonds generally have better risk-adjusted returns than portfolios with only stocks. If bond funds didn’t generate positive alpha, you’d be better off allocating a fixed percentage to cash rather than bonds to reduce your portfolio’s beta. The same logic here applies to asset allocations other than 50/50. For example, the net alpha and beta for a 20% S&P 500, 80% total bond fund would be four-fifths the bond fund’s alpha and 0.2, respectively. Again, we are assuming zero correlation between the two funds for the moment. Fixed Stock/Bond Portfolios With Leverage A common approach to achieve a net beta of 0.5 is to allocate 50% of assets to an S&P 500 fund, and 50% to a bond fund. But we can gain a notable advantage by using a leveraged S&P 500 fund to achieve the same beta. If we used a 3x daily S&P 500 fund, we would need to allocate 16.67% of assets to the 3x fund and the remaining 83.33% to the bond fund. Our portfolio beta is still 0.5, but our portfolio alpha is now five-sixths (rather than one-half) the bond fund’s alpha. A higher alpha for the same 0.5 beta translates to better raw and risk-adjusted returns. A More General Framework Suppose you wish to achieve some target beta by combining a leveraged S&P 500 fund and a particular bond fund. Let a represent the allocation to the leveraged S&P 500 fund. This is what we want to calculate. Let b represent the bond fund’s beta. Let c represent the leveraged fund’s target multiple. Let beta represent your desired portfolio beta. The necessary allocation to the leveraged fund is given by: a = ( b eta – b ) / ( c – b ) For a concrete example, suppose we wanted to use ProShares UltraPro S&P 500 (NYSEARCA: UPRO ), a 3x daily S&P 500 ETF, and Vanguard Total Bond Market ETF (NYSEARCA: BND ), to achieve a portfolio beta of 0.75. For b , I’ll use BND’s beta since inception, which is -0.035. Our target beta is 0.75 and c is UPRO’s leverage multiple, which is 3. a = (0.75 – -0.035) / (3 – -0.035) = 0.259. So we need to allocate 25.9% of our assets to UPRO, and the remaining 74.1% to BND. By doing so, we’ll retain 74.1% of BND’s alpha (which is 0.0191%). If we had used SPY rather than UPRO, we would have retained only 24.1% of BND’s alpha. The portfolio alphas would be 0.0142% and 0.0046%, respectively. Practical Considerations The main drawback of my approach is that it requires more frequent re-balancing to maintain a target asset allocation. This translates to more trading fees and possibly more short-term capital gains taxes. Also, leveraged funds have negative alpha due to their expense ratios. For example, UPRO’s expense ratio of 0.95% translates to a daily alpha of -0.0038%. For the above example, a 25.9% allocation to UPRO would contribute an alpha of -0.00098% (25.9% of -0.0038%), which is very small compared to BND’s alpha contribution of 0.0142% (74.1% of 0.0191%). An Illustration With UPRO and BND Time to put my money where my mouth is. Let’s look at growth of $100k for various target betas achieved by combining SPY with BND, and by combining UPRO with BND. For beta of 0.1, I rebalance whenever the effective beta goes outside 0.075-0.125; for beta of 0.25, 0.2-0.3; for beta of 0.5, 0.45-0.55; for beta of 0.75, 0.7-0.8; and for beta of 0.9, 0.85-0.95. I deduct $7 for each trade (i.e. $14 per rebalance) and assume BND has a beta of -0.035 throughout. (click to enlarge) Performance metrics are given below. Table 1. Performance metrics for SPY/BND and UPRO/BND portfolios with various target betas. Beta Funds Trades Final Bal. ($1k) CAGR (%) Sharpe MDD (%) Alpha (%) 0.10 SPY/BND 3 140.7 5.6 0.116 4.2 0.00018   UPRO/BND 33 143.2 5.8 0.113 4.7 0.00019 0.25 SPY/BND 3 156.4 7.3 0.109 4.2 0.00015   UPRO/BND 35 162.7 8.0 0.110 5.1 0.00018 0.50 SPY/BND 3 183.1 10.1 0.080 8.1 0.00009   UPRO/BND 82 197.5 11.4 0.090 7.7 0.00015 0.75 SPY/BND 2 214.8 12.9 0.068 12.9 0.00005   UPRO/BND 125 237.4 14.7 0.078 12.0 0.00013 0.90 SPY/BND 0 236.7 14.6 0.064 16.9 0.00001   UPRO/BND 153 264.2 16.6 0.074 14.9 0.00011 It makes sense that we see better performance with UPRO/BND with increasing target beta. The greater the target beta, the more we have to allocate to SPY in the SPY/BND portfolio, and the less alpha we retain from the BND allocation. UPRO allows us to allocate more to BND and thus utilize more of its alpha. Risks There are some reasons for caution when trading leveraged funds. I want to briefly re-iterate similar points as in my recent article, A Simple SPY Top-Off Portfolio . If SPY has an intraday loss greater than 33.33%, you could lose your entire balance in the leveraged ETF. UPRO and other leveraged S&P 500 ETFs have historically done an excellent job achieving their target multiple, but there is no guarantee they will continue to do so going forward. In between rebalancing periods, you can suffer some irrecoverable losses due to volatility decay. I would add that the strategy presented in this article uses leveraged funds, but only to achieve a net portfolio beta somewhere between 0 and 1. In that sense, some of the concerns normally associated with leveraged funds do not apply here (e.g. extreme volatility and potentially catastrophic drawdowns). Conclusions The “bonds” part of a stocks and bonds portfolio reduces risk. But so would cash. The reason we prefer bonds is that they generate positive alpha, which improves risk-adjusted returns. Typically, a stocks and bonds portfolio utilizes only a fraction of the bond fund’s alpha. An easy way to increase that fraction is to use leverage. Historical data for UPRO and BND support the notion that using a leveraged fund in place of SPY allows you to capture more a bond fund’s alpha, thus improving both raw and risk-adjusted returns.

Utilities Specialist Reaves Launches Its 1st Actively Managed Utilities ETF

Summary Reaves Asset Management – a company with 50 years researching and investing in utility assets – recently launched the Reaves Utilities ETF. It joins the relatively small list of actively managed ETFs but carries an expense ratio that would place it among the most expensive in the utilities ETF space. The fund’s managers believe that actively managing the inherent complexities of the utilities sector can unlock additional value for shareholders that a passive index can not. Reaves Asset Management – an investment management firm that specializes in the utilities and energy sectors – has been investing on the behalf of its clients for the past 3+ decades. Recently, the company entered the ETF space for the first time with the Reaves Utilities ETF (NASDAQ: UTES ). Reaves, however, is not new to the fund game. It also offers the open-end mutual fund Reaves Utilities and Energy Infrastructure Fund (MUTF: RSRAX ) and the closed-end fund Reaves Utility Income Fund (NYSEMKT: UTG ). Not only is Reaves entering the ETF space for the first time but it’s doing so with one of the few actively managed ETFs out there. Manager The Reaves company has been around for over 50 years and has been managing investor money for around 37. The company now manages a total of roughly $3B in a combination of its mutual funds, ETF and separately managed accounts. The ETF is managed by Louis Cimino, John Bartlett and Jay Rhame. Bartlett has been with the company for 20 years, Cimino 18 and Rhame 10. The research team at Reaves, according to the fund’s fact sheet, “averages over 20 years of experience.” Investment Process The management team uses a combination quantitative and qualitative approach in order to make investment decisions and, according to the fact sheet , uses the following criteria. Where this product differs from most other ETFs is that it’s actively managed. Betting that the fund’s active management can outperform a passive index may prove to be a risky proposition. In most cases, actively managed funds cost more to operate to than passive index funds due to the extra involvement necessary to manage the fund. According to ETFDB.com, this ETF’s 0.95% expense ratio would rank it as the highest annual expense ratio among the roughly two dozen utility-focused ETFs in the marketplace. The Utilities Select Sector SPDR ETF (NYSEARCA: XLU ) charges just 0.15% a year which means the Reaves ETF will need outperform by nearly a full percent per year just to come out ahead. That’ll be a tall order to fill regardless of who’s managing the fund. Holdings As of October 9, the fund has 21 holdings total. The top 10 holdings listed below account for 67% of fund assets currently. Prospects The ETF is debuting at a potentially advantageous time. Utilities as a whole have struggled this year – the Utilities Select Sector SDPR is down 4.8% year to date versus a 2.1% loss for the S&P 500. Investors had been anticipating a rate hike from the Fed and yields on the 10 year Treasury hit 2.5% earlier this year which made fixed income securities look more attractive and began rotating cash out of equities. As the prospect of a Fed rate hike looks to be getting pushed further out on the horizon and Treasury yields begin coming back down, the 3-4% yields offered by utilities began to look more and more attractive. While Reaves has been studying and managing utility assets for decades I still believe it’s going to have a difficult time overcoming the expense ratio over time. The fund currently has about $2.6M in assets and trades just a few hundred shares a day so bid-ask spreads could be large until the fund is able to operate a little more efficiently. All in all, due to the fund manager’s wealth of utility sector experience I would continue keeping an eye on this fund.