PBS Is Just What I’m Not Looking For In An ETF
Summary I’m taking a look at PBS as a candidate for inclusion in my ETF portfolio. A limited underlying index, high standard deviations, moderate correlation, weak yields and high expense ratios make this a poor fit for my tastes. The best things going for the portfolio is decent (but not great) liquidity. 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 Dynamic Media Portfolio (NYSEARCA: PBS ). 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 PBS do? PBS attempts to track the total return (before fees and expenses) of the Dynamic Media IntellidexSM Index. At least 90% of the assets are invested in funds included in this index. The index only includes the common stock of 30 companies, all of which are considered U.S. Media companies. PBS falls under the category of “Communications.” Does PBS 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 mediocre at 85%. I want to see low correlations on my 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 January 2012) The standard deviation is great. For PBS it is .9703%. For SPY, it is 0.7300% for the same period. SPY usually beats other ETFs in this regard, but this combination of standard deviation and correlation isn’t going to do much good under modern portfolio theory. Liquidity looks acceptable Average trading volume isn’t very high, a bit over 40,000, 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 PBS, the standard deviation of daily returns across the entire portfolio is 0.8182%. With 80% in SPY and 20% in PBS, the standard deviation of the portfolio would have been .7558%. If an investor wanted to use PBS as a supplement to their portfolio, the standard deviation across the portfolio with 95% in SPY and 5% in PBS would have been .7352%. 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 .50%. I simply don’t see this as a useful holding for retiring investors. The combination of mediocre correlation and high standard deviation results in an ETF that is unlikely to lower the total risk profile of the portfolio unless it was used in phenomenally small amounts. The distribution yield is weak, which means retiring investors may have a stronger temptation to sell shares if their income is too low. The point of building the portfolio with ETFs is to avoid active management outside of rebalancing. I can deal with a weak yield because I’m far from retirement, but it is starting to feel like the ETF is looking for a fairly small niche to fill. I’m not a CPA or CFP, so I’m not assessing any tax impacts. Expense Ratio The ETF is posting .62% for a gross expense ratio, and .62% for a net expense ratio. I want diversification, I want stability, and I don’t want to pay for them. For an ETF that already left me wanting more in most categories, being hit with a big expense ratio isn’t the way to draw me back in. Market to NAV The ETF is at a .04% 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 can’t be very good when there are only 30 companies in the underlying index. The chart below supports that assessment. The top seven companies are each more than 5% of the total holdings. (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 PBS 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. PBS won’t make the next round of comparison. It feels like the ETF would be most useful for making short-term bets on the sector. Some sector ETFs can provide additional value to a portfolio by improving the balance of different exposures, but I don’t see that benefit here.