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EWRS Brings Small Cap Exposure And Low Correlations, But Poor Liquidity Hurts It

Summary I’m taking a look at EWRS as a candidate for inclusion in my ETF portfolio. The low correlation is very attractive, but isn’t reliable because of poor liquidity. I’ll have to do further investigation to see if it is real. I’ll keep it on my list for potential exposure to small caps. The internal diversification of holdings within the ETF is excellent and an equal weighting scheme sounds very attractive relative to market cap strategies. I’m not assessing any tax impacts. Investors should check their own situation for tax exposure. How to read this article : If you’re new to my ETF articles, just keep reading. If you have read this intro to my ETF articles before, skip down to the line of asterisks. This section introduces my methodology. By describing my method initially, investors can rapidly process each ETF analysis to gather the most relevant information in a matter of minutes. My goal is to provide investors with immediate access to the data that I feel is most useful in making an investment decision. Some of the information I provide is readily available elsewhere, and some requires running significant analysis that, to my knowledge, is not available for free anywhere else on the internet. My conclusions are also not available anywhere else. What I believe investors should know My analysis relies heavily on Modern Portfolio Theory. Therefore, I will be focused on the statistical implications of including a fund in a portfolio. Since the potential combinations within a portfolio are practically infinite, I begin by eliminating ETFs that appear to be weak relative to the other options. It would be ideal to be able to run simulations across literally billions of combinations, but it is completely impractical. To find ETFs that are worth further consideration I start with statistical analysis. Rather than put readers to sleep, I’ll present the data in charts that only take seconds to process. I include an ANOVA table for readers that want the deeper statistical analysis, but readers that are not able to read the ANOVA table will still be able to understand my entire analysis. I believe there are two methods for investing. Either you should know more than the other people performing analysis so you can make better decisions, or use extensive diversification and math to outperform most investors. Under CAPM (Capital Asset Pricing Model), it is assumed every investor would hold the same optimal portfolio and combine it with the risk free asset to reach their preferred spot on the risk and return curve. Do you know anyone that is holding the exact same portfolio you are? I don’t know of anyone else with exactly my exposure, though I do believe there are some investors that are holding nothing but SPY. In general, I believe most investors hold a portfolio that has dramatically more risk than required to reach their expected (under economics, disregarding their personal expectations) level of returns. In my opinion, every rational investor should be seeking the optimal combination of risk and reward. For any given level of expected reward, there is no economically justifiable reason to take on more risk than is required. However, risk and return can be difficult to explain. Defining “Risk” I believe the best ways to define risk come from statistics. I want to know the standard deviation of the returns on a portfolio. Those returns could be measured daily, weekly, monthly, or annually. Due to limited sample sizes because some of the ETFs are relatively new, I usually begin by using the daily standard deviation. If the ETF performs well enough to stay on my list, the next levels of analysis will become more complex. Ultimately, we probably shouldn’t be concerned about volatility in our portfolio value if the value always bounced back the following day. However, I believe that the vast majority of the time the movement today tells us nothing about the movement tomorrow. While returns don’t dictate future returns, volatility over the previous couple years is a good indicator of volatility in the future unless there is a fundamental change in the market. Defining “Returns” I see return as the increase over time in the value known as “dividend adjusted close”. This value is provided by Yahoo. I won’t focus much on historical returns because I think they are largely useless. I care about the volatility of the returns, but not the actual returns. Predicting returns for a future period by looking at the previous period is akin to placing a poker bet based on the cards you held in the previous round. Defining “Risk Adjusted Returns” Based on my definitions of risk and return, my goal is to maximize returns relative to the amount of risk I experienced. It is easiest to explain with an example: Assume the risk free rate is 2%. Assume SPY is the default portfolio. Then the risk level on SPY is equal to one “unit” of risk. If SPY returns 6%, then the return was 4% for one unit of risk. If a portfolio has 50% of the risk level on SPY and returns 4%, then the portfolios generated 2% in returns for half of one unit of risk. Those two portfolios would be equal in providing risk adjusted returns. Most investors are fueled by greed and focused very heavily on generating returns without sufficient respect for the level of risk. I don’t want to compete directly in that game, so I focus on reducing the risk. If I can eliminate a substantial portion of the risk, then my returns on a risk adjusted basis should be substantially better. Belief about yields I believe a portfolio with a stronger yield is superior to one with a weaker yield if the expected total return and risk is the same. I like strong yields on portfolios because it protects investors from human error. One of the greatest risks to an otherwise intelligent investor is being caught up in the mood of the market and selling low or buying high. When an investor has to manually manage their portfolio, they are putting themselves in the dangerous situation of responding to sensationalistic stories. I believe this is especially true for retiring investors that need money to live on. By having a strong yield on the portfolio it is possible for investors to live off the income as needed without selling any security. This makes it much easier to stick to an intelligently designed plan rather than allowing emotions to dictate poor choices. In the recent crash, investors that sold at the bottom suffered dramatic losses and missed out on substantial gains. Investors that were simply taking the yield on their portfolio were just fine. Investors with automatic rebalancing and an intelligent asset allocation plan were in place to make some attractive gains. Personal situation I have a few retirement accounts already, but I decided to open a new solo 401K so I could put more of my earnings into tax advantaged accounts. After some research, I selected Charles Schwab as my brokerage on the recommendation of another analyst. Under the Schwab plan “ETF OneSource” I am able to trade qualifying ETFs with no commissions. I want to rebalance my portfolio frequently, so I have a strong preference for ETFs that qualify for this plan. Schwab is not providing me with any compensation in any manner for my articles. I have absolutely no other relationship with the brokerage firm. Because this is a new retirement account, I will probably begin with a balance between $9,000 and $11,000. I intend to invest very heavily in ETFs. My other accounts are with different brokerages and invested in different funds. Views on expense ratios Some analysts are heavily opposed to focusing on expense ratios. I don’t think investors should make decisions simply on the expense ratio, but the economic research I have covered supports the premise that overall higher expense ratios within a given category do not result in higher returns and may correlate to lower returns. The required level of statistical proof is fairly significant to determine if the higher ratios are actually causing lower returns. I believe the underlying assets, and thus Net Asset Value, should drive the price of the ETF. However, attempting to predict the price movements of every stock within an ETF would be a very difficult and time consuming job. By the time we want to compare several ETFs, one full time analyst would be unable to adequately cover every company. On the other hand, the expense ratio is the only thing I believe investors can truly be certain of prior to buying the ETF. Taxes I am not a CPA or CFP. I will not be assessing tax impacts. Investors needing help with tax considerations should consult a qualified professional that can assist them with their individual situation. The rest of this article By disclosing my views and process at the top of the article, I will be able to rapidly present data, analysis, and my opinion without having to explain the rationale behind how I reached each decision. The rest of the report begins below: ******** (NYSEARCA: EWRS ): Guggenheim Russell 2000 Equal Weight ETF Tracking Index: Guggenheim Russell 2000 Equal Weight Index Allocation of Assets: At least 80% in assets included in the index Morningstar Category: Small Blend Time period starts: April 2012 Time period ends: December 2014 Portfolio Std. Deviation Chart: (click to enlarge) (click to enlarge) Correlation: 73.45% Returns over the sample period: (click to enlarge) Liquidity (Average shares/day over last 10): 4,379 Days with no change in dividend adjusted close: 42 Days with no change in dividend adjusted close for SPY: Yield: 1.01% Distribution Yield Expense Ratio: .45% Discount or Premium to NAV: .10% premium Holdings: (click to enlarge) Further Consideration: I’ll keep EWRS in my potential list for now Conclusion: There are quite a few things I like about EWRS, but also a few problems will merit deeper analysis. The good things are the low correlation and the equal weighting of the index was very impressive diversification within the ETF. The largest hold at reached a market weight of .30%. That is incredible diversification within the ETF. Even if the ETF is aiming for an exact equal weighting, they can’t reasonably be rebalancing constantly so there should be some deviations. The bad news is that the liquidity is absolutely terrible and the terrible liquidity may have been a driving factor in the 42 days with no change in dividend adjusted closes. This is one of the ETFs where poor liquidity could be reducing the reliability of the statistics. If the correlation is significantly higher than it appears but is being understated because of poor liquidity, it would make the ETF significantly less attractive. The combination of poor liquidity and low yield makes the ETF substantially less attractive for investors that are seeking income or needing liquidity. While I’m willing to cope with those problems if the correlation turns out to be accurate, I still don’t like the expense ratio much. Given that the portfolio is to be equally weighted and has very small exposure to each individual stock, I would be willing to accept the expenses if I was using the portfolio as a small part of my portfolio. This may be a decent option for getting some small cap exposure into my portfolio. If I pick EWRS, I’d only plan on using it for 5% to 10% of the portfolio. If poor liquidity is a major issue when the markets are open, I would consider keeping an eye on NAV and using a (one day) limit order to try to buy up a piece for a 1 to 2% discount to NAV. I would consider the ETF fairly attractive if it could be purchased at that kind of discount to NAV.

How My Value Investing Strategies Performed In 2014

Summary 2014 was a tough year in the markets but there was a strategy that outperformed the market with a gain of 24.5%. Quarterly breakdown of results for the 15 different value investing strategies I follow are provided. A detailed look at the stock portfolio that outperformed in 2014. In ancient Roman mythology, there is a god with two faces. His name is Janus, and with two faces, he looks in both directions representing the past and future. It’s also where the word January came from. Although January 2015 is fully under way, it’s appropriate because we are still at a stage of looking back at 2014, while also looking at what lies ahead in 2015. Now one of the very last tasks of the year (or first of the year) that I do is to go through all the performances of the value stock screeners and see what worked and what didn’t. I don’t bother with gathering results for all different asset classes and sectors because there are plenty of people who are better than me at this. It’s easier to leverage the work of others and to put my value strategies into context. Here’s the best chart I came across showing the performance of the major asset classes. (click to enlarge) Yearly Asset Performance Chart (Credit: awealthofcommonsense.com ) Because my focus has always been on value stocks, the stocks shown on the value screens all fall into the large, mid and small cap boxes above. But most of those stocks should be categorized into the small cap group which managed 3% on the year. So in the grand scheme of things, no matter how good the strategy or quality of the company was, small caps had a rough 2014. It goes to show how difficult it is to beat the market. The market isn’t going to award you easily just because the company has strong fundamentals. What works one year, may not the next and it’s a test of conviction and temperament to see it through. That’s why having a clear process to buy and sell stocks and to focus on creating long term wealth is important over short-term gains. Sure it feels good when you beat the market, but that’s something you can leave to fund managers who are judged based on their quarterly or yearly results. You and I have the luxury of looking 5 or 10 years down the road and comparing performance then. A few bad years after having achieved 200% vs. the market’s 100% over a 10-year period isn’t important. The end goal is to outperform the market over the long run because you aren’t trying to invest for a few months and then call it quits. With that in mind, here are the final 2014 results for each of the Value Screeners . 2014 Value Screener Results Before getting into the results, a very common question that I receive daily is whether the OSV Analyzer will screen for stocks and tell people what to buy and sell. I want to start by clearing up that these strategies are not created with the OSV Analyzer. The OSV Analyzer is a deep fundamental analysis and valuation tool. A tool to drill down deeply into a single company quickly instead of just scratching the surface and looking at basic stats. Screening will come in the future. With that out of the way, here are the results. (click to enlarge) Out of 15 value strategies, only 4 managed to outperform the market at the end of the year. The outperforming strategies ( Altman , Graham , Piotroski ) were the ones that contained a lot of mid and large caps. With the Altman Z value screen leading the pack this year, here’s a look at the 20 stocks that made up the list from the beginning of the year and how each performed. (click to enlarge) There are stocks that I definitely wouldn’t purchase, but that’s the beauty of mechanical investing. It’s simplified down to how well you create a strategy and stick with it. This reduces many of the variables that go into individual stock picking. However, I still find it difficult to give up total control of my portfolio. I prefer to further filter the list with my analyzer because screeners still make mistakes. Manual analysis is also required because there are things like off balance sheet items screens can’t recognize and qualitative events that can’t be simulated. But if this was something that I want to follow with real money, I’ll want to create a new account with at least $20k instead of using money from my existing portfolio. Not the Time to Invest in US Net Nets One sure thing about 2014 was that it wasn’t a good year for net nets. It’s especially clear looking at the Net Net performance. Since the results are all US listed stocks, the horrible performance isn’t surprising. When markets are hot, stay away from employing a pure USA net net investing strategy. You need to expand to international net nets if you want to stick with Graham’s net nets. But right now, there aren’t many US net nets that you should be investing in. The ones you see floating around the stock market have serious issues. The official screeners identified around 5-6 stocks at the start of the year and the minimum that I test with is always 20 stocks. For any mechanical strategy where you have to trust the theory and the system, holding 5-6 stocks is going to get you killed. The full 20 stocks are required for the portfolio to be diversified enough for each strategy to work over the long run. As I showed previously , when the number of net nets increase, it’s definitely a sign that the market is getting cheaper and that’s the time to be loading up on good net nets. Just not now. In the next post, I’ll be listing the official stocks for each screen that will be tracked for 2015. It features a list of 225 value stocks you can download and to get ideas.

Watch These Europe ETFs If The ECB Prints Money

The European Central Bank (ECB) is apparently set to embark on the final voyage of its easing policy. At least, the ECB president Mario Draghi’s latest comments in a German financial newspaper give such cues. Going by what Draghi said, we can comprehend that the ECB is all for bank reforms, levying lower taxes and slashing excessive regulations to accelerate the Euro zone’s recovery, which the president was quoted as saying that it is presently “fragile and uneven.” The Euro zone’s manufacturing activity expanded slower than initially estimated in December with each month of Q4 recording the lowest PMIs since Q3 of 2013. Such downbeat data definitely creates a backdrop for the initiation of the QE policy. Thus, investors considered the president’s latest comments as the start of an asset buyback program or some other sort of stimulus program. Sensing potential easing, the common currency euro plunged to a nine-year low against the greenback. As a result, the CurrencyShares Euro Trust ETF (NYSEARCA: FXE ) kick started the New Year with a decent sized loss. Gains were invisible even in the broad large-cap Euro ETFs including the Vanguard FTSE Europe ETF (NYSEARCA: VGK ) and the SPDR Euro STOXX 50 ETF (NYSEARCA: FEZ ) which shed in the range of 0.2% to 0.5% as well. Needless to say, in a falling euro backdrop, hedged Europe ETFs turned out as winners as evidenced by the 0.6% gains offered by the WisdomTree Europe Hedged Equity ETF (NYSEARCA: HEDJ ). But some other areas of Europe investing should be closely watched if the ECB jumps on the bandwagon of QE movement like the U.S. and Japan have already implemented. Normally, smaller companies pick up faster than the larger ones in a growing economy. Since these pint-sized securities usually focus more on the domestic market, these are less ruffled by international worries than their globally exposed larger counterparts. This is especially true as a pile of woes hit the global economy last year. In short, likely monetary easing and currency weakness would support European consumption which in turn may boost small cap ETFs. Per CNBC , a sluggish euro will trigger purchases by the domestic consumers as they will have to pay less money for buying domestically manufactured goods than imported ones. Low oil prices should be another drive to spur consumer purchases. Investors should note that U.S. small-cap stock index Russell 2000 added about 85% return when the QE policy was underway. So, investors can expect the replication of the same trend on the European front. Market Impact Unlike VGK, the WisdomTree Europe SmallCap Dividend ETF ( DFE ) has added about 0.5%. Below, we highlight three ETFs that should be in focus if the QE is actually implemented. DFE in Detail This ETF provides exposure to the small cap segment of the European dividend-paying market by tracking the WisdomTree Europe SmallCap Dividend Index. It is one of the popular funds in the European space with AUM of $698 million. The fund charges 58 bps in annual fees from investors. The fund is heavy on industrials as this segment accounts for more than one-fourth of the portfolio while financials, information technology and consumer discretionary take the remainder. Among countries, United Kingdom (32.6%), Sweden (14.6%), Italy (9.5%) and Germany (8.7%) dominate the holdings list. Heavy focus on some of the better-positioned nations like the U.K., Sweden and Germany is positive of the fund. Plus, a tilt toward dividends was the icing on the cake in a yield-starved continent. The fund was down 1.62% in the last one month (the lowest loss in the space), but was up 0.8% in the last three months, indicating commendable performance in the pack of European ETF losers. iShares MSCI Germany Small Cap Index ETF ( EWGS ) Germany has been a better-placed economy in the Euro bloc. Zew Economic Sentiment Index in Germany expanded for the second successive month to 34.90 in December of 2014 from 11.50 recorded last month and also surpassed analyst expectations. The number was even higher than Euro Area average of 31.80 and 18.40 touched in the U.K. This gives EWGS – an ETF with $26.4 million under management – an edge over its other domestic cousins as well as broader Euro zone counterparts. The fund was up 4.44% in the last three month period – the second best show in the European pack, but lost about 2.4% in the last one month.