Tag Archives: opinion

AGG: A Solid Bond Fund Offering Low Expenses And Diversification

Summary The expense ratio on AGG is one of the drawing factors for this fund. At .08% it is one of the cheapest bond funds in the market. The fund has extensive diversification in the maturity of the bonds which provides more diversification in the risk. The credit ratings are fairly high with a significant allocation to treasury securities. Allocation to MBS does not thrill me since mREITs are available at material discounts to book value, but the low expense ratio still helps the expected return. Overall, there is more to like about this fund than to dislike. The major risk factor facing the fund is rising domestic rates. The iShares Core Total U.S. Bond Market ETF (NYSEARCA: AGG ) is a highly diversified bond fund with a reasonable yield, great expense ratio, and great liquidity. Expenses When I’m looking for a bond ETF, I normally want to see diversification in the holdings. The only real exception would be if I’m looking for treasuries with a fairly steady maturity date. Getting any thorough due diligence on the bonds in a fund can require having a higher expense ratio to cover the costs of doing research. The challenge for a bond fund with a high expense ratio to create solid returns is that it requires them to be doing sufficient research to consistently produce superior default estimates to those available in the market or to have a method for acquiring bonds at a discount by dealing in illiquid bonds where counterparties are more difficult to find. Some funds are able to offer low expense ratios and mitigate their risks by strictly dealing in the most liquid bonds where pricing is most likely to be efficient and relying on the market to ensure that the risk/return profile is appropriate. Generally I favor ETFs that have low expense ratios and strictly deal in highly liquid bonds where the pricing will be more efficient. The expense ratio for AGG is a .08%. This is one of the funds falls into my desired strategy of using highly liquid securities and a very low expense ratio to rely on the efficient market to assist in creating fair values for the bonds. Yield The yield is 2.41%. The desire for a higher yield should be fairly easy for investors to understand. Bond funds that offer a higher yield are offering more income to the investor. Unfortunately, returns are generally compensating for risk so higher yield funds will usually require an investor either take on duration risk or credit risk. In many situations, an investor will take on a mix of the two. Junk bond funds generally carry a high degree of credit risk but low duration risk while longer duration AAA corporate funds have only slight to moderate credit risk combined with a significant amount of duration risk. Theoretically treasuries have zero credit risk and long duration treasuries would have their risk solely based on the interest rate risk. Duration The following chart demonstrates the sector exposure for this bond fund: At the present time I’m concerned about taking on duration risk in early December because of the pending FOMC (Federal Open Market Committee) meeting. I believe it is more likely than not that we will see the first rate hike in December. I think a substantial portion of that probability has already been priced into bonds, so investors willing to take the risk prior to the meeting could see significant gains if the Federal Reserve does not act. Even though most of the impact is priced in, I suspect it will happen and that there will be some impact on rates which may trigger a solid opportunity for starting investments in bonds. I’ll be looking to increase my positions in interest sensitive assets if rates move higher. I’ve been focused on bond funds that are free to trade for me or have a longer duration exposure to corporate debt, but AGG is a pretty solid option for investors looking to add bonds in December. Credit Risk The following chart demonstrates the credit exposure for this bond fund: The exceptionally high rating to triple AAA stocks includes positions in treasury securities. The very high credit rating of this fund is excellent for investors looking for something that can withstand a sharp decline in the equity market. Rather than declining with equity markets this bond fund should see strength in share prices when investors are scared about the risk of higher defaults and weaker equity performance. When things look ugly, this fund should perform well. When things look great, this fund should underperform some of the riskier options. Sectors The following chart demonstrates the sector exposure for this bond fund: I have some concerns about the sector allocation including a substantial allocation to MBS Pass-Through securities. There are several mREITs where investors can get MBS exposure at a substantial discount to book value. On the other hand, that exposure also includes exposure to hedging the portfolio with Eurodollar Futures contracts in most scenarios and the expenses of management for an mREIT will dramatically exceed the .08% expense ratio of holding AGG. Conclusion Overall the diversification here is pretty solid and I don’t see much to complain about. This is one of the largest bond funds on the market and it offers great liquidity, a decent but not incredible yield, and a very low expense ratio. That liquidity extends to the point of millions of shares trading in a single day. That keeps the bid-ask spread small and makes trading in and out the ETF much easier for investors that want to use it to stabilize their portfolio value.

DMO Is The Best Of The Mortgage Bond Funds And It’s Bargain Priced

Summary DMO is a mortgage bond CEF that outclasses its competition and is well priced after a rough few months. I liked DMO in September. I like it more now. I liked DMO in September. I like it more today. When I last wrote about Western Asset Mortgage Defined Opp (NYSE: DMO ) I considered it to be the best of the mortgage-bond closed-end funds. It was selling at a small premium at the time, something I will generally avoid. But that premium was only 0.2%, so I decided to buy it anyway. It has been tracking down since, but that only makes me like it more. I’ve been watching it closely and am likely to add to my position before the end of the year. At the December 1 close, DMO had moved up smartly on the day (1.6%), but since that mid-September article, the fund is down -4.64% at market price and -2.55% at NAV. Why buy into a falling position? Let’s begin answering that question by having a look at how DMO compares to the entire fixed-income CEF category generally and mortgage-bond funds specifically. DMO vs. Its Categories This first chart shows total returns and distribution yields for DMO, along with median values for mortgage-bond CEFs (n=10) and all fixed-income CEFs (n=111). (click to enlarge) First thing to note here is that the past month and year have not been good to fixed-income CEFs across the board. This has been part of a broad trend for high-yield bonds. The large high-yield bond ETFs, iShares iBoxx $ High Yield Corporate Bond (NYSEARCA: HYG ) and SPDR Barclays High Yield Bond (NYSEARCA: JNK ), and the mortgage-bond ETF, iShares Mortgage Real Estate Capped ETF (NYSEARCA: REM ), are down comparable amounts. It doesn’t take intense scrutiny to see that DMO is beating its categories in all recent performance metrics. In the face of these numbers, I’m not terribly concerned about the dip since September. This is particularly evident if we turn our attention to NAV returns. Not that I like it, mind you, but I do not see it as cause for concern. Where everything else is negative, save REM’s meager 0.18% uptick for the past month, DMO’s NAV is solidly in the green. And NAV is what really counts in my view. But most of us look to a mortgage bond fund for income, not necessarily capital gains, right? DMO is yielding over 10% where the median mortgage-bond and fixed-income CEFs are paying 7.0% and 8.4%, respectively; and the high-yield bond ETFs are yielding near 6%. Only REM is paying more, but it is doing so with a consistent erosion of capital as we see in this price chart. (click to enlarge) Income investors will often give lip service to not caring about total return. If you’re investing in the likes of REM, I can see why you’d want to resort to that justification. You can, if you’re so inclined, look at REM in isolation in the total return chart and maybe feel okay about it. It has, after all, returned 35%, or would have done so had you been reinvesting dividends at no transaction costs. But look at that price chart above it. The 34% loss there is, in fact, a 34% loss of your capital if you invested in REM for current income five years ago. Sure, it’s been paying out a ton, but it’s been your own money in large measure, and you’ve had to pay taxes on it. If you had invested in DMO instead, you would have received 10% or so a year income plus your capital would have grown by 18%. Of course if you reinvested the distributions (again, assuming that magical chart-universe where there is no cost for doing so) you’d have more than three times what you would have had from the high-yield bonds or REM. So, as I said about UBS ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN (NYSEARCA: MORL ) in September, you can get a better yield than DMO, but with DMO you get to keep your money. I’ll not go into MORL again, other than to note that there are a substantial number of Seeking Alpha income-seekers who will sing its praises, praises that are completely unjustified in my opinion. A more complete look at MORL is on my to-do list, so if you’re interested in my take on it, it should be on your screen soon. I hope I’ve at least begun to convince you that DMO is an outstanding performer in the mortgage-bond space. If you need more, there are additional comparative historical performance data (in particular comparisons to the other mortgage bond CEFs and MORL) in the September article to assist in your due diligence. Why do I like it more as of December 1? Well, I did like it even better the day before, but even with the December 1 gain, DMO is much more attractively priced than it was in September when my only hesitation was that it was priced at that small premium coming off an uncharacteristic discounted period. At that time, I thought the trend would continue and the premium would continue to grow, so I felt it was as good an entry as the fund was going to present for a while. Wrong, obviously; it’s even better now. Premium/Discount Dynamics DMO has moved from a small premium to a decent discount, a move accompanied by that modest decrease in NAV (-2.6%). Distribution yield is up 60bps from mid-September as a consequence. While -1.87% is not a particularly deep discount in the CEF universe, it is, in my view, excellent for a fund of this quality. And the discount is moving in the right direction, according to the Z-scores. (click to enlarge) Where the mortgage-bond and fixed-income categories are, despite their lackluster performances, less discounted than their means (positive Z-scores) over the past 3 and 6 months, DMO is solidly in the other direction. The current discount is almost 1½ standard deviations more negative than the three-month mean. As I noted, one does not expect a fund of this quality to be running a deep discount, so that -1.87% looks pretty good to me right now. If you accept that it is a high-quality fund, and you consider Z-scores to at least suggest a direction for mean reversion, DOM looks good here. Distribution Sustainability Finally, a word about the sustainability of the distribution. This is always a consideration in fixed-income CEFs. Many high yielders maintain their yields by returning investor capital. This cannot continue indefinitely and, all too often, such funds will be forced into making drastic distribution cuts that lead to sharp price drops. One indicator of distribution sustainability is UNII, Undistributed Net Investment Income. DOM reported UNII of $0.62/share at the end of September. Its distribution is $0.21/share monthly, so there is little indication of a problem on that front. Summary I continue to like DMO and think it remains one of the best income opportunities. It has faltered lately, but less so than its peers. It is paying an attractive distribution. And there is no indication that the distribution payment is at risk as the fund is holding a quarter’s distributions worth of UNII. I realize that there is a lot of uncertainty and anxiety regarding a changing interest-rate environment, but I do not see a truly disruptive change on the near horizon. I do not anticipate anything like a devastating blow from a 25 to 75 bps raise from the Fed over the next year, which is what I consider as most likely scenario. My one caution is that it is best accommodated in a tax-deferred account because, as with any bond fund, the distributions are ordinary income and receive no favorable tax treatment.

VT: A Simple Choice For Getting Global Exposure

Summary The ETF has a good expense ratio, but investors can get a lower ratio by combining VEU and VOO. Investors need to remember the importance of international diversification even as domestic equity as thoroughly outperformed during the latest bull market. While I support having some international diversification, this fund offers almost 45% of the holdings as international equity. That is a bit too high for me. I see this fund as being maximized by investors that want to add it to their domestic allocations or investors with a long time horizon. The Vanguard Total World Stock ETF (NYSEARCA: VT ) is a great ETF for getting exposure across the world. The holdings are about 55% domestic and around 45% international. Expenses The expense ratio is a .17%. Vanguard regularly sets the bar for creating low fee investment vehicles for investors to gain solid diversification with low costs. My one concern in this area is that investors could use the Vanguard FTSE All-World ex-US ETF (NYSEARCA: VEU ) for international allocations with a .14% expense ratio and the Vanguard S&P 500 ETF (NYSEARCA: VOO ) for domestic equity with an expense ratio of .05%. You could average those in any way you wanted since both parts offer lower expense ratios than the Vanguard Total World Stock ETF. Aside from that potential strategy to lower ratios, this is a very solid fund and a viable option for one stop shopping on equity exposure. Holdings I grabbed the following chart to demonstrate the weight of the top 10 holdings: For a total world ETF, I think investors had to expect Apple (NASDAQ: AAPL ) to be the top weight. The company is simply huge and their sheer size makes it necessary to give them a significant weight in any index attempting to replicate the entire world of equity securities. We have only stock that I think of as an international allocation within the top holdings. That, of course, is Nestle S.A. ( OTCPK:NSRGY ). As an international company, their sales are providing even further diversification as they rely on both developed and emerging markets for growth in sales. Nestle is the kind of dividend machine that SA Author Dividends Are Coming has suggested investors should buy and hold forever . The company is not always considered as a perennial dividend champion by domestic investors because their dividends appear to have suffered in a few years due to the currency exchange impacts. In their domestic currency, they are a great dividend growth company. Sectors (click to enlarge) If I was going to use a single ETF as the primary source of equity for my entire portfolio, I think I would prefer to see a slightly more defensive allocation strategy. For investors willing to go with the more aggressive allocations, such as having around 38% of the portfolio in the cyclical sectors, this is the kind of fund investors should consider for automatic investing. To avoid excess risk, that is a strategy for investors with a long enough time horizon to make up for losses as there should be both bull and bear markets over the next few decades. Region Domestic equities get a heavier weighting than international equities, but the international weights are fairly high. I must admit that as an investor I have a significant home country bias and I would not be comfortable with having even close to 45% of my equity in the form of international investments. For me the limit on international equity is closer to 30% and I prefer to run it closer to 15% to 20% of the total portfolio. I do feel compelled to point out that the allocation to emerging markets is within reason, so my concern would be coming from the strength of the allocations to developed markets. Generally developed markets are going to be less volatile than emerging markets but in this case the allocation to the developed markets is substantially larger and thus it is capable of generating more volatility at the portfolio level because of the weighting. Conclusion This is a solid ETF though the more attractive traders that don’t mind a more complex allocation may want to consider combining VEU and VOO if they really want to chase their expense ratios down to be as low as possible. In my opinion, this ETF should be combined with additional domestic allocations because the international allocations are simply a little too high for my taste. For investors that don’t mind the heavy international allocation and have a long time horizon to recover from any bear markets, this fund should be considered for regular purchasing.