Tag Archives: opinion

FXG: Consumer Staples With Less Of The Consumer Staples

Summary The portfolio for FXG just doesn’t look right to me. The ETF uses fairly low allocations for some core consumer staple holdings. I’d like to see a heavier weighting for companies with massive market share or addictive products because those firms should be able to protect margins better. 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. One of the funds that I’m considering is the First Trust Consumer Staples AlphaDEX ETF (NYSEARCA: FXG ). 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. Expense Ratio The expense ratio for FXG is a fairly unappealing .67%, which leaves me feeling that there is some substantial room for improvement. Holdings I was able to grab a chart with all of the holdings for FXG: (click to enlarge) Is this really a consumer staples portfolio? Procter & Gamble (NYSE: PG ) is only 1.68% of the portfolio? Altria Group (NYSE: MO ) is less than 1% of the portfolio? Costco (NASDAQ: COST ) is entirely absent from the portfolio. Coca-Cola (NYSE: KO ) and Pepsi (NYSE: PEP ) are entirely absent. When I’m looking at an ETF of consumer staples, I want to see products that people are going to buy regardless of what is happening in the economy. I’m not a fan of smoking, but I wouldn’t mind a substantial allocation to tobacco. For that matter, I would prefer a portfolio built on companies that have enormous market share and sell addictive products. The fundamental goal of creating a consumer staples allocation in the portfolio is to provide the portfolio with more protection from weakness in the economy. Despite the challenges with firms missing, I do think a large allocation to Tyson Foods (NYSE: TSN ) and ConAgra Foods (NYSE: CAG ) does make sense. There has been enough concentration in this part of the industry that the major players are controlling a large part of the market and are unlikely to be forced to take major price cuts even if the market enters another recession. Building the Portfolio This hypothetical portfolio has a moderately aggressive allocation for the middle-aged investor. Only 25% of the total portfolio value is placed in bonds and a fifth of that bond allocation is given to high-yield bonds. If the investor wants to treat an investment in an mREIT index as an investment in the underlying bonds that the individual mREITs hold, then the total bond allocation would be 35%. Given how substantially mREITs can deviate from book value, I’d rather consider the allocation as an equity position designed to create a very high yield. This portfolio is probably taking on more risk than would be appropriate for many retiring investors since a major recession could still hit this pretty hard. If the investor wanted to modify the portfolio to be more appropriate for retirement, the first place to start would be increasing the bond exposure at the cost of equity. However, the diversification within the portfolio is fairly solid. Long-term treasuries work nicely with major market indexes, and I’ve designed this hypothetical portfolio without putting in the allocation I normally would for equity REITs. An allocation is created for the mortgage REITs, which can offer some fairly nice diversification relative to the rest of the portfolio and they are a major source of yield in this hypothetical portfolio. The portfolio assumes frequent rebalancing which would be a problem for short-term trading outside of tax advantaged accounts unless the investor was going to rebalance by adding to their positions on a regular basis and allocating the majority of the capital towards whichever portions of the portfolio had been underperforming recently. Because a substantial portion of the yield from this portfolio comes from REITs and interest, I would favor this portfolio as a tax exempt strategy even if the investor was frequently rebalancing by adding new capital. The portfolio allocations can be seen below along with the dividend yields from each investment: Name Ticker Portfolio Weight Yield SPDR S&P 500 Trust ETF SPY 35.00% 2.06% Consumer Discretionary Select Sector SPDR ETF XLY 10.00% 1.36% First Trust Consumer Staples AlphaDEX ETF FXG 10.00% 1.60% Vanguard FTSE Emerging Markets ETF VWO 5.00% 3.17% First Trust Utilities AlphaDEX ETF FXU 5.00% 3.77% SPDR Barclays Capital Short Term High Yield Bond ETF SJNK 5.00% 5.45% PowerShares 1-30 Laddered Treasury Portfolio ETF PLW 20.00% 2.22% iShares Mortgage Real Estate Capped ETF REM 10.00% 14.45% Portfolio 100.00% 3.53% The next chart shows the annualized volatility and beta of the portfolio since April of 2012: (click to enlarge) A Quick Rundown of the Portfolio Using SJNK offers investors better yields from using short-term exposure to credit-sensitive debt. The yield on this is fairly nice, and due to the short duration of the securities, the volatility isn’t too bad. PLW on the other hand does have some material volatility, but a negative correlation to other investments allows it to reduce the total risk of the portfolio. FXG is used to make the portfolio overweight on consumer staples with a goal of providing more stability to the equity portion of the portfolio. FXU is used to create a small utility allocation for the portfolio to give it a higher dividend yield and help it produce more income. I find the utility sector often has some desirable risk characteristics that make it worth at least considering for an overweight representation in a portfolio. VWO is simply there to provide more diversification from being an international equity portfolio. While giving investors exposure to emerging markets, it is also offering a very solid dividend yield that enhances the overall income level from the portfolio. XLY offers investors higher expected returns in a solid economy at the cost of higher risk. Using it as more than a small weighting would result in too much risk for the portfolio, but as a small weighting, the diversification it offers relative to the core holding of SPY is eliminating most of the additional risk. REM is primarily there to offer a substantial increase in the dividend yield which is otherwise not very strong. The mREIT sector can be subject to some pretty harsh movements, and dividends from mREITs should not be the core source of income for an investor. However, they can be used to enhance the level of dividend income while investors wait for their other equity investments to increase dividends over the coming decades. If you want a really quick version to refer back to, I put together the following chart that really simplifies the role of each investment: Name Ticker Role in Portfolio SPDR S&P 500 Trust ETF SPY Core of Portfolio Consumer Discretionary Select Sector SPDR ETF XLY Enhance Expected Returned First Trust Consumer Staples AlphaDEX ETF FXG Reduce Beta of Portfolio Vanguard FTSE Emerging Markets ETF VWO Exposure to Foreign Markets First Trust Utilities AlphaDEX ETF FXU Enhance Dividends, Lower Portfolio Risk SPDR Barclays Capital Short Term High Yield Bond ETF SJNK Low Volatility with over 5% Yield PowerShares 1-30 Laddered Treasury Portfolio ETF PLW Negative Beta Reduces Portfolio Risk iShares Mortgage Real Estate Capped ETF REM Enhance Current Income Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. Despite TLT being fairly volatile and tying SPY for the second highest volatility in the portfolio, it actually produces a negative risk contribution because it has a negative correlation with most of the portfolio. It is important to recognize that the “risk” on an investment needs to be considered in the context of the entire portfolio. To make it easier to analyze how risky each holding would be in the context of the portfolio, I have most of these holdings weighted at a simple 10%. Because of TLT’s heavy negative correlation, it receives a weighting of 20% and as the core of the portfolio SPY was weighted as 50%. Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio. Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. (click to enlarge) Conclusion FXG has resisted weakness in the market as demonstrated by both the lower annual volatility and the lower max “drawdown” of -9.8% relative to the market’s worst performance of -11.9%. Despite that, the portfolio composition simply does not match the way I would want the consumer staples exposure constructed. Simply put, the portfolio does not offer strong enough allocations to some of the companies that have both enormous market share and addictive products. Heavy allocations to a few food companies look solid, but I’d rather see less of the convenience stores and more of the major retail low cost leaders such as Costco and Wal-Mart (NYSE: WMT ). Even if WMT is having a rough time lately, it is a long-lived dividend champion with a large market share and powerful economies of scale. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

How To Build An Alpha-Rich Portfolio Around Preferred Shares

Summary After taking a look at PFF, I decided it would be worth looking into ways that an investor could use it heavily in a low risk portfolio. The resulting portfolio underperforms SPY in a strong bull market, but does very well at limiting volatility. Looking at the max drawdown shows that over the last 4 years the worst drawdown on the portfolio was only 7.9%. If investors are considering holding cash in their portfolio to reduce the volatility, they may want to consider this style of portfolio instead. After covering the iShares U.S. Preferred Stock ETF (NYSEARCA: PFF ) and noticing that it had some very attractive risk characteristics and a very strong yield at 6%, I decided it was worth looking into the impacts of designing a portfolio for very low volatility at the portfolio level while maintaining a fairly strong yield for investors. I think this is one of the most reasonable ways to incorporate a heavy allocation to PFF in a portfolio. I built a portfolio using only a few tickers so it is reasonably simple to duplicate. Portfolio The Portfolio uses the Schwab U.S. Dividend Equity ETF (NYSEARCA: SCHD ) as the core of the portfolio since it has been noticeably less volatile than whole market ETFs, has a respectable dividend yield with dividends regularly growing, and an expense ratio of only .07%. The next major allocation is a very long duration treasury ETF, the Vanguard Extended Duration Treasury ETF (NYSEARCA: EDV ). The iShares U.S. Preferred Stock ETF gets the same 20% allocation as EDV. The next holding is the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ) because it has a fairly low beta and fits very well in portfolios designed to minimize total risk at the portfolio level. The final allocation goes to the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEARCA: EMB ) with 5% of the portfolio. This is incorporated because it has such unique risk factors that it ends up having only moderate correlations with each other investment while having a yield just over 4.5%. The portfolio is demonstrated below: (click to enlarge) The great thing about this portfolio is that over a sample period of nearly 4 years the annualized volatility is only 6.5% which puts the portfolio volatility at slightly under half of the volatility on the SPDR S&P 500 Trust ETF ( SPY). In other words, an investor holding 50% SPY and 50% cash would have witnessed a higher level of volatility in their portfolio. During the period the worst drawdown was falling 7.9%. All around this is a very resilient portfolio because the risk factors have been so effectively diversified. Alpha Investors may notice that this portfolio has materially underperformed SPY over the sample period, but it is meant to underperform SPY during strong bull markets. When SPY is up almost 77% in less than 4 years, I’m going to call that a strong bull market even if we saw some huge shocks in August. The annual rate of return on SPY is about 16%. The annual rate of return on the portfolio was 11.4%. If investors start from portfolio volatility (rather than beta) for establishing alpha, this portfolio would to create about half of the difference between SPY and the risk free rate. Since the portfolio only underperformed SPY by 4.66% annually during a solid bull market. If we round up the risk on the portfolio to being half of SPY, then we subtract (4.66% * 2) or 9.31% to find the risk free rate necessary to eliminate the entire alpha. The risk free rate that would have neutralized the alpha is 6.73%. I think it is reasonable to say that this portfolio performed very well on a risk adjusted basis relative to investors that were going 100% into SPY or another very similar broad ETF. Correlations A major reason for the strong performance is the correlation within the portfolio. The long term treasury ETF has only a slight positive correlation with the emerging market bond fund, but it is negative with everything else. Both SCHD and USMV have lower levels of volatility than SPY and PFF and EMB have reasonably low levels of annualized volatility combined with moderate correlations to the rest of the portfolio. Conclusion Over the last 4 years this ETF strategy has demonstrated very reasonable returns while being substantially more resilient to periods of weakness. In a prolonged bull market it will fall behind SPY, but on a risk adjusted basis it is still performing very well and if there was a major correction it would be in position to lose substantially less. In my opinion, this kind of strategy is the most reasonable way to incorporate a heavy allocation of PFF into a portfolio. Why would you want to build a portfolio with a heavy allocation to a preferred share ETF? I can think of one solid reason off the top of my head, a dividend yield over 6% at a time when interest rates in much of the economy fail to offer any compelling returns. Disclosure: I am/we are long SCHD. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

USMV: It Lives Up To The Name, This Is One Durable Fund

Summary USMV offers investors fairly low volatility and a low beta that make it easy to fit into a portfolio. The holdings start with a heavy position in telecommunications, but less than 5% of the portfolio is in the sector. The exposure to consumer staples, health care, and utilities look nice. Having seen USMV get hit by the absurd sell off on 8/24/2015, investors should avoid using stop loss orders. 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 iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ). 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. Expense Ratio The expense ratio on USMV is .15%. It isn’t as cheap as many of the Schwab or Vanguard funds, but this is still well within reason for an investor trying to control the amount of their wealth that flows out to expense ratios each year. Largest Holdings The iShares MSCI USA Minimum Volatility ETF has a fairly diversified group of holdings. When I pulled the numbers nothing was over 1.7% of the portfolio. This internal diversification is great for reducing any idiosyncratic risk from concentrated positions. Looking through the portfolio investors may notice that there appears to be a bias towards companies that pay high dividends. Since those companies are rapidly returning money to shareholders, they have an easier time maintaining a solid valuation since their values are tied to dividends that are more predictable than future growth which may require more estimation. I’ve been fairly bearish on telecommunications since it became clear Sprint (NYSE: S ) intended to create a price war that I expected to drag down profits for AT&T (NYSE: T ) and Verizon (NYSE: VZ ). However, these are huge companies with a long track record, high dividend yield, and solid business model. I’m not completely sold on them, but with the level of diversification in the portfolio I don’t see it as a big problem. If they were combining to be 10 to 15% of the portfolio, I wouldn’t find USMV so attractive. Sectors The following chart breaks down the sector holdings for the fund. The first thing I was checking was for any other exposure to telecommunications. While there are two major telecommunications firms in the top 3 holdings, the total weight in the portfolio is only 4.23% which reassures me that the portfolio wouldn’t be heavily exposed to the price based competition in the telecommunication arena. On the other hand we do see some solid weights for healthcare, consumer staples, and utilities. These are three sectors that I expect to have very solid demand over the next decade. These sectors are simply very hard to replace. Even if we see substantial changes in the economy as technology changes, these sectors remain highly relevant due to the impacts of an aging population, a need for basic supplies, and a desire to keep our homes heated (or cooled). Building the Portfolio This hypothetical portfolio has a slightly aggressive allocation for the middle aged investor. Only 30% of the total portfolio value is placed in bonds and a third of that bond allocation is given to emerging market bonds. However, another 10% of the portfolio is given to preferred shares and 10% is given to a minimum volatility fund that has proven to be fairly stable. Within the bond portfolio, the portion of bonds that are not from emerging markets are high quality medium term treasury securities that show a negative correlation to most equity assets. The result is a portfolio that is substantially less volatile than what most investors would build for themselves. For a younger investor with a high risk tolerance this may be significantly more conservative than they would need. The portfolio assumes frequent rebalancing which would be a problem for short term trading outside of tax advantaged accounts unless the investor was going to rebalance by adding to their positions on a regular basis and allocating the majority of the capital towards whichever portions of the portfolio had been underperforming recently. (click to enlarge) A quick rundown of the portfolio The two bond funds in the portfolio are the iShares J.P. Morgan USD Emerging Markets Bond ETF (EBM) for higher yielding debt from emerging markets and for medium term treasury debt. The iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) should be useful for the highly negative correlation it provides relative to the equity positions. EMB on the other hand is attempting to produce more current income with less duration risk by taking on some risk from investing in emerging markets. The iShares U.S. Preferred Stock ETF (NYSEARCA: PFF ) gives investors a respectable current yield in a period of very weak interest rates. The position in the iShares MSCI USA Minimum Volatility ETF offers investors substantially lower volatility with a beta of only .7 which makes the fund an excellent fit for many investors. It won’t climb as fast as the rest of the market, but it also does better at resisting drawdowns. It may not be “exciting”, but there are plenty of other areas to find “excitement” in life. Wondering if your retirement account is going to implode should not be a source of excitement. The position in the PowerShares Buyback Achievers Portfolio ETF (NYSEARCA: PKW ) makes the portfolio overweight on companies that are performing buybacks. The strategy has produced surprisingly solid returns over the sample period. I wouldn’t normally consider this as a necessary exposure for investors, but it seemed like an interesting one to include and with a very high correlation to the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) and similar levels of volatility it has little impact on the numbers for the rest of the portfolio. The core of the portfolio comes from simple exposure to the S&P 500 via SPY, though I would suggest that investors creating a new portfolio and not tied into an ETF for that large domestic position should consider the alternative by Vanguard’s Vanguard S&P 500 ETF (NYSEARCA: VOO ) which offers similar holdings and a lower expense ratio. I have yet to see any good argument for not using or another very similar fund as the core of a portfolio. In this piece I’m using SPY because some investors with a very long history of selling SPY may not want to trigger the capital gains tax on selling the position and thus choose to continue holding SPY rather than the alternatives with lower expense ratios. Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. To make it easier to analyze how risky each holding would be in the context of the portfolio, I have most of these holdings weighted at a simple 10%. Because of IEF’s heavy negative correlation, it receives a weighting of 20%. Since SPY is used as the core of the portfolio, it merits a weighting of 40%. Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio and with the S&P 500 . Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. Conclusion The USMV fund has a solid correlation to the S&P 500, coming in around 90%, but the low annualized volatility allows it to achieve a beta of only .69 which makes the required returns on the ETF substantially lower than the required returns on pure equity positions. While the performance of the portfolio trailed the S&P 500 and may regularly trail it, it is also more resilient to selling pressure. Perhaps there should be one caveat stated. During the panic on 8/24/2015 the ETF sold off dramatically and hit an absurd low of $26.41 before bouncing back to close at $39.25. The biggest message there is that investors seeking stability may want to look at USMV, but they shouldn’t be eager to put in stop losses. During the selling that impacted many stocks and ETFs, USMV was not immune to the sudden and absurd price drop. Simply using USMV as a large allocation should be enough to materially decrease portfolio risk. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.