Tag Archives: opinion

PFF: A Quick Way To Get Your Preferred Stock Exposure

Summary There are two issues with the ETF, one is a high expense ratio and the other is sector concentration. The geography exposure is not a problem for me, but I wouldn’t mind seeing a little more diversification. The fund offers negative correlation with at least one treasury ETF while delivering a beta of around .22. Many investors build their portfolio without any meaningful positions in preferred stock. The iShares U.S. Preferred Stock ETF (NYSEARCA: PFF ) is one quick solution to that problem. Expense Ratio The expense ratio on the ETF is .47%. I’d really prefer to see a lower expense ratio with long term holdings since the nature of preferred stock suggests positions would not need to be changed frequently. When I pulled up the turnover ratio for the portfolio, it was coming up as 13%. That is higher than I would have expected but not high enough that I would expect the high expense ratio to be necessary. This may simply be a case of an ETF in a niche market having a long track record (established in 2007) and high volume (over 3 million shares per day) being a position where it can demand a higher expense ratio. Largest Holdings The largest holdings of the ETF show a heavy concentration towards the financial sectors. It isn’t just the top 10 though, as you’ll see in the next section. The sector exposure for PFF is heavily concentrated on banks and “Diversified Financials.” Sector The sector exposure is extremely concentrated and that would be an area of concern for me. Since my goals in using preferred shares within a portfolio would be to diversify the risk factors for the portfolio, I would prefer to only need one ETF of preferred stock and to have that ETF bring in a substantially lower level of concentration. I don’t know what would cause the sector to tumble, but very heavy sector exposure leaves investors hoping no black swans appear. This is a risk I would prefer to avoid if possible. Since black swan events by their very nature are unpredictable, the most effective defense is simply to include substantial diversification. Geography The map below shows the geographic distribution of the holdings. I don’t see any problems here. It is interesting that the U.K. was showing up as more than 12% of the portfolio, but diversification is exactly what I was wanting. I’d be interested in seeing even more diversification here, but doubt it will happen. That could make PFF an interesting fit with an international bond portfolio. 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 (NYSEARCA: EMB ) for higher yielding debt from emerging markets and the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) for medium term treasury debt. 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 position in the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ) 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 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 the SPDR S&P 500 Trust ETF (NYSEARCA: 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, the 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 PFF has a positive correlation with each of the hypothetical holdings except for the treasury ETF which is interesting. Since PFF should have more duration exposure than IEF, but also more credit risk, there is some fairly solid diversification benefits here. The beta of only .22% is also excellent for indicating that PFF will fit very well within a portfolio. While EMB (emerging market bonds) also have a very low beta, PFF is has done it without having a positive correlation with treasury ETFs. That makes it a great fit for the more conservative investor that is holding more treasuries in the portfolio and less equity. The distribution yield on PFF is over 6%, so this is an option for solid income while maintaining a favorable risk profile. Ideally an investor would be able to combine this with a position in an emerging bond fund like EMB to avoid concentration of risk and then toss some higher dividend yielding ETFs in at the core position and offset the equity risk with some long term treasury exposure. In short, I’m not thrilled with the expense ratio but the fund fits very well within a portfolio. I would love to see more preferred share ETFs coming out to drive up competition and drive down expense ratios. 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.

Why The Drop In Stocks Feels So Painful

Summary The last week and a half has certainly been a roller-coaster ride of emotions in the stock market. Many investors may be surprised at how deeply their accounts fell, despite the intention of having a relatively balanced or even conservative asset allocation. One of the most underwhelming asset classes during this sell-off in stocks has been the lack of performance in high-quality bonds. The last week and a half has certainly been a roller-coaster ride of emotions in the stock market. After a 3-day sell-off that culminated in extreme levels of fear, broad-based equity benchmarks managed to stage a sharp rally that has alleviated (some) feelings of panic. By the numbers, the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) fell 12% from its all-time July high to the depths of the August lows. It has subsequently rebounded half of that decline as we head into the first days of September. While there is still a great deal of work to be done in order to recoup the full extent of those losses, examining how your portfolio performed in the midst of the chaos can be a helpful exercise. Many investors may be surprised at how deeply their accounts fell, despite the intention of having a relatively balanced or even conservative asset allocation . The Shock Absorber Is Missing In Action One of the most underwhelming asset classes during this sell-off in stocks has been the high-quality bonds. Since SPY peaked on July 20, the iShares U.S. Aggregate Bond ETF (NYSEARCA: AGG ) has gained just 0.39%. This weak follow-through was mirrored in the iShares Investment Grade Corporate Bond ETF (NYSEARCA: LQD ) and the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ), which gained a timid 0.19% and 1.57% respectively. Typically, during periods of extreme stock market volatility, we see a flight to quality in bonds that helps cushion the drawdown in our portfolios. This is one of the primary benefits of multi-asset diversification, and helps alleviate overwhelming conviction in a single high-risk outcome. Those who have come to rely on the strength of bonds during a sell-off have been let down over the last several weeks. Put simply, if your bonds aren’t marginally offsetting the losses in stocks, you are going to feel the pain of those losses more acutely. In my opinion, most of this indecision in the bond market is due to three factors: We had a strong sell-off in Treasury yields (jump in bond prices) during June and July that left fixed-income investors near the high end of relative valuations. This put the bond market in a precarious spot right as the mini-stock storm descended. Many investors in stocks are wary about transitioning to high-quality bonds in front of a near-term interest rate hike by the Federal Reserve. After 6 years of zero interest rate policy, there is no way to know exactly how the fixed-income markets will react to this first adjustment. The CBOE 10-Year Treasury Note Yield (TNX) jumped sharply higher as stocks staged a comeback late last week. This may point towards an opportunistic rotation out of bonds and back into stocks for those that were looking for a spot to buy well off the recent highs or feared missing out on a V-shaped recovery. The Bottom Line Most aggregate bond funds are sitting near the flat-line for the year and have yet to participate in a meaningful way for 2015. Nevertheless, I’m not looking to reduce my overall exposure for clients at this juncture. In my opinion, this asset class still represents a solid foundation for balanced or conservative investors to bolster their income and lower total portfolio volatility. I prefer the risk management and security selection that comes with an actively managed ETF, such as the SPDR DoubleLine Total Return Tactical ETF (NYSEARCA: TOTL ). Now more than ever, it is important to be flexible with respect to credit and interest-rate positioning as the Fed transitions to a new fiscal policy phase. I pointed out last week that it’s important to make changes on the stock side of the portfolio that are based on rational intermediate or long-term strategy, rather than short-term fear. This may include lightening up overexposure into a rally or taking advantage of new opportunities from your watch list during a correction. Above all, don’t let these periods of uncertainty get the better of you. Make sure you have a game plan for what you are going to hold or when it makes sense to fold . That way you are prepared for multiple outcomes and able to implement a decisive investment strategy to improve your long-term results. Disclosure: I am/we are long TOTL. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: David Fabian, FMD Capital Management, and/or clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell, or hold securities.

Debunking The Misleading Big Data ETF

PureFunds introduces new big data-focused ETF, tracking the ISE big data index. A deeper look at the index reveals social media networks, credit data providers, and Internet companies in the ETFs’ top holdings. Investors should look under the hood of non-trivial sector-focused ETFs. ETF provider PureFunds is a relatively new player in the ETF market, competing fiercely with financial giants that dominate the ETF market, like Vanguard, Blackrock’s (NYSE: BLK ) iShares, State Street’s (NYSE: STT ) SPDR, etc. PureFunds is familiar to most investors as the provider of the Cyber Security ETF (NYSEARCA: HACK ) that was launched in November 2014, which attempts to provide a passive investment vehicle into the emerging cybersecurity market. Since its inception, HACK yielded a 10% return, providing a modest return for the $1.1B in net assets that were invested in the ETF. As shown in Chart 1 below, HACK’s return is much lower than the leading cyber security stocks, but it also offers a passive investment vehicle into the industry that allows investors to invest in this emerging industry without cherry-picking particular stocks. Since PureFunds introduced the HACK ETF, the firm released three more ETFs: the PureFunds ISE Junior Silver ETF (NYSEARCA: SILJ ), the PureFunds ISE Mobile Payments ETF ( IPAY ), and the PureFunds ISE Big Data ETF ( BDAT ). As a strong believer in the growth potential of the big data industry and its leading players, I cover many big data topics, both in Seeking Alpha and in my firm, from industry trends through earnings reviews to extensive long/short investment thesis and ad-hoc analyses. There are so many public companies involved in the big data industry including analytics, visualization, Hadoop integration, and IaaS/PaaS services that I was pretty excited when I first heard of Purefunds Big Data ETF. However, as the title implies, I was very disappointed by the outcome. The general idea of Purefunds to launch investment vehicles that invest in emerging sectors, such as big data, mobile payments, and cyber security, is great, and I think there is a demand for such vehicles. However, an ETF is a passive investment tool that tracks a third party index – in BDAT’s case, it is the ISE Big Data™ Index. Looking at the component eligibility requirements in the index methodology guide unveils a wider definition of a big data company as shown in the excerpt below. According to the document, there are two types of companies that are entitled to join the index: either a big data product developer/service provider or a company that aggregates massive data sets. While the first part makes sense-this is a big-data index and should include big-data companies-the second part (bullet ii above) basically paves the way for any large Internet company to join the index, whether it has some connection to the big-data market or not. Let’s look at ETF’s top 10 holdings, as presented below in an excerpt from the fact sheet, and see how many big-data companies are there. Out of the top 10 holdings, five companies have very weak links to the big-data industry and are included in the ETF just because of bullet point ii above-Facebook (NASDAQ: FB ), Twitter (NYSE: TWTR ), Thomson Reuters (NYSE: TRI ), Nielsen (NYSE: NLSN ), and Yahoo (NASDAQ: YHOO )-while the other five have stronger links to big data, but it is absolutely not their core business nor the main impact on their financials. Going down the list of holdings (31 in total) will also reveal LinkedIn (NYSE: LNKD ) and Dun & Bradstreet (NYSE: DNB ), which also have a weak link to the big-data industry. I agree that it might be difficult to find 30 companies that are big data focused, but if the criteria are widened, I believe Amazon (NASDAQ: AMZN ), Rackspace (NYSE: RAX ), and EMC (NYSE: EMC ) will be found to have more to do with big data than the social media companies introduced in the index and ETF. In my opinion, this is a big deal. A big data ETF should include big data pure-play companies or companies that directly relate to that industry; having Facebook and Twitter in the top 10 holdings is missing the point. If ISE and PureFunds couldn’t find enough suitable companies to be included in the big data ETF, I would have suggested for them to include prominent SaaS, IaaS, and PaaS providers, rather than social media networks and credit/business data providers, as they have stronger links to the industry and are strongly impacted by it. For now, as BDAT does not provide pure big data exposure, I suggest investors to avoid using this ETF as an investment vehicle into the big data industry. Once PureFunds/ ISE have adjusted their ETF holdings/Index criteria, I will revise the avoid recommendation above, and if another big data ETF is introduced, I will perform the same due diligence again. 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: The information provided in this article is for informational purposes only and should not be regarded as investment advice or a recommendation regarding any particular security or course of action. This information is the writer’s opinion about the companies mentioned in the article. Investors should conduct their due diligence and consult with a registered financial adviser before making any investment decision. Lior Ronen and Finro are not registered financial advisers and shall not have any liability for any damages of any kind whatsoever relating to this material. By accepting this material, you acknowledge, understand and accept the foregoing.