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Hedge Rising Yields With These Junk Bonds ETFs

The path of junk bond ETFs has been patchy for the last couple of months. The space put up a dull show in 2014. The acute plunge in oil prices in the second half of the last year weighed heavily on the space, especially on the energy bonds. This was because the U.S. energy companies spread their presence widely to the high-yield bond market to materialize the shale-oil boom. Thus, fears of their default amid the oil price massacre prompted junk bond sell-offs. Since things have not meaningfully improved on the oil price front especially with the signing of the Iran nuclear deal and sluggish global demand backdrop, junk bonds started taking cues from the Fed interest rate policy. The Fed emphasized the strong U.S. growth momentum in the second half of 2015 that alternatively means the start of policy tightening sometime later this year. The exit from the rock-bottom interest rate policy would raise yields on the treasury notes, thereby hurting the bonds’ prices. In such a scenario, junk bond ETFs could emerge as intriguing options as these are high-yield in nature. Demand for strong and steady current income will likely prevail in the coming months. Investors’ drive for higher yield has become so obvious in the zero-or-negative-yield scenario in the Euro zone and Japan that the global high-yield space has gained immense traction lately, even at the cost of higher risks. Meanwhile, Grexit worries that brewed for over a month frittered away lately with the approval of a new bailout program. Chinese stocks have also stabilized after a wild rout. All these whet investors’ risk-on sentiments to some extent. As a result, the ultra-popular iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) and SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ) enjoyed ‘their largest daily inflows’ in the week ended July 17, 2015. On July 15, JNK and HYG witnessed 4% and 2.23% rise in AUM topping the fixed income list, per etf.com . In such a backdrop, junk bond ETFs with outsized yield mentioned below may weather the rising rate risks to a large extent. These funds could provide investors with a strong income potential and relatively stable returns while maintaining low correlated assets, and thus could be in focus for high-yield seekers: Interest Rate Hedged High Yield Bond ETF (NYSEARCA: HYGH ) Along with high yield, this fund hedges rise in rates and thus serves as an option to play rising yield in the U.S. The fund holds in its basket iShares iBoxx $ High Yield Corporate Bond ETF while taking short positions in U.S. Treasury futures to diminish rising rate concerns. HYGH has a weighted average maturity of 4.60 years while its effective duration stays ultra-low at negative 0.32 years. HYGH is high yield in nature as evident from its 30-day SEC yield of 5.68%. HYGH charges 0.55% of expense ratio. The fund added about 1.8% in the last five trading sessions (as of July 16, 2015) and is up 0.8% year to date. ProShares High Yield Interest Rate Hedged ETF (BATS: HYHG ) This fund also behaves in the same fashion as that of HYGH while tackling rising rate worries. Its strategy is to take a short position in U.S. Treasury futures. Like HYGH, it also has a pretty high yield (and a modest expense ratio of just 50 basis points) of 5.6% in 30-Day SEC terms, indicating that this could be a safer bond and yield play for investors anxious about the possibility of rising rates. This $105.8 million ETF was up 1.8% in the last five trading sessions (as of July 16, 2015). High Yield Long/Short ETF (NASDAQ: HYLS ) The fund seeks to provide current income by investing primarily in a diversified portfolio of below investment-grade or unrated high-yield debt securities. Though capital appreciation is its secondary motive, it has added a bit this year, gaining 4.5% YTD. The product thrives on long-short strategies. Net weighted average effective duration (considering the short positions) is 2.91 years indicating low interest rate risks. The fund is meant for an intermediate term as evident from 6.18 years of weighted average maturity. The product is expensive with an expense ratio of 1.29% per annum. Volume is light, trading in less than 35,000 shares per day that ensures extra cost for the product in the form of a wide bid/ask spread. The fund yields 6.40% (as of July 16, 2015). iShares Global High Yield Corporate Bond Fund (BATS: GHYG ) This fund tracks the Markit iBoxx Global Developed Markets High Yield Index. The index captures the performance of the global high yield corporate bond market. The fund’s effective duration stands at 4.09 years suggesting moderate interest rate risk. It charges an expense ratio of 40 bps and yields around 4.90%. The fund has added about 1.1% so far this year and was up over 1.9% in the last five trading sessions. Original Post

Eureka! A Valuation-Based Asset Allocation Strategy That Might Work

By Wesley R. Gray, Ph.D. We’ve had a few posts showing that asset allocation systems relying on market valuation indicators (e.g., Shiller CAPE ratios) as a timing signal may end up in disappointment… Nonetheless, we’ve continued on the quest to improve tactical asset allocation using market valuation data. The data speaks clearly when it comes to the association between valuations and long-term realized returns – high valuations are associated with low long-term realized returns. However, as Michael Kitces highlights, tactically allocating using valuation information is challenging . Moreover, there are arguments that the association between CAPE and LT returns may be more complex than was previously thought. In short, valuation-based asset allocation strategies haven’t been that exciting, but… The folks at Gestaltu inspired us with a unique twist on basic valuation-based timing methodologies: … we chose the cyclically adjusted earnings yield as the valuation metric, which is just the reciprocal of the Shiller PE. We then adjusted the yield value for the realized year-over-year inflation rate to find the real earnings yield. Finally, we used an ‘expanding window’ approach to find the percentile rank of the real earnings yield to eliminate as much lookahead bias as possible. Note that because we are using real earnings yield rather than nominal earnings yield, markets can get cheap or expensive in three ways: changes in inflation changes in earnings changes in price Gestaltu’s post used 1/CAPE as the valuation metric, or the “earnings yield,” as a baseline indicator; however, they “adjusted the yield value for the realized year-over-year (yoy) inflation rate” by subtracting the year-over-year inflation rate from the rate of 1/CAPE. To summarize, the metric looks as follows if the CAPE ratio is 20 and realized inflation (Inf) is 3%: Real Yield Spread Metric = (1/20)-3% = 2% Fairly simple. Strategy Background: We performed our own replication of the first two strategies from the post: Average Valuation-based asset allocation: Own S&P 500 when valuation < long-term average, otherwise hold cash. In other words, if last month's CAPE valuation is in the 50 percentile or higher, buy U.S. Treasury bills (Rf); otherwise stay in the market. 80th Percentile Valuation-based asset allocation: Own S&P 500 when valuation < 80th percentile, otherwise hold cash. In other words, if last month's CAPE valuation is in the 80 percentile or higher, buy U.S. Treasury bills (Rf); otherwise stay in the market. Some adjustments are applied in the replication: The Bureau of Labor Statistics (BLS) publishes the CPI on a monthly basis since 1913; however, the data is one-month lagged (possibly longer). For example, the CPI for January won't be released until February. So, when we subtract the year-over-year inflation rate from the rate of 1/CAPE, we do a 1-month lag to avoid look-ahead bias. We use the S&P 500 Total Return index as a buy-and-hold benchmark. Our back test period is from 1/1/1934 to 12/31/2014, while the article looks over the period from 1/1/1934 to 12/31/2012. The results are gross of any fees. All returns are total returns and include the reinvestment of distributions (e.g., dividends). Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Our Replication Results The first table shows the results from the Gestaltu post: The results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request. Our backtest results show similar CAGRs, but higher volatilities than the results from Gestaltu. This could be due to changes in experiment design. Overall, the "Abs Return 80%" strategy outperforms buy-and-hold, while the "Abs Return 50%" strategy underperforms buy-and-hold. We include a long-term moving average rule for reference (S&P 500 if above the 12-month MA, risk-free if below the 12-month MA). Summary statistics are below: (click to enlarge) The results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request. Bottom line: The system looks promising. Robustness Tests: Adjusting the Starting Point for the Look-Back Window Gestaltu set 1/1/1924 as the starting date, and then uses an expanding window as the look-back period. We investigate how changing the start date affects the results. The results shown are from 1/1/1934 to 12/31/2014. The table below shows the results of the "Abs Return 80%" strategy using different starting dates for the expanding window: 1924, 1900, and 1881. The starting date for the expanding window calculation can create marginal differences in the results. For example, the Sharpe ratios vary from 0.57 to 0.63. Overall, the results appear robust to the expanding look-back window start date. (click to enlarge) The results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request. Bottom line: The system looks promising. Robustness Tests: Rolling Look-Back Window In this section, we try a 10-year rolling look-back period calculation. For example, we measure the percent rank of CAPE on 12/31/2014 relative to the past 10 years (12/31/2004 to 12/31/2014); while an expanding window (results already shown above) would measure the percent rank of CAPE on 12/31/2014 relative to the whole time period (from the start date to 12/31/2014). The results below highlight that a rolling-window technique yields similar results to the expanding-window technique. (click to enlarge) The results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request. Bottom line: The system looks promising. Robustness Tests: Inflation-Adjusted P/E Ratio In this section, we use the old-fashioned price-to-earnings ratio in place of the CAPE ratio. We use a rolling 10-year window look-back method and adjust inflation with a 1-month lag. Full Sample Results: 1/1/1934 to 12/31/2014 Inflation-adjusted P/E strategies work better than simple Moving Average rules and buy-and-hold. They also work better than CAPE-based strategies. (click to enlarge) The results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request. Bottom line: The system looks promising. First-Half Results: 1/1/1934 to 12/31/1974 Inflation-adjusted P/E strategies work well in the first half. (click to enlarge) The results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request. Bottom line: The system looks promising. Second-Half Results: 1/1/1975 to 12/31/2014 Inflation-adjusted P/E strategies work well in the second half. (click to enlarge) The results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request. Bottom line: The system looks promising. Robustness Tests: Different Thresholds In this section, we look at different percentile thresholds to determine the timing signal. For example, the results are strong when the timing signal is based on the average or the 80th percentile, but what happens if we use different signals? We use a rolling 10-year window look-back method and adjust inflation with a 1-month lag. Full Sample: 1/1/1934 to 12/31/2014 Higher thresholds increase maximum drawdowns (relative to lower thresholds, such as the 50th and 80th percentiles). The results are better than pure buy-and-hold, but this does highlight a potential robustness issue. (click to enlarge) The results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request. Bottom line: The system may have robustness issues. Robustness Tests: Staggered Allocations In this robustness test, we vary holding percentages based on the percentile rank of earnings yield - realized inflation. For example, if last month's E/P - CPI is in the 12th percentile based on the past, then we allocate 12% to stock and 88% to T-bills. We use a rolling 10-year window look-back method and adjust inflation with a 1-month lag. Full Sample: 1/1/1934 to 12/31/2014 Staggered allocations strategies are better than buy-and-hold. (click to enlarge) The results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request. Bottom line: The system looks promising. Robustness Tests: Changing the Real Inflation Component of the Signal In the post, " Market Valuations based on CAPE - A Deeper Dive ", we take the 1/CAPE and subtract the inflation adjusted 10-year U.S. Treasury yield, so that we can examine how expensive the market is relative to real returns available via a bond alternative (a stock investor would prefer a higher spread, all else being equal). To summarize, the metric looks as follows if the CAPE ratio is 20, realized inflation (Inf) is 3%, and the 10-Year Treasury is 5%: Real 10-Year Spread Metric = (1/20)-(5-3)% ~ 3% Full Sample: 1/1/1934 to 12/31/2014 This new measure doesn't work - at all. Understanding why a seemingly small change in technique destroys the results is puzzling and worthy of more investigation... (click to enlarge) The results are hypothetical, and are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request. Bottom line: The system may have robustness issues. Conclusion After enduring years of frustration trying to identify a valuation-based asset allocation technique - that actually worked - I think the team at Gestaltu is on to an interesting concept. By simply looking at real spreads between equity valuations and realized inflation (high spreads are good for equity; low spreads are bad for equity), one can devise a timing rule that captures most of the upside, but protects on the downside. Of course, this is all historical data and could very well be an exercise in data mining. That said, the concept of buying equity assets when they have much higher yields than current inflation is intuitively appealing. We'll continue our investigations into the subject, but we wanted to give a quick view into some of our high-level research on the subject. Original Post

5 Portfolio Moves For The Second Half

After a relatively calm few months, market volatility is back. In recent weeks, stocks have swung between ups and downs, as investors have attempted to digest the latest news out of Greece , the recent bear market in China and the growing likelihood that the Federal Reserve (Fed) will hold off on raising rates until after its September meeting. Some of this shouldn’t come as a surprise. At BlackRock, we have long been saying that the second half was likely to be characterized by more volatility, given increasing investor attention on the Fed’s next move. We also have long viewed China’s market as expensive. However, not everything has played to script, like some of the twists in Greece’s debt crisis and the possible delay of a Fed rate hike. That said, the big-picture economic themes we discussed in the beginning of the year still appear to be in place: slow but steady growth, low inflation and low rates. Even recent events in Greece and China aren’t likely to have a longer-term impact on the global economy or markets. Against this economic backdrop, we’re sticking with our basic market views. So, to help prepare your portfolio for the second half, investors can consider these five portfolio moves, as I write in the Mid-Year Update to The BlackRock List: What to Know and What to Do in 2015 . Favor stocks over bonds Stocks in general still look more attractively valued than bonds, but certain stock segments offer more value than others. We like international stocks over U.S. ones (more on that in the next bullet point). Meanwhile, within the U.S., we’re cautious on segments that will likely be most affected when interest rates go up, such as utilities. Greater value can be found in sectors positioned to benefit from economic growth, such as technology and financials. Consider more international equity exposure With the U.S. in the sixth year of a bull market, better value exists overseas, particularly in Europe and Japan. While it’s true that Europe is no longer cheap and faces political challenges, contagion from the situation in Greece is unlikely, and we still expect European equities to notch decent performance relative to pricier U.S. stocks. Europe and Japan should also continue to benefit from market-friendly central bank easing, while the U.S. is poised to raise rates soon. Within bonds, favor credit over duration. While bonds remain expensive, it’s important to have some exposure to fixed income. Given that rate volatility will likely remain elevated in coming months, investors may want to look to the high yield sector, which is typically less sensitive to rate movements than other fixed income sectors. We also like tax-exempt municipal bonds, which currently offer attractive yields. Look for tactical opportunities within fixed income Income seekers must keep in mind that rates around most of the world will remain low for some time despite any Fed action, so flexibility and selectivity are critical in fixed income asset allocation. Consider alternatives, but remain cautious on commodities Finally, in a slow-growth world where many traditional assets look pricey, you may want to consider casting a wider net toward alternative investments in an effort to optimize your portfolio’s results. Nontraditional asset classes such as infrastructure or real estate may be worth considering. Commodities, on the other hand, are likely to remain challenged, particularly if real rates continue to rise. The bottom line: As volatility continues, resist the temptation to abandon the markets. A better strategy for long-term investors would typically be to stay the course, assuming your portfolio is aligned properly. Source: BlackRock Original Post