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FXG Vs. RHS: To Weigh Or Not To Weigh

Both funds have excellent returns. Both funds are defensively structured. However, each favors a different bias within the Consumer Staple sector. Successful investors redirect funds according to economic conditions. During the lean times, the object is to get defensive. During the prosperous times, the investor can take more risks. One of the defensive sectors is Consumer Staples . According to Investopedia : Consumer staples are goods that people are unable or unwilling to cut out of their budgets regardless of their financial situation. Consumer staples stocks are considered non-cyclical, meaning that they are always in demand, no matter how well the economy is performing. Naturally, the investor may ‘pick and choose’ their favorite defensive holdings or may save a lot of time and effort by investing in an appropriate ETF. Two good examples are the First Trust Consumer Staples AlphaDEX ETF (NYSEARCA: FXG ) and the Guggenheim S&P 500 Equal Weight Consumer Staples ETF (NYSEARCA: RHS ). Fund 1-Month 3-Months Year-to-Date 1-Year 3-Year 5-Year Inception Inception Date Expense Ratio FXG -4.38% -1.16% 4.45% 12.26% 23.60% 21.60% 11.61% 5/8/2007 0.67% RHS -4.97% -1.34% 2.70% 10.50% 18.05% 18.09% 11.60% 11/1/2006 0.40% (Data from First Trust and Guggenheim) The above table indicates that in the short term, the First Trust fund slightly outperforms the Guggenheim fund and in the 1 to 5 year range First Trust fund outperforms Guggenheim fund by a respectable margin, however, returns since inception (only six months apart) are nearly identical. What makes this interesting is that the Guggenheim fund is an equally weighted fund; in particular, the Guggenheim fund tracks the S&P 500® Equal Weight Index which weights each of its component holdings at 0.2% of the index, rebalancing quarterly. On the other hand, the First Trust fund tracks the NYSE StrataQuant® Consumer Staples Index [STRQC] . The First Trust methodology is a little complex, but in essence, it is weighted by growth. It’s interesting to note the similarity between the two in a price history chart. (click to enlarge) Since one fund is performance weighted and the other equally weight it would make more sense to compare holdings; similarities and differences. First, where do they differ, if at all? The Guggenheim fund has 37 holdings; the First Trust has 39. Two of the First Trust holdings are “rights”, that is to say that the fund has the ‘right’ to “… purchase additional shares directly from the company in proportion to their existing holdings…—Investopedia “. Hence, aside from the ‘rights’ the funds have the same number of holdings. The following table lists the identical holdings but the weighting refers only to the First Trust fund, since in theory, the Guggenheim fund is equally weighted. Companies in Common FXG Weighting (RHS holdings are all equally weighted) Tyson Foods (NYSE: TSN ) 4.86% ConAgra Foods (NYSE: CAG ) 4.61% CVS Health (NYSE: CVS ) 4.59% Archer-Daniels-Midland (NYSE: ADM ) 4.35% Constellation Brands (NYSE: STZ ) 4.29% Walgreens Boots (NASDAQ: WBA ) 4.09% Reynolds American (NYSE: RAI ) 3.24% Hormel Foods (NYSE: HRL ) 3.17% Monster Beverage (NASDAQ: MNST ) 2.85% Whole Foods (NASDAQ: WFM ) 2.40% Sysco (NYSE: SYY ) 2.08% Campbell Soup (NYSE: CPB ) 2.05% Dr Pepper Snapple (NYSE: DPS ) 2.01% McCormick (NYSE: MKC ) 1.95% Brown-Forman (NYSE: BF.B ) 1.84% Procter & Gamble (NYSE: PG ) 1.70% Molson Coors (NYSE: TAP ) 0.99% Altria Group (NYSE: MO ) 0.94% J.M. Smucker (NYSE: SJM ) 0.90% General Mills (NYSE: GIS ) 0.85% Philip Morris (NYSE: PM ) 0.85% Average 2.60% (Data from First Trust and Guggenheim) Hence, the above table demonstrates that the well-known, well established, large cap consumer non-cyclicals as one would expect, are in both funds. However, there’s a divergence in those holdings not shared by the funds and it may be clearly observed in the following comparison tables. First Trust FXG Market Cap (Billions) Dividend Beta Weighting Guggenheim RHS Equally Weighted Market Cap (Billions) Dividend Beta Bunge (NYSE: BG ) $10.26 2.12% 0.93 2.32% Coca-Cola Enterprise (NYSE: CCE ) $11.3300 2.26% 1.04 Church & Dwight (NYSE: CHD ) $11.06 1.59% 0.33 0.86% Colgate-Palmolive (NYSE: CL ) $56.7710 2.41% 0.5 Edgewell (NYSE: EPC ) $5.31 2.34% 0.87 4.15% Clorox (NYSE: CLX ) $14.6110 2.71% 0.41 Flowers Foods (NYSE: FLO ) $5.11 2.38% 0.62 2.19% Costco (NASDAQ: COST ) $63.1140 1.11% 0.5 GNC (NYSE: GNC ) $3.81 1.60% 1.21 0.84% Estee Lauder (NYSE: EL ) $29.1270 1.23% 1.19 Hain Celestial (NASDAQ: HAIN ) $5.96 0.00% 0.068 4.81% Keurig-Green Mountain (NASDAQ: GMCR ) $9.2660 1.91% 0.83 Herbalife (NYSE: HLF ) $5.37 0.00% 1.44 2.97% Hershey (NYSE: HSY ) $14.8820 2.49% 0.35 Ingredion (NYSE: INGR ) $6.29 1.91% 1.37 4.19% Kellogg (NYSE: K ) $24.1810 2.92% 0.55 Pinnacle Foods (NYSE: PF ) $5.33 2.23% 0.1 0.83% Kimberly Clark (NYSE: KMB ) $39.0720 3.28% 0.3 Pilgrim’s Pride (NASDAQ: PPC ) $5.60 0.00% 0.57 3.56% Coca Cola (NYSE: KO ) $170.3020 3.37% 0.52 Rite Aid (NYSE: RAD ) $8.72 0.00% 1.56 3.91% Mondelez (NASDAQ: MDLZ ) $69.3500 1.58% 0.81 Spectrum Brands (SFB) $5.83 1.35% 0.82 3.65% Mead Johnson Nutrition (NYSE: MJN ) $15.1660 2.21% 0.86 WhiteWave Foods (NYSE: WWAV ) $8.11 0.00% 1.72 4.48% PepsiCo Inc. (NYSE: PEP ) 136.7190 3.02% 0.43 Averages $6.67 1.19% 0.893 2.98% Averages $50.2310 2.35% 0.63 (Data From Reuters, Yahoo!Finance) The difference is outstanding. The First Trust growth weighted fund is taking more risk with companies having smaller market capitalizations, a higher beta, (although still less than 1), and much smaller dividends. On the other hand, the Guggenheim Equally Weighted fund contains a real home run hitting line-up. The average market capitalization of the non-overlapping companies of the Guggenheim fund is a whopping $50.2310 billion compared with the First Trust fund’s non-overlapping companies $6.67 billion; that’s over 7.5 times! Even when excluding Coca-Cola and PepsiCo whose combined market cap is $346.87 billion, the average market cap of the non-overlapping Guggenheim companies is $31.533 billion, almost 5 times the market cap of the non-overlapping First Trust funds. The average dividend yield of the non-overlapping Guggenheim companies is nearly twice that of the First Trust non-overlapping companies and lastly the average beta of the Guggenheim non-overlapping companies is 29.45% less than average non-overlapping companies’ beta; 0.893 vs 0.63. The First Trust fund is tracking an index containing slightly more volatile stocks with smaller market caps and lower yields. They are consumer staple companies to be sure, but towards the more volatile end of the consumer staple spectrum. The Guggenheim fund, on the other hand, tracks an index which equally weights the crème de la crème of consumer staple companies. Since inception, the Guggenheim fund has returned $11.41 in dividends but the First Trust fund has returned $2.77 per share. (Please note that for the sake of compactness, the above comparison price/dividend history chart begin from the end of 2010). Lastly, some ETF metrics of both funds are summarized in the table below. Fund Total Net Assets (Billions) Daily Volume Shares Outstanding Rebalance Frequency Price/Earnings Price/Book Beta Sharpe Ratio Dividend Yield (TTM) FXG $2.712996 364,741 61,550,000 Quarterly 17.21 3.34 0.95 1.71 1.58% RHS $0.336326 59,471 3,100,000 Quarterly 23.83 4.47 0.98 1.77 1.82% (Data From Reuters, Yahoo!Finance) It’s fair to say that both funds are excellent representations of the Consumer Staple sector. One slightly outperforms the other in terms of market price and the other having a relatively good regular dividend, particularly important for disciplined dividend reinvesting. The deciding factor depends on the individual investor’s outlook. The First Trust Fund has a slight bias towards the risky end of consumer staples having more volatile components, whereas the Guggenheim Fund evenly weights with the sector best and stable companies, hence very much towards defense. Hence an investor with an optimistic outlook would obviously desire capital appreciation whereas an investor with a less optimistic outlook would obviously desire a solid defense. However, either one seems suitable for the investor with a long term savings outlook. 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: CFDs, spreadbetting and FX can result in losses exceeding your initial deposit. They are not suitable for everyone, so please ensure you understand the risks. Seek independent financial advice if necessary. Nothing in this article should be considered a personal recommendation. It does not account for your personal circumstances or appetite for risk.

VDC: If You Can Trade It For Free, It Belongs In Your Portfolio

Summary VDC has a reasonable correlation with SPY and less volatility. The heavy focus on consumer staples resulted in the fund performing substantially better on risk-adjusted metrics. Using VDC as a portion of the equity portion of a portfolio would be appropriate for the majority of investors. I’m glad Schwab and Vanguard have been competing to offer the lowest cost funds, but I’d love to have VDC added to my “Free to trade” list. 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. The Vanguard Consumer Staples ETF (NYSEARCA: VDC ) ETF looks like an interesting option for risk reduction. 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 maximize risk-adjusted returns by minimizing risk without destroying the potential for returns by being too conservative or spending too much on trading costs or high expense ratios. Does VDC provide diversification benefits to a portfolio? Each investor may hold a different portfolio, but I use SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) as the basis for my analysis. I believe SPY, or another large cap U.S. fund with similar properties, represents the reasonable first step for many investors designing an ETF portfolio. Therefore, I start my diversification analysis by seeing how it works with SPY. I measured correlations using daily and monthly returns over five-year periods and two-year periods. Depending on the measurement periods and intervals, the correlation will generally run around 75% to 80%. The correlation is low enough that there is the potential for a reduction in risk. When I checked the volatility of the ETF over the last five years, the annualized volatility was 11.1%, which compares very favorably with the S&P 500 having an annualized volatility of 14.8%. On top of the low correlation and lower volatility, the max drawdown for the period was -11.2%. The worst drawdown for SPY in that range was -18.6%. By any risk measurement, VDC should be seen as a lower risk option for the portfolio. Returns were not destroyed either. VDC outperformed SPY during the holding period by 1% with gains of 115.1% compared to 114.1%. So far, VDC is looking fairly impressive. Yield & Taxes The yield is only 1.85%, which is not ideal for retiring investors seeking stronger yields from their portfolio, but the volatility numbers are excellent for investors that want lower levels of risk in their portfolio. Expense Ratio The ETF is posting .12% for an expense ratio (both gross and net). I want diversification, I want stability, and I don’t want to pay for them. I view expense ratios as a very important part of the long-term return picture because I want to hold most of my investments for a time period measured in decades. The .12% expense ratio is solid and it gives investors a good value on their investment. Largest Holdings The diversification within the ETF is not a selling point for me. The top position being over 10% is the antithesis of diversification, but Procter & Gamble (NYSE: PG ) do have quite a bit of diversification within the company, so the concentration of the position within one company is not as bad as it might seem at first. Coca-Cola (NYSE: KO ) and PepsiCo (NYSE: PEP ) being the next two provides me a little concern again because the portfolio is holding 15% of the value in these fairly similar companies. Despite that, they are both solid companies with global distribution and enormous product lines. Phillip Morris (NYSE: PM ) is selling products that are literally addictive and Wal-Mart (NYSE: WMT ) is a fairly large piece of the retail pie. Despite the concentration to a few of the companies at the top, the portfolio is still quite intelligent given that the ETF is being restricted to the “Consumer Staples” sector. Absent an enormous scandal at one of the large companies, the diversification within product lines should provide material protection from weakness in the economy. (click to enlarge) Conclusion This is simply a great ETF. If the ETF used a higher distribution yield to push more cash back into the hands of investors, it might be one of the best core holdings a retiring investor could find for reducing their risk on the equity side of the portfolio. Absent the high distribution yield, the fund is still a very solid choice for any long-term investor with a higher level of risk aversion. Even for those with only moderate levels of risk aversion, it would make sense to be a little overweight on consumer staples. The downside for investors that don’t have free trading on the ETF is that optimal use of the ETF would involve rebalancing the portfolio occasionally to ensure the weightings across the portfolio remain within a reasonable tolerance band. My estimates on reasonable allocations for a highly risk-averse investor would be running 20% to 30% of the equity portion of the portfolio. Note that this is specific to the equity portion; the investor would still need to determine their own bond to equity ratios and adjust accordingly. For the investor with a lower emphasis on reducing portfolio risk, the fund would still be a very reasonable allocation for 5% to 10% of the equity portfolio if the investor has free trading on it. The only real downside I see here for investors that are not taking distributions (so yield won’t matter) is that the fund is only going to be free to trade with certain brokerage companies. That’s a shame because this fund is such a solid holding under modern portfolio theory that it could be stuck into most real investor’s portfolios to improve the expected risk/return. If this fund were on my “free to trade” list, I’d be adding a small allocation to my portfolio. 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.

VDADX: A Great Mutual Fund That Is Remarkably Low On 2 Key Sectors

Summary VDADX offers investors a great start to building a dividend portfolio. The fund is missing almost all exposure to the utility sector and to oil and gas. The expense ratio is exceptionally low, and the historical volatility has been better than that of the market. 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. Despite my frequent use of ETFs in my personal investing, many retirement accounts still use mutual funds as a major source of their investing. When it comes to assessing the mutual funds, one of my earlier favorites is the Vanguard Dividend Appreciation Index Fund (MUTF: VDADX ). Largest Holdings I’m starting the analysis by looking at the largest holdings in VDADX. As you can guess from the name, there is a heavy emphasis on receiving dividends from the portfolio. (click to enlarge) The holdings are a little on the heavily concentrated side with several holdings over 3%, and it is interesting that the fund opted to include heavyweights on both Coke (NYSE: KO ) and Pepsi (NYSE: PEP ). However, I don’t see any real disadvantage to holding both for better diversification since the investor won’t be stuck paying trading costs to buy each individually. The thing that really stands out to me is that there is no Exxon Mobil (NYSE: XOM ) or Chevron Corporation (NYSE: CVX ) in the top 10. XOM is yielding over 3.5% and CVX is up near 5%. That really concerns me. Though I did not chart the rest of the top 100 holdings, I did scan through them looking for Exxon or Chevron. Neither was included anywhere in the top 100 holdings. Granted oil prices are plummeting and oil stocks may seem “risky”, but a small inclusion would be entirely appropriate for a portfolio focused on dividends. The yields are high, and the companies would benefit from higher gas prices while many parts of the economy would be disadvantaged by high fuel prices. For diversification purposes, it is very strange not to have them included. On the other hand, Vanguard is including quite a few other holdings that I wouldn’t put at the top of the list for a fund focused on dividends. For instance, Costco (NASDAQ: COST ) is included in the portfolio despite having a yield of only 1.09%. There is nothing wrong with Costco as a company from my perspective, but the portfolio already has quite a bit of retail exposure and is lacking in the big gas companies. Diversification Benefits The correlation to SPY is just under 97%, so diversification benefits are not very substantial. However, the volatility on the fund is materially lower at only 87% of the level on SPY, which is nice for investors who would prefer more stability in their portfolio values. Yield & Taxes The SEC yield is 2.19%. Again, this feels fairly low for a dividend portfolio and brings me back to the question of why companies like Chevron were not given a prominent weighting in the portfolio. Expense Ratio The mutual fund is posting an expense ratio of .10%. I want diversification, I want stability, and I don’t want to pay for them. An expense ratio of .10% is absolutely beautiful and makes VDADX a solid choice for investors. Sector Allocations To go a little deeper into the absence of the major oil companies I like to see included in a dividend growth portfolio, I grabbed a chart of the sector allocations. (click to enlarge) As you can see, the oil and gas sector was only 1.3% for the fund. That matches the index that the fund is tracking; however, I find it interesting that the index was designed to limit the exposure to oil and gas. If I were establishing a dividend index for a fund that could be used as a major portion of an investor’s portfolio, I would want to increase the oil and gas weightings to around 10%. The other interesting factor is that utilities are also mostly absent. Unless the investors are buying utility companies themselves, the ideal allocation, in my opinion, would include a higher weighting for utilities in the 10% to 15% range. Conclusion For investors looking at the very long-term picture, the extremely low expense ratio is beautiful. Vanguard has been one of the best in the business at creating low-fee mutual funds. I don’t think a fund should be chosen purely for the expense ratio, but I do believe investors should be very aware of it. When I’m putting together hypothetical portfolio positions, one of the things I include is the expense ratio on the individual positions to track the overall expense ratio on the portfolio. The overall portfolio looks solid with the exception that oil and gas is largely absent and the utility sector is strangely underrepresented despite several utility companies having strong yields. If I were using VDADX as a core holding in my retirement accounts, I would want to complement it with specifically increasing allocations to large-cap oil and gas companies and a geographically diversified group of utility companies. 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.