PLW Is A Nicely Designed Treasury ETF
Summary PLW has a diversified ladder of maturities. The fund does a solid job of providing negative beta to reduce the volatility of the portfolio. Using longer maturity treasury securities offers better yields and a stronger negative beta because price movements are larger. The PowerShares 1-30 Laddered Treasury Portfolio ETF (NYSEARCA: PLW ) is an ETF with a fairly even distribution of maturities across the yield curve. It is an interesting ETF because most treasury ETFs are focused on a single duration range. As a treasury ETF that includes long maturities it shows a fiercely negative correlation with major equity indexes, but the individual volatility of the ETF is reduced compared to longer treasury ETFs because there is also a substantial allocation to the shorter parts of the yield curve. Expense Ratio The expense ratio on PLW is .25%. That isn’t too bad, but there are quite a few cheaper options out there if investors don’t mind having their holdings concentrated across certain maturities. For investors that want diversification across maturities, it may still be worth considering simply buying short, medium, and long term ETFs with lower expense ratios. There isn’t a great deal of “expertise” that goes into picking which bonds to hold in a treasury ETF. Most funds have a guideline establishing which part of the yield curve they will buy and it is really easy to decide which issuer to buy. There is no assessment of the credit rating of different companies or the impacts of the industries, this is simply buying up treasury ETFs and forwarding interest payments to shareholders. Maturity The diversification across the yield curve is clearly demonstrated here. This is far more diversified than most treasury ETFs, but I would favor replicating the portfolio with lower expense ratio funds. Characteristics The fund is showing an effective duration of 10.73 years, so investors should expect to see some material volatility when interest rates are shifting. The nice thing about that is the volatility tends to be headed in the opposite direction of the equity indexes. Perhaps I’m being a little strange, but I actually prefer longer durations on treasury ETFs because of the negative correlation with the market. When correlations are substantially negative, an increase in volatility for the individual ETF will often result in a decrease in volatility for the portfolio. That is, of course, assuming that the individual ETF is a fairly small portion of the total portfolio. For investors that want to go heavy on treasury securities and light on equity, the logic of going for longer duration and higher volatility falls apart. Building a Sample 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 PLW offers investors a fairly solid exposure to the treasury securities across the yield curve and will help equity heavy portfolios reach a substantially lower level of volatility. If an investor is willing to do the work, they may be able to replicate PLW at a lower cost by simply buying a few treasury ETFs that each offer exposure to a particular sector of the yield curve. Exposure to the shorter parts of the yield curve reduces the total volatility of PLW which makes sense for investors that are going heavy on bonds and light on equity, however the reduction in volatility can be counterproductive for investors that are going heavy on equity securities. Strong price movements on treasury ETFs can be desirable because of the negative correlation with the equity market.