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5 ETF Ways To Keep Volatility At Bay

The Fed is poised to hike the benchmark interest rate in two weeks after almost a decade, oil prices are hitting fresh lows on supply glut and overvaluation concerns over the U.S. market are doing the rounds. Together, these aren’t creating the best backdrop to invest in the equity markets. Moreover, the slowdown in China and the eurozone, the recession in several emerging markets and a technical recession in the Japanese economy continue to cast a shadow over global growth. Plus, broader commodities are slouching, putting mining companies at risk. The sought-after investment broker Goldman Sachs expects weakness in the market next year, with the S&P 500 predicted to close out 2016 at 2,100. The U.S. index presently trades at 2,088, implying almost no change in gains in the coming 13 months. Among the top ETFs, investors have seen the S&P 500-based fund SPY adding about 1.4% and the Dow-based fund DIA losing about 0.3%. Only the tech-laden Nasdaq-based fund QQQ has advanced 11% so far this year (as of December 7, 2015). Higher interest rates post lift-off will result in a stronger greenback, which, in turn, curtailed the profit outlook of the companies. In Q3, earnings from the S&P 500 were down 2.4%, while revenues declined 3.9%. As per Zacks Earnings Trends , earnings for Q4 are projected to be down 6.5% on 3.4% lower revenues. Though the majority of the Fed’s lift-off move is priced in at the current level and the investing world is expecting a slow and small rate hike trajectory, as the U.S. economy is yet to attain the central bank’s inflation goal, a certain level of initial shocks are inevitable once the step is taken. This might lead many investors to seek refuge in low-risk products rather than sticking to highly volatile options and enduring the economic data and Fed-infused storm. In such a scenario, the low-volatility products could be intriguing choices for those who want to stay invested in domestic equities, but like the idea of focusing on minimum volatility. Low-volatility ETFs generally tend to offer positive risk-adjusted gains, though not huge. Investors should note that in down years like 2015, low-volatility products outperform the traditional benchmark. Over the long term as well, low-risk products are seen to surpass the high-risk securities. Below, we highlight five low-volatility ETFs and offer the key features of each so that you can find out which of them is best suited to look after your portfolio . PowerShares S&P 500 Low Volatility Portfolio ETF (NYSEARCA: SPLV ) This $67.1 million low-volatility ETF consists of the 100 stocks from the S&P 500 Index with the lowest realized volatility over the last one year. The fund is heavy on Financials (28.2%), followed by Consumer Staples (21.3%), Industrials (16.7%) and Healthcare (12.4%). It charges 25 bps in fees. SPLV is up over 2.2% so far this year (as of December 7, 2015), and has a Zacks ETF Rank #2 (Buy) with a Medium risk outlook. PowerShares S&P MidCap Low Volatility ETF (NYSEARCA: XMLV ) This overlooked ETF looks to follow the S&P MidCap 400 Low Volatility Index. The product invests about $118.4 million in assets in 80 stocks. From a sector look, Financials make up half of the portfolio, followed by about 11.26% of assets invested in Industrials and 10.54% in Utilities. The portfolio has minimal company-specific concentration risk, with no company accounting for more than 1.71%. The product charges about 25 bps in fees. It is up 5.4% so far this year. iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ) USMV measures the performance of equity securities in the top 85% by market capitalization of U.S. equities that have lower absolute volatility. It has garnered an asset base of $6.85 billion. This fund is home to 171 securities in total, and assigns double-digit allocation to the Financials (21.2%), Healthcare (19.6%), Information Technology (15.71%) and Consumer Staples (14.43%) sectors. The product also has an edge over its peers when it comes to expenses, as it charges a fee of just 15 basis points annually, while it yields about 1.89%. It has delivered a return of over 4% so far this year. PowerShares S&P 500 ex-Rate Sensitive Low Volatility Portfolio ETF (NYSEARCA: XRLV ) This ETF has already amassed over $113 million in assets. It offers investors dual benefits. First, it is targeted at low-risk stocks, and second, it is insulated from the impending Fed rate hike, as it considers stocks which are less rate-sensitive. Holding 100 stocks in its basket, the fund dose not put more than 1.29% of the total in a single security. It is heavy on Financials (28.2%) and Industrials (21.5%). It charges 25 bps in fees. This product has returned 3.2% in the year-to-date frame (as of December 7, 2015). SPDR Russell 1000 Low Volatility Focus ETF (NYSEARCA: ONEV ) This brand-new ETF gives exposure to low-volatility investing in large cap equity securities. The 424-stock fund is heavy on Financial Services (20.2%), trailed by Consumer Discretionary (16.62%), Producer Durables (15.98%) and Consumer Staples (12.2%). It charges 20 bps in fees. Original Post

All The Time, Every Time

Most investors, especially those at or near retirement, would give a limb or two for consistent returns. They wouldn’t even have to be staggering, Bernie Madoff 12% consistent returns. 4-5% real returns year in and year out is a pension trustee’s dream. Of course, it’s not surprising then that so many investment products and strategies promise this, or something that smells enough like it to pass muster. Some of these have become quite popular in recent years as investors are still trying to avoid another 2008-2009 bear market but keep stock-like returns (or at least something better than a 2.2% Treasury yield). Some risk parity or “all-weather” strategies have gained notoriety, including a spin on Ray Dalio’s All-Weather retail strategy highlighted in Tony Robbins’ recent book (which I covered in some detail here ). So just how all-weather has said strategy been of late? I ran a historical simulation with publicly available products to fill in the allocations as follows: 40% long-term Treasury bonds (NYSEARCA: TLT ) 30% US stocks (NYSEARCA: VTI ) 15% intermediate bonds (NYSEARCA: BND ) 7.5% commodities (NYSEARCA: GSG ) 7.5% gold (NYSEARCA: GLD ) Now, as I’ve pointed out before, this portfolio allocation is bond heavy and duration heavy. When long-term bonds hold up, this portfolio will too. When they don’t, it’s going to be tough going. Year to date through 11/30/2015, this allocation is down -2.30% despite long-term bonds (TLT) having an impressive gain of 9.07% over the same period. Commodities have been crushed (-42.35%) and gold is down (-8.79%), wiping out gains elsewhere. It’s not like I’m sitting here saying -2.30% is terrible. The Vanguard Balanced Index Fund (MUTF: VBINX ) is only up 1.80% over the same period (YTD through 11/30/2015). But the “All Weather” portfolio doesn’t come with any guarantees. The worst 12-month period in my simulation (4/2007-11/2015) had a double-digit loss like most other strategies (-15.26 through 2/2009). And we honestly haven’t seen an environment with rising rates to really test this out. The returns from long-term bonds (TLT) over this period drove more than 100% of the return of this “All Weather” strategy over the test period. That’s right, diversifying away from long-term bonds hurt you (How many people made that bet when the Fed took the Fed Funds rate to zero?). If you think that long-term returns from high-duration bonds are going to be 7-8% from here, you might have a surprise coming. With an average duration of 14.30 in this portfolio, there’s no escaping the impact of higher long-term rates on performance, if and when they come. My real point here isn’t to pick on the All-Weather portfolio per se. It’s to help us all understand that no strategy is ideal. Nothing is going to work all the time, every time. “All Weather” is a misnomer. It’s not totally unreasonable to think there is a period of time when rates can go up (long bonds go down) and stocks are flat or down. Or when rates are up enough to offset any potential gains from stocks. Or a year like 2015 when losses in commodities are sufficient to take out healthy gains from the long-term bonds. Despite our best attempts, investing involves risk. We can mitigate that through portfolio diversification, but there is no eliminating inconsistent short-term returns. Some years are going to be better, and some will be worse. I don’t know which will be the case for your portfolio next year, but if you aren’t prepared for that, you’re going to find yourself making some nasty mistakes.

The Dangers Of Non-GAAP Earnings

Summary Non-GAAP earnings are not quality measures of business success. We’ve identified over 18 items that are removed from GAAP earnings, many of which are standard operating expenses. The exploitation of non-GAAP earnings only makes analyzing a company a more difficult task. It’s no secret that non-GAAP earnings allow management to directly manipulate their performance metrics. Investors must look past non-GAAP metrics to protect their portfolios. While non-GAAP tricks may provide some short-term boosts to stock prices, eventually reality sets in and the true economics of the business rule the day. Why Non-GAAP Can’t Be Trusted We spend lots of time explaining how GAAP earnings are not reliable measures of corporate profits, and non-GAAP earnings are worse. Most of the time non-GAAP earnings are blatant misrepresentations of profits for the benefit of corporate insiders at the expense of regular shareholders . Case in point is one of Bill Ackman’s favorites: Valeant Pharmaceuticals (NYSE: VRX ). That stock has cratered recently on the heels of long overdue coverage of its questionable accounting practices, about which we warned investors back in July 2014 . While arguments may persist over the future of Valeant, one thing is clear: the company’s use of non-GAAP earnings, or as they call it, “cash earnings”, has only misled investors while serving executives in four distinct ways . Since management wants investors to focus on cash, not earnings, we find the discrepancy between Valeant’s “cash earnings” and the company’s true cash flows alarming. Figure 1 shows: while the company’s “cash earnings” have been highly positive and grown from $421 million to $3.55 billion from 2010 thru the latest trailing-twelve-months (TTM), free cash flow has been highly negative with a cumulative -$38.4 billion in losses over the same time frame. Cumulate non-GAAP earnings, during the same time, are $11.2 billion. Figure 1: Valeant’s Non-GAAP Tricks Have Tells For Those Who Look Closely (click to enlarge) Sources: New Constructs, LLC and company filings Non-GAAP Leads Investors Farther Away From The Truth About Profits The key point for investors to remember about non-GAAP earnings is they are like lipstick on a pig. They only cover up the ugly, and they cannot change it. The more managers have to adjust GAAP, the worse the situation is likely to end for investors. Non-GAAP tricks may work for a while, but they cannot disguise a bad business forever. Another example is Demandware (NYSE: DWRE ). After rising 160% from January 2013 to June 2015, DWRE is down 30% since we placed it in the Danger Zone in July 2015 . Figure 2 shows how much Demandware tried to fool investors by peddling non-GAAP earnings while GAAP and economic earnings were headed in the opposite direction. Only after the stock has cratered do we see non-GAAP earnings decline. Note that the current decline in non-GAAP sets management up for an easier comparison in subsequent reporting periods as well. Figure 2: Demandware’s Non-GAAP Creates Illusion of Profits (click to enlarge) Sources: New Constructs, LLC and company filings Expenses Management Excludes To Create Non-GAAP Earnings Because non-GAAP earnings are entirely at the discretion of management, any number of items can be removed from traditional GAAP earnings. The following are just some of the items we have come across that companies remove from GAAP earnings to calculate non-GAAP or “adjusted earnings”: Stock based compensation Payroll tax expense related to stock based compensation Compensation expense related to contingent retention bonuses Acquisition related expense Depreciation and amortization Foreign exchange effect on revenue Purchases of property and equipment/ property and equipment purchased under capital lease Unrealized gain/loss on fuel price derivatives Deferred loan costs associated with extinguishment of debt Gains on divestiture Preopening expenses Management recruiting expenses Management and consulting fees General and administrative expenses Litigation expenses Integration costs Restructuring costs Gross profit deferred due to lease accounting As should be clear, companies are removing not only a large amount of items, but also items that should most certainly be included when determining a business’s profitability. We find it hard to accept any argument for the removal of certain, natural costs of doing business like consulting fees, recruiting costs and compensation costs. Details On How Companies Exploit Non-GAAP Earnings The following examples are just a sampling of how management is creating the illusion of higher profitability. Wex, Inc. (NYSE: WEX ) – Click here to see the non-GAAP reconciliation Wex adds back certain acquisition expenses, non-cash tax adjustments, stock based compensation, and amortization of intangible assets to calculate adjusted net income. The company also removes certain income items such as the unrealized gain on derivatives and gain on divestitures. When totaled in 2014, the adjustments actually caused adjusted net income to be lower than GAAP net income. While this may seem counter intuitive, this is not a problem because the magnitude of beating targets is not nearly as important as just beating targets when using non-GAAP earnings to boost executive pay. In addition, this lowered adjusted earnings number will set up an easy comp in 2015. Marketo, Inc. (NASDAQ: MKTO ) – Click here to see the non-GAAP reconciliation Marketo is very transparent about all the items it removes from GAAP earnings and actually breaks down how each item is removed from cost of revenues, gross profits, operating expenses, and net income. However, this doesn’t detract from the fact that Marketo removes these items to appear less unprofitable than they truly are. Marketo removed $25 million in stock based compensation in 2014, or nearly 17% of revenue to derive non-GAAP net income. Tesla Motors (NASDAQ: TSLA ) – Click here to see the non-GAAP reconciliation In addition to some of the other items mentioned above, such as removing $156 million in stock based compensation in 2014, Tesla treats its non-GAAP calculation in a unique manner. Rather than just removing expenses to derive a non-GAAP net income, Tesla adds back deferred profits due to lease accounting. By adding this profit to net income, Tesla was able to report a non-GAAP net income of $20 million in 2014, compared to a GAAP net loss of $294 million. Demandware ( DWRE ) – Click here to see the non-GAAP reconciliation As shown above, Demandware uses non-GAAP net income to appear profitable when GAAP income and economic earnings both would prove otherwise. In 2014, Demandware removed $26 million in stock based compensation (16% of revenue) and $3 million in compensation expense related to contingent retention bonuses. Overall, Demandware reported a GAAP loss of $27 million in 2014, despite a non-GAAP profit of $4 million. How Non-GAAP Could Harm Your Portfolio Look at the stocks in Figure 3 for a few more examples of how bad your portfolio can be burned if you trust companies using misleading non-GAAP results. Figure 3: Non-GAAP Only Delayed The Inevitable (click to enlarge) Sources: New Constructs, LLC The stock market can be a dangerous place if you do not do your homework. Wall Street and corporate insiders are not afraid to trick you, and I think we have shown they have the lawful right-of-way to trick you. Investors need to do their homework in order to make the right investments consistently. To learn even more about the Dangers of Non-GAAP Earnings, watch our recent webinar and ensure you don’t get burned by non-GAAP earnings. Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector, style, or theme.