Tag Archives: xlf

XLF: The Heavy Financial Sector Exposure Doesn’t Appeal To Me

Summary The fund offers a reasonable expense ratio and incorporates more than banks. One of the challenges for investors is the combination of REITs and other stocks in a single ETF. Looking into the REIT holdings, I’d rather not see such a huge focus on the biggest companies. The historical volatility on the fund demonstrates the risk of going so heavy on the sector. 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. I’m working on building a new portfolio and I’m going to be analyzing several of the ETFs that I am considering for my personal portfolio. One of the funds that I’m considering is the Financial Select Sector SPDR Fund (NYSEARCA: XLF ). 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 minimize costs while achieving diversification to reduce my risk level. Index XLF attempts to track the total return (before fees and expenses) of the Financial Select Sector Index. Substantially all of the assets (at least 95%) are invested in funds included in this index. XLF falls under the category of “Financial”. It sounds like the ETF would be very highly concentrated, but it includes everything from diversified financial services to REITs and banks. When I was first reading about the holdings, I was expecting more diversification than I found. You’ll see what I mean when I get to the holdings section. Expense Ratio The expense ratio is .14%. It could be a little better, but it isn’t too bad. Industry The allocation by industry is interesting. Investors that are new to the fund may simply assume that it allocates everything to “financials”, but the fund’s website goes much deeper in explaining which parts of the financial sector is going to get the weights. The allocation to banks is heavy, but it is also well below 100%. The fund also uses heavy allocations to insurance and REITs. I certainly prefer this strategy to going exceptionally heavy on the banking sector, but I find the holdings somewhat problematic as I prefer to run my REIT exposure through tax advantaged accounts. This is a challenge for any ETF that wants the diversification benefits of incorporating REITs. There isn’t much an ETF can do to get around this other than simply not holding REITs. Holdings Since I’m primarily a REIT analyst, the REIT exposure is the first part of the portfolio that my eyes are drawn to. The heaviest REIT allocation here is Simon Property Group (NYSE: SPG ) which I find a little disappointing. I find the REIT sector attractive for investing, but REITs should be divided between types the same way that banks and insurance companies were split up into different sectors. SPG is an absolutely enormous REIT, but I’d rather see exposure to Realty Income Corporation (NYSE: O ) or the fairly new STORE Capital (NYSE: STOR ). I simply prefer triple net lease REITs like O and STOR to most other types of REITs. Realty Income Corporation is included in the portfolio, but it is only .43% of the total portfolio. Since I prefer keeping REIT exposure inside tax advantaged accounts, there was already one challenge with the REIT allocation. I’m not thrilled with the allocation strategy for choosing REITs, which creates another challenge. Return History Historical returns shouldn’t be used to predict future returns, however the historical values for factors like correlation and volatility over a long time period can provide investors with a base line for setting expectations on whether the asset would fit in their portfolio. I ran the returns since January of 2000 through Investspy.com and came up with the following charts: (click to enlarge) Since 2000 the ETF has a total return of about 45% compared to the S&P 500, represented by SPY , having a return of 90.3%. The underperformance isn’t so much of an issue as the risk level. The fund had an annualized volatility of 33% compared to 20% for SPY. There were two market crashes during that period which leads to much higher volatility numbers, but the general premise remains. The fund is substantially more volatile. Since the holdings are also more concentrated, that makes sense. Unfortunately, when we switch to using beta as our measurement of risk the problem remains. The sector allocation simply lends itself to too much volatility for my portfolio. Conclusion XLF is a huge ETF for exposure to the financial sector. There are some bright spots for the fund, but the overall product is a little lacking for my tastes. The combination of other financial sectors with REITs may be acceptable for investors that have plenty of room in their tax advantaged accounts or investors that aren’t concerned with tax planning. Even moving past that, I’m not thrilled with the methodology for selecting REITs as it results in prioritizing enormous REITs. That is an area where I’d rather be adding individual stocks or using REIT specific ETFs with lower expense ratios. Seeing the enormous volatility reinforces my concerns about overweighting this particular sector. The fund may do very well in a continued bull market, but I’d rather keep a more defensive allocation. I just don’t like the risk of facing a third correction before the decade is over. I’ll keep most of my portfolio in equity, but I’ll stick to the more defensive companies and sectors.

Valuation Dashboard: Financials – November 2015

Summary 4 key factors are reported across industries in the Financial sector. They give a valuation status of industries relative to their history. They give a reference for picking stocks in each industry. This article is part of a series giving a valuation dashboard by sector of companies in the S&P 500 index (NYSEARCA: SPY ). I follow up a certain number of fundamental factors for every sector, and compare them to historical averages. This article goes down to the industry level in the GICS classification. It covers Financials. The choice of the fundamental ratios has been justified here and here . You can find in this article numbers that may be useful in a top-down approach. There is no analysis of individual stocks. A link to a list of individual stocks to consider is provided at the end. Methodology Four industry factors calculated by portfolio123 are extracted from the database: Price/Earnings (P/E), Price to sales (P/S), Price to free cash flow (P/FCF), Return on Equity (ROE). They are compared with their own historical averages “Avg”. The difference is measured in percentage for valuation ratios and in absolute for ROE, and named “D-xxx” if xxx is the factor’s name (for example D-P/E for price/earnings). The industry factors are proprietary data from the platform. The calculation aims at eliminating extreme values and size biases, which is necessary when going out of a large cap universe. These factors are not representative of capital-weighted indices. They are useful as reference values for picking stocks in an industry, not for ETF investors. Industry valuation table on 11/4/2015 The next table reports the 4 industry factors. For each factor, the next “Avg” column gives its average between January 1999 and October 2015, taken as an arbitrary reference of fair valuation. The next “D-xxx” column is the difference as explained above. So there are 3 columns for each ratio. P/E Avg D- P/E P/S Avg D- P/S P/FCF Avg D- P/FCF ROE Avg D-ROE Commercial Banks 15.42 15.24 -1.18% 2.97 2.06 -44.17% 19.79 13.44 -47.25% 8.78 8.89 -0.11 Thrifts & Mortgage Finance* 18.66 20.66 9.68% 2.97 2.03 -46.31% 21.55 14.75 -46.10% 6.25 5.02 1.23 Diversified Financial Services 21.45 17.85 -20.17% 4.36 2.94 -48.30% 19.78 16.13 -22.63% 8.04 6.38 1.66 Consumer Finance* 11.58 13.15 11.94% 1.64 1.47 -11.56% 6.68 8.22 18.73% 13.36 11.83 1.53 Capital Markets* 16.39 18.07 9.30% 3.58 3.06 -16.99% 19.55 19.62 0.36% 8.96 7.89 1.07 Insurance 14.24 13.7 -3.94% 1.29 1.07 -20.56% 10.77 8.99 -19.80% 9.31 8.71 0.6 REITs** 35.85 35.42 -1.21% 5.36 4.56 -17.54% 49.26 38.74 -27.16% 5.24 4.07 1.17 Real Estate Management** 30.22 31.19 3.11% 3.79 3.06 -23.86% 24.68 25.55 3.41% 4.27 -1.33 5.6 * Averages since 2003 – ** Averages since 2006 Valuation The following charts give an idea of the current status of industries relative to their historical average. In all cases, the higher the better. Price/Earnings: Price/Sales: Price/Free Cash Flow: Quality (ROE) Relative Momentum The next chart compares the price action of the SPDR Select Sector ETF (NYSEARCA: XLF ) with SPY (chart from freestockcharts.com). (click to enlarge) Conclusion XLF and SPY have distinct ways but very similar returns in the last 6 months. From the valuation charts above, we can note that some industries look overpriced, but all of them are above or close to their historical averages in quality. Two industries in the sector look more attractive than others: Consumer Finance and Real Estate Management & Development. For both of them, 2 valuation factors out of 3 and the quality factor are better than their respective averages. Commercial Banks, Diversified Financial Services, Insurance and REITs are overpriced for the 3 valuation ratios. Commercial Banks look the weakest industry of this study, with all metrics in negative territory. However, there may be quality stocks at a reasonable price in any industry. To check them out, you can compare individual fundamental factors to the industry factors provided in the table. As an example, a list of stocks in Financials beating their industry factors is provided on this page . If you want to stay informed of my updates, click the “Follow” tab at the top of this article. You can choose the “real-time” option if you want to be instantly notified.

The Amazing Beauty Of Equal Weight

Summary Most investors look only at capital-weighted indices. They miss two positive anomalies of equal weight. Here are equal-weight ideas and ETFs for passive investing and tactical allocation. Capital-weighted indices in the broad market and specific sectors are getting all the attention of investors. This article aims at proving that equal-weighted indices are better investment vehicles for passive investing and tactical allocation. We will stay in the S&P 500 universe. A few words of theory The statistical bias in favor of an equal weighted set of stocks over the same set weighted on market capitalization has two reasons: Size effect: Lower-range large-caps usually perform better than mega-caps. Rebalancing: Periodically equalizing position sizes in dollar amount among a big set of stocks is a simplistic “buy-low-sell-high” strategy. Simplistic, but not stupid. The interest bias in favor of capital-weighted indices has also good reasons: It is a good representation of real economic activity. Inheritance of the pre-computer era, capital-weighted indices are easier to calculate manually. They are linear functions of share prices, adjusted of structural and corporate events (component list modifications, splits, public offerings, buybacks). It generates less transaction costs for a mutual fund or ETF following it. Equal-weighted S&P 500 The next chart shows in red the equity curve of all S&P 500 stocks, equal-weighted rebalanced on weekly opening between January 1999 and September 2015. The blue line is SPY . In both cases, dividends are accounted and reinvested. It is impossible to implement as a strategy for an individual investor because of the capital needed to absorb transaction costs. Moreover, there is an ETF for that: the Guggenheim S&P Equal Weight ETF (NYSEARCA: RSP ). Since inception on 4/24/2003, it has an annualized excess return of 2% over SPY, making it a better instrument of passive index investing. On the same period, the theoretical annualized excess return of equal-weight S&P 500 with dividends is 3.5%. The difference can be explained by trading costs, management fees, rebalancing frequencies. Next chart: RSP in red versus SPY in blue since 4/24/2003: (click to enlarge) S&P 500 with sectors in equal weight The next chart shows the equity curve of an equal weight portfolio of the 9 Select Sector SPDR ETFs rebalanced weekly: utilities (NYSEARCA: XLU ), energy (NYSEARCA: XLE ), materials (NYSEARCA: XLB ), financials (NYSEARCA: XLF ), healthcare (NYSEARCA: XLV ), industrials (NYSEARCA: XLI ), IT & telecom (NYSEARCA: XLK ), consumer staples (NYSEARCA: XLP ), and consumer discretionary (NYSEARCA: XLY ). Here, the size effect is questionable, but the rebalancing bias applies. (click to enlarge) Individual sectors in equal weight Guggenheim has also sector equal-weight ETFs. The next table compares their annualized returns with the Select Sector SPDR series since inception date (11/1/2006), and the theoretical return of stocks rebalanced weekly in equal weight: Sector Stocks Eq. Weight weekly Eq. weight ETF Ann. return Cap. weight ETF Ann. return Cons. Disc. 9.76% (NYSEARCA: RCD ) 8.63% XLY 9.96% Industrials 9.08% (NYSEARCA: RGI ) 7.64% XLI 7.01% Cons. Staples 12.61% (NYSEARCA: RHS ) 11.72% XLP 9.92% Materials 7.63% (NYSEARCA: RTM ) 6.73% XLB 5.16% Energy 2.83% (NYSEARCA: RYE ) 1.97% XLE 3.26% Financials 2.46% (NYSEARCA: RYF ) 0.02% XLF -2.63% Healthcare 14.91% (NYSEARCA: RYH ) 14.18% XLV 10.96% Technology 8.41% (NYSEARCA: RYT ) 6.95% XLK 8.32% Utilities 7.24% (NYSEARCA: RYU ) 6.33% XLU 5.59% In theory, equal weight brings a better or similar return in all sectors, except energy. After management fees and tracking errors, the consumer discretionary and technology equal-weight ETFs are also failing. Equal weight of equal-weighted sectors As a last paragraph, here is the return since the inception of the Guggenheim ETFs in equal-weight rebalanced weekly compared with the Sector SPDR ETFs in equal weight, RSP and SPY. 1/01/2006-09/16/2015 Guggenheim series eq. weight SPDR series eq. weight RSP SPY Ann. Return 8.35% 7.16% 7.43% 6.31% The solutions with individual stocks in equal weight for each sector work better (1st and 3rd columns), which makes sense: size effect is more beneficial. For an individual investor seeking an equal-weight strategy on the broad index, RSP may be a better solution than the Guggenheim series in equal weight after transaction costs, depending on transaction fees and portfolio size. Conclusion With the exception of the energy sector, equal weight has been systematically superior to capital weight in the S&P 500 universe on the 2 last market cycles (1999-2015). In ETF implementations, fees and tracking errors result in a lag for 2 other sectors. Investors can find here useful investing instruments and ideas for passive investing and sector tactical allocation. Data and charts: Portfolio123 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: I short the S&P 500 for hedging purposes