Scalper1 News
Summary ECON is heavily focused on consumer goods and services across the emerging markets. The holdings are unfortunately heavily concentrated into single companies. The companies come from a very diverse group of countries that offer investors exposure that they would struggle to replicate. The high expense ratio creates a problem from long term returns but investors could use the fund with tolerance bands to ensure buying low and selling high. One of the funds I’m examining is the EGShares Emerging Markets Consumer ETF (NYSEARCA: ECON ). 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. Expense Ratio The expense ratio is a massive .83%. That is just incredibly heavy, but we should keep looking through the fund to see what is unique about the ETF. Industry (click to enlarge) The sector exposure is fairly simple. I’d rather see a further break down within the Consumer Goods and Consumer Services to establish “Staples” relative to “Discretionary” firms. I would be more interested in using an international ETF that focused on consumer staples than consumer discretionary companies. Largest Holdings (click to enlarge) The largest holding is over 10% of the portfolio and the rest of the top 10 are all greater than 3.5%. Investors may start to wonder where the expense ratio is going because it shouldn’t be going to trading expenses when the portfolio is so complicated. Geography (click to enlarge) This is easily the best part of the portfolio in my opinion. With the exception of China you aren’t likely to find many ETFs that are going to overweight the rest of these countries. The nice thing about this selection is that it creates excellent diversification. The one drawback to using diversification this way is that correlations increase dramatically during periods of crisis so the actual benefits to the portfolio value during a major correction won’t be as substantial as it should be. The other concern here is that I don’t like seeing China as a major weighting here. I’ve been a bear on China since summer. Their market moved up dramatically earlier in the year and has been correcting fairly hard. I’d rather avoid that source of risk in the current environment, but a few months can dramatically move prices and result in a very different assessment. Aside from my concerns about the Chinese economy, I would give this ETF a very solid 10 of 10 on incorporating countries that are often very low weights in an investor portfolio. Keep in mind that these emerging markets should be a fairly small weight in the investor portfolio, so a heavy allocation to ECON would be extremely dangerous. This kind of geographic diversification should be limited to no more than 5% to 10% of the portfolio, but I would want investors to be very aware of the risks before they went towards that 10% allocation. Building the Portfolio The sample portfolio I ran for this assessment is one that came out feeling a bit awkward. I’ve had some requests to include biotechnology ETFs and I decided it would be wise to also include a the related field of health care for a comparison. Since I wanted to create quite a bit of diversification, I put in 9 ETFs plus the S&P 500. The resulting portfolio is one that I think turned out to be too risky for most investors and certainly too risky for older investors. Despite that weakness, I opted to go with highlighting these ETFs in this manner because I think it is useful to show investors what it looks like when the allocations result in a suboptimal allocation. The weightings for each ETF in the portfolio are a simple 10% which results in 20% of the portfolio going to the combined Health Care and Biotechnology sectors. Outside of that we have one spot each for REITs, high yield bonds, TIPS, emerging market consumer staples, domestic consumer staples, foreign large capitalization firms, and long term bonds. The first thing I want to point out about these allocations are that for any older investor, running only 30% in bonds with 10% of that being high yield bonds is putting yourself in a fairly dangerous position. I will be highlighting the individual ETFs, but I would not endorse this portfolio as a whole. 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 10.00% 2.11% Health Care Select Sect SPDR ETF XLV 10.00% 1.40% SPDR Biotech ETF XBI 10.00% 1.54% iShares U.S. Real Estate ETF IYR 10.00% 3.83% PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB 10.00% 4.51% FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT 10.00% 0.16% EGShares Emerging Markets Consumer ETF ECON 10.00% 1.34% Fidelity MSCI Consumer Staples Index ETF FSTA 10.00% 2.99% iShares MSCI EAFE ETF EFA 10.00% 2.89% Vanguard Long-Term Bond ETF BLV 10.00% 4.02% Portfolio 100.00% 2.48% The next chart shows the annualized volatility and beta of the portfolio since October of 2013. (click to enlarge) Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. You can see immediately since this is a simple “equal weight” portfolio that XBI is by far the most risky ETF from the perspective of what it does to the portfolio’s volatility. You can also see that BLV has a negative total risk impact on the portfolio. When you see negative risk contributions in this kind of assessment it generally means that there will be significantly negative correlations with other asset classes in the portfolio. The position in TDTT is also unique for having a risk contribution of almost nothing. Unfortunately, it also provides a weak yield and weak return with little opportunity for that to change unless yields on TIPS improve substantially. If that happened, it would create a significant loss before the position would start generating meaningful levels of income. A quick rundown of the portfolio 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 Health Care Select Sect SPDR ETF XLV Hedge Risk of Higher Costs SPDR Biotech ETF XBI Increase Expected Return iShares U.S. Real Estate ETF IYR Diversify Domestic Risk PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB Strong Yields on Bond Investments FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT Very Low Volatility EGShares Emerging Markets Consumer ETF ECON Enhance Foreign Exposure Fidelity MSCI Consumer Staples Index ETF FSTA Reduce Portfolio Risk iShares MSCI EAFE ETF EFA Enhance Foreign Exposure Vanguard Long-Term Bond ETF BLV Negative Correlation, Strong Yield 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 ECON has some very interesting geographical concentrations. While the regression shows a fairly high correlation with the S&P 500, the ETF has had a very weak return over the last 5 years which is precisely the opposite of what I would say about the S&P 500. When comparing the correlation between returns, occasionally unrelated assets can appear to have a substantially higher level of correlation due to the daily measurements of returns or due to negative shocks creating a bias in the data. The correlation with EFA is fairly strong though. Investors using ECON would be wise to take advantage of temporary deviations by preparing a plan to rebalance in advance. Ideally that plan would focus on tolerance ranges rather than the frequency of rebalancing. In short, if they assigned a 5% allocation to ECON, they might rebalance the position whenever it exceeded 6% of the portfolio or fell below 4% of the portfolio. While I like the geographic diversification in this portfolio, it is not enough to justify paying a substantially higher expense ratio. Over the longer term, I think the best chance for this ETF to provide solid returns is for shareholders to plan to use the rebalancing strategy to ensure that they are buying in low and selling high. If an investor is willing to rebalance that way and accept modern portfolio theory, it would be ironic if they still felt that a very high expense ratio fund was going to offer superior returns over the long haul. Scalper1 News
Scalper1 News