Unpacking Global Sectors
Posted on 17. Nov, 2009 by Kyle Waller
Recently, many have reasoned that it is sectors which drive market returns. Using the complete lineup of global sector ETFs from iShares, an investor can utilize the power of sectors within the US while reaching into developed and emerging international markets for simple to complex asset allocation strategies.
By breaking down the global sector ETF products on the market, the investor can get a grasp of the best way to capture sector returns throughout the globe, in domestic, developed, and emerging markets.
Businesses throughout the globe seem to correlate most with other companies within sector groups even before country, region, size, and style. Therefore, when using a strategy involving sectors, reaching outside the US, even into emerging markets, makes sense as a way to add better risk and reward possibilities while controlling sector exposure which tends to be correlated even across regions and borders.
Global returns can be explained by sector returns. Correlations among countries can even be explained in a great deal by sectors and the differences in asset allocations between their respective market indexes.
The Global Benchmark
The 10 global sector iShares ETFs represent the sector makeup of the S&P Global 1200, which represents 70% of the world’s market cap. The sectors are broken down from this index based on the 10 GICS (Global Industry Classification Standard) sectors, which are jointly managed by S&P and MSCI Barra. Below is a chart of the iShares global sector ETFs. Each ETF represents a GICS sector from the S&P Global 1200 Index. Also included are each ETFs total net assets.
The GICS sectors are designed to place companies throughout the globe into sector categories. Currently, the S&P Global 1200 Index, which is made up of the 10 GICS sectors, is broken down below as of 9/30/2009.
Data: Morningstar Office 9/30/2009
Why Global
Since sectors have a higher correlation globally compared to different sectors domestically, investing on a global sector basis could provide significant risk reward profiles, as making sector decisions for the US is benefitted by global correlations and the higher growth possibilities abroad and the lower correlations to the overall US market. Instead of concentration on sectors domestically and adding international exposure, moving to a global sector strategy is a way to capture both domestic and international exposure. Since,sectors seem to correlate throughout the globe, from US companies to companies within emerging markets, using global sector ETFs is a way to efficiently execute an investment strategy involving sectors.
Data: Morningstar Office 10/1/2004-9/30/2009 (US sectors are the S&P 500 GICS Sectors and Global Sectors are the GICS Sectors from the S&P Global 1200 Index.)
The above scatter plot displays the similar risk and total return characteristics of the US sectors, shown as circles, and the global sectors, shown as squares of similar colors. Note that the global sectors do include a significant allocation of US holdings and the chart merely shows the movements of a sector as international developed and emerging markets are added. In general, the movement from US to global has a positive risk reward effect.
Comparing global sectors to the S&P 500 GICS Sectors shows the benefit that could be added to US sectors by adding international holdings. The differences vary throughout the different sectors; however, typically, the global sectors (squares) are above and often to the left, showing higher total return and less risk throughout the last five years. This is what using global sectors would have added even if the investment decision was based on the more familiar US sector analysis. Based on the above chart, over the past five years, adding international sector holdings to US sectors had a positive effect.
Reaching Out Internationally
The Global Sector ETFs, being market cap weighted have heavy US allocations. This provides a way for the investor to make global sector allocation decisions while leaving domestic and international, developed and emerging market, and market cap decisions to the index or marketplace since correlations among sectors runs high across borders.
This means that the risk of adding international sectors to sector strategy decisions has a low marginal affect on risk relative to the overall sector decision. This is because correlations have been proven to be high within sectors, explaining returns. Therefore, the largest risk factor is in the sector and the risks associated with it. Emerging and developed international markets will bring unique risks however the risks of the sector are among the most dominant.
The below graph breaks down the exposures of US, international developed, and emerging market holdings within the iShares ETF series. It is interesting to note that the breakdown of developed verses emerging markets shows the areas where emerging markets have the greatest effect on the global economy. For example, the iShares S&P Global Materials Sector Index Fund (NYSE Arca: MXI) has an 8.5% exposure to emerging markets, which shows the growth of the world’s demand of developing countries’ mining products, metals, and other materials.
Data: Morningstar Office 10/6/2009
Sectors Have A Place
Keep in mind that this is not necessarily a call to abandon broad diversification but a need to focus on the importance of sectors, as they relate to global return. Also, when investing with sectors, using and adding international exposure has returned benefits to almost every sector. In this way, an investor can analyze and invest among US sectors, while gaining correlated international exposure, which has higher long term risk and reward potential.
Commodity ETFs Having Problems
Posted on 27. Aug, 2009 by Kyle Waller
Recently, some commodity ETFs have been forced in stop the creation process of ETF creation units, meaning that the funds and trusts are being forced to act like closed in funds. CEFs have a very limited way to arbitrage away premiums or discounts, investors buy more of the fund when at a discount and sell when at a premium. In contrast, typical ETFs have a great incentive to keep premiums and discounts to a minimum through various methods.
“Neither the Trust nor the Investing Pool is an investment company registered under the Investment Company Act. Shares of the trust are not subject to the same regulatory requirements as mutual funds,” said iShares in a new warning on its Web site about GSG. (Quote Source: IndexUniverse.com)
“The different set of regulatory approvals needed by commodity pools includes government approval to issue more shares at certain predetermined periods.” Murray Coleman, Editor of IU.com, said in a report on the subject.
Why?
Since I’ve been studying ETFs, there have been rumors of potential problems with commodity ETFs that the regulatory agencies have been overlooking. Recently, the problem came up with the United Natural Gas Fund (NYSEArca: UNG) after quickly gaining assets this spring. The fund stopped issuing shares in mid August due to regulatory investigation into the commodity marketplace and the role of these kinds of ETFs. Basically, UNG was controlling the vast majority of all trading in the natural gas market. UNG’s management is looking for ways to reopen the ETF and minimize the use of futures-this may be through the use of SWAP agreements. This fund since closing has traded at a significant premium-16% last week.
The Main Issue
The main issue being looked at is position limits for these funds. For example the SPDR, GLD, holds more gold than many of the world’s central banks, including Canada. Possible outcomes are unknown as the CFTC (Chicago Futures Trading Commission) looks further into the matter. According to analysts, the CFTC will not overlook the use of SWAP agreements by ETFs. If size limits are enforced, funds may be forced to sell shares.
Closing Announcements
- The U.S. Natural Gas Fund (NYSEArca: UNG): Halted
- iShares S&P GSCI Commodity Index Trust (NYSEArca: GSG): to close when shares reach 55.9 million (currently 52 mil)
- The iPath Dow Jones-AIG Natural Gas (NYSEArca: GAZ): Halted
- The PowerShares DB Crude Oil Double Long ETN (NYSEArca: DXO): Halted
Leverage ETFs in the News…Again
Posted on 06. Aug, 2009 by Kyle Waller
Leveraged ETFs Under Investigation
The Massachusetts Secretary of State, William Galvin, is looking into the marketing of leveraged ETFs and reportedly has written letters to the three biggest players in this market, ProShares, Direxion, and Rydex.
In addition, FINRA, a regulatory agency for brokers and advisors has issued a warning that leveraged ETFs are usually unsuitable for investors who plan to hold them for longer than one day.
At this time, all leveraged ETFs have the objective to provide a daily short or leveraged position in an index. The key word is daily and often the returns can vary greatly from that expectation.
The firms issuing these ETFs are very clear to that point and advise that the funds are only intended to give daily exposure.
The concern is loses for the Massachusetts Secretary of State, as he wants to determine whether the issuing ETF providers are at fault, leading the unknowing brokers to these kind of products.
What I think is mostly overlooked and is that FINRA is setting up a situation for brokers to be at fault.
The Distinction
There is a major distinction between brokers and advisors which I believe may surface here. Brokers should, but aren’t required, to act in client’s best interest, as long as investments are suitable. An investment is suitable if it makes sense to be in a client’s portfolio-not whether it is the highest quality product or whether it is prudent.
Advisors on the other hand are required to act in the client’s best interest. Investments must be suitable, appropriate, and represent the client’s best interest.
Advisors Not Off the Hook
I have looked, with a lot of detail, at leveraged ETFs and the issuing companies and prospectuses are clear that the ETFs will not meet their objective longer than a day.
With FINRA and other Government agencies catching on to this and looking for someone the blame for major losses investors take in these funds, advisors and brokers who have misused these funds will be soon coming under a lot of heat.
Know Your Investments
Here at Wiser Wealth we have always understood the risks of leveraged ETFs and have been very surprised to see that many of our peers do not. In 2008, if you shorted the S&P 500, you would have actually lost money. How is this possible? The S&P 500’s up days were (in percentages) higher than the down days. Since leveraged ETFs compound daily and the up days had bigger losses than the down day gains, you got the perfect losing recipe.
There have been a few infamous ETFs to bite the dust because of poor design and complex strategies that did not work. Adopting a policy of ”if you cannot explain how the investment works to a client, then it doesn’t make the list”, might be a good idea for professionals that take everything at face value.
Clearly the regulatory authorities understand the leverage risk. Do you?
Harvard Endowment Looks to Become More Liquid
Posted on 25. Jun, 2009 by Kyle Waller
The managers of the Harvard Endowment have long been hailed as innovators. Their alternative investments include commodities like timber (famously employing lumberjacks), private equity, and hedge funds.
Recently, I’ve seen it reported that Harvard’s endowment portfolio performed well during 2008 because of alternative investments. As it turns out, the reporter meant their fiscal year 2008, which ends in June. It was a perfect time to end the year, right before all asset classes lost significant value…great reporting.
So, as a follow-up to that original article, let’s look at fiscal year 2009.
President Obama: An Index Investor
Posted on 29. May, 2009 by Kyle Waller
A blog posted on CNNMoney.com’s Money and Main Street, Click Here, discusses a vague disclosure report from the White House concerning President Obama’s household assets and investments.
Page two of the original report, which the blogger links to, lists the President’s assets, where and what they are held in, and an estimated value.
What is most interesting is that the President has somewhere between $1-5 million in US Treasury Bonds and the second largest holding of somewhere between $115-250 thousand in the Vanguard FTSE Social Index.
The Obama Portfolio
When President Obama was first elected, there were many people who advertised “Obama Portfolios.” As it turns out, the original Obama Portfolio favors US Treasury issued debt and socially responsible companies in a simple index fund package.
The interesting part is that the President of the United States, who would have the best investment advisors at his disposal, chose a low cost, diversified portfolio of US stocks.
PowerShares Set to Close 19 ETFs
Posted on 04. May, 2009 by Kyle Waller
PowerShares announced in a May 1, 2009 press release that it will be closing 19 of its ETFs, representing roughly 1% of Invesco PowerShares assets and will mainly include smaller funds representing slices of the market.
In light of recent market turmoil, many ETF industry commentators are saying the ETF market place is too crowded and grew faster than it was able to attract assets.
Bruce Bond, president and CEO of Invesco PowerShares, said this about the closings in the press release, “After carefully evaluating numerous factors including shareholder considerations, length of time on the market, asset levels, and the potential for future growth, we proposed closing certain portfolios that have not gained sufficient acceptance with investors.”
PowerShares closes some of the category of funds it is best known for, the FTSE RAFI Index tracking ETFs and 4 ETFs tracking Dynamic Intellidex Indexes.
12 of the closing ETFs are ETFs following the RAFI Indexes created by Robert Arnott, RAFI standing for Research Affiliates Fundamental Index, which weight index components by five fundamental factors. Fundamental indexing proponents propose that market capitalization weighted indexes tend to overload themselves with overvalued stocks, the opposite of what an investor would want to do. These weigh an index based on fundamental factors and not by market cap which is a function of price. The 12 ETFs are all sector funds and the PowerShares FTSE RAFI Asia Pacific ex-Japan Small-Mid Portfolio.
The other seven ETFs closing represent either small slices of the market or niche concepts like the PowerShares High Growth Rate Dividend Achievers Portfolio, PHJ, which seeks to track an index that includes 100 companies with the highest dividend growths rates who have increased their annual dividends for the last ten consecutive years.
The closing Process
ETFs have closed in the past and since ETF assets are held outside of the company’s balance sheet, in trust, ETF assets are returned to an ETF investor upon the issuing company closing for bankruptcy or the ETF closing.
As PowerShares has announced, it will begin the process of closing the funds in the first part of May. During this time, the funds will no longer be required to meet their investor objective of tracking the index but will be seeking to get best price and execution of the underlying securities. This will cause tracking error to increase.
As of May 19, 2009, the 19 closing ETFs will no longer allow new investors in the funds. Investors who hold the ETFs at the close of trading on May 18, 2009 will receive the NAV of the ETFs as of May 22, 2009 as a cash deposit in their brokerage accounts.
Up to the closing of the funds to new investors, on May 19, creation and redemption of the funds can still take place to ensure that the ETFs represent the basket of underlying securities, which will keep this period of ETF closing orderly. Investors will be able to trade the ETFs up to the closing of new investments and should seek receive prices close to NAV, which may include the using limit orders.
Hedge Fund ETFs: They’re Here
Posted on 21. Apr, 2009 by Kyle Waller
Click Here to view PDF With Charts inserted.
IndexIQ recently launched its first hedge fund ETF, Wednesday, March 25, 2009. This is following in the wake of 2008 where many hedge funds were affected by mass withdrawals and highly leveraged bets went bad, causing many to shut down. IndexIQ, through its new ETF, gives a way for investors to access a low cost, no commitment, and highly liquid hedge fund replication vehicle. The introduction of this hedge fund ETF allows access to the category at any net worth size, opening doors for clients’ portfolios, where before they were limited.
Unlike what it may seem, the IQ Hedge Multi-Strategy Tracker ETF, QAI, does not invest directly in hedge funds, nor does it follow an index of hedge funds. Instead, IndexIQ replicates the return, risk, and low correlation characteristics of hedge funds using ETFs as the underlying investment. In this way, using ETFs within an ETF, allows investments to stay as liquid and transparent as possible as IndexIQ implements its proprietary methodology in creating hedge fund replication.
Gold Revisited
Posted on 14. Apr, 2009 by Kyle Waller
In recent years, gold has seen spectacular price increases. Looking at some history may reveal where gold is heading in the future and why.
In Barron’s March 9, 2009 issue, Andrew Bary, reported in the issue’s cover story that over a six month time span, gold had risen $140 to its current price at the time of $942 an ounce.
The point of the article was to show stocks relative value. The relationship between gold and stocks indicated that stocks may be undervalued, as seen in the following quote.
“The S&P 500 index is worth about 75% of an ounce of gold, verses a peak of more than five times the value of gold in 2000 when the S&P peaked at more than 1,500 and gold languished around $300 an ounce. Over the past 40 years, the S&P has averaged 1.6 times the value of an ounce of gold.”
Gold and other precious metals are an interesting investment and have gained a lot of press recently through radio and TV advertising. During this current credit crisis, gold has been seen as a “safe” investment that never loses its value like stocks and bonds because it is gold, the asset that was once used to peg many currencies, including that of the US during the time of the gold standard.
Even as a perceived safe investment, the increase in its price shows that investors view that gold is perceived as a quality and safe investment relative to other asset classes. The question is whether gold deserves a long term place in an investor’s portfolio and in what proportion. In the same way, the question is not whether gold is rare or was useful to pegging currencies, but how an investor should view gold as an investment in the short and long term.
There are some that view physically holding gold as insurance for “end of the world” type situations. Other than those investors, gold inventories held by small, individual investors are very impractical. The cost or risks of this kind of investing through physically holding gold must be fully realized. The cost of insurance, security, storage, transporting, inspecting, and insuring true quality may make this kind of investment completely impractical. A better, more efficient way to purchase gold is through ETFs and ETNs, which track the price movement of gold by following a gold index. These ETFs track indexes, a range of investment options from physical gold to rolling gold futures. Precious metal ETFs like GLD, actually hold physical gold in trust in secure bank vaults. There are unique tax implications when investing in these ETFs that should be understood before investing.
Forbes Best & Worst ETFs List
Posted on 31. Mar, 2009 by Kyle Waller
Something I’ve been big on lately is ETF tracking error. An ETF’s ability to track an index can be a bigger cost (implicit cost) to an ETF, and investors should be very concerned with this. This ability of an ETF to track its index is the tracking error, measured by standard deviation from the index. It measures how well the ETF’s managers design and create the Net Asset Value (NAV) of the ETF to replicate the indexes performance, Market prices can also be used to measure tracking error and are more appropriate in some cases. This is the objective and goal of any ETF. Of course, no one cares when the ETF has a positive tracking error, returning better performance than the index, but where an ETF has a large positive variance from the index, there is also potential for negative variances. Investors need to be aware of this.
Forbes has picked up on this and has made a slideshow of the worst and best index-tracking ETFs. The article “ETFs Behaving Badly” links to the slideshow.
Most notably, there were many emerging market ETFs in the list from all the major ETF providers; SSgA, iShares, and PowerShares. Preferred Stock and individual real estate sectors seem to be broadly included in the worst list. Also, the TDAX Independence Lifecycle Funds were included in the list with large tracking errors, however, these ETFs cover some different indexes designed by Zacks.
Barclays Selling iShares
Posted on 17. Mar, 2009 by Kyle Waller
Barclays Global Capital announced Monday that the rumors were true and they plan to sell iShares. There has been no confirmation as to who is interested in the ETF issuer but Barclays said it has
held discussions with a number of potentially interested parties as part of its practice of regularly reviewing the group’s portfolio of business.
The potential sale of its ETF subsidiary is in light of Barclays announcement to participate in the British government’s asset protection program. Potential buyers of iShares could be from any number of financial companies wanting to get at 46% of all of the ETF assets.
For iShares ETF Investors
For investors holding iShares ETFs, there is zero threat of assets being lost from any corporate action. ETF assets are held in trust, separate from the issuing companies balance sheet. In the case of the company closing the funds, the assets of the ETF will be liquidated and delivered back to the investor.
