2014

February 4, 2015

The SmallTrades Portfolio holds investments in five financial markets.  Tax expenses are reduced by trading the Portfolio’s underlying holdings in a tax protected brokerage account.  For tax reasons, any stock or exchange-traded index fund (ETF) issued by a partnership is excluded from investment.

The Portfolio has two subgroups:

  1. Established ETFs that are traded infrequently in the markets for global stocks, global gold, U.S. real estate, and U.S. bonds.
  2. Common stocks that are traded frequently in the U.S. market.

Both subgroups contain high risk investments which are expected to outperform a benchmark index called the Standard and Poors 500 Total Return Index.

The investment performances of the Portfolio and its benchmark index are measured graphically by plotting changes in the market value of an invested dollar (chart).

performance2014

For every dollar invested on the inception date of 12/31/2007, the market values of the Portfolio and benchmark index dropped by nearly half during the Recession year of 2008.  Recovery from the Recession left the performance of the Portfolio lagging behind the benchmark due to the underperformance of a large subgroup of stocks.  Starting in 2013, the Portfolio’s investment capital was gradually shifted from stocks to ETFs and the result was a gradual rise in market value.   Starting in 2014, the ETF for emerging-market stocks (VWO) was replaced by one for global stocks (VT).  At the end of 2014, the market values of the holdings were distributed into a 79.4% portion from ETFs and 19.7% portion from stocks (table).

 portfolio2014

The Portfolio’s performance is measured statistically by its compound annual growth rate (“CAGR”) of market value since inception.  The performance improved during 2014 (CAGR -3.3%) compared to 2013 (CAGR -5%), but still lagged the benchmark index (CAGR 7.3%) and U.S. inflation of prices (CAGR 1.8%) by considerable margins.

Calendar year 2014 was the inaugural year for graphing the performance of the ETFs and Stock subgroups.  The following chart shows that stocks outperformed ETFs during the first year of assessing subgroups.

subgroups2014

ETFs subgroup

The ETFs subgroup is designed to match the performance of financial market indices for global stocks, U.S. investment-grade bonds, U.S. real estate, and global gold bullion when equal amounts of cash are invested in each market.  The market indices for global stocks and U.S. real estate are expected to outperform the U.S. bond index.  The gold index is expected to fluctuate according to changes in investor sentiment for stocks, bonds, currencies, and commodities.  The gold index typically moves moves up when investors seek the gold market and down when investors seek other markets.

The main risk of losing money from established ETFs is derived from a large decline in market prices.   Consequently, the risk management strategy is to rebalance every asset class to 25% of total market value when any asset class drifts below 18% or above 32% of the total market value.  Drifts did not trigger a rebalance of asset classes during 2014 (chart).

ETFassets2014

Stocks subgroup

The investment strategy is to buy stocks at a discount price and sell them at a premium price.  Discount prices are selected from undervalued companies in several ways:

  • Use of a stock screen
  • IPO’s of potentially successful companies after the first day of public trading
  • Media disclosure of good companies
  • Previously owned stocks

Premium prices are discovered by setting alerts for rising prices and placing conditional sell orders in the broker’s trading platform.

The typical holding is selected by a stock screen, held less than one year, and sold with a conditional sell order.  Small-cap stocks characteristically offer better growth potential and higher returns – but at a higher risk – compared to large-cap stocks.  Consistent with the Portfolio’s high-risk investment goal, the total market value of the Stocks subgroup is divided into portions of 22% for large-cap stocks and 88% for lower capitalizations (chart).

MktCaps2014

Conclusions

The SmallTrades Portfolio is an unleveraged, diversified collection of high-risk securities that are traded in the U.S. stock market.  The Portfolio continues its gradual improvement in performance following the 2008 Recession, but its performance still lags that of the benchmark index.  Acceleration of the Portfolio’s performance will depend on the future resurgence of stocks in the emerging markets coupled with high performance of the U.S. real estate market.  Rebalancing the Portfolio’s holdings is expected to partially offset the potential loss from a future declining market.

Copyright © 2015 Douglas R. Knight


Be Frugal

August 3, 2014

Every individual must pay fees to invest in securities. The inescapable fees are:

  1. Brokerage fees
  2. Taxes

Additional fees can erode investment returns. They are:

  1. Middle managers’ fees (e.g., fund managers, investment advisers)
  2. Subscriptions (e.g., journals, non-profit investment groups, tool kits, data bases)

Tips for minimizing costs:

  1. Discount brokerage firms charge lower trading fees than full service firms.  The discount firm should provide tax information such as cost basis and annual tax reports.
  2. Reduce taxes by opening tax-deferred retirement savings accounts
  3. Passively managed funds typically charge lower fees than actively managed funds
  4. Avoid investment advisors by doing your own research. Start at the library and use search engines.
  5. Choose your subscriptions wisely. Use a free-trial first. Seek ratings and recommendations.

Investment strategy of the SmallTrades ETF Portfolio

February 14, 2014

An index ETF is designed to capture the investment returns from a financial market.  The SmallTrades ETF Portfolio (“Portfolio”) uses index ETFs to invest in several financial markets.  The goal of the Portfolio is to earn returns at a faster rate than possible by investing in risk-free bonds or the broad market of U.S. stocks, thereby ensuring that the accumulation of returns outpaces the inflation of prices in the American economy.  Success is measured by the following benchmark indices:

Investment strategy

The Portfolio is a high-risk, high-return investment in ETFs that duplicate well-established market indices for global stocks, U.S. bonds, U.S. real estate investment trusts, and gold bullion.  Twenty five percent of the portfolio’s market value is allocated to each index.  The ETFs generate at least 99% of the portfolio’s value and any remaining value is stored in a money market fund.  The ETFs will be held indefinitely except when faced with the advantage of replacing one with a more suitable ETF for the same index.

Table of holdings

ETF trading symbol Market Allocation
 AGG   U.S. bonds 25%
 GLD   Gold bullion 12.5%
 SGOL     Gold bullion 12.5%
 VNQ     U.S. real estate investment trusts 25%
 VT  Global stocks 25%

Expected return

Unfortunately there is no 50-100 year history of ETF performance that enables the forecast of an expected return.  To compensate for this limitation, two models were used to test the allocation plan shown in the table of holdings.  In one model of the 15-year recovery from the 1997 Asian Financial Crisis, the allocation plan outperformed the U.S. stock market.  In the other model of the 5-year recovery from the 2008 Global Financial Crisis, the allocation plan underperformed the U.S. stock market.  Among both time periods, the lowest return of the model portfolio was 8.5%.

  • MARKETS portfolio of financial-market returns from 1997 to 2011: The global-stocks market was simulated by a mixture of 75% U.S. large capitalization stocks and 25% emerging markets stocks.  Trading and management fees were excluded from the model.  The annualized return of the portfolio was 8.5% in comparison to the 5.7% annualized return of U.S. large capitalization stocks.
  • ETF portfolio of historical prices from 2008-2013: Trading fees, but not management fees, were included in the calculations (– management fees are charged in the primary market before ETFs are listed in the stock market).  The annualized return of the portfolio was 10.9% in comparison to the 17.8% annualized return of SPY, an ETF that tracks the Standard & Poor’s 500 Total Return.

Risk management

The holding period will be at least 5 years.  Fluctuation in market prices is the main risk of investing in index ETFs.  The likelihood of incurring a loss from a declining market decreases as the length of the holding period increases (– e.g., the risk of loss from stocks and bonds declines by 50% as the length of the holding period increases from 1 to 5 years; and, the risk declines by 80% when the holding period is extended to 10 years (1)).

The Portfolio will be rebalanced as needed to maintain the allocation plan within an acceptable limit of 28% error.  The Portfolio is concentrated in 4 markets and losses may occur when one or several markets decline.  The 25% allocation plan assigns equal weightings to each financial market in order to smooth the effect of market declines.  After accounting for trading fees, the strategy of rebalancing a large allocation error is more cost-effective than using a rebalancing schedule.

The Portfolio holdings are investable, have established reputations, charge low management fees, and are safely structured.  Although there’s no guarantee that the index ETFs will sustain their historical performance, the stock market, bond market, and real estate market ETFs provide diversified investments in underlying assets.  The risk of investing in these ETFs is lower than the risk of investing in an underlying asset.  Gold bullion ETFs are non-diversified investments in the volatile gold market.  Gold bullion is theoretically susceptible to physical damage by theft or fire.  This risk is diminished by investing in two funds, GLD and SGOL, that store the bullion in separate vaults located in London and Lucerne.

The investor’s tax burden can be reduced by holding these index ETFs in a tax-deferred retirement account.

Copyright © 2013 Douglas R. Knight

References

1.           James B. Cloonan, A lifetime strategy for investing.  American Association of Individual Investors, Chicago, 201


#ETF Scorecard, Vanguard Total World Stock ETF (VT: nyse)

January 31, 2014

The Vanguard Total World Stock ETF (VT) is an index fund that holds stocks and REITs issued by companies in the emerging and developed markets. Stocks from the frontier markets are excluded by the Fund. The following chart shows that VT is an established fund which efficiently manages its stock portfolio with the good prospect of sustaining its operations:

VTprofile

The following scorecard rates VT as a wealthy, tax efficient fund with several risks: 1) market volatility. 2) potential management error. 3) fluctuating exchange rates for foreign currency.

VTscorecard

Index

The FTSE All-World Index is derived from the FTSE Global Equity Index Series (GEIS), which covers 98% of the world’s investable market capitalizations. The FTSE All-World Index is a market-capitalization weighted index of the large- and mid-cap stocks listed in developed and emerging markets; frontier markets are excluded. The stocks are selected and weighted to ensure that the GEIS is an ‘investable’ index.

Fund operations

VT operated a $3 billion, diversified portfolio of 800 stocks in the year 2013. Most of the stocks had large capitalizations (77% large cap, 13% mid cap, 10% small cap) and most were issued in developed markets. The regional distribution of stock issuers was greatest in North America & Europe (78%) followed by Asia (19%), Latin America (2%), and Africa (1%).

According to the ETF.com website (1), VT’s major competitors in 2013 were ACWI, ACIM, ACWV, HECO, and ONEF. Among these, VT offered the lowest annual expense ratio, 0.19%. VT, ACWI, and ACIM operated in very similar ways to match the performance of their market indices; their returns were tax-efficient. In comparison, ACWV, HECO, and ONEF sought to outperform the global equities market.

The following chart was found in the ETF.com website (1). Visual inspection of the chart gives an impression that the net asset value (NAV) of VT’s portfolio closely tracked the performance of its index (the underlying FTSE index) and the market segment’s index (MSCI All World Investable Markets + Frontier).

VTtracking

According to the ETF.com website (1), VT’s operations were less transparent than the competitors’ due to Vanguard’s practice of reporting holdings on a monthly rather than daily basis. Similar to other competitors, VT lent its portfolio holdings to help offset the Fund’s expenses. Institutional investors incurred a higher cost for buying creation units from VT than from other Funds.

Recommendation

VT is a good long-term investment.

References
#01. http://www.etf.com/, © ETF.com 2014


Design of the investable ETF portfolio

August 28, 2013

[revised on September 3, 2013 and February 3, 2014.  The latest revision is an updated ETFportfolioDESIGNER2 that includes Vanguard’s Total World Stock ETF (VT).  It was necessary to reset the DESIGNER’s time period to 2009 through 2013.  Appropriate changes were made in the following discussion.]

Summary

I ‘like’ a portfolio of exchange traded funds (ETFs) that are listed in the New York Stock Exchange by trading symbols AGG, GLD, VNQ, and VWO [VT is an alternative to VWO]. Equal portions of capital are allocated to each fund. The best way to manage the portfolio is by rebalancing the ETFs. Ordinary investors can be cautiously optimistic about this high risk portfolio after reviewing the following information:

Model

Among previously tested portfolios, a 4-sector model held hypothetical investments in market indices for emerging markets stocks, U.S. bonds, U.S. REITs, and global precious metals.  The model was not an investable portfolio.

Conversion

The 4-sector model was converted to an investable portfolio by substituting index ETFs for the market indices and assigning equal weightings (ref 1) to the ETFs. The big advantage of choosing index ETFs is their ease of trading in the stock market (ref 2).  The objective of the investable portfolio, hereafter called the SmallTradesETFportfolio, is to outperform the U.S. stock market in the long term.

The conversion began by screening funds according to geography and asset class (ref 3).  Selected ETFs were compared to their financial markets, appraised for risk, and tested for optimal portfolio mechanics.

Comparisons.  Chart 1 shows the time course of total returns from ETFs and financial markets. The total returns are charted as monthly percentages of change in market value based on price changes and cash distributions (see endnote) .

ETFpf1

Chart 1. Time course of total returns: All panels show the time course of monthly total returns from a market sector (black dashed line), older ETF (solid blue line), and newer ETF (solid orange line). ETFs are identified by 3-letter trading symbols. Total returns were set to 0% at inception of the newer ETF.

In chart 1, any spread between an ETF and its market sector illustrates the difference in investment performance. Smaller spreads, and therefore closer matches to sector performance, occurred among ETFs aligned to the precious metals and emerging markets stock sectors. Wider spreads appeared when AGG outperformed the U.S. Bond sector by 3-15 percentage points during the 2008 Credit crisis; also when VNQ and REZ consistently underperformed the Equity REIT sector by an average 8 percentage points.

Correlations. Chart 2 shows the correlation of returns between an ETF and its market index.

ETFpf2

Chart 2, Correlation of total returns: ETFs are identified by 3-letter trading symbols. All panels compare the monthly returns of ETFs to their corresponding market sector. Monthly returns were calculated as a percentage change in market value that includes the accumulation of cash distributions from underlying holdings. The identity line shows hypothetically equal returns. “r” values are correlation coefficients for the relationship between ETF and sector returns. “r” values were not calculated for newest funds, CORP and GLTR, due to the scarcity of monthly returns.

In chart 2, the correlation coefficient (“r”) signifies the degree of alignment between concurrent monthly returns. If r were 1.0, the data would lie on an identity line where fund returns match the market returns. All r values in chart 2 were exceptionally high, which supports the visual impression from chart 1 that ETFs traced the time course of their market sectors. All of chart 2’s data except those for AGG were closely aligned to an identity line. About 12 of AGG’s monthly returns outperformed the U.S. Bond market during the 2008 Credit crisis and appear as outliers to their line of identity. The few outliers exerted no practical effect on AGG’s correlation coefficient.

ETF appraisals. The SmallTradesETFportfolio contains healthy, wealthy ETFs with proven ease of trading. Every ETF is eligible for holding in a tax-deferred brokerage account and otherwise offers a low tax burden when held in a taxable account (exception: returns from the precious metal held by GLD are taxed at the higher rate for ordinary income rather than lower rate for long-term capital gains). Here are the investment strategies and risks of the funds, with a link to their scorecards (ref 4):

  • AGG (iShares Core Total U.S. Bond Market ETF) invests 95% of its capital in a basket of U.S. investment grade bonds that reflect the Barclays Capital U.S. Aggregate Bond Index. AGG receives fixed income and capital gains from the bonds. The fixed income is derived from payments of interest and returns of principal. Investment grade bonds are less likely to default on payments of fixed income than non-investment grade (‘junk’) bonds. Investment grade bonds generally pay lower interest than junk bonds and are low-risk investments (ref 5).
  • VWO (Vanguard FTSE Emerging Markets ETF) invests 95% of its capital in a representative sample of stocks listed in the FTSE Emerging Markets Index. Emerging markets stocks are more volatile and less liquid than U.S. stocks. Stocks are generally high-risk investments that reward investors with payments of dividends and capital gains. VWO invests in emerging market stocks which have characteristically higher risk and higher returns than developed market stocks (ref 5).
  • VT (Vanguard Total World Stock ETF) invests in stocks issued in the emerging and developed markets.  VT is an alternative to VWO.
  • VNQ (Vanguard REIT ETF) invests in real estate properties by purchasing shares of real estate investment trusts (REITs). Equity REITs are companies who invest pooled money into the ownership of real estate and distribute at least 90% of their taxable income to shareholders. Equity REITs are considered low-risk, high-return investments (ref 5). Because VNQ concentrates on real estate, its primary risk is a decline in the real estate market.
  • GLD (SPDR Gold Trust) is a physical commodity fund that invests all capital in gold bullion. Gold only provides income when sold in the market for a profit. Investors typically buy gold bullion as an insurance policy against the devaluation of currency (ref 5). GLD shareholders risk losses from declining prices and damage or theft of the bullion.

Portfolio mechanics

Market forces continually change the value of a portfolio either to the benefit or detriment of the investor. The investor’s choices are to make no adjustments (“buy-and-hold”), sell rising assets to buy declining assets (“rebalance”), sell declining assets to buy rising assets (“reallocation”), or revise the investment strategy (ref 6).

The choices to buy-and-hold or rebalance the SmallTradesETFportfolio were examined by using a computer-assisted program to test a set of 5-year historical returns from the ETFs [the computer-assisted program is outdated and therefore replaced by ETFportfolioDESIGNER2.  The discussions of Tables 1 and 2 are outdated, but they remain instructive]. The buy-and-hold strategy was to purchase each ETF with 25% of the total invested money and automatically reinvest the cash distributions. The rebalance strategy was divided into 2 plans for correcting the buy-and-hold portfolio.  The scheduled plan made regular corrections during the life of the portfolio. The signaled plan made irregular corrections depending on when the holdings drifted from the allocation plan by an assigned error signal (ref 7).

The data in table 1 show that all choices outperformed the benchmark investment in U.S. stocks.  Both rebalancing plans enhanced the portfolio CAGR of the buy-and-hold strategy, namely by 1.3 percentage points when rebalanced yearly and by 2 percentage points when rebalancing a 32% allocation error.

ETFpf3

COLUMN HEADINGS: The investment strategies for the ETF Portfolio are “Buy-and-hold”, “Rebalance #1”, and “Rebalance #2”. The “Benchmark” portfolio is an index of the U.S. Stock Market.
ROW HEADINGS: “Rebalancing plan” shows the best schedule for “Rebalance #1” and best error signal for “Rebalance #2”. “Rebalance episodes” are the total number of rebalances. “Final market value” is computed from the weighted market returns. “Portfolio CAGR” is the compound annual growth rate; higher CAGRs reflect higher returns. “Sharpe ratio” is an adjusted annual rate of return; higher ratios reflect higher returns.
ASSUMPTIONS: Every portfolio is funded with $10,000 and 25% of the $10,000 is allocated to each holding. There are no fees for financial services, all cash distributions are automatically reinvested, and the portfolio holdings are never withdrawn.

Efficient investment. The total returns in table 1 were earned under the best of circumstances because there was no payment of fees for financial services and plenty of money was used for making the initial investment. Without fees, all levels of initial investment are equally efficient in yielding a return. But additional fees create a penalty margin that reduces returns by as much as 25 percentage points with $1,000 investments and 2 percentage points with $10,000 investments (ref 8).

So, how might trading fees and initial investment affect the SmallTradesETFportfolio? Table 2 demonstrates the efficiency of earning returns based on the initial investment and a $10 trading fee.

ETFpf4

The data are total returns as measured by CAGR; higher CAGRs reflect higher returns. All trading fees are $10/trade.
ROW HEADINGS: “Initial investment” is the total amount of money spent on creating the portfolio, including trading fees. “Buy-and-hold” means that no trading occurred during the 5-year holding period, 2008-2012. “Rebalance #1” is a plan to rebalance the holdings on an annual basis. “Rebalance #2” is a plan to rebalance the portfolio when a holding drifts from the allocation plan by a 32% difference.

In table 2, the maximal returns of the buy-and-hold and rebalanced portfolios were achieved when the initial investment reached $15,000. There was no advantage to rebalancing the portfolio with only $2,000 of invested capital.

Financial services fees. ETF managers charge an annual expense ratio to specialists in the primary market, not to ordinary investors in the secondary market.  The expense ratio reduces the net asset value of ETF shares in the primary market and the net asset value determines ETF share prices in the stock market (ref 2). Ordinary investors may pay an advisor’s fee when they are clients of a financial institution (do-it-yourself investors take pride in avoiding this fee). The typical advisory fee, about 1% of the annual portfolio value, reduces the total return of the portfolio by an amount that can be estimated in the computer-assisted program.

Recommendation

The SmallTradesETF Portfolio is designed for risk-tolerant investors who seek to outperform the U.S. Stock Market over a time period of many years. Each ETF tracks a unique sector of the financial markets with proven transparency, durability, and liquidity of fund operations. In terms of risk management, rebalancing the holdings helps protect from losses incurred during market declines. An initial investment of $4,000 is needed to gain the advantage of rebalancing the portfolio. Better results are obtained by investing at least $10,000.   I prefer using a 30% 28% rebalancing signal (rather than a schedule) to rebalance the SmallTradesETFportfolio. The signaled rebalancing method is easy to obtain and use by clicking on this link, Rebalancing an Investment Portfolio.

Cautious optimism

Similar portfolios are advocated in newspapers (ref 9) and books (refs 10-12). The unique features of the SmallTradesETF portfolio are its simple allocation plan and tested rebalancing strategy. A major disadvantage is the uncertainty about future market returns. Fifteen years of historical data for a model portfolio and 5 years of historical data for an ETF portfolio are unreliably predictive of future returns (ref 10). Consider that ¼th of the Portfolio is invested in emerging markets stocks and that today’s emerging markets are in decline after attaining a historical peak (refs 13,14). How long will these markets decline? The optimist could argue that over 75% of the world’s population lives in the emerging economies where there’s tremendous capacity for growth. Today’s emerging economies have nearly half of the world’s GDP and their share of the global GDP seems to be growing despite blips in the trajectory  (ref 14).

Endnote:  Cash distributions are made by fund managers to fund shareholders. The typical sources of cash distributions are dividends and capital gains earned from the fund’s underlying assets.

Copyright © 2014 Douglas R. Knight

References

1. Beginners’ Guide to Asset Allocation, Diversification, and Rebalancing, U.S. Securities and Exchange Commission, SEC.gov/investor/pubs/assetallocation, Modified: 08/28/2009.
2. ETF structure, Small Trades Journal, a blog at WordPress.com.
3. XTF, ETF experts. XTF.com/Research/.
4. #ETF-scorecard, Small Trades Journal, a blog at WordPress.com.
5. Asset classes, Small Trades Journal, a blog at WordPress.com.
6. Jason Van Bergen, 6 Asset Allocation Strategies That Work. ©2013, Investopedia US, A Division of ValueClick, Inc., October 16, 2009.
7. #SmallTradesPortfolioREBALANCER, Small Trades Journal, a blog at WordPress.com.
8. Beware of trading fees, Small Trades Journal, a blog at WordPress.com.
9. Anna Prior. A Portfolio That’s as 2-sector as One, Two, Three. The Wall Street Journal, July 7, 2013.
10. William Bernstein. The Four Pillars of Investing: Lessons for Building a Winning Portfolio, McGraw-Hill, 2002.
11. Mebane T. Faber and Eric W. Richardson. Top of the Class: A review of The Ivy Portfolio. 4/6/2009, Advisor Perspectives, DShort.com.
12. John C. Bogle, The Little Book of Common Sense Investing. John Wiley & Sons, Inc. Hoboken, 2007.
13. Emerging economies: When giants slow down. Jul 27th 2013. The Economist.
14. Emerging vs developed economies: Power shift. Aug 4th 2011, 17:34 by The Economist online.


#ETFscorecard_SPY, SPDR S&P 500 ETF

July 12, 2013

SPY was the first exchange-traded index fund sold in the U.S. Stock Market.   Today’s investment goal remains the same from inception: to earn returns, before expenses, that correspond to the price and yield performance of the S&P 500 Total Return Index.  The S&P 500 index measures the intraday value of the 500 largest stocks listed in U.S. stock exchanges.  SPY’s annual expense ratio is 0.09% and the Fund is considered to be tax-efficient.   It is structured as a unit investment trust (UIT) to protect the Fund from management error.  The following profile and scorecard support a long-term investment in SPY.

Profile

SPY1

Scorecard

SPY2

Copyright © 2013 Douglas R. Knight


#ETFscorecard_VWO, Vanguard FTSE Emerging Markets ETF

June 28, 2013

VWO is an index fund that invests in stocks issued by companies in the emerging markets.  The following profile shows that VWO is an established fund that operates at a low rate of turnover.

 VWOprofile

The VWO scorecard (below) reveals a wealthy, experienced index fund that offers tax-efficient returns.  The risks to underperformance are 1) market uncertainty and volatility, 2) erroneous judgment in management of the portfolio holdings, and 3) unfavorable exchange rates for foreign currency.

 VWOscorecard

Fund operations

The Fund is a registered investment company for tax purposes.  The annual expense ratio is 0.18% and the net assets are about $46 billion.  The Fund’s strategy is to invest 95% of assets in stocks of the index diversified across industrial sectors (financial 27%, energy 13%, technology 11%, basic materials 10%, etc.) and regions of emerging markets (China 19%, Taiwan 13%, Brazil 12%, India 8%, South Africa 8%, Russia, 6%, other).  Dividends are distributed quarterly.

The FTSE Transition Index currently tracks ~800 stocks from emerging markets, including South Korea.  In 2014, the “transition index” will be replaced by an FTSE Index that excludes South Korea.

RISKS:  Emerging market stocks may be more volatile and less liquid than domestic stocks.  Emerging markets are less regulated than developed markets.  Foreign countries have different regulatory mechanisms and risks of disaster.  Foreign currency may decline in value, lowering the stock values.

VWO is a good investment for diversifying your ETF portfolio.


#ETFscorecard_VNQ, Vanguard REIT ETF

June 28, 2013

VNQ is an index fund that invests in U.S. real estate properties by purchasing shares of real estate investment trusts (REITs).  The following profile shows that VNQ is an established fund that operates at a low rate of turnover.

VNQprofile

The VNQ scorecard (below) reveals a wealthy, experienced index fund that invests in a well-developed market for REITs.  The fund may be tax inefficient when cash distributions are taxed as ordinary income.  The risks to underperformance are 1) erroneous judgment in management of the portfolio holdings, and 2) generic risks of investing in the real estate market.

VNQscorecard

 

Fund operations

The Fund is a registered investment company for tax purposes and issues quarterly dividends.  The annual expense ratio is 0.1% and the net assets are valued at approximately $17 billion dollars.

The benchmark Index measures the performance of 85% of the U.S. Equity REIT market (~116 REITs) and is rebalanced quarterly.  The equity REITs are diversified among residential and commercial properties.

Real estate is an illiquid asset, but equity REITs are easily traded in the stock market.  Equity REITs own and manage real estate.  They must receive 75% of income from rents and sales and they must distribute 90% of taxable income to shareholders.  Equity REITs earn income by attracting tenants, renewing leases, and financing property purchases/improvements.  REIT stocks are typically small and mid-cap sized.

The main investment risks are: 1) concentrated investment in the REITs/real estate industries, and 2) competing interest rates may attract investors away from REITs.

VNQ is a good investment for diversifying your ETF portfolio.


#ETFscorecard_AGG, iShares Core Total U.S. Bond Market ETF

June 28, 2013

AGG holds a portfolio of investment-grade U.S. bonds and distributes monthly dividends.  The following profile shows that AGG is an established fund that operates at a high rate of turnover.

AGGprofile

The AGG scorecard (below) reveals a wealthy, experienced index fund that invests in a well-developed market for bonds.  The fund is tax inefficient due to the high rate of turnover of portfolio holdings.  The risks to portfolio underperformance are 1) erroneous sampling of the bond index, 2) erroneous judgment in management of the portfolio holdings, and 3) generic risks of investing in the bond market.

AGGscorecard

Fund operations

AGG is a registered investment company for tax purposes.  Its strategy is to invest 95% of capital in a diversified basket of U.S. investment grade bonds that serve as a representative sample of the benchmark index.  The portfolio’s profile is that of an average A credit rating of the issuers, average intermediate term bonds, average 4.86% effective duration, average 4.06% weighted coupon, and average $107.46 weighted price. The remaining 5% of capital resides in cash-equivalent securities and bonds excluded from the index.  Fund management may lend up to 33% of the underlying securities to outside investors.  High portfolio turnover rate will increase the Fund’s operating expenses.

The benchmark Index measures the performance of the total U.S. investment grade bond market.  The bonds must be USD denominated, non-convertible, and have a fixed rate.  The Index is updated monthly.

Fluctuating interest rates in the bond market may reduce the investment performance of the Fund.  In the case of declining interest rates, the Fund may replace Called bonds with those of lower interest rates.  During periods of rising interest rates, long-term bonds with low interest rates will effectively reduce the Fund’s income. Rising interest rates can also lower the market value of the bonds.  A portion of the Fund’s mortgage-backed securities are not issued by government agencies and are therefore not protected against default.

AGG is a good investment for diversifying your ETF portfolio.


#ETFscorecard: ETFS Physical Swiss Gold Shares (nyse: SGOL)

May 12, 2013

SGOL is a commodity fund that owns gold bullion.  It differs from other gold sector ETFs that invest in mining firms or gold futures.  The following profile shows that SGOL is a relatively new, but wealthy, fund that does not distribute cash dividends to investors.

SGOLprofile

The SGOL scorecard reveals several negative features: 1) inexperienced operation, less than 5 years; 2) increased tax burden; 3) no cash distributions; 4) gold bullion is susceptible to theft; and, 4) volatile share price.  The positive features are: 1) Fund operations are supported by plenty of wealth; and, 2) Fund shares can be held in a tax deferred account.

SGOLscorecard

Fund operations

The Trust does not insure its holdings of gold.  Rather, the custodian (JP Morgan Chase Bank NA) maintains insurance for its business, bullion holdings, and all bullion held by subcustodians.  One subcustodian is a Zurich bank that stores the gold bullion in a vault.  The gold vault is inspected twice a year, one scheduled and one randomly chosen by the sponsor.

Shareholders have limited recourse against the trust and custodians.  One of the Risk factors is that the custodian might not have sufficient insurance to cover any liability for the loss of gold holdings.

Gold price

Reference prices for gold trading are fixed in London at 10:30 am and 3:00 pm by 5 participating banks, all members of the London Bullion Market Association (LBMA).  The LBMA is an international trade group representing the wholesale market for gold and silver.  The price of Gold is determined by auction in the global market, which in turn is influenced by

  1. speculator attitude
  2. central banks  (announcements and gold-trading activity)
  3. political news
  4. economic news
  5. other forces of supply (e.g., mine production) and demand (e.g., gold futures investors).

Gold market1

Gold is traded in the over-the-counter spot market (physical gold) and derivatives markets.  The main physical gold markets are in London and Zurich.

The participants are miners, bullion bankers, central banks of gold-holding countries, investors, and manufacturers.  The average 5-year production of gold is 4,000 tons per year.  About 20% of the above-ground gold is held by central banks (including the Federal Reserve Bank of New York).  The demand for gold is high among jewelers and investors (especially ETFs).

INVESTMENT STRATEGY

The investor’s only source of income is from personal capital gains.  The gold price is cyclic as shown by the following chart1 .

GoldPrice

Reference

  1. Rob Curran.  Does a Big ETF Drive Gold’s Price? Some pros cite sales by SPDR Gold for the metal’s 2013 decline. JOURNAL REPORT: WEALTH MANAGEMENT, The Wall Street Journal, May 5, 2013.

%d bloggers like this: