Exchange Traded Funds for Investment Portfolios

Transcription

1 Exchange Traded Funds for Investment Portfolios by Heinz Diebel

2 Disclaimer Carefully consider investment objectives, risks factors and charges and expenses of any ETF before investing. Get a prospectus from your broker or the investment company and read it carefully before investing. All investments involve risk, including loss of principal. Diversification does not eliminate the risk of experiencing investment losses. ETFs are subject to risk similar to those of stocks including those regarding short-selling and margin account maintenance. ETFs can entail market, sector, and industry risks similar to direct stock ownership, and trading prices may not reflect the actual net asset value of the underlying securities. This presentation is not a recommendation or endorsement of any particular investment or investment strategy. I am not responsible for third party information or services. I take no responsibility for any information contained in this presentation. June 7,

3 Exchange Traded Funds (ETFs) Fastest growing financial product in the US (50% asset growth in 2007) US Assets by end March 2008: mutual funds $11.7 trillion index funds 1 trillion ETFs $571 billion Growing popularity of passive index investing A lot of attention in the media June 7,

4 History I: The Beginning 1993 first ETF: SPY (tracking S&P 500 Index) 1995 MDY S&P 500 Mid-Cap 1996 EWx ishares MSCI regional Index 1998 XLx Select Sector SPDR, DIA: tracking DJIA 1999 QQQ (later QQQQ) tracking Nasdaq 100 by end 1999: 32 ETFs June 7,

5 Growing Number of ETFs Total Number of ETFs Trading ETFs trading per May 15, 2008 June 7,

6 History III: The Bubble 2006: 151 new ETFs 2007: 279 new ETFs, many financial institutions getting on the bandwagon 2008: 39 new ETFs by May 15 ETFs trading Total Number of ETFs Trading June 7,

7 The Bust? Bond, Currency, Commodity, Short,... Specialty ETFs Indexes created to justify ETF? Active managed ETFs end the era of index tracking only ETFs compete with stock picking mutual funds supposedly more transparent and maybe tax advantage Make sure you understand what you buy! June 7,

8 What are ETFs? ETFs were invented to track a market index, enabling index investing Passively managed portfolios of securities ETFs represent shares of a basket of securities representing the index Traded on stock exchanges like regular stocks June 7,

9 How ETFs Work Represent baskets of equities (units) e.g. the basket of stocks representing 50,000 shares Creation and redemption of units as market demands Authorized Participants: Create units giving baskets to the fund and then sell shares of the fund on the market (stock exchange). They redeem units by returning shares to the fund and receiving baskets of stocks. June 7,

10 How ETFs Work Investor Buy Sells Shares of ETF Exchange Buys Securities Sells Shares Buys Shares Sell Securities Authorized Participant Shares Baskets Hands In Basket (creation unit) Gets Shares Returns Shares Redeems Basket Basket Basket Basket Basket Fund June 7,

11 Authorized Participant Buys securities (stocks) in the market Builds baskets to give to the fund Receives Shares of the fund Sells the shares in the market Buys shares of the ETF in the market Returns shares to the fund and receives baskets of securities Sells securities (stocks) in the market June 7,

12 Why ETFs? Alternative to mutual funds and individual stocks Index investing (passive investing) Diversification Cost reduction Flexibility and manageability Transparency Liquidity June 7,

13 Index Investing Created to track equity indexes (S&P 500, MidCap S&P 400, MSCI, Sectors) Closely match index risk/return Meanwhile every index (and more) covered by at least one ETFs But: Indexes may be created to justify an ETF June 7,

14 Diversification Inherent Diversification (many stocks) An ETF for every purpose: stocks, bonds commodities currencies national, international broad market indexes market sectors real estate special indexes investment styles short leveraged hedged active managed passive managed risk / duration ultrashort bond June 7,

15 Cost Reduction Online trading like stocks Commissions and fees like stocks No load # ETFs ETF Management Fees < 0.3% < 0.4% < 0.5% < 0.6% < 0.7% < 0.8% < 0.9% Low management fees most ETFs < 0.5%; only 3 of 470 > 1%, but 220 n/a Mutual Funds 1% to >3%, competition drives price down But: cost averaging may be expensive (commissions) Mgmt Fee Fee ETFs < 0.2% 34 < 0.3% 115 < 0.4% 157 < 0.5% 208 < 0.6% 270 < 0.7% 320 < 0.8% 411 < 0.9% 470 n/a 220 Total 693 June 7,

16 Flexibility and Manageability Trade intra-day on stock exchanges like stocks (limit, stop orders) Can buy on margin Can sell short Optionable (buy/sell put/call) No minimum hold time (day trading) No minimum investment (but full shares only) Allow taxable gain/loss management June 7,

17 Transparency Index composition is well known and communicated (mostly) Index is consistent over a long period (mostly) -> low turnover Intra-day real time quotes: you know what you pay and get But: spread between NAV and market price June 7,

18 Liquidity Ability to trade when you need to, with a low spread between bid and ask Liquidity largely defined by: the number of shares traded per day the fund s holdings: can they quickly create and redeem units? The shorter your timeline, the more liquid the asset should be. June 7,

19 ETF Risks Market risk of underlying basket: if market goes down, so will the ETF Market pricing: spread between the basket and the shares (NAV vs. trade price) Fees, commissions, and timing lead to tracking errors vs. index The underlying index: understand the underlying index well before making a decision June 7,

20 Legal Structure of ETFs Open-end index mutual fund Unit investment trust Exchange-traded grantor trust Other structures June 7,

21 Open-end Index Mutual Funds Most common structure Registered with SEC as investment companies ishares, Select Sector SPDRs re-invest dividends immediately may use stock index futures to equitize dividend stream may loan stock June 7,

22 Unit Investment Trust Less common Registered with SEC as investment companies SPDRs (SPY), Qubes (QQQQ), DIAMONDS (DIA) re-invest dividends quarterly June 7,

23 Exchange Traded Grantor Trust Merrill Lynch s HOLDRS Underlying is a basket of stocks (industry, sector, group) Allow to keep ownership in underlying stock (voting rights, dividends, take delivery) Commodity Trackers, CurrencyShares ETFs (ishares COMEX Gold Trust, streettracks Gold Shares) Taxation like underlying asset (Gold: as Collectables) not registered under Investment Company Act ask you tax advisor June 7,

24 Other Structures PowerShares DB Commodity Tracking Funds: track commodity pools not registered under Investment Company Act tax implications (K-1) Exchange Traded Note (ETN) Barclays ipath ( Commodities,, Currencies, Emerging Markets, Strategies trade in secondary market, mature not regulated June 7,

25 Largest Fund Families There are about 60 Families of ETFs. The ones with the most ETFs: ishares: 159 [Funds: 11, Inc.: 28, Trust: 120] PowerShares: 96 [Trust: 85, Trust II: 11] ProShares Trust: 60 Claymore ETF: 28 [Trust: 19, Trust 2: 9] SPDR Series Trust: 38 Rydex ETF Trust: 24 June 7,

26 Portfolios using ETFs.

27 Why should Investors have ETFs in their Portfolio? Inherent and explicit diversification reduces risk. Cost Very well suited for technical analysis because of diversification (smoother than single stocks) June 7,

28 Market Timing ETFs like to trend and revert to the mean. Can be used for short term trades. ETFs with large number of holdings establish trends and exhibit reversions to the mean. (Trend trading, buying lows and selling highs) Not ideal for day trading (exception maybe QQQQ, SPY, DIA) June 7,

29 ETFs Liquidity Daily Volume (3 Month Avg): 78 ETF have daily volume > 1 M 109 ETFs have daily volume > 500k 208 ETFs have daily volume > 100k 299 ETFs have daily volume > 50k This makes them good choices for shorter term portfolio changes. June 7,

30 Rotation based on technical indicators Trades max 3 ETFs at 33% of capital each, out of sample of 100 Entry based on RSI and 200 period SMA Exit based on new high Result: less profit than Buy and Hold, but lot less drawdown. And only IN 26% of the time. June 7,

31 Gerald Gardner, Trent Gardner: Profit with ETFs. Technical Analysis of Stocks and Commodities, June 2008, pp21-24 June 7,

32 June 7,

33 Re-Balancing Strategies We define a lower limit, goal, upper limit as a percentage of the portfolio. If an asset is above the upper limit, we reduce it back to the goal, and allocate the proceeds to assets below the lower limit, starting with the one with the biggest distance from the lower limit. The remainder goes to Cash. June 7,

34 Sector Rotation Strategies Structure portfolio into segments: style, sector, international Rotate to the leadership segments My observations: good diversified portfolio and buy and hold is almost as good June 7,

35 Fidelity Morningstar ishares Portfolio Portfolio: Morningstar ishares Weight ishares Morningstar Large Core Index (JKD) 27.8% ishares Morningstar Large Growth Index (JKE) 23.6% ishares Morningstar Large Value Index (JKF) 22.5% ishares Morningstar Mid Core Index (JKG) 6.9% ishares Morningstar Mid Growth Index (JKH) 6.7% ishares Morningstar Mid Value Index (JKI) 6.2% ishares Morningstar Small Core Index (JKJ) 2.1% ishares Morningstar Small Growth Index (JKK) 2.1% ishares Morningstar Small Value Index (JKL) 2.1% June 7,

36 Fidelity Morningstar ishares Portfolio June 7,

37 Rebalancing Result June 7,

38 Critique: Diversification ishares Morningstar Large Core Index (JKD) 0.91, ishares Morningstar Large Growth Index (JKE) 0.88, 0.84, ishares Morningstar Large Value Index (JKF) 0.88, 0.90, 0.89, ishares Morningstar Mid Core Index (JKG) 0.87, 0.94, 0.85, 0.94, ishares Morningstar Mid Growth Index (JKH) 0.86, 0.86, 0.92, 0.97, 0.90, ishares Morningstar Mid Value Index (JKI) 0.83, 0.85, 0.83, 0.96, 0.91, 0.95, ishares Morningstar Small Core Index (JKJ) 0.85, 0.92, 0.83, 0.93, 0.98, 0.88, 0.93, ishares Morningstar Small Growth Index (JKK) 0.82, 0.82, 0.85, 0.95, 0.87, 0.97, 0.97, 0.89, ishares Morningstar Small Value Index (JKL) Very high correlations of the segments with the US Stock investment styles. Just diversifying within the investment styles alone will not do it. June 7,

39 Which you can see in the Charts The 4 corners of investment styles. See the lockstep? June 7,

40 4 Methods Compared June 7,

41 Basic Rotation Strategy DIA.ASE,DIAMONDS Trust Series IJS.NYS,iShares S&P SmallCap 600 Value IJT.NYS,iShares S&P SmallCap 600 Growth IWM.NYS,iShares Russell 2000 Index MDY.ASE,MidCap SPDRs QQQQ.NAS,PowerShares QQQ SPY.ASE,SPDRs June 7,

42 Basic Rotation Strategy My Implementation of Basic Rotation Model. David Vomund: ETF Trading Strategies Revealed June 7,

43 Compare 4 Methods June 7,

44 Interpretation I think the portfolio is not well balanced The proof is in the correlations DIAMONDS Trust Series 1 (DIA.ASE) 0.77, ishares S&P SmallCap 600 Value Index (IJS.NYS) 0.81, 0.95, ishares S&P SmallCap 600 Growth (IJT.NYS) 0.78, 0.98, 0.97, ishares Russell 2000 Index (IWM.NYS) 0.80, 0.90, 0.95, 0.94, MidCap SPDRs (MDY.ASE) 0.81, 0.75, 0.83, 0.80, 0.84, PowerShares QQQ (QQQQ.NAS) 0.95, 0.87, 0.91, 0.90, 0.91, 0.87, SPDRs (SPY.ASE) June 7,

45 Let us find a better universe SPY.ASE, SPDRs, EWS.NYS, ishares MSCI Singapore Index XLE.ASE, Energy Select Sector SPDR IWM.NYS, ishares Russell 2000 Index SMH.ASE, Semiconductor HOLDRs EWZ.NYS, ishares MSCI Brazil Index XLF.ASE, Financial Select Sector SPDR June 7,

46 Correlations SPDRs (SPY.ASE) 0.76, ishares MSCI Singapore Index (EWS.NYS) 0.62, 0.51, Energy Select Sector SPDR (XLE.ASE) 0.90, 0.73, 0.63, ishares Russell 2000 Index (IWM.NYS) 0.73, 0.45, 0.42, 0.67, Semiconductor HOLDRs (SMH.ASE) 0.56, 0.56, 0.77, 0.53, 0.34, ishares MSCI Brazil Index (EWZ.NYS) 0.74, 0.58, 0.19, 0.65, 0.40, 0.26, Financial Sel. Sector SPDR (XLF.ASE) June 7,

47 Better Results June 7,

48 Proprietary Software developed by Heinz Diebel, Copyright Heinz Diebel June 7,

49 DIAMONDS Trust Series 1 (DIA.ASE) 0.34, ishares MSCI Japan Index (EWJ.NYS) -0.13, 0.19, streettracks Gold Shares (GLD.NYS) 0.95, 0.42, -0.12, SPDRs (SPY.ASE) June 7, 2008 Proprietary Software developed by Heinz Diebel, Copyright Heinz Diebel 49

50 References Maria Crawford Scott, Cara Scatizzi: Exchange-Traded Funds The Individual Investor s 2007 Guide to Exchange-Traded Funds; AAII Journal October 2007 Technical Analysis of Stocks & Commodities, June 2008 Motley Fool Morningstar Yahoo Finance finance.yahoo.com Rosenberg et al: ETF Strategies and Tactics Ferri: The ETF Book Koesterich: The ETF Strategist Delfeld: ETF Investing around the World Vomund: ETF Strategies Revealed Bernstein: The Intelligent Asset Allocator June 7,

51 My development and trading environment. June 7,

52 Thank You! Questions? Comments? Want a copy of the slides? Want to test your ideas? Want your own software written? [email protected] June 7,