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Geoff Considine
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Geoff is the founder of Quantext. Geoff was an early contributor to SeekingAlpha and now writes regularly for Advisor Perspectives and Financial Planning. He has been working in asset management analytics and research for more than ten years. Before entering finance, Geoff was a research... More
My company:
Quantext
My blog:
Income Focus News
My book:
Survival Guide for a Post Pension World
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  • Stability Of Yield, Risk, And Interest Rate Exposure For Utilities

    In my last regular blog post here, I compared two utilities ETFs (JXI for international and IDU for domestic) to a model portfolio that combined JXI with a number of individual utility stocks. The purpose of the comparison was to show that it was straightforward to identify a portfolio of utilities with higher yield than the ETFs, about the same volatility, and neutral exposure to Treasury yield.

    The exposure to Treasury yields is measured using the correlation between the returns of a portfolio or individual stock or ETF and the 10-year Treasury yield. This is a very important variable because utilities tend to be somewhat interest rate sensitive. In addition, given the current environment, it is worth paying careful attention to how your portfolio may perform in the face of rising rates.

    In my article, I noted that there was a substantial difference between the correlation of JXI to 10-year Treasury yield using three years of historical data vs. give years. Given this, I chose to use a five year period as the basis for comparison between my model portfolio and the utility ETFs. This discussion may have caused some confusion. One comment asked why I would think it is meaningful to use the correlation to 10-year Treasury yield as a guiding variable if it changes so much with the sample historical period. This issue deserved a good answer.

    The same question may be leveled at the use of any historical statistical metric. Given that these change in time--correlations are notoriously unstable, but volatility is also quite variable--does it really make sense to use these metrics to guide portfolio construction. To be sure, care must be taken. In the table below, I show statistics for yield along with volatility over 3-, 5-, and 7-year periods as well as correlations of portfolio returns to 10-year Treasury yields over these same periods.

     

     

    PortfolioYieldHistorical VolatilityCorrel. to 10-Yr Treas. Yield
    3 years5 years7 years3 years5 years7 years
    Model Utility Portfolio5.3%10.5%13.5%14.8%2.6%0.0%2.5%
    100% JXI4.0%11.5%14.9%15.6%17.5%-0.4%2.3%
    Equal wt. to JXI, XLU, IDU3.7%10.2%12.6%14.1%-11.2%-5.3%-2.0%

    While the values vary in time, the relative relationships are quite consistent. In particular, the model utility portfolio from my previous post has higher yield than JXI or a mix of JXI, IDU, and XLU, with about the same level of risk and a correlation to 10-year Treasury yield that ranges from very slightly positive to zero.

    Disclosure: I am long SO, OTCQX:EONGY.

    Dec 03 10:33 PM | Link | Comment!
  • Comparing Multi-Asset Income Funds

    One interesting and useful type of fund is what is called a multi-asset income fund. These are funds that hold a range of asset classes and for which the goal is to provide a high level of income. The manager of a fund can exploit diversification across asset classes managing risk, while seeking out higher-yield assets.

    Examining Income Funds

    There are three key questions for investors considering one of these funds:

    1) How much income does the fund provide?

    2) How risky is the fund?

    3) What is the interest rate exposure?

    4) What are the expenses?

    I have summarized these key variables for a number of these funds in the table below. There is one ETF and four mutual funds. The mutual funds vary in terms of expense ratios, but all have loads. These funds range in yield from 4.4% to 5.5% and have trailing 3-year volatility levels ranging from 6.2% to 11.2%. For reference, the S&P500 has a trailing 3-year volatility of 12.5% and the Barclays Aggregate Bond Index has a volatility of 2.83%.

    The iShares Corporate Bond ETF (LQD) has a yield of 3.8% and trailing 3-year volatility of 5.6%. It is notable, however, that LQD has a -52% correlation to 10-year Treasury yield which means that this asset class will tend to lose money if interest rates rise. The income funds listed here all have a modest positive correlation to 10-year Treasury yield, so they should do okay in a rising rate environment.

    The average projected volatility for these five funds is 10% and the average correlation to 10-year Treasury yield is 32%. This level of risk and interest rate exposure corresponds to one of the model ETF portfolios on the 'efficient yield frontier.' This portfolio has a 10% projected volatility and a 30% correlation to the 10-year Treasury yield and a 5.5% yield. This portfolio also has a constraint that no more than 20% of the portfolio can be allocated to any single asset class.

     

     

    NameTickerYieldExpected VolatilityTrailing VolatilityCorrelation to 10Yr Treasury YieldExpense RatioLoad
    Guggenheim Multi-Asset IncomeCVY5.4%12.7%11.2%34.7%0.8% 
    Franklin Income FundFKINX5.5%10.2%9.2%38.5%0.6%5.5%
    Thornburg Investment IncomeTIBAX5.2%10.5%9.8%29.2%1.2%4.5%
    JP Morgan Income BuilderJNBAX4.5%9.7%9.0%29.0%0.7%4.5%
    BlackRock Multi-Asset IncomeBAICX4.4%6.7%6.2%27.9%0.8%5.3%
    4 ETF Model PortfolioModel5.2%10.0%7.4%35.5%0.6% 

    The last entry in the table above is for a 4-ETF model portfolio, which has volatility levels consistent with the five funds, a yield of 5.2%, and a 35% correlation to the 10-year Treasury yield. The weighted expense ratio of the funds in the portfolio is 0.6%. The 4-ETF model portfolio is simply this:

    NameTickerAllocation
    SPDR Barclays 1-3 Month T-BillBIL2%
    Vanguard Total Stock Market IndexVTI10%
    Alerian MLPAMLP46%
    iShares S&P U.S. Preferred StockPFF42%

    In summary, then, the risk levels and yields of the available multi-asset income portfolios all look quite reasonable and their positive correlations to changes in Treasury yields are exactly what one would want. The only downside to these funds is their high expenses when we include the loads. CVY is the exception, with a fairly reasonable 0.8%. It is notable, however, that CVY is a bit of an outlier here with regard to risk. The historical and projected volatility levels for CVY are much higher than the other funds and higher than the 4-ETF portfolio and this higher risk comes with only incrementally higher yield.

    On the other hand, CVY has delivered substantially higher total returns than the other funds and the model portfolio:

    NameTicker3yr Avg Annual Return 
    Guggenheim Multi-Asset IncomeCVY13.6% 
    Franklin Income FundFKINX10.7% 
    Thornburg Investment IncomeTIBAX9.7% 
    JP Morgan Income BuilderJNBAX8.6% 
    BlackRock Multi-Asset IncomeBAICX9.1% 
    4 ETF Model PortfolioModel7.8% 

    CVY has a demonstrated ability to deliver higher price appreciation in a rising stock market which is compensation for its higher risk level. The question for investors is the degree to which they are comfortable with the higher volatility. When I run an unconstrained optimization for a risk level equal to CVY and with a 35% correlation to 10-year Treasury yield, I find that it is possible to achieve a 6.4% yield with the following allocation:

    VTI33.00%
    AMLP37.00%
    REM20.00%
    PFF10.00%

    Please note that I am in no way suggesting that this portfolio would be appropriate for any specific person.

    Conclusions

    Despite the low yields on Treasury bonds, there remain income opportunities in other asset classes. As I have noted previously, there appears to be a decoupling between Treasury bonds and other fixed income classes, such that Treasury bonds are less and less representative of the opportunities. As I have shown, it is possible to create ETF portfolios with similar risk and interest rate exposure that have yields of 5.5% and above. For investors who prefer to buy a single fund, CVY meets many of these criteria. The other multi-asset income funds examined here provide an attractive yield for their risk levels, but their expense levels make them less attractive.

    Disclosure: I am long PFF.

    Nov 26 6:24 PM | Link | Comment!
  • A REIT With Notable Risk-Adjusted Yield

    Government Properties Income Trust (GOV) is a REIT that leases office space to government clients. GOV owns 71 properties across 21 states and the District of Columbia comprising a total of 9 million square feet of rentable space. Almost 92% of the company's revenue comes from the U.S. government and the United Nations. The current yield from GOV is almost 7%, which is much higher than that of the largest REIT ETFs such as ICF (iShares Cohen and Steers REIT ETF, yield of 3.3%), RWR (SPDR Dow Jones REIT ETF, yield of 3.2%), or IYR (iShares U.S. Real Estate ETF, yield of 4.1%).

    Let's assess the income provided by GOV using the yield-vs.-risk approach. I have summarized the relevant statistics in the table below.

     

     

    TickerCorrelation to 10-Year Treasury YieldBeta vs. S&P500Expected VolatilityImplied VolatilityTrailing 3-Year Volatility3-Year Average Annual ReturnYield 
    GOV25%102%21%21%18%5.4%7.0% 
    ICF11%103%20%22%17%11.5%3.3% 
    RWR12%104%20%23%17%12.4%3.2% 
    IYR12%100%19%21%16%11.2%4.1% 

    GOV has substantially under-performed the broader REIT indexes over the past three years. The average annual return shown is the arithmetic average return. GOV's high yield is partly due to lower price appreciation in recent years. When I run GOV through my standard battery, what I find is intriguing. GOV has a higher positive correlation to Treasury bond yields than the REIT index ETFs which suggests that GOV has not tended to be hit as hard when REITs have been sold off as bond yields rise. GOV has a Beta with respect to equities that is essentially identical to the REIT indexes. No flags there.

    I have calculated an expected future volatility for GOV and the REIT ETFs using Quantext Portfolio Planner (Expected Volatility in the table above) and these are very close to the implied volatility of at-the-money put options (Implied Volatility above). Implied volatility from options is considered to be the best forward-looking estimate of risk. This agreement between Expected Volatility from Quantext Portfolio Planner and the option implied volatility is an important validation in my approach. If these agree, I have more confidence that risk is being priced consistently across assets.

    I have used the longest available options for GOV (expiring in June 2014) and then chosen the options on the ETFs with the closest expiration dates to June 2014. These results suggest that GOV's risk level is very close to that of the broad REIT indexes, which is somewhat surprising. In general, we would expect that a single REIT would be riskier than a broad index. The trailing historical volatility level for GOV is slightly higher than that for the ETFs, but not markedly so.

    Given that GOV has a yield of 7%, almost twice the average of the three large REIT ETFs in the table above, and a risk level that is very close to these REIT ETFs, GOV seems under-valued as compared to its asset class. This apparent under-valuation must be considered in light of the fact that REITs generally don't look remarkably attractive as compared to other income generating assets. Consider, for example, that you can get 6.2% in yield from high-yield bonds (HYG) and 5.9% from MLPs (AMLP) for considerably lower expected risk levels. As compared to the universe of other income assets, GOV appears to be generally on par.

    Disclosure: I am long GOV.

    Nov 22 4:01 PM | Link | Comment!
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