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David Fry
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David Fry writes a subscription newsletter focused on technical analysis of exchange-traded funds, called ETF Digest (www.etfdigest.com). Dave founded the ETF Digest in 2001 and was among the very first to see the need for a publication that provided individual investors with information and... More
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Create Your Own ETF Hedge Fund, a DIY ETF Strategy for Private Wealth Management.
    Jun 7, 2011 1:09 PM | about stocks: SHY, IEF, TLT, IEI, AGZ, TIP, STPZ, IPE, STIP

    Investors seeking income often begin with U.S. government bonds as their first choice given perceived safety considerations. It’s ironic given recent comments from Moody’s, for example that the U.S. credit rating may be under review for a downgrade in the next month. Given this news and the heavy supply of issuance needed to fund government operations its odd yields remain near historic lows. The reason for this is a combination of factors: QE (Quantitative Easing) operations have the Fed buying bonds which takes some supply off the market. This QE is scheduled to end this month. Further, economic data has been weak leaving authorities with little choice but to keep interest rates low. Demographics result in an aging population in the west seeking income over growth. Tied to this has been an outflow of funds from equities to bonds given both demographics and a lack of trust in equities.

    We look at 10 different bond ETF sectors including those that are repetitive varying only slightly by holdings and perhaps more so by varying embedded fees and expenses. While we’ll look at just 10 issues overall, we’ll mention the competitive issue and variance in fee structure.

    Large institutions (insurance companies and pension plans) and even smaller asset allocation models either include government bonds as components in portfolio structure with some being mandated to do so. Large institutions use bonds to meet various actuarial table requirements to meet retirement schedules and life insurance tables. Financial Planners and Advisors use bonds traditionally as a portfolio risk management tool given their historical noncorrelation to equity sectors.

    We’ll also view popular so-called inflation-protected issues but with some reluctance and caution. These issues, no matter the maturity/duration features are primarily linked to the same inflation measurement—the relative CPI (Consumer Price Index). Personally, I find this linkage to be unfair to the borrower versus the issuer given the flawed nature of the index. It’s my opinion, and that of others, these measures understate true inflation. (Shadow Stats does an excellent job of detailing a better view of inflation data.) Another factor for taxable investors to consider is they must pay ordinary income taxes on the so-called “imputed rate” of interest earned but not paid on the inflation component. Lastly, many institutional investors are required to own these securities by the terms of their mandate and other considerations whereas individual investors need not be so restricted.

    Let’s look at typical choices...READ MORE

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