High Yield ETFs Take a Tumble

High-yield corporate bond ETFs tumbled today.

“This looks to be an exit trade from this asset class,” said Chris Hempstead, director of ETF execution services at WallachBeth Capital in a note, rather than a move to receive delivery of actual bonds.

Specifically, Hempstead’s desk has been very active in SPDR Barclays Capital High Yield Bond ETF (JNK), which dropped 1.3% to $38.19; iBoxx $ High Yield Corporate Bond Fund (HYG), which fell 1.4% to $87.59; PowerShares Fundamental High Yield Corporate Bond Portfolio (PHB), down 0.4% to $18.46, and SPDR Barclays Capital Short Term High Yield Bond ETF (SJNK), down 0.6% to $29.70.

After a redemption of about $725 million in the SPDR Barclays Capital High Yield Bond ETF last week, allegedly for delivery of actual bonds, Hempstead says the pace of selling in high yield ETFs needs to be closely monitored.

So far this year, each of these funds has seen a significant increase in assets, for a total of more than $6 billion year-to-date. With the iBoxx fund holding $14.8 billion in assets under management, the SPDR high yield ETF holding $11.2 billion, the PowerShares ETF at $943 million and $119 million in the SPDR short-term high yield, all the funds have about doubled their assets since January 2011, says Hempstead.

“We are watching closely to see how well the Street can absorb a short-term exit strategy from these funds,” said Hempstead in a note. “How would the fixed income world respond to a heavy and swift sell-off in an ETF product space that has seen a steady inflow of assets for almost 18 months?”

He adds the products have started trading at a discount to their respective NAV, which is not uncommon, but they have a tendency to trade at a premium for longer periods than at a discount.

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ING Offers Positive Outlook for 2012

Europe, Shmeurope. If you looking for good news, ING has it.

“Don’t listen to noise coming out of Europe,” said Douglas Cote, chief market strategist of ING, at a press conference Wednesday where the firm offered its outlook for the new year. “The [European Central Bank] will be forced to jump in. I expect an end-of-year rally.”

Paul Zemsky, ING’s chief investment officer of Multi Asset Strategies, says while Europe may suffer a mild recession in 2012, the U.S. will experience tepid growth between 2% and 2.5% With housing weak and the Federal Reserve not raising interest rates until 2013, he says inflation won’t be a problem, staying around 2%. However, he says this growth won’t be enough to bring down the unemployment and if per-capital income remains stagnant, this could cause some social unrest. And while the housing sector has bottomed out, he says it may take another year before the market begins to see a sustained recovery. The main risk to the U.S. economy is the contagion of a European slowdown.

Still companies continue to post record profits, keeping expenses low by not hiring new workers. Zemsky expects the S&P 500 to surge 9% by the year’s end to 1325, and again to 1450 by the end of 2012. “Unless,” he adds, “ Europe blows up.”

You can track the benchmark with the largest ETF in the world, the SPDR S&P 500 (SPY).

“How can you not be in the market with earnings hitting record highs?” asked Cotes, suggesting market fundamentals will continue to be strong in the face of rising global risk. In addition to rising corporate profits, he sees U.S. manufacturing expanding and retail sales at their highest levels after seven consecutive monthly increases. “As far as eye can see we see positive quarters.”

Mid-capitalization stocks are the “sweet spot of the economy,” he says, because they have the financial wherewithal of large-caps and the growth of small-caps.” He also like emerging market stocks and global real estate investment trusts.

For mid-cap stocks take a look at SPDR S&P MidCap 400 ETF (MDY).

As for those global risks, Cote says Europe’s “bank recapitalization plan is an effective fence around the crisis.” In addition, if China begins to experience a slowdown, South Korea and Turkey will pick up the slack.

Really?

The Institute of International Finance said the recapitalization plan has “serious problems” that will hurt economic growth.

Meanwhile, China is one of South Korea’s major trading partners. If China stops buying South Korea is going to have to find a lot of other clients just to break even.

Christine Hurt sellers, ING’s fixed income chief, continued the trend of discounting Europe, “there are a lot of good opportunities, unless you think there will be a massive global recession.” U.S. companies are well prepared for any credit crunch because they have nearly $1.5 trillion in cash on their balance sheets.

She likes high-yield bonds, because spreads are wide, but not consumer cyclicals. She also recommends buying sovereign debt in emerging markets. With emerging markets seeing inflation declining and credit quality increasing people should “take advantage of the shift in liquidity out of Europe.”

She expects the ECB to come save the euro zone, but if you wait until the ECB acts, it will be too late. Because there is very little liquidity in the credit markets, she says you need to buy bonds you are willing to hold for a long time.

I wasn’t very satisfied with their optimistic answers about Europe’s problems. Even though the ECB is the chief monetary authority for counties that use the euro, European Union treaties forbid it from being the lender of last resort for member countries. And as Roubini said last week, that’s not going to change.

Hurtsellers said Italy’s high bond yields are worrisome and if Italy doesn’t get enough tie to restructure, the whole thing could balloon out of control. If that happens, “market’s can create their own chaos and we’ll see more pressure on Germany.”

Zemsky added that while the ECB has remained out of the picture in terms of directly financing governments, if the European banking system seizes up, the ECB would supply quantitative easing. Why did he think that? “Because in 2008, the Fed stepped in to where we never would have expected it before, but they did it to save the world.” True, but the Fed had the power to do that and the ECB doesn’t.

“The ECB will stand behind a bank if they have enough collateral. If that doesn’t happen,” said Zemsky, “that’s the worst case scenario and will lead to a much worse recession of possibly negative 4% gdp growth in Europe.”

That should put our minds to ease.

Stocks Appear to Ignore Good News From Libya

At Friday’s close of 10817.65, the Dow Jones Industrial Average is down 16% from its high of 12928.45 on May 2. My friend, Lewy Katorz, an angel investor, predicts a 30% drop, which means we are going down to about 9050. That seems about right to me.

Libyan rebels moved into Tripoli on Sunday and captured two of Col. Moammar Gadhafi’s sons. Even though this should push the price of oil lower, stock futures Sunday night were still in the red.

CNBC’s Rick Santelli uses some extremely wacky logic to determine the bond rally will end on Monday. But, I’ll stick with the Wall Street Journal’s in depth report of the obvious, bond ETFs rally when stocks sink.

WSJ offers a nice chart showing the performance of the long-term bond ETFs. Ironically, the fund with the biggest advance this year through Aug. 4, the Pimco 25+ Year Zero Coupon U.S. Treasury (ZROZ), up 18.8%, actually saw net outflows of $16 million.

ETF Assets Fall in June

The combined assets of all exchange-traded funds fell sequentially in June by $10.85 billion, or 1.4%, to $772.21 billion, reports the Investment Company Institute, the trade organization for the mutual fund and ETF industries.

Over the past 12 months, ETF assets increased $181.87 billion, or 30.8%. Since June 2009 assets in domestic equity ETFs increased 24%, or $86.43 billion, to $445.2 billion and global equity ETFs assets rose $48.21 billion, or 32%, to $197.3 billion. Year-over-year, bond funds surged 57% to $129.48 billion. Hybrid funds also jumped 57% to $236 million. During June, the value of all ETF shares issued exceeded that of shares redeemed by $11.66 billion. In June 2009, ETFs experienced a net issuance of $15.61 billion.

At the end of June, the number of ETF had climbed 20% for a total of 872, with 470 in domestic equity, 276 in global equity, 120 in bonds and 6 hybrid funds.

Cautious Forecast for Next 6 Months

Pardon the obvious, Wall Street is a pretty bullish place. So, it’s refreshing to hear someone down there actually say things don’t look so good.

Ed Keon is one of the few.

“There remains a high level of caution and pessimism in the country among the average consumer and business executive,” said Keon, managing director and portfolio manager for Quantitative Management Associates. He spoke Tuesday at Prudential’s 2010 Midyear Market Outlook panel, the one with the tantalizing title: “Will the economy double-dip?” He added, “There’s plenty of money to invest, but people are reluctant to do so.”

He says the stock pullback is a symbol of not just the economic activity, but also a malaise among the American people. But he believes stocks represent a good value, compared to the long-term bond. The dividend yield for the S&P 500 Index is 2%. Considering that a quarter of the index doesn’t pay dividends, many of the stocks in the index are paying 3% to 6%, compared to the 10-year bond’s yield of 2.9%. When you can get a better return from risky large-cap stocks than Treasury’s you know stocks are cheap. Remember, prices move inversely to yield. So as prices move lower, yields rise.

For a full explanation of the relationship of yields to prices and dividends, check out Dividends Stocks for Dummies.

Not only are stocks cheap, but earnings are strong and will come in above expectations, said Keon. Still he cautions again the expectation that stocks will see a sudden resurgence of confidence. Until we address the structural problems in the economy, Keon said we won’t be able to get moving until we deal with the giant levels of debt. He says he’s currently holding allocations near benchmark weights, but is underweight TIPS bonds.

Top ETFs holding TIPS in alphabetical order:

• Barclays Capital TIPS Bond Fund (TIPS)
• PIMCO 1-5 Year U.S. TIPS Index Fund (STPZ)
• SPDR Barclays Capital TIPS ETF (IPE)
• SPDR DB International Government Inflation-Protected Bond ETF (WIP)

Getting Some TIPS from PIMCO

Pimco, the world’s largest bond fund manager by assets, launched its second ETF, the PIMCO 1-5 Year U.S. TIPS Index Fund (STPZ). The ETF began trading Monday on the NYSE Arca. It tracks the Merrill Lynch 1-5 Year U.S. Inflation-Linked Treasury Index. This unmanaged index holds TIPS (Treasury Inflation Protected Securities) with a maturity between one and five years, and averaging about three years. The fund charges in expense ratio of 0.20%.

STPZ is the first of three ETFs on TIPS, U.S. Government-issued fixed-income securities that give investors explicit inflation protection and the potential for additional yield. The principal value of TIPS is adjusted monthly according to the rate of inflation measured by the U.S. consumer price index.

Pimco said in a written statement that the new fund is the “first ETF to focus specifically on the short maturity segment of the TIPS market and aims to offer investors a high degree of protection against the immediate effects of inflation on their portfolio. Shorter-dated TIPS have historically shown a significantly higher correlation with current inflation and lower volatility relative to an index that covers the entire TIPS maturity spectrum.”

Currently, inflation remains close to non-existent, with deflation a bigger threat to the economy. But, that situation just can’t last. The government’s spending surge from the unprecedented fiscal stimulus bill passed earlier this year has the potential to significantly boost prices across the economy.

Pimco has been one of the most active participants in the TIPS market since the product’s inception in 1997. Next month, the bond fund firm expects to launch two more TIPS ETFs. The PIMCO 15+ Year U.S. TIPS Index Fund (LTPZ) will address the long end of the market while the PIMCO Broad U.S. TIPS Index Fund (TIPZ) will give TIPS exposure across the maturity spectrum. These two will take on the two TIPS ETFs already on the market, the iShares Barclays TIPS Bond Fund (TIP) and the SPDR Barclays Capital TIPS ETF (IPE).

“By focusing on the short end of the maturity curve, we’re addressing the two main concerns we’ve heard from investors (inflation protection and protection against the risk of rising interest rates),” John Cavalieri, a Pimco senior vice president and real return product manager, told IndexUniverse. He said while the ETFs on the market provide inflation protection, STPZ is uniquely positioned to protect against the risk of rising interest rates. “It boils down to this ETF providing exposure to the short end of the maturity curve, which limits interest rate sensitivity.”

Pimco launched its first ETF in June.

ProShares Launches Mild Short Bond Fund

With interest rates near 0%, the only direction they can go is up. And as anyone who has ever read a story about bonds knows, when interest rates go up, bond prices fall. When that will happen is anyone’s guess. But ProShares is getting ready for that day. ProShares timed the market perfectly last time by launching a series of ETFs to short the equities markets just in time to capitalize on the crash that started in October 2007. Now, they are priming the market for the popping of the bond bubble.

The ProShares Short 20+ Year Treasury ETF (TBF), a fund designed to provide short exposure to long-term U.S. Treasury bonds, launched Thursday on the NYSE Arca. This ETF will try to match the inverse performance of the Barclays Capital 20+ Year U.S. Treasury Index each day. The Barclays Capital 20+ Year U.S. Treasury Index trackes the performance of U.S. Treasury bonds with maturities of 20 years or greater.

ProShares says it’s launching this in “direct response to strong investor demand for a single beta2 short treasury fund.” I believe them. The inverse bond ETFs will soon become very hot.

Currently, ProShares offers two bond funds that offer a 200% inverse move of two other indexes. The ProShares UltraShort 7-10 Year Treasury ETF (PST) gives double the inverse return of the Barclays Capital 7-10 Year U.S. Treasury Index, while the ProShares UltraShort 20+ Year Treasury ETF (TBT) does the same for the Barclays Capital 20+ Year U.S. Treasury Index. All three charge an expense ratio of 0.95%

Of course, if negative 200% is a little too tame for you, Direxion offers short Treasury funds that seek an inverse 300% return to their tracking indexes. The Daily 10-Year Treasury Bear 3x Shares (TYO) and the Daily 30-Year Treasury Bear 3x Shares (TMV) also charge a fee of 0.95%.

The new ProShares bond ETF stands out from this crowd in that it’s the only one to offer a 1-to-1 inverse ratio, just a mild negative 100% of its tracking index.

TheStreet.com says the recent uproar over leveraged ETFs has led UBS and Ameriprise to stop selling the funds.

Making the Case for Index Funds

Investing is long term. Speculation is short term.

Can you watch the market every day? If not, you should invest, rather than speculate. Without a doubt indexing is the way to invest. The crash of 2008 has not only highlighted the risk of owning single stocks, but also exposed the dirty underbelly of actively managed mutual funds.

Going for the index avoids getting stuck with the stocks that might be left behind. If you believe in the concept of diversification, then single stock risk is just too huge of a risk to take. And while you might be able to buy 20 stocks and build out a nice portfolio, one bad stock can wipe out 5% of your portfolio and two bad stocks decimate the fund. (Get it? Decimate? Remove 10%. Ok, moving on. …)

If you want to own financials, 30 are better than two stocks. If the two financials you owned last year were Bear Stearns and Lehman Brothers, you, my friend, have completely lost your portfolio of financials, and maybe your entire portfolio. Buying an index fund tracking the financial sector of the S&P 500, such as the Financial Select Sector SPDR (XLF), gives you 80 stocks, about 11% of the S&P 500. You can get more exposure to one narrow niche of the market and diversification at the same time, hence less risky. Sure, the financials took a hit, but considering most of them are still in business, you still have some of your investment.

So, single stock risk is out if you’re not buying for dividends. But what about actively managed mutual funds? The whole point of the actively managed fund is to give you, the investor, alpha, those extra percentage points of return that comes from the fund manager’s skill and intellect. The financial crisis has shown how hard it is to find true alpha.

It’s pretty much common knowledge these days that only about 20% of active fund managers beat the major market benchmarks. Considering many active funds are essentially index fund copycats, you will never beat the market with their huge management fees. Fund managers counter that even if they don’t beat the market going up, they at least have the ability to post narrower losses on the way down, because they can sell off the worst performing sectors while the index can’t. I think a little bit of research will show they are also posting returns worse that the indexes on the loss side as well.

And even those that don’t post worse losses, is a 35% loss that much of an improvement over a 37% loss?

So, if you eliminate single stock purchases and actively managed funds, deductive reasoning says you must go with the index. Of course, this mostly applies to U.S. equities. In some markets, such as emerging markets, a smart manager might have some market knowledge that hasn’t disseminated widely, but in the U.S. that kind of information gets spread around pretty quickly.

Indexes can be volatile and risky. If the stock market falls, an index tracking the stock market will fall. However, with the index fund you can rest in the knowledge you matched the market and didn’t do worse than most of the market.

If you really want a lesson, John Bogle, the inventor of the index mutual fund, explains why indexing is better than stock picking in “The Little Book of Common Sense Investing.” Essentially, Bogle says you can maximize returns and lower risk by not buying single stocks but mutual funds. Followers of Bogle have written a book called “BogleHeads” which expands on this theme.

Now in a shameless plug for myself, my book ETFs for the Long Run takes Bogle’s argument one step further. I agree with Bogle that indexing is the way to invest. Bogle likes the mutual fund structure, but I think Exchange Traded Funds are the mutual fund for the 21st century. In the book, I explain indexing, the advantages of buying mutual funds instead of single stocks and then why ETFs are better than mutual funds. The key reasons being they are cheaper, more tax efficient, more transparent and more flexible. I also explain how to buy and sell ETFs and how to use them to build a portfolio.

Since you don’t know what sector of the market will rise, you should own a broad market index, such as the Vanguard 500 mutual fund, (VFINX), or buy an ETF such as the SPDR, (SPY), or the iShares S&P 500 Index (IVV). The Diamonds Trust (DIA) tracks the Dow Jones Industrial Average and the PowerShares QQQ (QQQQ) follows the technology heavy Nasdaq 100 index. The Vanguard Total Bond Market (BND) is a broad bond index.

Then you break it down into sector specific indexes that you want to follow.

Finally, you need to watch fees. ETFs typically charge smaller expense ratios than mutual funds. However, if you are dollar cost averaging, which in this market is the only way to go, the ETF’s commission will significantly eat into your returns if you invest less than $1,000 a pop. If you are investing less than $1,000 a pop, then go with a no-load index fund. Buying an index fund with a load is like paying for your own security in a gated community. It’s a waste of money.

New ETF Tracks Long Term Corporate Market

State Street Global Advisors launched the SPDR Barclays Capital Long Term Credit Bond ETF (LWC) Wednesday on the NYSE Arca. It has an annual expense ratio of 0.15%.

The fund will track the Barclays Capital U.S. Long Credit Index. The index is comprised of dollar-denominated investment grade corporate and non-corporate credit bonds that have a remaining maturity of greater than or equal to 10 years. As of Dec. 31, 2008, the index held 965 issues with an average dollar-weighted maturity of 24.39 years.

“Demand for access to high quality, long term credit bonds is on the rise as investors search for alternatives to U.S. Treasuries that will improve the yield on their fixed income portfolios,” says Anthony Rochte, senior managing director at State Street Global Advisors in a written statement. “The SPDR Barclays Capital Long Term Credit Bond ETF is the longest-maturity credit bond ETF available to investors and a key addition to our growing family of fixed income SPDRs, which have attracted more than $800 million in net inflows in just the first two months of 2009.”

Currently, there are six long-term bond ETFs on the market. While those focus on Treasuries, the LWC follows corporate bonds, with the possibility of government bonds.

SSGA Launches Intermediate Bond Fund

State Street Global Advisors launched the SPDR Barclays Capital Intermediate Term Credit Bond ETF (ITR) Thursday on the NYSE Arca. It was SSGA’s third bond ETF this month. The fund’s will track an index that tracks the intermediate term (1-10 years) sector of the U.S. investment bond market.