Commodities, ETF, Mutual Fund, Uncategorized
A price war is breaking out in the exchange traded fund (ETF) industry. While it’s not good news for everyone — ETF sponsors, for instance — investors can now get more for their money than ever before! And that makes you the winner of this war.
I talk a lot about the many advantages of ETFs. Very little in this world comes for free, though, and that includes ETFs. The people who design, create, operate and distribute these instruments don’t work for free. Nor should they. But consumers always want value for what they spend, and rightly so.
Today I’m going to tell you a few things about the costs of owning an ETF. As you’ll see, some kinds of expenses are more important than others.
ETF Costs, Inside & Out
The costs of an ETF fall into two broad categories: Internal and external.
Internal costs are the expenses of running the ETF itself. Typically they are paid to the sponsor or other service providers, like lawyers and accountants. These cover things such as management fees, regulatory registration and auditing. Investors never really see these costs because they come out of the ETF assets via the expense ratio of the fund.
External costs are paid separately by investors and are not extracted from the fund. The most common external cost is the commission brokers charge when you buy or sell an ETF.
The good news is that both kinds of costs are falling fast. Why? Part of it is the deflationary economic climate. Wages and many other costs are flat or falling. But the primary reason is growing competition in the ETF industry …
Less than five years ago, at the end of 2005, there were just 224 ETFs and ETNs listed for trading on U.S. stock exchanges. The quantity has more than quadrupled since then hitting 673 by the end of 2007 and 925 last year. So far this year we’ve seen an increase of 130, pushing the total to 1,055.
A few months ago I told you how ETF overload has led to practically identical ETFs from different firms jockeying for a limited audience. And the competition just keeps on growing. I’m sure there will be a shakeout at some point. But for now expenses are one of the few ways sponsors can distinguish their offerings.
For example, just this month Vanguard launched nine new ETFs including Vanguard S&P 500 (VOO). This is a direct attack on the grandfather of all ETFs, SPDR S&P 500 (SPY). SPY alone accounts for about a third of all ETF dollars traded every day. Now VOO is available to cover the same large-cap index at an estimated annual expense ratio one-third lower: 0.06 percent vs. 0.09 percent for SPY.
You might think an advantage of only 0.03 percent a year is negligible. And you’re right. Three basis points on a $100,000 account — which is probably more than most people can or should allocate to any one type of ETF — is only $30.
On the other hand, if you are an institutional portfolio manager with a billion dollars to invest, the difference is about $300,000 a year — enough to buy an exotic sports car.
The pennies saved can add up for big money managers.
What about those external costs, especially trading commissions? Well …
Zero Commissions Are Here!
When the price hits zero it is safe to say trading can’t get any cheaper. And that’s where we are — at least for some investors in certain funds.
Three top firms — Fidelity, Charles Schwab, and Vanguard — now have commission-free ETF trading programs. Buy and pay zero. Sell and pay zero. Do it all over again and pay zero. Nice.
There is some fine print, of course. Each program applies only to selected funds. At Schwab and Vanguard, zero commissions are only for their in-house brand of ETFs. At Fidelity, you can trade for free in some of the iShares ETFs as well as the firm’s one proprietary ETF.
There are other restrictions, too. But I’m guessing they will ease over time. ETF sponsors have figured out that their business is now commoditized. One large-cap growth index fund is as good as any other in many cases.
The differences that attract investors relate more to the bottom line after expenses.
ETF transaction processing is mostly automatic now.
If you were actively investing back in the 1990s, you might remember how revolutionary it was when Schwab introduced their “OneSource” no-transaction-fee mutual fund marketplace. I think something similar will develop for ETFs. Furthermore, trade processing, whether stocks or ETFs, is now so automated that the incremental cost for the broker is negligible.
The sponsors affiliated with brokerage firms, like Schwab, will initially favor their own ETF brands. Yet they won’t be able to sustain that model for long. Once investors have a taste for commission-free trading, it will become as expected as free restrooms in service stations.
And if you don’t have it, your customers will go somewhere else.
We’re not to that point yet. Right now you’ll still end up paying for your ETF trades in most cases. However, you can pay quite a bit less if you shop around.
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Commodities, ETF, Mutual Fund, Uncategorized
In 1998, Long-Term Capital Management (LTCM) lost $4.6 billion in less than four months. Although the hedge fund was led by Nobel Prize winners, noted professors, a Federal Reserve Vice Chairman and well-known Wall Street arbitrage experts, it made two basic, but costly, investment mistakes.
Investing always carries an element of risk. But even the smartest investors can greatly reduce their exposure to unnecessary losses by avoiding common, but often overlooked errors.
Over the Labor Day weekend, I was invited to speak at the annual Lone Star Mensa Conference. Mensa is the largest and oldest high-IQ society in the world. My talk was entitled “The Top 12 Mistakes Made by Brilliant Investors.”
Of the 12 mistakes I covered in my talk, three are especially prevalent — and potentially costly — in today's market. They are not difficult to understand nor are they hard to fix. But it is crucial that investors step up to the plate and tackle these issues right now.
1. Raise cash when you need it the least
One mistake LTCM made was probably the most common mistake smart investors make. It ran out of cash at the wrong time. The hedge fund got caught in one bad investment. To get themselves right again, it had to sell off sound investments. In the end, it turned one loss into many.
As investors, we've been made to believe that to maximize our returns we need to have every penny of our portfolio actively working for us. If we're not fully invested, we equate that with being inefficient or overly cautious. LTCM fell into that same trap. In its heyday, it had the chance to take on more cash and more investors and turned it down. When the “you-know-what” hit the fan, the hedge fund couldn't find the cash.
You can find an investment professional who will sell you on anything — stocks, bonds, real estate, gold, structured products and annuities. But you won't find many who talk about the advantages of cash. It's probably because they don't make a commission on cash.
Gold performed well during the last market crash. Guess what? So did cash. I made money on my cash. I increased my cash position near the top of the market in 2007. Was I a genius? No. I've just been riding in this rodeo a long time.
The better things get, the more you want to be thinking about cash. Cash allowed me to sleep through the night. It also allowed me to pick up bargains at the bottom of the market, without having to sell off my other positions at a loss.
2. Stop protecting your downside risk by limiting your upside potential
Mark Twain once said, “The cat, having sat upon a hot stove lid, will not sit upon a hot stove lid again. But he won't sit upon a cold stove lid, either.”
Almost everyone who was in the market in the last five years got burned. The silver lining is that if we didn't know what our tolerance for risk was — we do now.
But this revelation jarred some investors. They withdrew from the market. In Godfather parlance, they “took to the mattresses.” And unfortunately, they missed out on much of the recovery.
If you got burned, it doesn't mean you have to stay away from the stove. You just have to develop ways to measure your tolerance for heat and the temperature of the stove. I didn't make big changes in my investments. I did, however, change in how I manage those investments.
Just because I was more sensitive to risk than I thought I was, I didn't plow all my money into bonds or CDs — although I do own both. I did, however, start using more tools to protect my gains and limit my losses on riskier assets.
For instance, I bought shares of Olin Corporation (NYSE: OLN) for $12.92 a share for my Stock of the Month portfolio. At the time, about two-thirds of Olin's revenue came from chemicals, making it a very volatile holding. But the remaining third of Olin's revenue was coming from ammunition sales. At the time, ammunition was in tight supply — most stores resorted to rationing just to keep a small inventory on the shelves.
I was down -11.4% on OLN in July of 2009 and set a stop loss to protect against a potential -17% loss. The stock rebounded and I reset my stop loss to protect a +20% gain. As the stock continued to climb, I continued to bump up my stop.
I was finally stopped-out of my Olin position at $19.62 per share in May 2010. Including dividends, I had a total return of +58.0%.
3. Don't invest in what you know best
Peter Lynch became a superstar managing Fidelity Investment's Magellan Fund. From 1977 to 1990, the fund returned an average of +29.2% annually under his watch. One of his famous investment principles was to “invest in what you know.” But this can lead to another common, but costly, error.
Research has concluded that investing in what you know best isn't such a great idea. A recent study looked at 10 years of stock transaction data, comparing it with investors' jobs. The expectation was that individuals' investments in the industries they worked in should outperform the market. After all, they had better access to information and could better understand the significance of that information. But that's not what the data showed.
Instead, all of the study's estimates showed that in cases where investors put money into stocks within their own industries, they underperformed the market.
It's hard to be objective about our own area of expertise. A software developer may get really pumped up about a new application he or she is working on. But maybe a competitor has a better product waiting in the wings. Or even if the new application is successful, the rest of the company's product line might be under pressure.
Sometimes even knowing your company is trumping the competition isn't enough. Industries are cyclical and even the top dog can languish on a down cycle. For instance, Ford (NYSE: F) has had the upper hand on most of its rivals, but all automobile stocks were hit hard going into the recession.
The last thing you want to do is invest solely in what you know or where you work. Many Enron employees had all their investment eggs in the energy company's basket when the company went bankrupt in 2001.
A side note about Peter Lynch and me: I worked summers at Brae Burn Country Club in my home town to earn money for college. Although I got my high school letter in golf, I decided not to work as a caddy. Caddying was hard work and I wasn't exactly big and strong. Instead I worked on the kitchen staff.
Peter Lynch, however, was a caddy at Brae Burn. He ended up working for Fidelity after caddying for Fidelity's president. I ended up putting on four pounds. This was a case where I probably should have invested — at least my time — in what I knew best.
Action to Take –> Remember: Cash is not the enemy. It is your friend. And the time to think about cash is when things are going well — not after the bottom falls out. And even though you might be more sensitive to risk than you once thought, you don't have to sacrifice upside potential. Learn to manage the risk of riskier assets with simple tools offered by almost every brokerage service.
At the end of this year, a series of tax cuts implemented by George W. Bush and his administration between 2001 and 2003 are set to expire. In what now seems like an entirely different era, the cuts were approved at a time when the U.S. government budget was in a surplus and the motivation was to return some of this excess to taxpayers and jump start a tepid economy.
Also at that time, a lack of a clear majority to approve the cuts was a concern. As a result, a special provision was used to ensure the passage of the cuts. Unfortunately, a condition of using this unique provision (and the same one that was used to push dramatic healthcare reforms through earlier this year) was that the federal budget could only be altered for the next 10 years.
Well, the decade since the cuts were put in place flew by and the United States finds itself in a deficit scenario, a Democratic majority, and an economy that is recovering from one of the worst financial crises in history and could slip back into recession at any time.
Luckily for investors, pro-business sentiment has improved and is swaying Congress to consider extending many of these tax cuts. The current belief is that most of the Bush cuts will be extended, except for high-income individuals and families. High income means the 2% of households with incomes above $250,000 per year or individuals making more than $200,000 annually. However, nothing is set in stone and until an agreement is reached, the safest conclusion is to hope for the best but plan for the worst.
Here is a recap of the most important changes that will occur if Washington reaches gridlock and a full expiration of the tax cuts occurs. Starting at the lower end of income levels, the 10% tax bracket will revert back to 15%. The 25%, 28%, and 33% rates will all increase 3%, respectively, while the 35% rate would revert back to 39.6%.
From an investment standpoint, long-term capital gains taxes will go back to 20% from 15% for those in the middle and upper tax brackets. The taxes on dividends will go up dramatically, reverting back to regular income tax rates from the current 15%.
Estate taxes will return with a vengeance and will reach up to 55%. More generally, standard deductions will decrease for married couples, the child tax credit will fall by half to $500, and other exemptions for individuals with high incomes will no longer be allowed.
Statistics abound over what these changes will mean to taxpayers. If everything expires, middle class taxpayers are predicted to see an average rise in taxes of $1,500 each. The average tax rate for all income classes would raise to about 23.5% if everything expires, which would be up from 20.8% currently. If the President gets his way, however, this blended rate will rise only slightly, to about 21.4%.
Action to Take —> With that, there are a number of ways you can position your portfolio. For starters, consider shifting income-producing investments into retirement accounts and other buckets that may provide a shelter from taxes. For the biggest bang for your buck, consider high dividend-paying stocks, high-yield bonds, master limited partnerships (MLPs) or bonds picked up on the cheap during the height of the credit crisis.
Other strategies to consider consist of taking capital gains before the end of 2010 or even selling higher-yielding investments for those with total return potential focusing on price appreciation, so that capital gains can come from unrealized gains.
There are plenty of options for investors looking for appealing opportunities. For more individual strategies, here is an extremely useful report that can help you generate ideas. Specifically, it offers approaches that can allow you to avoid getting hit by any coming tax hikes and collecting above-average income at the same time.
– Ryan Fuhrmann
A graduate of the University of Wisconsin and the University of Texas, Ryan Fuhrmann, CFA, adheres to a value-based investing viewpoint that successful companies…
Investors have got the fever. After seeing 3PAR (NYSE: PAR) jump from $10 to $30 a share and ArcSight (Nasdaq: ARST) zoom ahead from $25 to $43 in the last month, they are pushing up shares of any name they think might be the recipient of the next sweet buyout offer. And now investors have set their sights on Akamai Technologies (Nasdaq: AKAM), pushing its shares up from below $40 in late July to a recent $51. Trouble is, shares were likely overvalued before that surge began, and are now very overvalued when measured against the fundamentals. If a suitor doesn't emerge — and it's not clear that one will — then shares could give back all of the recent gains.
A CDN pioneer
Akamai helps major web sites provide very fast response times to users located anywhere in the world. If you're downloading a popular video in Madrid, there's a decent chance that a local Akamai server is serving up that file, eliminating the need to transmit that content over long distances while the user sits and waits. And in recent years, the company has developed other software tools to help customers stay on the cutting edge with its Content Delivery Network (CDN).
As consumers looked to consume more media and entertainment online, demand for Akamai's services exploded, helping sales rise at an average of more than +30% per year from 2004 to 2008. But success — and an increasingly large industry opportunity — has a way of attracting new competition. And that began happening in recent years, which helps explain why growth cooled to less than +10% in 2009. Akamai's shares, which hit $50 in early 2007, fell below $15 in late 2008 as investors realized that the CDN industry had become crowded and very cost-competitive.
A 2010 and 2011 rebound
Akamai is once again on the upswing as renewed industry growth, along with a push into ancillary services, is offsetting a steady decrease in CDN pricing. (These companies get paid monthly fees for providing CDN services, and contracts are usually renewed at ever-lower prices). The favorable industry trends are likely to push Akamai's sales up nearly +20% this year and another +15% in 2011.
But more headwinds loom. Companies such as Amazon.com (Nasdaq: AMZN) are vowing to make a bigger push into the CDN business, and major telecom operators such as AT&T (NYSE: T) also realize that their networks are ideally suited to carry higher volumes of CDN traffic. As a rule of thumb in this industry, increased competition invariably leads to faster CDN pricing declines.
None of this suggests that Akamai is in real trouble. Demand for CDN services will keep growing, the company has a very strong balance sheet, and many of its customers are likely locked in for the long-haul. But this is not a great long-term story from a revenue growth perspective, thanks to those ever-present price decreases.
Yet shares have zoomed ahead to levels that give the impression that Akamai is a young fast-growing upstart. Shares trade for more than 30 times next year's projected profits and close to 20 times EBITDA, on an enterprise value basis. The shares are currently trading just below $51 — analysts at Maxim Group think fair value is closer to $35. Citigroup's analysts are slightly more bullish, assuming a $42 target price, noting that shares deserve to trade no higher than at 25 times next year's profits.
Action to Take –> Shares of Akamai took a big hit in 2008 as investors realized that this is becoming an increasingly crowded business with real price pressures, so potential buyers are unlikely to pay much of a premium after the recent run-up. It's not even clear that any potential acquirer could justify buying the company now and make the deal work from an EPS growth perspective. For that matter, who knows if Akamai is in play at all?
If you've been holding Akamai in your portfolio, this looks like a great time to exit that position. If no buyer emerges for the company in coming weeks and months, then shares are likely to move back toward those analyst price targets. Moreover, shares are so richly valued that they have created an excellent opportunity for shorts, which may see this stock move back below $40 as a deal fails to materialize. The main risk to the short thesis is an actual buyout, which again, appears unlikely.
– David Sterman
David Sterman started his career in equity research at Smith Barney, culminating in a position as Senior Analyst covering European banks. David has also served as Director of Research at Individual Investor and a Managing Editor at TheStreet.com. Read More…
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.
This article originally appeared on StreetAuthority
Author: David Sterman
A Great Time to Short This Overvalued Stock
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A Great Time to Short This Overvalued Stock
Everywhere I turn, I see headlines about the “bond bubble.”
“The Great American Bond Bubble” — August 18, 2010, The Wall Street Journal
“The Unstoppable Bond Bubble” — August 16, 2010, Fortune
Clearly, the demand for bonds has been rising — pushing prices up and pushing yields down. The Investment Company Institute reported that from January 2008 through June 2010, bond funds saw an inflow of $559 billion. Equity funds, in contrast, experienced withdrawals of $242 billion.
But are bonds overpriced? Do they represent more risk? Are they bubbling?
The chart below shows the yield spread between the 10-year Treasury note and corporate bonds rated “Baa.” According to Moody's, “Baa”-rated bonds are investment-grade, but still carry moderate credit risk.
As you can see, the difference between corporate bond yields and Treasury note yields grew during the financial crisis. In December 2008, corporate bonds were yielding 8.4%. At the same time, investors clamored for the safety of U.S. Treasuries. The yield on the 10-year Treasury fell to 2.4% — 600 basis points lower.
As the financial credit crisis improved, the yield spread narrowed. But it still sits above pre-crisis levels. The “Baa” corporate bond yield in August was 5.7%, just about where it was five years ago. The yield on the 10-year Treasury, however, is 150 percentage points lower than it was five years ago.
If I had to pick a group of bonds that may be a little pricey, it would be U.S. government debt. I understand why investors may be reluctant to buy equities. It takes a strong stomach and an acute eye to withstand the rocking and rolling of the U.S. equity market these days.
But I'm a little stymied at why investors would settle for the 2.7% yield on a 10-Year Treasury note — or the 0.12% yield on the 3-month Treasury bill.
Corporations are Stronger
The U.S. economic recovery may be slowing, but companies have strong balance sheets. The non-financial companies in the S&P 500 are sitting on $837 billion in cash at last count — which is much higher than normal — and +26% more than they had last year.
The default rate on even the most speculative corporate bonds has dropped this year. In June, the ratings agency Fitch reported that the default rate on high-yield bonds was running at a full-year rate of roughly 1%. In 2009, the default rate for speculative bonds was 13.7%.
Many Non-U.S. Economies Are Stronger
While U.S. economic growth could slow, other economies in the world continue to show strength. Vietnam's economy grew +6.4% in the second quarter of 2010 and could grow by +7.0% this year. The International Monetary Fund expects India's economy to grow +9.4% in 2010. And Chile just reported its best quarter of economic growth in five years.
It's true, other countries are leaving the U.S. economy in the dust, and paying our significantly higher yields on their government debt. [Read: How to Lock in 8% Government Yields]
Action to Take –> While U.S. debt is considered a classic safe haven, the price of safety may have become just a little too high. There is not much upside potential left for U.S. Treasuries. And there certainly is little yield compensation — especially when compared to the 8.0% yield of the PIMCO Corporate Income Fund (NYSE: PCN) and other bond funds.
Bonds are in demand; there is no denying it. But there are some good reasons to like corporate and foreign debt.
Inflation is low — increasing just +1.2% in the last 12 months. The U.S. equity market is being stingy with returns — the S&P 500 is up just +2% year-to-date. Many corporations and emerging markets have healthy balance sheets, easily carrying their debt burdens. And baby boomers are growing older, ensuring a continued demand for fixed income securities for the foreseeable future.
A 10% yield is high in any market. In today's market, it's stratospheric. The S&P 500 is only yielding 2% and a three-year CD currently pays about 1.77% on average.
Is a 10% yield too good to be true?
Often it is. A yield that high usually just means that the stock price has plummeted because of deteriorating earnings and fundamentals. But, could there be 10% yields out there with strong earnings and fundamentals behind them? If so, they are a tremendous find in today's flat markets. After all, a 10% yield not only provides an income but also gives investors a +10% return per year, even if the stock price does nothing. That beats the S&P 500's return during the past 10 years by about 11% per year.
There are special risks and opportunities associated with these high dividend payers. But, here are three high yielders worth a second look.
PennantPark Investment Corp (Nasdaq: PNNT) is an interesting high yield play from the world of business development companies (BDCs). This company makes money by finding promising medium-sized private companies in need of capital and loaning them money at high rates of interest.
BDCs are strong dividend payers because they do not pay income taxes at the corporate level. PennantPark has paid steadily rising quarterly dividends since its IPO in 2007 and the last payment increased in April to $0.26 per share. At the current rate, the stock yields a not-too-shabby 10%.
Can the company keep it up?
Lately, PennantPark has been raising money to grow earnings in the capital markets.
Real Estate, Uncategorized