How High-Yield Assets are Performing in 2015

Everything with a Yield is in Trouble

There was a whole lot of crazy in the markets this week. From Greece to China to the corner of Wall St. and Broad St., things were indeed wild.

Greece’s bailout woes, China’s stock market plunge and a computer outage on the trading floor of the NYSE all contributed to the strange week. Yet, by midday Friday, stocks in the Dow were up some 200 points, and the major U.S. indices were on pace to enjoy a winning week.

This is the kind of trading week that’s easy to get caught up in. It’s also easy to lose track and forget what’s gone down for most of the year.

Given our tendency to focus on the very short term, I want to step back and take a look at the performance table here of the biggest exchange-traded funds (ETFs) by assets during Q2 and year to date.

By doing so we can identify the operative patterns influencing our investments, as well as what investment trends are most likely to net us positive results going forward.

Top 20 ETFs by Assets in Q2, YTD

The dominant theme I see here when assessing the data is: everything with a yield is in trouble.

During Q2, we saw many Q1 winners falter, including the major exchange-traded funds (ETFs) such as the SPDR S&P 500 (SPY), iShares MSCI EAFE Index (EFA) and iShares MSCI Emerging Markets Index (EEM).

The big reversals of fortune were in high-yield categories, with the Vanguard REIT ETF (VNQ), iShares Lehman Aggregate Bond (AGG) and iShares iBoxx $ Liquid Investment Grade Bond (LQD) all seeing a big downturn in Q2.

What all of these funds have in common is that they all are interest-rate sensitive. That means they’ve sold off in anticipation of the Federal Reserve’s first interest-rate hike in nearly a decade.

If you have a lot of exposure to high-yield income funds, now is the time to check your positions out and make sure you can absorb the inevitable downturn here once the Fed squeezes the trigger and finally raises the cost of capital.

That first rate hike is most likely going to come this year, so you had better be prepared.

ETF University: Learning the Lingo (Parts I, II)

Exchange-traded funds have come a long way during the past several years, yet despite how far they’ve come, I still encounter many investors who aren’t familiar with some of the basic terms and lingo associated with ETFs.

The lack of solid foundational knowledge when it comes to ETFs is something we’ve moved to correct with of ETF University at the ETFU.com website.

During the past two weeks, we’ve gone back to basics so that we all are on the same page when it comes to “speaking ETF,” learning the basic ETF lingo that’s crucial to further your understanding of these most excellent investment vehicles.

This week, I wanted to present both Parts I and II of our lingo series, so that in case you missed either one you can have them all here this week.

The following are the top 10 key terms and concepts that you must become familiar with if you are going to invest using ETFs.

1. ETF Expense Ratio: This is the cost of ownership in a given ETF. Basically, this is what it costs an investment company to manage the fund. Expense ratios in ETFs are far less, on average, than they are in mutual funds. The cost efficiency with ETFs is one of their most-attractive attributes.
2. Leveraged ETFs: These ETFs employ futures and options contracts on a particular sector or index in the pursuit of a specific performance goal. Some leveraged ETFs are designed to deliver twice the daily results of the underlying index, while others are designed to deliver three times the daily performance. These funds should be used sparingly, as they are more volatile than non-leveraged ETFs.
3. Inverse ETFs: Funds that are designed to deliver the opposite of an index’s performance. For example, if an index falls 2% during a given trading session, an inverse ETF should rise 2%. Inverse funds are usually used during bear markets, as they allow investors to profit from falling equity or bond prices.
4. Country-Specific ETFs: Funds that hold equities based only in a specific country. The focus of these funds means you get targeted exposure to that country’s equity market.
5. Currency-Hedged ETFs: These are ETFs that use currency futures to help hedge out the influence of currency fluctuations on their underlying holding’s performance. These funds work well when country-specific funds have a struggling currency.
6. Market-Cap-Weighted ETFs: These are ETFs that follow the traditional market-capitalization-weighted indexes like the S&P 500. Companies with the largest market capitalizations will have the highest weights in the index, and thus the highest allocations in a specific ETF. The opposite here is an Equal-Weight ETF, which invests in each component of an index equally.
7. Long/Short ETFs: Funds that employ a strategy of going long one sector while shorting another. The strategies here can be complex, or relatively simple, depending on the fund. Traditionally, long/short ETFs have offered lower volatility and a lower correlation to the major domestic markets.
8. Developed Market ETFs: These are funds that invest solely in the developed world’s equity markets, e.g. the euro zone, the United Kingdom and the United States.
9. Emerging Market ETFs: These funds invest only in emerging market countries, specifically China, Brazil, India, Russia and many others.
10. Frontier Market ETFs: This segment of the ETF market invests in very small, undeveloped countries that typically are much riskier than emerging markets. Sometimes referred to as “pre-emerging market countries,” they include nations such as Argentina, Egypt and Nigeria.

For more information regarding all things ETFs, check out ETFU.com.

Clarity and ‘Fed Speak’

“If I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.”

— Alan Greenspan

The former chair of the Federal Reserve and the concept “clarity” don’t usually go hand in hand, but here Alan Greenspan flips the script on us, implying that his infamously cryptic “Fed speak” was all part of the plan. Remember this the next time you try to decipher the current version of Fed speak.

Wisdom about money, investing and life can be found anywhere. If you have a good quote you’d like me to share with your fellow Weekly ETF Report readers, send it to me, along with any comments, questions and suggestions you have about my audio podcast, newsletters, seminars or anything else. Ask Doug.

In case you missed it, I encourage you to read my e-letter column from last week about how key sector ETFs performed in Q2 2015. I also invite you to comment in the space provided below.

Upcoming Appearance

I will be attending the San Francisco MoneyShow, July 16-18, at the Marriott Marquis. To register, click here. Mention priority code 038970.