Bond ETF Investing And The Debate Over Long-Term Treasuries: Don’t Get Distracted.

Aug 29, 2010 in Bonds

We have watched with amusement all the discussion of bond ETF investing as it relates to ‘bubbles.’  Remember that the bond market as defined by the Aggregate Bond Index has a duration[1] in the 4-5 year range.   This is where the real investable bond market is – not 30 year treasuries.  

Indeed, by our ETF database (which covers >96% of overall ETF/ETN assets), we see that less than 10% of total treasury bond ETF assets are in bond funds with durations greater than 10 years.  Our overall weighted average estimate of the duration of ETF investors aggregate duration in the Treasury bond grouping is 4.9 years.

Now, it IS true that the risk of drawdown for 10- 30 year bonds becomes more significant after a parabolic spike up like the one we have been in – but this should be obvious as this is just the nature of volatility.   Long duration bonds are very volatile securities – and when a highly volatile security goes parabolic, drawdown risk will increase.  We find it irrelevant and distracting to listen to this talk of bond bubbles and more practical to think in terms of actual drawdowns within the bond market sub-segments.    

Here is an ETF Volatility Chart of relative volatilites across some different kinds of ETFs. We included IEI (~4-5 year duration U.S. Treasury ETF) because it represents the weighted average duration of all Treasury bond ETF investor assets:



[1] Duration measures how fast you are to be paid your money back.  It adjusts for the stated coupon so that if your bond pays a high coupon, the duration is lower as you are being repaid more quickly and therefore the variability of possible cash flows is reduced. 



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ETF Total Return vs Price Return Chart Review

Aug 17, 2010 in Total Return

Given the markets strong preference for yield this summer -- witness repeated new highs in Corporate Bond Indexes, Preferred Stock Indexes, Master Limited Partnership (MLP) Indexes, High-Yield Bonds, Emerging Market Bonds etc...  we wanted to update some charts to show how the difference between total return and price return works out:

Longer-Term Treasury Bonds (TLT):

Utility Stocks (XLU):

Consumer Staples (XLP):

High-Yield Bonds (HYG):


ETF List of New Highs Can Help You Understand Money Flows

Jul 28, 2010

This summer is a good reminder that ETF investing does not revolve exclusively around equities.  After assuming a leadership role in early May, many non-equity forms of ETFs have made repeated new highs over the past few months.  Treasury Bond ETFs have been the most obvious example of relative strength but other groups performing well include: the Master Limited Partnership products (AMJ), Emerging Market Bond ETFs (EMB, PCY), Preferred Stock ETFs (PFF,PGX, PGF) and more recently, U.S. Utility Stock ETFs (XLU, IDU, VPU).  

What do the majority of these ETFs have in common? Most of the recent 6-month ETF list of new highs involves indexes associated with yield (and lower relative volatility vs the S&P 500).

Try the interactive functionality of the above webpage here: New Highs and Lows App

With regard to equities, we’ve seen some new multi-month highs made in some select Asian and Latin American equity indexes.   We will be watching to see to what extent other equity country funds can confirm this new potential leadership area (emerging markets equity).     

U.S. stocks made fresh six-month lows at the beginning of this month.   The drawdowns of some of the primary indexes this year have been -15.7% for the S&P 500, -20.1% for the Russell 2000 (IWM) and -22.8% for the Vanguard Europe ETF (VGK) (drawdown is the maximum high to low correction using closing prices).   These groups have rallied hard over the past 20 days but they appear to be in a holding pattern as evidenced by their poor/mediocre rankings on 3 & 6 month relative strength lists.

Another important item to point out is that owning bonds and yield-oriented hybrid securities (like those listed above) has been a LOWER volatility method to making money these past few months.

When the market gets volatile – as it does during corrections – buying inverse ETFs may seem like a good way to make money -- but remember, the Sharpe Ratio penalizes for volatility and you must expect large returns to offset taking on such rising volatility environments.  Short-sellers have been punished hard this month while lower volatility funds (like those listed above) have appreciated.

In some respects, owning bonds -- particularly treasuries -- is a dominant method over shorting stocks.   The volatilities are far lower if you keep your maturities reasonable.  Thus you can express a bearish view without taking the same risk as you do during hard short-squeezes in equity markets.

We think it’s important to stay abreast of what the market itself is telling us through relative strength. When combined with your own fundamental ETF ideas, this market-generated information can be the key edge you have in terms of finding profitable entries and exits.

As we proceed further into the 2nd half of 2010, we have every intention of finding market segments that stay consistent with our global relative strength models.  Near-term, look for pullbacks in some of the improving relative strength ETFs to make any adjustments necessary to your portfolios net exposures.


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Stock-Picking vs ETF Relative Strength

Jul 09, 2010 in Relative Strength


The issue with ‘value-add’ in investment management is complicated.  Strong performance by stock-pickers is in many cases due to implementation of a particular strategy (such as strongly overweighting ‘financials’ or ‘foreign stocks’). 

If a manager does a good job in finding good strategies such as ‘financials’ -- that is, financial stocks do well – then do we really care that much about the extra return on top of that of stock-picking?   Remember, stock-pickers who perform in one era don’t often repeat it – usually because their particular ‘strategy’ goes out of favor.  

If we pick 2 managers that have a core ‘financials strategy’ --- and the financials sector goes up 45% --- do we really care that one manager did +48% and the other did +42%?   Your allocation made a lot of money as you captured that 45% gain, on average.   But we could also just do the same thing buying a low-cost financial index ETF and get the same +45% index result and have zero risk of underperformance.  

Core ‘beta strategies’ like this can all be replicated with ETFs at very low cost.  If a portfolio manager or investment advisor is good at picking market segments (good at picking ETFs), then they should be paid a fee for capturing the return of a good idea -- even if they don’t outperform that segment.  An investment advisor that picks good ETFs is adding significant value.      

For a private investor, doing it yourself makes a lot of sense in a world of low-cost ETFs.  You will of course need good, well-structured data in order to make good investment decisions.  Everyone does  -- from high-end hedge fund managers to individual investors to professional investment advisors.   We provide users with good ‘institutional-grade’ analysis apps that focus on precise methods and techniques for helping you with specific, backtested entries and exits on timing investment STRATEGIES (ETFs).


Snapshot of an ETF Relative Strength Strategy Using Bond ETFs (Starting Point End of 2007 -- near inception date of JNK -- and INCLUDES the credit crisis that hit Junk Bonds in 2008). 



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The IBD 100 is Essentially A Relative Strength Index

Jul 08, 2010 in Relative Strength


The Investors Business Daily (IBD) 100 is at its core a Relative Strength backtest of the IBD stock universe. Note that IBD's method is to also use its larger market BUY and SELL signals and these do not show up in the chart below.

If you use fixed-income ETFs in your screening/backtesting lists -- you effectively automate the 'Buy-Sell' signals by naturally rotating into the higher relative strength bond ETFs as stocks breakdown and bonds rally. We suggest using intermediate or short-term bond ETFs in your lists. Long-dated treasury ETFs can suffer from very high volatility -- and a key concept is to avoid highly volatile securities UNLESS they offer high expected returns. This is unlikely the case for most bond ETFs -- bond ETFs best attribute is their stability in times of turbulence.

Note also that while the IBD 100 is compared to the S&P 500 below, it does often own foreign stocks that trade on U.S. exchanges. While we cannot calculate the volatility of the IBD-100 since we don't have the data series, we suspect its volatility is far greater than the S&P 500. Remember that when volatility is HIGHER, you would EXPECT larger relative drawdowns.


This image captures the cumulative return of the IBD 100 index up through June 18, 2010 (note the massive drawdown in 2008).





Bond ETF Year To Date Total Return

Jun 22, 2010 in Total Return

True leadership in bond ETF segments continues as new 6-month highs today in a number of key bond indexes. You must understand total return in order to properly understand this as price charts through standard websites do not track the total return of the indexes. New 3 & 6-month highs among many major bond ETFs -- here are two:



ETFreplay continues to work hard on new functionality and will continue to release new products so check back in. In the meantime, we have listened to users requests and have made a number of enhancements such as:

* Much improved printing in the charts and tables (on ETF Charts, note the user 'control' at bottom of page -- a check box option -- to set up page for printing with white background - it prints quite nicely).

* The moving average backtest now has choice of either daily or monthly moving average.

* We have updated the video for the Relative Strength Backtest page


If you have any comments or requests, use the Contact Form to send us a message.


kind regards,




ETF rotation made easier to view and analyze with new ETF App

Jun 13, 2010 in Relative Strength | Video

ETF rotation is the focus of this video -  showing how our portfolio ranks summary 'app' Portfolio Screener Ranks-- can be used as an easy way to visualize leadership in custom ETF lists created by the user.

This video shows this new functionality by using recent news involving Bill Gross of Pimco and how relative strength LEADS the news.


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ETF Relative Strength Update:

Jun 04, 2010 in Relative Strength

US equities had led all asset classes for many months headed into late April. When global volatility picked up on the problems in Europe, this caused global equity correlations to rise. Since rising volatility is a negative contributor to expected equity returns, we forecasted a move down in the relative strength rankings for US equities relative to bonds and gold.

We highlighted a move to gold that triggered in our Relative Strength Application at the end of April. Gold has already shown its worth as gold had a positive return in May of +3% (+1100 basis points vs S&P 500) despite possible deflationary conditions in the Eurozone.

Our ETF Screener models tell us how money is flowing and US Treasury bond ETFs continue to lead the ETF relative strength rankings and are attractive on pullbacks. Because long-duration treasuries are quite volatile and don’t offer much yield, we prefer the 3-10 year treasury maturities. The chance of a large drawdown with an average duration in the 5-7 year range is quite low because of the very structure of intermediate bonds. We can look at history as a guide on this and see that while there were very large drawdowns in long-dated treasuries during the 2009 bond-market correction, the mid-term treasuries were significantly safer. So while a continued ‘flight-to-safety’ trade benefits long-duration treasuries most, we think investors should always consider risk in relation to return. And so for risk reasons, our preference is for intermediate treasury ETFs (for example IEI, IEF, BND).

This is a common situation ETF investors should get used to --- where you can like an area of the marketplace but choose to simply avoid the highest volatility ETF’s within that segment in order to control portfolio risk and target Sharpe Ratio (risk-adjusted returns).

Controlling drawdowns is a significant aspect to money management and is a primary reason we created ETFreplay. The very first application we built was a portfolio management module in order to help investors understand volatility and that implication for drawdowns. Remember this basic rule: the higher the volatility, the higher the drawdown.

On the negative side of the ETF Screener models, global forces have continued to aggressively sell equities. As seen below, the broad FTSE All-World Ex-US ETF (VEU) has so far experienced an -18.8% high to low drawdown over the last 6 weeks.



Summary: risk budgeting is a very important aspect to portfolio management . For sophisticated investors, discussing return without the context of risk is meaningless. Our backtest portfolio app allows users to simulate risk budgets by entering ETF weightings and viewing various market segments (as represented in ETFs) relative to some common major benchmarks, whose properties are well understood.



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Examining The Important Link Between Volatility and Drawdown

Jun 01, 2010 in Drawdown | Volatility

You hear the term ‘volatility’ thrown around a lot but it is really not well understood outside of the options market community.  Ask people outside the options community how to calculate volatility and they will likely stutter (including professional advisors).  

Using a chart in combination with volatility can visually show the important link between volatility and ‘drawdown.’  This chart looks at a simple comparison between the Barclays Aggregate Bond Index, the S&P 500 and the ProShares 2x Leveraged Long S&P 500 ETF.

ETF Charts

In this case, we know that the ProShares fund has exactly 2x the daily volatility of the S&P by design and so we expect it to have 2x the daily volatility, by definition (excluding tracking error and any expense ratio differences – which are usually trivial).    

But we would like to take this one step further -- as you observe various indexes, you can and should use the relative volatility of any ETF as a general guide to how much it may lose relative to the market in a correction.  It’s not that the precise historical volatility figure will predict the future volatility, it won’t.   But the historical volatility will offer a very good estimate of the RELATIVE size of a correction vs something like the S&P 500.

It’s a good rule to remember: the higher the volatility, the higher the drawdown.   If you buy and hold the most volatile ETFs, it’s just a matter of time before you will face a significant drawdown.   

Below is a chart that replaces the ProShares 2x ETF with an unlevered fund:  the very popular Brazil fund (EWZ).   

ETF Charts

Note the extremely high relative volatility --- and the larger drawdown.  If I graph volatility historically, you will see that in every observed instance, EWZ is materially more volatile than the S&P 500.   This does not by itself make EWZ unattractive – it depends on your return forecast for EWZ.   Should your return forecast for EWZ justify the increased volatility, then this is good news -- you would own it.

Summary:  the securities with the highest marginal contribution to portfolio risk should provide the highest expected returns.  This entirely logical concept tells the portfolio manager if their portfolio positioning is consistent with their own beliefs.



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Video Blog: Using and Understanding the Portfolio Relative Strength Application

May 27, 2010 in Backtest | Video

This video discusses some ideas related to our powerful new ETF Relative Strength Application. The key to understanding how it works is to understand its relationship with the ETF screener

Comments and feedback appreciated.

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