3 reasons why you aren’t diversified
Few investors truly understand what it means to have a diversified portfolio. Most believe that owning 20-50 stocks, or a few mutual funds, means that they are diversified. But they are dead wrong. “Dead” because without being properly diversified, in extreme market situations, a portfolio can permanently lose capital and never recover. Those who owned a “diversified” portfolio of technology stocks in early 2000 when the Nasdaq reach 5000, have never recovered. Neither have those who held a “diversified” portfolio of financial stocks like General Electric (GE) and Bank of America (BAC) going into 2008.
Proper diversification is about managing risk — making sure that when the markets are down, you lose as little as possible, and when they are up, that you recover and capture your fair share of returns. Being well diversified is the “only free lunch” in finance because using methods from proven and scientific knowledge about investing, you can dramatically lower risk without suffering a reduction in returns … and it really is free!
Just like following a prized recipe, the ingredients of diversification are simple to acquire, but rarely followed. Here are three tests to make sure you have a truly diversified portfolio.
Asset Classes. A well-diversified portfolio is not about US stocks — it includes at least six asset classes. You should have at least 5% of your portfolio—but no more than 30% — in all six core asset classes: U.S. and foreign developed countries (Europe, Japan, Asia), emerging-market countries (Brazil, Russia, India China) bonds, real estate and commodities.
Like each instrument in a jazz band, each one of these asset classes plays a valuable role in different economic circumstances. US Treasury bonds protect against economic meltdowns like the one experienced in 2008, but they lose value from inflation and slow down overall portfolio growth. Real estate hedges against inflation, provides a steady income stream, and can appreciate like stocks, but it is not immune to economic cycles. How much to invest in each asset class differs depending upon your stage in life — but everyone should have all six. A retiree seeking income, may have 80% of his portfolio in bonds, but also own global equities as an inflation hedge.
The term asset class is widely misunderstood. Industries and sectors are not asset classes. Economic sectors (technology, utilities, financials, basic materials, or consumer durables) are not asset classes. Nor are the industries within a sector. The software, communication equipment and computer hardware industries are within the technology sector. For U.S. investors, foreign countries are not asset classes.
Number of Securities. Within each asset class, diversified means you must own hundreds of stocks or bonds to reap the returns of that asset class. You do not want any individual company or country (besides the U.S.) to have an impact on your portfolio. A typical MarketRiders portfolio includes over 6000 stocks and 3000 bonds.
For example, if you want exposure to emerging markets, owning 20 stocks from a few different countries won’t do it. Owning a China fund like iShares FTSE China 25 Index Fund (FXI) is not enough diversification. But Vanguard’s Emerging Markets ETF (VWO) allows you to own over 900 companies in 28 countries, giving you fantastic diversified exposure. You are riding entire economies of many countries without worrying about getting hurt by an individual business within them. Sure, you’ll miss the joyride you get owning an Apple (AAPL), but you will also miss the dread when a company like Citibank (C) loses 80% of it’s value.
Funds, Not Stocks. It is nearly impossible to be well diversified owning individual stocks. Trading costs and the software required to own the necessary number of stocks required are beyond the reach of individual investors. So you must own funds.
Actively managed mutual funds have wide discretion in how they can invest. Most funds can invest 10%-25% outside of their “advertised” charter. You could invest in a Foreign Developed country fund and find that a large percentage of your investment is in the U.S. You can’t manage your allocation when your managers don’t have to stick to their charter. It would be like having your guitar player suddenly decide to start playing a flute.
Owning ETFs gives you razor-sharp precision in your allocations. If you own, for example, the iShares Small Cap US Stock ETF (IJR) you won’t find foreign stocks in that holding. And ETFs are dirt cheap — our portfolios are built solely with ETFs and have an average expense ratio of .2% which is an average of 80% less than a mutual fund portfolio. Cheap and precise … how do you beat that?
Look under the hood of your portfolio. Do you own over 10,000 securities? Are your funds overlapping, giving you double or triple ownership in the same stocks? Is your money spread all over the world, in all sectors, all industries, and in all kinds of debt? If not, you are missing that free lunch, and during the next recession, you will feel it way more than those of us who have taken true diversification to heart.
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UDR Completes Asset Sale – Analyst Blog
UDR Inc. (UDR), a leading multifamily real estate investment trust (REIT), has recently completed the sale of 15 unencumbered apartment communities totaling 4,931 units for gross proceeds of $477 million.
The asset sale is part of the long-term strategy of the company to exit the Phoenix, Arizona; Jacksonville, Florida; and Fredericksburg, Virginia markets. The divesture of the non-core assets is also expected to fully fund the $500 million development and redevelopment expenditures likely to be incurred by UDR in 2012.
UDR is among the best-positioned multifamily apartment REITs in the U.S., with the majority of its portfolio located in California, Florida and on the Atlantic Coast. These are areas where housing costs have soared in the past few years, and despite the drop in home values, the rent vs. ownership spread remains high. The housing meltdown will continue to help apartment REITs like UDR and we expect this sector to remain comparatively stable in the coming quarters as well.
Furthermore, UDR has a geographic diversification that increases investment opportunity and decreases the risk associated with cyclical local real estate markets and economies. It thereby works to increase the stability and predictability of the earnings.
UDR has also continuously upgraded the overall quality of its portfolio by selling smaller market, older properties and replacing them with newer assets in better long-term markets. This provides an upside potential for the company. As of March 31, 2012, the company owned 60,211 apartment homes, including 2,972 homes under development.
We maintain our Neutral recommendation on UDR for the long term, which currently has a Zacks #3 Rank that translates into a short-term Hold rating. We also have a long-term Neutral recommendation and a Zacks #2 Rank (short-term Buy rating) for Apartment Investment & Management Co. (AIV), one of the competitors of UDR.
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FDA Nod for Perrigo Generic – Analyst Blog
Perrigo Co. (PRGO) recently announced that it had received US Food and Drug Administration (FDA) approval for its abbreviated new drug application (ANDA) for the generic version of Duac Gel.
With the Perrigo ANDA being the first para IV filing, Perrigo should be entitled to 180-days marketing exclusivity for its generic version. The FDA is yet to decide on the exclusivity status. Perrigo has already started shipment.
Duac Gel, developed by Stiefel, a GlaxoSmithKline plc (GSK) company, is a clindamycin phosphate and benzoyl peroxide 1.2%/5% topical gel for the treatment of inflammatory acne (pimples). The product recorded annual sales of around $130 million last year.
We note that the acne market has been in the news recently with Mylan, Inc. (MYL) and Impax Laboratories Inc. (IPXL) receiving FDA approval for their respective generic versions of Warner Chilcott’s (WCRX) Doryx (150 mg). Mylan has already commenced shipping the product.
We note that Perrigo has received quite a few approvals on the generic front over the past few weeks. Earlier this month, Perrigo received FDA approval for its generic version of hyperphosphatemia drug Phoslo Gelcaps.
The FDA also cleared Perrigo’s generic version of KV Pharmaceutical Company’s vaginal cream Gynazole. Moreover, the FDA gave final approval to Perrigo to market its generic version of Novartis’ (NVS) heartburn drug, Prevacid. Approval was granted to treat patients suffering from frequent heartburn (two or more days in a week). Perrigo launched the drug in the US following receipt of final approval from the FDA.
Our Recommendation
We note that the availability of generic equivalents will be easy on the pockets of patients as generic drugs are much cheaper than their branded counterparts.
We currently have a Neutral recommendation on Perrigo. The stock carries a Zacks #3 Rank (short-term Hold rating).
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AIG Issues Notes Worth $750M – Analyst Blog
According to a report from Thomson Reuters, American International Group Inc. (AIG) recently vended off senior unsecured notes worth $750 million. The notes were issued through reopening of a similar $750 million offering that was completed on May 24, 2012, thereby increasing the size of debt issuance to $1.5 billion.
These long-term unsecured notes of $750 million were issued at a price of $101.942 and dated to mature on June 1, 2022. These callable 10-year fixed rate notes are projected to have a spread of 300 basis points (bps) over the US Treasuries, bearing a coupon rate of 4.875% and yield rate of 4.628%.
Interest on the notes will be payable semi-annually, in equal installments, commencing on December 1, 2012. Further, AIG appointed Citigroup Inc. (C) and Goldman Sachs Group Inc. (GS) as the joint book-running managers for the sale.
Earlier, in May this year, AIG had also issued another set of 10-year unsecured notes worth $750 million at an issue price of $99.077, scheduled to mature on June 1, 2022. Additionally, these notes were projected to have a spread of 325 bps over the US Treasuries, bearing a coupon rate of 4.875% and yield rate of 4.993%. Meanwhile, Barclays Capital of Barclays plc (BCS), BNP Paribas, Citigroup and RBC acted as the joint book-running managers for the sale.
Besides, both the set of unsecured notes carry a rating of “Baa1,” “A-” and “BBB” from Moody’s Investor Service of Moody’s Corp. (MCO), Standards & Poor’s (S&P) and Fitch, respectively. These ratings cast a stable outlook on AIG’s debt.
AIG expects to utilize the proceeds from the notes sold for enhancing its operating leverage and for refinancing a debt that is due to mature in 2013. Meanwhile, all the prime three rating agencies remain confident about the strong market positions of AIG’s core operations, i.e. Chartis and SunAmerica Financial Group, coupled with the company’s capital flexibility and credit profile. Moreover, AIG is making consistent efforts to repay the government bailout loan, reducing it by about 83% till date.
AIG’s strategic asset divestments have also relieved it off the redundant operations, while also aiding the company to focus on its core property and casualty businesses. The company also enjoys a modest cash position with a pro-forma debt and financial leverage of about 14% and 20%, respectively, based on the steady balance sheet deleveraging over the past 12–18 months.
Going ahead, AIG may warrant a rating upgrade if it is able to maintain its total financial leverage below 30% and pre-tax interest coverage in high single digits, while simultaneously improving its credit curve and earnings potential from Chartis and SunAmerica.
Moreover, AIG’s fixed charge coverage improved to 6x at the end of first quarter of 2012 from 3.0x at 2011-end. The rating agencies are quite optimistic about the company’s core earnings and underwriting profitability for the rest of 2012.
Nevertheless, the rating agencies have raised concerns regarding AIG’s ability to reduce the volatility in reserves of non-life operations, which could in turn hamper underwriting profitability and earnings of the company. Additionally, any deterioration in the financial leverage could severely hit the credit profile and capital flexibility of the company. Hence, AIG requires keeping up a healthy credit and cash position despite the ongoing balance sheet deleveraging and debt repayments.
Overall, we believe that barring the macro-economic factors and interest rate volatility, AIG has the potential to liberate itself from the clutches of the government, while also being able to maintain a strong and competitive business profile in future. Currently, AIG carries a Zacks Rank #1 implying a short-term Strong Buy rating.
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PTX: Double-Edged Sword for Juniper – Analyst Blog
The core routing market has been a headache for Juniper Networks (JNPR) in recent times, given extreme sluggishness in demand (particularly in the U.S.). To make matters worse, competing products have made it to the market with aggressive pricing strategies chipping away at its market share.
Juniper’s answer was its PTX supercore switch, which is priced lower than some of its offerings for the core routing segment. Based on its patented Express chipset, this packet transport switch helps simplify the network, thereby making it denser and more scalable, at the same time optimizing costs.
Juniper is recommending its PTX switches with its T-series core router, which in combination is expected to modernize the network, making it suitable for cloud-delivered services and bandwidth-intensive applications. We believe that this product line will do extremely well in the second half of the year, as carrier spending improves, with incremental revenues for Juniper.
There is a downside, however. PTX will cannibalize some of its existing higher-margin products and will therefore have a negative impact on its margins. However, we think this is preferable to market share losses, so we believe it is a positive longer-term.
Juniper faces stiff competition in each of its market segments, especially from industry leader Cisco Systems (CSCO), which usually launches innovative products and charges higher prices for these premium products. Cisco is very well positioned at the Edge and we wouldn’t be surprised to see Juniper losing some market share in this area.
In addition, Juniper faces competition from Alcatel-Lucent, Ericsson, Extreme Networks, Inc., as they are also launching competitive products in the market.
New product and technology launches have always been a focus area for Juniper. Apart from traditional networking products and related services, the company has ventured into the security software segment to diversify its business model and add new revenue streams. The acquisition of Myconos Security reflects this strategy of the company, as it will fight against hackers and help the company expand in the security segment.
However, Juniper’s investment in new products and platforms are expected to tell on its margins.
Therefore, despite Juniper’s strong product line up and continuous deal wins, the company reported mediocre first quarter 2012 results, which missed the Zacks Consensus Estimate. Moreover, stiff competition from industry stalwarts such as Cisco and Hewlett-Packard Company (HPQ), as well as Juniper’s European exposure could weigh on the stock.
Currently, Juniper has a Zacks Rank of #3, implying a short-term Hold rating.
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Fox’s "Arrested Development" on Netflix – Analyst Blog
Netflix Inc. (NFLX) is set to exclusively stream the new season of the Twentieth Century Fox’s cult-comedy series “Arrested Development” for the subscribers of the U.K. and Ireland from early 2013.
Arrested Development had received critical acclaim after it debuted in 2003. Despite the show winning six Emmy awards and a Golden Globe, its viewership declined with every passing season and higher production costs compelled Fox to discontinue the show in late 2006. The first three seasons of the show were already available for streaming on Netflix, and the huge response that it received compelled the company to revive the sitcom's production.
Netflix subscribers will also be able to stream other series from Fox’s library such as Modern Family, The League, Lie to Me, Sons of Anarchy and The Killing. Moreover, Netflix had already been streaming 24, Prison Break and It's Always Sunny in Philadelphia from Fox’s library since it debuted in the U.K. and Ireland in January this year.
We believe that the new content will not only improve Netflix’s competitive edge in the U.K. and Irish market, but will also boost subscriber growth going forward. The company is trying to gain a foothold in the U.K. and Ireland, as there is no dearth of streaming providers with good and popular content. Moreover, Internet penetration and use is high, so the market is ripe for the kind of services provided by Netflix.
Of course, this also means that competition is stiff. Therefore, similar streaming services such as Amazon.com Inc.’s (AMZN) Lovefilm, and other online players such as Channel 4, the BBC, British Sky Broadcasting Group Plc and ITV Plc are already present.
However, the video on demand market in the U.K. is expected to surge by 35% to £379 million from a mere £11 million just five years ago, according to Screen Digest. Therefore, if Netflix is able to provide comparable services, there is no reason why it should not be able to grab a share of this million dollar opportunity.
Netflix’s future growth strategy in the international market is entirely based on the online streaming business. In the recently concluded quarter, its international subscriber base increased by 1.21 million net subscribers on a sequential basis. Revenues from international operations increased 48.3% sequentially.
We maintain our Neutral recommendation over the long term (6-12 months). Despite the higher costs, we think that Netflix will probably see sales strengthening, as subscribers take note of its improving portfolio. This would ultimately enable the company to build a strong position for itself.
However, we believe that increasing costs related to licensing and renewal fees and higher capital expenditure due to international expansions can hurt growth in the near term. We currently have a Zacks #3 Rank on Netflix, which translates into a Hold rating in the short term.
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Rating Action on MetLife Europe – Analyst Blog
As per media sources, Standard & Poor's Ratings Services (“S&P”) confirmed its long-term financial strength rating and counterparty credit ratings of 'A+' on MetLife Europe Ltd. (“MEL”), a subsidiary of American Life Insurance Co. (“ALICO”), which is an operating subsidiary of MetLife Inc. (MET). The outlook remains stable.
These rating affirmations came on the back of MEL’s strong credit portfolio, solid positioning in the U.K. variable annuity markets, strong capitalization and better investment profile. S&P is also looking forward to solid results being delivered by the MEL as a subsidiary of MetLife. However, lack of multiple business lines and the prevalent sluggish environment of the industry continue to be headwind in the path of the company’s growth.
MEL will play a substantial role in MetLife’s international growth, especially in the markets in U.K as both the company and ALICO are listed to be marketed by it. The rating agency expects MEL's sales of variable annuities to exceed GBP 800 million while intense competition and regulatory issues will weigh on the sales of pension and protection products.
Alongside, MEL constitutes a very small part of MetLife and represents less than 5% of ALICO’s generally accepted accounting principles (GAAP) capital and is far below the consolidated capital of the parent company.
According to the expectations of the agency, if MEL continuously receives MetLife’s support as it is doing presently, it can better its capital position and maintain a stable risk profile, leading to volume growth. It also expects the company to perform well beyond 2013.
Even though the rating agency is less likely to increase its current ratings, it expects the company to register solid operating results with an increase in total sales. However, the ratings might be downgraded if MetLife decides to divest MEL, if there is a sharp decline in its profitability or growth prospects, or if MetLife discontinues its capital support to MEL.
MetLife currently retains a Zacks #2 Rank, which translates into a short-term Buy rating. We also maintain a long-term Neutral recommendation on its stock.
American International Group Inc. (AIG), one of the closest competitors of MetLife scores equally well with the rating agencies. Last month, Fitch Ratings reiterated Issuer Default Rating (IDR) of 'BBB' on the company with a positive outlook and the Insurer Financial Strength ratings of ‘A’ on its operating units with a stable outlook.
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ETP to Raise Fresh Capital – Analyst Blog
Dallas, Texas-based Energy Transfer Partners L.P. (ETP) has commenced a public offering of 13,500,000 common units representing limited partner interests.
The transportation and storage master limited partnership (MLP) also intends to provide the underwriters with a 30-day option to purchase up to 2,025,000 additional common units. Energy Transfer plans to use the net proceeds from this offering to pay back the outstanding debt under its revolving credit facility, to finance capital expenditures associated with pipeline construction projects and for general partnership purposes.
Energy Transfer owns and operates a diversified portfolio of energy assets. It is engaged primarily in the gathering, processing, storage and transportation of natural gas.
Additionally, the partnership holds a 70% stake in Lone Star NGL LLC, a joint venture that owns and operates natural gas liquids (NGL) storage, fractionation and transportation assets in Texas, Louisiana and Mississippi.
Energy Transfer Partners, which competes with other large-cap pipeline MLP peers like Enterprise Products Partners L.P. (EPD), Kinder Morgan Energy Partners L.P. (KMP) and Plains All American Pipeline L.P. (PAA), currently retains a Zacks #3 Rank (short-term Hold rating). We are also maintaining our long-term Neutral recommendation on the unit.
Energy Transfer Partners remains a premier MLP with strategically-positioned assets that serve major North American natural gas-producing basins. We like the partnership’s robust organic growth profile, stable fee-based operating income and strong liquidity position.
While the partnership kept its distribution unchanged, we expect growth to resume shortly, driven by the completion of a broad array of organic growth projects. Additionally, the proposed acquisition of Philadelphia-based refining and petroleum product marketing company Sunoco Inc. (SUN) for $5.3 billion will help Energy Transfer to diversify its asset mix by adding crude and refined products pipelines to the partnership’s existing natural gas and NGL infrastructure.
However, we believe that the near- to medium-term outlook for the partnership’s natural gas gathering and processing business continues to be weak, which remains a major liability in our view.
As such, we expect the pipeline operator’s growth potential to be restrained with little room for meaningful upside from current levels.
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