Types of ETFs (Part 2)

Leverage ETFs

Leverage ETF allow investors to boost their return 2 or 3 times higher. For example, should S&P 500 index goes up 1 percent, leverage ETF would provide a gain of 2 or 3 percent. However, the losses will be magnified should the index fall. A 1 percent loss of the index will convert to 2 or 3 percent loss with leverage ETFs.

How the underlying performance of leverage ETFs can be achieved by the fund manager is by using derivative instruments such as future contracts, equity swaps and etc.

Below are some of the Leverage ETFs:

Ticker Symbol Market Type
UDOW Dow 30 Index (3x)
SSO S&P 500 Index (2x)
XPP FTSE China 25 Index (2x)
UPV MSCI Europe Index (2x)
DXD Short Dow 30 Index (-2x)
SPXU Short S&P 500 Index (-3x)
EWV Short MSCI Japan (-2x)
EEV Short MSCI Emerging Markets Index (-2x)
URTY Russell 2000 Index (3x)

For information can be found from http://www.proshares.com/

Currency ETFs

Currency ETFs are available as an alternative channel for exposure to foreign currency investment. For example, Exchange rate for Australian Dollar (AUD) to US Dollar (USD):

1 AUD = 1.0210 USD

Ticker Symbol for Currency ETF → FXA

Price of FXA → 102.10

Should AUD gets stronger and USD gets weaker, prices of FXA will go up, and investor will make capital profit.

Below are some of the Currency ETFs:

Ticker Symbol Currency ETF
FXA Australian Dollar Trust
FXB British Pound Sterling Trust
FXC Canadian Dollar Trust
FXCH Chinese Renminbi Trust
FXE Euro Trust
FXY Japanese Yen Trust
FXM Mexican Peso Trust
FXRU Russian Ruble Trust
FXS Swedish Krona Trust
FXF Swiss Franc Trust

For information can be found from http://www.currencyshares.com/

Types of ETFs (Part 1)

Other than index and sector ETFs, there are other types of ETF which allow investors to invest.

Regional & Country ETFs

ETFs are available if investors are interested to invest in other regional markets index such as the BRIC (Brazil, Russia, India, China), or indexes in different countries, such as Japan, Germany and Hong Kong.

Below are some of the ETFs:

Ticker Symbol Market Type
BIK S&P BRIC 40 Index
FEU STOXX Europe 50 Index
AIA S&P Asia 50 Index
GML S&P/Citigroup BMI Latin America Index
GAF S&P/Citigroup BMI Middle East & Africa Index
VWO MSCI Emerging Markets Stock
MCHI MSCI China Index
RBL S&P Russia Capped BMI Index
EWJ MSCI Japan Index
EWH MSCI Hong Kong Index
EWA MSCI Australia Index
EWG MSCI Germany Index
EWS MSCI Singapore Index
EWM MSCI Malaysia Index

More information can be found from companies below who manage the ETFs :

Inverse ETFs

ETFs are available if investors are interested to make gains by betting against the direction of the market. In order words, short selling by buying the ETF. So let say you feel that S&P 500 index is going to fall due to some kind of financial shock news, and you decide buy ProShares Short S&P500 (ETF). So when S&P 500 index drop points, you make money.

A good scenario would be during a bear market, where all the stocks and indexes are declining. Instead of selling away the holding stocks which give investors high dividend yield, investors can buy inverse ETF to hedge against potential capital losses.

Below are some of the inverse ETFs:

Ticker Symbol Market Type
SH Short S&P500 Index
DOG Short DOW 30 Index
PSQ Short NASDAQ-100 Index
EUM Short MSCI Emerging Market Index
RWM Short Russell 2000 Index
YXI Short FTSE Xinhua China 25
SBM Short Dow Jones U.S. Basic Materials Index
DDG Short Dow Jones U.S. Oil & Gas Index
REK Short Dow Jones U.S. Real Estate Index

More information can be found from company below who manage the above inverse ETFs :

http://www.proshares.com/

What Is Exchange Traded Fund – ETF?

ETF is a type of security that tracks the movement of index, prices of commodity, currency, bonds and many other available assets. It is being traded like a stock in the exchange where investors are able to perform buying and selling of ETF.

Why Trade ETF?

Index & Sector Investing

ETF provides investors a variety of investment opportunities, instead of getting a single return by investing in one company; investors get the chance to receive the return of a group of companies. This reduces the risk of investing in one single company which gives negative return.

Imagine if you decide to invest in Company A in the banking sector, which turns out to give a negative return of 20% due to whatever reasons (scandal,  lawsuit, bad earnings). However, by investing in ETF which tracks the movement of a group of banks, the positive return of other banks will offset the negative return of Company A.

Example below:

Company Return
A -20%
B +10%
C +18
D +15
E +17
Scenario Company A ETF (A,B,C,D,E,F)
Investment Amount $10,000 $10,000
Return -20% (-20+10+18+15+17)/5 –> 8%
Value $8,000 $10,800

The downside? Well investor could miss out the higher return of companies which are performing very well. The question is, how good are you in picking the right company?

Below are some of the popular ETFs based on Index & different sector listed on NYSE ARCA Exchange. More information can be found on https://www.spdrs.com/

Ticker Symbol Type
SPY S&P 500 Index
DIA Dow Jones Industrial Average Index
XHB Homebuilders
XLY Consumer Discretionary
XLP Consumer Staples
XLE Energy
XLF Financials
XLV Health Care
XLB Materials
XLK Info Tech
XLU Utilities
XRT Retail
XOP Oil & Gas Exploration & Production
XES Oil & Gas Equipment & Services
KIE Insurance
KME Mortgage Finance
KBE Banks
KRE Regional Banks
XHS Health Care
XHE Health Care Equipment
XBI Biotech Select
XPH Pharmaceuticals
XTN Transportation
XAR Aerospace & Defense
XLI Industrial
XME Metals & Mining
XSW Software & Services
XSD Semiconductor Select
XTL Telecom

Technical Analysis – Moving Average

Ever heard of such saying, “Do not go against the trend” when buying a stock? So, how do you know when is the uptrend so you can confidently open your position, and when is the downtrend so you can consider closing the position by selling the stock?

Moving average is one way to tell if a stock is on a downtrend or uptrend.

How To Calculate Moving Average?

For example, a 30-day moving average is calculated by summing up all the stock closing prices for the last 30 days, and do a division by 30. Looking at the chart by plotting the trend using the moving average, you can tell if the stock is in a uptrend or downtrend.

Classification of moving average can be used as below:

5 – 20 Days (Short Term Trend)
20 – 50 Days (Mid Term Trend)
100 – 200 Days (Long Term Trend)

Let’s look at example below:

 Chart courtesy of StockCharts.com

 Another example:

 Chart courtesy of StockCharts.com

In general, the shorter moving average crosses ABOVE the next longer moving average, the stronger the uptrend. When the stock price is ABOVE the longer moving average, the stronger the uptrend.

On the opposite, the shorter moving average crosses BELOW the next longer moving average, the stronger the downtrend. When the stock price is BELOW the longer moving average, the stronger the downtrend.

What Are The Disadvantages?
1. Moving average is lacking indicator since it is calculated using the past closing prices. No one can predict future stock prices. But it does help to allow investors to set a target buy or sell price.

2. Moving average has nothing to do with the fundamental value of the stock. It is very dangerous to ignore the fundamental value (such as Price/Earning ratio, PEG ratio, Price to Book ratio). It is because even the stock is in a uptrend, it might be very much overvalue. The stock might come crashing down when something unexpected happen.

Interpretation of Cash Flow Statement (CFS)

The sole purpose of CFS is to provide ease of understanding cash movement of a Company. Easier said than done, understanding the story behind it turn out to be the opposite.

Format of CFS

Data from the CFS is extracted from both the Income Statement (IS) and Balance Sheet (BS). Despite the inter-connected relationship, CFS is distinct from the IS and BS, as shown below:-

CFS – Measures ‘real’ cash movements

IS and BS – Measurement based on accrual accounting

CFS allows investors to see cash movements by the major categories, namely; Operating, Investing and Financing activities. Under each category is details of cash flow movement during the financial period.

Operating Activities

Measures cash movement from core business operations, reflecting cash generated from sales of company’s products or services and cash paid from purchase of inventories. Examples of accounts affected by company’s business operations are; cash, receivables, inventory, payables, inventory.

Investing Activities

Measures cash movement from investment in property, plant and equipment. Due to the nature of investing activities, cash movements are usually cash outflows. Cash inflow will only occur when the company sells of an asset.

Financing Activities

Measures cash movement from debt, loans and dividends. Loans received from bank or new capital raised through bond issue are considered as cash inflows, while dividend payments and loan repayments are considered cash outflows.

Analyzing a CFS

Let us examine the categories and accounts of a CFS and how we can interpret the movement at our advantage.

2012

2011

Cash flow from operating activities

$’000

$’000

Source

Explanatory notes
Net profit

29,500

21,200

IS

Obtained from the IS, showing positive profit from operating activities
Adjustments for:
– Depreciation

2,500

2,150

IS

Non-cash item are added back, only considered as cash when sold
– Income tax

5,150

11,800

IS

Non-cash item are added back, only considered as cash when paid
– Interest income

(500)

(450)

IS

Non-cash item are added back, only considered as cash when received
Operating cash flow before working capital changes

36,650

34,700

Change in operating assets and liabilities
– Trade and other receivables

30,850

28,510

BS

Positive amount here represents lower receivables from customers versus prior year
– Inventories

(17,670)

6,750

BS

Negative inventory here represents higher inventory held on hand versus prior year
– Trade and other payables

9,160

(30,720)

BS

Positive amount here represents higher payables outstanding to suppliers versus prior year
Cash generated from operations

58,990

39,240

Income tax paid

(10,990)

(19,220)

BS

Actual income tax paid to the Inland Revenue Authority
Interest received

400

200

BS

Actual interest income received from bank deposits
Net cash provided by operating activities

48,400

20,220

Cash flows from investing activities

 

 

Purchases of property, plant and equipment

(13,500)

(140)

BS

Payment for PPE
Net cash used in investing activities

(13,500)

(140)

Cash flows from financing activities

 

 

Bank loan paid

(5,000)

Repayment of bank load due during the financial year
Dividend paid

(50,000)

(8,000)

BS

Dividend paid to shareholders
Net cash used in financing activities

(55,000)

(8,000)

Net movement in cash and cash equivalent (CCE)

(20,100)

12,080

CCE at beginning of financial year

240,760

252,840

BS

CCE at end of financial year

220,660

240,760

BS

From the above CFS, we can see a drop in CCE from $240,760k in 2011 to $220,660k in 2012. Changes in CCE can be seen from the self-explanatory CFS, which is mainly caused by dividends paid ($50,000k) and purchases of PPE ($13,500k). This is a very good explanation for the current financial year, so let us look at how we can interpret and forecast what is going to happen next year.

As mentioned, operating activities are real cash movement from the company’s core business activities. The majority of the company’s positive cash inflow are coming from this area, with an increase of $28,180k (2012: $48,400k vs. 2011: $20,220k). This is good news and it means that the core operations are generating favorable cash inflow. This also allows the company to invest in new equipment ($13,500k) and purchase more inventory ($17,670k) for growth and capturing of new market share. It is not an obligation for the company to distribute dividends, but the directors had agreed to share the company’s earnings with all shareholders, in hope of securing trust of current shareholders and getting more investments in future.

The amount of cash surplus available to the company should ease investors’ concern on future loan repayments and hope of more dividends payout next year.

Ultimate Weapon When All Else Fail – Fiscal stimulus

During severe economic recessions, increasing money supply through monetary policy (cut down interest rate) has failed to stimulate growth and reduce unemployment level. There is one last resort that the government can do to revive the economy, by running budget deficit.

The concept of budget deficit is to spend more than the taxes that have been collected. This is like an individual spend more on credit card than his/her personal income. To get that extra money to spend, government will have to issue more bonds.

Central bank will massively create new money to buy government bond, this process is known as Quantitative Easing (US). In a way the central bank is printing more money that will be used to buy government bond. Also, other countries can also fund the government by buying more of those bonds.

In running budget deficit, government will increase their spending to do more projects, such as public infrastructure upgrade; building new roads and freeways; expand rail network; public healthcare upgrade; build more schools and etc. All this activities and projects will encourage investment from companies, employment level will also start going up. And ultimately spur the economy into growth.

Risk of deficit

Inflation
In case you are wondering, yes the central bank can print money at will. However, massive printing of money will depreciate the value of the currency and create high inflation. If the central bank fails to manage it, high inflation will damage the economy.

Tax Increase
Running deficit might force the government to raise tax in future. Nobody likes tax increase. This will increase public dislikes against the government.

Unrealized Loss From Other Foreign Bond Holders
By having massive money supply, it will greatly depreciate the value of the currency. If foreign countries bond holders were to sell back those bonds or wait until maturity, they might suffer losses the moment they convert the money back to their own currency.

Undercut Private Investment

In the bond market, companies will have to compete with the government in selling bonds. Companies, to make their bonds more attractive to investors, will have to drive up the interest rate of those bonds. In the end, companies might find that it is not worth to sell those bonds with such high interest.

As a result, companies will not have enough funding, and started cutting down on investment on new projects.

Possible Unexpected Scenarios When Increase/Reduce Money Supply.

Although the main objective to control money supply is to either stimulate or cool down the economy. Sometimes things do not work as it supposed to be. Let’s explore various scenarios.

Scenario 1 – Country In Recession

With the country slipping into recession, central bank decided to reduce interest rate to stimulate the economy to encourage spending and investment. However, disaster strike, like a major earthquake; terrorist attack; or banks going into default for whatever reason. The public went into panic mode, rush to banks and do a massive withdrawal of money for emergency use.

In this case, the demand of money far outweighs the supply; the commercial banks will have to raise the interest rate to curb withdrawal. Despite the effort from the central bank, interest rate went up instead of down. In short term, prices of different classes of assets will likely reflect as below:

Asset Class Expected Reaction Likely Actual Reaction
Stock Market & Real Estate Up Down
Bond Prices Up Up
Bond Yield Down Down
Gold Up Down
Interest Rate (Federal Fund Rate) Down Up
Currency Down Up

In this scenario, increase of money supply by reducing the interest rate has failed to stimulate the economy.

Scenario 2 – Country with Loose Monetary Policy and Form Asset Bubble

With the economy is already doing very well, commercial banks are still able to lend out money at low interest rate, assets such as housing prices and stocks will appreciate to an unsustainable level and form asset bubble. The economy is overheating.

At the same time, inflation is creeping up. When the public begin to feel the pain of inflation, cut down spending and save money, and stop buying assets because they are too expensive. That’s when the bubble burst. Assets prices will start to fall as investors will start bidding down the prices to obtain cash.

Companies will start doing badly as business demand is slowing since everybody is saving cash due to inflation. Unemployment will start rising as companies begin to cut their expenses.

Commercial banks are making losses because people who took up the loan are not able to pay back the balance loan even after selling the assets, because the prices of asset have fallen. More and more people are getting bankrupt. Because of this, commercial banks will also curb lending as they are afraid of bad loans.

By then, there is little that central bank can do because monetary policy was already loose (low interest rate).

It gets worse, to improve business, companies will start to bring down prices on products and services, and economy will begin to experience deflation. With deflation, companies will have to do more job cuts to improve earnings. This brings unemployment rate even higher, bringing the economy into a downward spiral.

Scenario 3 – Sudden Increase of High Interest Rate and Slam the Overheat Economy

Let’s assume central bank realize the economy is overheating, and decide to cool it down. However, instead of increasing the interest rate slowly, the central bank hikes the interest rate at a rate that is so high that took everyone by surprise. This is like putting a jam brake on a sports car speeding on highway; the sports car can lose its control, flip and crash. Same things can happen to the economy.

When the money supply is reduced at such level which took everyone by surprise:

Business lending will drop dramatically due to high interest rate, and this slows down business investment. Less business investment mean lesser projects, and companies provide goods and services will begin to experience loses.

Currency will appreciate as there is lesser supply with the increase of interest rate. As the currency is appreciating, goods and services will appear to be more expensive to foreign countries; this will impact the export businesses of the country.

Unemployment will start rising as companies begin to cut spending to avoid losses.

Ultimately the jam brake brought down the economy to its knees.