Active Bond Funds
Most investors have a portion of their portfolio devoted to fixed income investments. For decades, the traditional ’60/40 portfolio’ has long been used as a guidepost for a moderate risk investor—a 60% allocation to stocks for capital appreciation and a 40% allocation to fixed income for income and risk mitigation.
One key component of your fixed income allocation should be an active bond fund.
What Are Active Bond Funds?
A bond portfolio can be managed in several ways. The primary methods are active, passive, or a hybrid of the two. Active bond portfolio management simply means that a professional manager takes an active role in the running of the bond portfolio.
Active management of bond funds involves portfolio managers who seek out bonds that are high performing and that they believe are more likely to surpass a benchmark index performance over time.
The ultimate goal is to create and manage a fund that performs at or above the index, including identifying and investing in bonds that are undervalued. Active bond portfolio management may also involve buying bonds that hedge against movements in interest rates.
Active managers can adjust their funds’ average maturity, duration, average credit quality, and position among the various segments of the fixed income market.
Why Invest in Active Bond Funds?
A major advantage is that an active manager controls the holding period of the bonds. All bonds come with a maturity date. Passively managed funds typically hold a bond until it matures. In an actively managed fund, however, the manager can benefit the fund’s investors by selling off bonds with a lower yield and shorter duration.
When interest rates rise, selling off such bonds boosts the yield of the portfolio overall, reducing the interest rate risk to investors. Generally speaking, bonds can be invested in more profitably by selling them at advantageous times in the interest rate cycle that occur prior to maturity.
In addition to the aforementioned interest rate risk, active bond managers can also help investors alleviate the greatest risk for bond investors – credit risk. That’s the risk that occurs if an issuer fails to pay interest or principal on its debt. The warning signs will be clear as an issuer’s financial condition deteriorates, causing rating agencies to downgrade the rating on an issuer’s bonds. The active manager can sell these bonds. With a passive bond fund, you’re stuck with these bonds.
In simple terms, an active bond fund manager can intentionally adjust the levels of credit and interest-rate risk to improve the performance of their bond portfolios. These capabilities allow active managers to add value in a wide range of market conditions. This flexibility is especially valuable when market conditions have introduced increasingly high levels of credit and interest-rate risks.
This flexibility is not possible for passive funds.
Examples of the “flexibility” active bond managers have include: adding value by including smaller issuers in their portfolios; buying variable rate securities, such as floating-rate notes or hybrid securities (fixed-to-floating rate notes) to benefit from changes in interest rates; adding allocations to inflation-linked bonds, such as U.S. Treasury Inflation Protected Securities (TIPS); take advantage of opportunities in shorter-maturity bonds, which carry much less interest-rate risk than longer-maturity bonds; and, when conditions warrant, add bonds rated below investment grade to enhance portfolio performance.
Of course, if you invest in an active bond fund, you do take the risk that the manager may underperform the bond benchmark indexes.
How to Invest in Active Bond Funds
Active bond funds – mutual funds and ETFs – can be bought just as easily as stock funds through any brokerage firm.
Such funds are gaining popularity. Through September 2021, Morningstar data showed that investors poured $330 billion into active-bond-funds in 2021. That was over $100 billion more than the $215 billion they put into passive fixed income funds.
Your search for the right active bond fund can be made much easier by using Magnifi, a search-based investing platform that can help match investments to your goals. Magnifi’s AI driven system finds investment suggestions for you based on just a few inputs of your data, such as risk tolerance and investment time horizon.
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The information and data are as March 1, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Mid-Cap
Mid-cap stocks are an important part of any diversified portfolio. They offer the “best of both worlds”. That is, within mid-caps you will find both ‘off-the-beaten-path’ value stocks, as well as growth stocks.
What Is Mid-Cap?
Mid-cap (or mid-capitalization) is defined as companies with a market capitalization — or market value— of between $2 and $10 billion. As the name implies, a mid-cap company falls in the middle between large-cap (or big-cap) and small-cap companies.
These companies tend to be substantial firms with solid businesses, with an established foothold in their respective market. Mid-caps are often domestic or niche companies that are looking to expand.
And since mid-cap stocks may often offer both dividends and price appreciation, they can balance investment portfolios between income and growth. In effect, mid-caps offer a compromise between the growth, risk and volatility trade-offs of their larger and smaller counterparts.
There are two main benchmarks for mid-cap stocks:
The S&P MidCap 400 Index tracks the performance of 400 mid-sized U.S. companies with valuations between about $2 billion and $8 billion. As of September 2021, the median market cap of companies in this benchmark was nearly $5.5 billion.
The Russell Midcap Index tracks nearly twice the number of companies than the S&P index — more than 800 — and is a subset of the larger Russell 1000 Index. The companies in this index had a median market cap of $11.3 billion as of September 2021.
Why Invest in Mid-Cap Stocks?
Despite being often overlooked by investors, mid-cap stocks have delivered performance. Since 2012, the aforementioned S&P MidCap 400 Index has outperformed the Dow Jones Industrial Average.
And, according to Hennessy Funds, the longer mid-cap stocks are held, the more likely they are to outperform. In fact, 76% of the time, mid-caps outperformed small-cap and large-cap stocks over any 10-year rolling period in the past 20 years.
Hennessy (using Morningstar data) says that, not only have mid-cap stocks generated higher absolute returns over a longer time frame, but they have also provided these returns with less associated risk.
Over the 20-year period ended 12/31/21, investors in mid-caps have experienced higher returns and lower risk relative to investors in small-caps. In addition, while mid-caps had more risk than large-caps, investors have been rewarded with a higher return over the same period.
The outperformance of mid-caps stems from the fact that many of these companies exhibit solid growth, either as they expand overseas or into new products and services.
And historically, mid-cap companies offer one of the best ways to profit from an economic recovery. That is a result of their large exposure to the industrial sector.
The historical outperformance is clear to see.
After the early 2000s recession, mid-cap equities outperformed large caps for three consecutive years – 2003 through 2005. And similarly, mid-caps performed well after the global financial crisis, beating large caps four out of five years from 2009 through 2013.
How to Invest in Mid-Cap Stocks
It’s not wise for investors to randomly pick any mid-cap company. After all, mid-cap companies could be the large-caps of the future or of the past.
Your individual asset allocation will vary based on your risk tolerance and investment goals. However, mid-cap stocks do deserve a place in any portfolio.
That’s why the American Association of Individual Investors (AAII) in their model conservative, moderate and aggressive investment strategies have a 10% to 20% allocation to mid-cap stocks.
Investing in mid-cap stocks is easy. You can invest in a group of mid-cap stocks by buying mid-cap index funds, either mutual funds or exchange-traded funds (ETFs). There are about 40 such ETFs and 600 mutual funds.
By doing so, you can reduce the risk associated with owning any individual stock while positioning your portfolio to benefit from broader market gains.
You can find funds that track key mid-cap benchmarks, styles of investing like growth versus value and mid-caps in specific industries.
Your search can be made easier by using Magnifi, a search-based investing platform that can help match investments to your goals. Magnifi’s AI driven system finds investment suggestions for you based on just a few inputs.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the February 25, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Multifactor ETFs
As investors seek protection from stock market volatility and potential downturns, products have been developed to take up this challenge.
One of these types of products is the multifactor ETF, which first appeared in 2003.
What Are Multifactor ETFs?
Multifactor funds provide exposure to stocks with different characteristics—or factors—such as value and momentum, all in the same product. These ETFs take a broad index, like the S&P 500, and apply a rules-based quantitative process to select stocks based on the chosen factors.
These funds are part of the concept of “smart beta”, which involves building portfolios skewed to “factors” that have historically been correlated with outperformance. These include value, dividend generation, momentum, small size, quality, profitability and low volatility.
Much academic research has been done regarding these “factors”.
A landmark 1992 study, by University of Chicago Professor Eugene Fama and Dartmouth College Professor Kenneth French, argued that – based on history – focusing on smaller stocks and those with lower relative prices may improve a portfolio’s expected return. Subsequent research conducted by University of Rochester Professor Robert Novy-Marx identified profitability as another factor that enhances expected returns.
The beauty of multifactor ETFs is that they combine two or more of these elements. This approach is designed to increase diversification and provide a smoother ride for long-term investors since it sits between passive and active strategies.
The funds’ goal is to provide less risk than passive funds that track broad-based indexes, and at a lower cost than many active funds.
Why Invest in Multifactor ETFs?
Some investors dumped multifactor ETFs late in 2020. That’s because some of these funds underperformed the market average (S&P 500). This was almost solely due to the poor performance of value investing, which by one measure had its worst run for 200 years.
U.S. markets are more concentrated now than they have been in the past 40 years, with technology stocks, such as Amazon, Apple, Microsoft and Alphabet representing over 20% of the S&P 500.
So if an ETF is tracking the S&P 500, the portfolio will be highly concentrated in a few stocks, which will increase stock-specific risk that quite often should be diversified away, depending on your individual financial circumstances.
Multifactor ETFs seek to provide better risk diversification by identifying companies across a variety of areas, rather than focusing on a small number of heavily concentrated positions. By providing simultaneous exposure to multiple, uncorrelated factors, multifactor ETFs aim to enhance risk-adjusted returns over traditional passive ETFs and provide investors with a more consistent return profile over a full market cycle.
A key strength of these ETFs is their ability to manage the correlation between different factors in a way that a series of single-factor funds could never replicate.
The active returns of single factors have low correlation to each other, so it’s unlikely multiple factors will underperform at the same time. This means diversifying across multiple factors can smooth out your return without reducing performance potential.
Multifactor funds also have an advantage wherever performance fees are levied, in that they allow the netting of fees. An investor does not have to pay a performance fee for one factor that has shot the lights out, if another has tanked and dragged the overall performance back down.
How to Invest in Multifactor ETFs
Multifactor ETFs can be bought through any brokerage firm.
However, you should not invest in these funds blindly. How a multifactor ETF can enhance the existing investments in your portfolio has to be considered.
You will need to do some due diligence. Investors need to look well beyond just the fund’s name.
For instance, there are many different ways to measure the value factor, including price-to-book, price-to-earnings, and price-to-sales ratio. There are also numerous ways to measure profitability, another key factor.
The bottom line is that how a factor is measured can have a major impact on how the fund performs and interacts with the other factors bundled into the fund, as well as your own portfolio.
Importantly, keep in mind that multifactor funds can have a prominent place in portfolios, especially when different investment styles are fighting for dominance.
For help in finding the right multifactor ETF to fit your portfolio, please be sure to check out the Magnifi website under multifactor funds.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the February 15, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Preferred Securities
Preferred securities are investments that are popular with investors looking for a source of safe and steady income. It is a hybrid security, blending characteristics of both stocks and bonds.
What Are Preferred Securities?
Preferred securities are fixed-income investments with equity-like features. Many of them are issued by large banks and insurance companies.
Some of the key differences between common and preferred stocks include: preferred stockholders having a higher claim on distributions (dividends) than common stockholders; preferred stockholders usually have no or limited, voting rights in corporate governance; and, in the event of a liquidation, preferred stockholders’ claim on assets is greater than common stockholders but less than bondholders.
Here are some of the common characteristics of preferred securities:
Price and Yield: preferred stock shares are issued at a $25.00 price with a set yield. In order to get the annual dividend rate, multiply the yield times the share price.
Perpetual, but Callable: most preferreds are issued as perpetuals (they have no stated maturity date), but the issuer will have an option to “call”, or redeem the stock at a fixed value, before the maturity date – usually at 5 or 10 years after issuance.
Fixed and Floating Rates: preferreds with more debt-like traits can have fixed rate, floating rate, or fixed-to-floating rate dividends. Floating rate structures offer much lower interest rate risk than fixed rate bonds.
Cumulative or Non-Cumulative: deferred or missed payments on cumulative preferred securities accumulate as obligations of the issuer, and must be paid out to holders of preferred securities before common shareholders can receive any dividend payments. However, with non-cumulative preferred securities, missed payments do not accumulate as obligations of the issuer and shareholders are not entitled to receive missed payments.
High Quality Ratings: preferreds are often issued by investment grade entities, and even though they are typically ranked two or more notches below an issuer’s senior debt, many preferreds still garner investment-grade ratings.
Distributions are dividends, not coupon payments: preferreds pay dividends on a fixed schedule, rather than coupons like a bond. And in periods of severe financial stress, the issuer may skip a payment without triggering a default. Income earned from preferreds are usually taxed at a federal rate which is considerably less than ordinary income tax rates that are applied to other fixed income securities.
Junior Capital Structure Ranking: preferreds rank lower than senior debt, but higher than common stock in a company’s capital structure. That means, in the event of an issuer’s default, investors holding that company’s preferreds will get paid back after the bondholders and before the stockholders.
Why Invest in Preferred Securities?
While preferreds are stocks, they are vastly different from common stocks. So don’t get them confused. . .they’re a world apart when it comes to risks and rewards.
In brief, preferred stocks can make an attractive investment for investors seeking steady income, with a higher payout than they’d receive from common stock dividends or bonds. However, these investors may miss out on the upside potential of common stocks and the safety of bond payments.
In an environment of low interest rates and rising volatility, preferred securities are attractive because of their historically high relative yields and their ability to weather changing interest rate environments. They also may help diversify a fixed income portfolio, due to their historically low correlation to other bond and stock asset classes.
And since preferreds are predominantly investment grade securities, it helps investors manage their portfolio’s credit risk.
In addition, there is tax-advantaged income potential, since many preferred security structures pay qualified dividend income (QDI).
A few firms issue convertible preferred securities. They can typically be exchanged for a specified amount of a different security, often the common stock of the issuing company. Convertible preferred securities may combine the fixed income characteristic of bonds with the potential appreciation characteristics of stocks. There are often provisions attached to convertible preferred securities that place restrictions on when they can be converted. Since convertible preferred securities can be exchanged for shares of the issuer’s common stock, the value of these securities will be more volatile than your typical preferred security.
How to Participate in Fixed Income Investing/preferred Securities
Preferred securities, like other stocks and fixed income securities, can be purchased through your brokerage firm.
However, keep in mind that no two preferred securities are alike. So take the time to read the ‘fine print’ and determine whether a particular preferred issue aligns with your investment needs, risk tolerance, and goals.
Another aid for investors – either to find preferred securities, ETFs or funds, or even individual preferred stocks – is to check the Magnifi website under preferred stocks.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the February 9, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Real Assets
Real assets exist in the physical world, and their value derives from their physical qualities. This is in contrast to financial assets, like stocks, bonds, cash and cryptocurrencies.
However, one similarity between real and financial assets is that their valuation depends on their cash flow generation potential.
What Are Real Assets?
Real assets can be categorized into several categories: real estate; natural resources – oil & gas, metals and minerals, timber and farmland/agricultural commodities; infrastructure – energy pipelines, transportation (roads, airports, railroads), utilities, telecommunications infrastructure (cell phone towers, etc.); physical equipment (factories, machinery, buildings, etc.).
These real assets have their valuations tied to cash flow and how much investors are willing to pay for the future stream of earnings. However, one of the primary differences between many stocks and real assets is that real assets have intrinsic value in and of themselves.
Investing in a real asset typically has the following benefits:
- It earns good cash on cash yield
- Is contracted for a long duration
- Have a stream of cash flows that are tied to inflation
- Have lower volatility because they are privately owned
That is why real assets are so popular with institutional investors. Overall, real assets represent more than $10 trillion out of $27 trillion of global institutional assets under management in 2019.
Why Invest in Real Assets?
Due to their low correlation to other financial assets, real assets offer investors the opportunity for diversification. Diversifying one’s portfolio is key to limiting exposure in order to lower investment risk.
As Cesar Perez Ruiz, chief investment officer (CIO) at Pictet Wealth Management, said to the Financial Times: “Real assets are a good late-cycle investment, when increasing volatility can offer interesting entry points into areas that have low correlation with other asset classes.”
This asset class tends to be more stable than financial assets. Inflation, currency fluctuations, and other macroeconomic conditions affect real assets less than financial assets.
Real assets are particularly well-suited investments during inflationary times because of their tendency to outperform financial assets during such periods. The S&P 500 Real Assets Index, which launched at the end of 2005, has outperformed the S&P 500 in every high inflation year since its inception.
The asset management giant Blackrock looked at average annual returns in different regimes of growth and inflation over the past 20 years. It found that U.S. and global real estate, as well as global infrastructure, beat stocks and bonds when inflation is high. Outperformance was seen in both low and high periods of growth.
All that some real assets, such as commodities, need is a whiff of inflation to get rolling. For example, the Bloomberg Commodity Spot Index ended 2021 with a gain of 27%. That was the biggest yearly jump since 2009.
Also, real assets have appeal to investors searching for reliable income. Cash flow from real assets like land, infrastructure, and real estate projects provide sound and steady income streams to investors.
However, keep in mind that real assets are often less liquid (harder to sell quickly) than financial assets.
Another major plus for real assets versus say U.S. stocks is that the real assets market is often riddled with inefficiencies. The lack of knowledge about specific real assets (such as a copper mine or a cell phone tower) offers investors the potential for high profits.
How to Invest in Real Assets
The good news is that you do not need a lot of money to invest into real assets.
You could buy the actual real asset, such as silver coins. Or buy futures contracts on physical commodities. Or invest in real estate via fintech companies for just a few hundred dollars.
Investors can also gain exposure to these types of investments through individual stocks, ETFs and mutual funds. A simple search on Magnifi will help you find numerous ways to invest into real assets.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the February 9, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Outperformance
What Is Outperformance?
Outperformance is used to describe the returns of an investment producing better results when compared to another. The term is commonly used to compare an investment’s return to a benchmark index, such as the S&P 500.
For example, investors could say they “outperformed” the market, if their portfolios produced better returns than the S&P 500.
There are a number of reasons why stocks can outperform the market. These may include: a company’s revenues or earnings growing faster than expected versus its peers, superb management decisions, market preferences, network effects, its industry sector was undervalued and has now rebounded, or even sheer luck.
So how can you find stocks that will outperform the overall stock market?
Finding Outperformance
Investors are often able to achieve outperformance by determining where the economy/business is in its cycle, the strength of different sectors, and then picking the strongest stocks within those sectors to invest in.
An economic cycle, sometimes referred to as a business cycle, is the periodic growth and decline of a nation’s economy. Economic cycles can be broken down into four parts, each of which is associated with the outperformance of certain sectors:
Early recession:
The economy begins to slow and consumer expectations are falling. Growth is slowing as inflation climbs higher, and stock prices begin to look high compared to earnings. Interest rates are rising and the yield curve is flat or even inverted (meaning that long-term interest rates are equal to or lower than short-term rates).
Historically, the following sectors have profited during these times: consumer staples, such as food producers and grocery retailers, healthcare and utilities.
Recession:
Economic growth is down (GDP is contracting), and industrial production is at a low point. The unemployment rate is high and rising. Interest rates begin to fall, and the yield curve is normalizing (meaning that long-term rates are higher than short-term rates). Although consumer expectations are low, they are beginning to improve.
The best sectors in this phase include utilities, healthcare, and consumer staples early on and then cyclicals (such as energy and materials) near recession-end.
Early recovery:
The economy begins to improve, and consumer expectations continue to rise. Industrial production begins to grow. Interest rates are falling. Corporate earnings grow. People spend.
The sectors to consider investing in at this stage include: other cyclicals like transportation as well along with technology.
Late/full recovery:
Interest rates are on the rise and the yield curve has flattened. Industrial production is slowing and consumer expectations are beginning to fall. Sectors to consider include consumer staples and precious metals.
Part of the big picture analysis involved in deciding where we are in the business cycle includes interest rates and inflation.
How Interest Rates Play a Role in Outperformance
Interest rates rise and fall as the economy moves through periods of growth and stagnation and are important in crafting a portfolio.
When interest rates rise, some stock sectors – considered to be defensive – rise. These include the likes of healthcare, consumer staples and precious metals.
Also financial stocks may benefit as banks can earn more from the spread between what they pay to savers and what they can earn from highly-rated debt like Treasuries.
On the other hand, there are stock sectors that rise when interest rates decline. These include technology, utilities (and other high dividend payers) and commodities. And since lower interest rates tend to boost economic growth, small and midcap stocks also benefit.
How Inflation Plays a Role in Outperformance
Research from the investment firm Schroders found that equities outperformed inflation 90% of the time when inflation has been low (below 3% on average) and rising – that is where we have been for many years.
When inflation is on the rise, there are certain sectors that usually outperform the market. These include commodity-related sectors such as basic materials and energy, as well as some utility stocks.
Another industry to consider is real estate (equity REITs) – it is a real asset that produces steady income.
Investors can gain exposure to these types of investments through ETFs and mutual funds. A simple search on Magnifi indicates numerous ways for investors to access an array of funds with low fees.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the February 9, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
FANG Stocks
What are the FANG stocks?
The term FANG stocks was coined by CNBC’s well-known “Mad Money” host, Jim Cramer, in 2013. It is now widely used by market commentators, analysts and investors.
“FANG” is an acronym that refers to four of the world’s largest and most popular stocks: Facebook (which is now Meta), Amazon, Netflix and Google (which is now Alphabet). In 2017, Apple was added by many Wall Street analysts to this acronym, creating “FAANG.”
What Is FANG?
FANG stocks are all well-known and richly-valued technology companies that have shown extraordinary growth in recent years in both revenues and profits. The 5 FAANG stocks constitute a market cap of over $7 trillion.
Because of their large market caps, and since tech is seen as the cutting-edge sector for U.S. economic growth, the FANG stocks have a huge influence on both the NASDAQ index and the S&P 500, and are seen as an indicator of the health of the stock market as well as the economy.
So if you’re a passive index investor, you have a major exposure to FANG stocks whether you know it or not.
And while their business models do vary, each company has one common trait: the use of advanced technologies, such as artificial intelligence, to acquire and retain users.
These companies are all great beneficiaries of the network effect. This is the concept that the value of a product or service increases as the number of people who use that product or service increases.
Each of these companies has an enormous user-base, which:
- Generates more value for their products
- This leads directly to seller services becoming more attractive to third-party merchants
- All of this, in turn, leads to valuable data analytics and feedback to drive content and services
Bottom line – their extensive network of subscribers, members and users gives these companies an enormous competitive advantage.
Why Invest in FANG?
These companies also share another trait… despite exhibiting growth stock behavior, FANG stocks are less volatile than many stocks. When the stock market rebounds after a dip, it is these stocks leading the charge.
It is this relative stability – along with delivering superior rates of return over many years – that has made these stocks so attractive to investors.
Over the past decade, the FANG stocks have grown faster than the overall S&P 500 or the more tech-focused NASDAQ. These companies have grown to be the top stocks on the S&P 500 through innovation and service diversification, enabling them to weather market changes and recessions.
For example, during the pandemic in 2020, FANG stocks were up 43% compared to the rest of the tech sector that lost around 4%.
That’s why this group of stocks has become a barometer of the investment health of the overall technology sector.
How to Invest in FANG?
To gain exposure to FANG, investors may want to invest in the individual FANG stocks, options, or FANG ETFs. While most FANG ETFs are not exclusive to FANG stocks, the FANG stocks heavily influence the performance of the fund. And using an ETF may be a less volatile way to gain exposure to these stocks.
For help finding FANG stocks-related investments, make sure you check out the magnifi.com website to help you find the right ETF to meet your investment goals.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the January 17, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Natural Gas
What Is the Gas Industry?
Over millions of years, the remains of plants and animals (such as diatoms) built up in thick layers on the earth’s surface and ocean floors. Over time, these layers were buried under sand, silt, and rock. Pressure and heat changed some of this carbon and hydrogen-rich material into coal, some into oil, and some into natural gas.
Specifically focusing on natural gas (the cleanest fossil fuel), its largest component gas is methane, a compound with one carbon atom and four hydrogen atoms (CH4). Natural gas also contains smaller amounts of natural gas liquids (NGLs) and non-hydrocarbon gasses, such as carbon dioxide and water vapor.
Natural gas systems include wells, gas gathering and processing facilities, storage, as well as transmission and distribution pipelines. These components are all important aspects of getting natural gas out of the ground and to the end user.
Natural gas systems encompass the following industry segments:
- Production: Getting raw natural gas from underground formations.
- Gathering and Processing: This involves stripping out impurities and other hydrocarbons and fluids to produce pipeline grade natural gas that meets specified targets. Pipeline quality natural gas is 95% to 98% methane).
- Transmission: This encompasses delivering natural gas from the wellhead and processing plants to city gate gas stations and/or industrial end users. Transmission occurs through a vast network of high pressure pipelines. Natural gas storage falls within this sector. Natural gas is typically stored in depleted underground reservoirs, aquifers, and salt caverns.
- Distribution: Delivery of natural gas from the major pipelines to the end users.
Why Invest in Gas?
The reason for investing in the natural gas industry is very basic – increasing demand and limited supplies.
In its International Energy Outlook 2021, the U.S. Energy Information Administration (EIA) predicted a nearly 50% increase in global energy use from 2020 to 2050. This is primarily a result of projected economic and population growth in the developing world, particularly in Asia.
Global natural gas demand is forecast to grow by 50% to 5.92 trillion cubic meters by 2050 from 2019 levels, the Gas Exporting Countries Forum said about a year ago in its Global Gas Outlook.
Its forecast for gas demand growth is broadly in line with forecasts from other organizations on an annualized basis. The International Energy Agency (IEA) sees global gas consumption reaching 5.22 trillion cubic meters by 2040. S&P Global Platts Analytics forecast global gas demand at 5.29 trillion cubic meters in the same time frame.
LNG (liquified natural gas) is set for strong growth, as domestic supply in key gas markets will not keep up with demand growth. LNG demand is expected to grow 3.4% a year to 2035, with some 100 million metric tons of additional capacity required to meet both demand growth and decline from existing projects. LNG demand growth will slow, but will still grow by 0.5% from 2035 to 2050, with more than 200 million metric tons of new capacity required by 2050.
All this demand has run smack into a lack of investment in the industry.
Moody’s recently released research in which it found the energy industry will need to increase its capital investments by as much as 54% to avoid a major supply crunch in the coming years. The firm estimated that the $352 billion of industry capital investment during 2021 would need to rise to $542 billion in order to keep pace with new demand.
Moody’s report is consistent with earlier reports by Rystad Energy and Wood MacKenzie estimating the industry has been under-investing since 2015 in the finding and development of new reserves that will be needed to meet rising demand.
How to Invest in Gas
So how can you invest into the natural gas industry and its bullish fundamentals?
Exchange traded funds (ETFs) are one possibility, as is buying a futures contract or investing in natural gas stocks.
There are five natural gas ETFs to choose from currently. Please note that some ETF investments offer exposure to both the oil and gas markets simultaneously.
If you decide to invest in natural gas futures, keep your eyes peeled on Thursdays, when the U.S. Department of Energy releases its weekly natural gas storage report.
Lastly, investors can opt to invest in companies involved in the natural gas market. As with ETFs, many companies that are exploring for or producing natural gas are also focused on oil. It is difficult to find companies that are aimed purely at natural gas.
For help in finding natural gas-related investments, make sure you check out the magnifi.com website.
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The information and data are as of the January 10, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Oil Industry
Crude oil or petroleum are called fossil fuels because they are mixtures of hydrocarbons that formed from the remains of animals and plants (diatoms) that lived millions of years ago in a marine environment. Over millions of years, the remains of these animals and plants were covered by layers of sand, silt, and rock. Heat and pressure from these layers turned the remains into what we now call petroleum, which means rock oil or oil from the earth.
The vast majority of crude oil is refined and used by the transportation industry to power our cars, trucks, planes, boats, etc. Crude oil is also used for heating oil, petrochemical feedstocks, waxes, lubricating oils, and asphalt.
Oil is measured in barrels (bbl). One barrel is about 100–200 liters (26–53 gallons). According to the U.S. Energy Information Agency (EIA), in 2020, total U.S. petroleum production averaged about 18.375 million barrels per day, of which 11.283 million barrels per day of crude oil was produced.
What Is the Oil Industry?
After crude oil is removed from the ground, it is sent to a refinery where different parts of the crude oil are separated into usable petroleum-based products. These products include gasoline and distillates.
There are two benchmarks for oil globally. Here in the U.S., the benchmark is WTI (West Texas Intermediate). It is a light, sweet, high-quality crude that is easy to refine.
The other is Brent crude, which is the benchmark for European, African and Middle Eastern crude oil.
The term “sweet crude” refers to petroleum that has less than 1% sulfur content. Both WTI and Brent crude are lighter, or less dense, compared to other crude oils available. In addition, their sulfur content is well under 1%, making them simpler to refine into products like gasoline. Because of this, they sell for higher prices on commodity markets.
Why Invest in Oil?
The reason to invest in oil is straightforward – it remains the lifeblood of the global economy. The fossil fuel industry generates an estimated $3.3 trillion in revenue globally every year.
That’s because, to date, there are yet not enough sources of alternative forms of energy to power the global economy.
This is especially important in the light of the forecast from the EIA that global energy demand will rise by 47% over the next thirty years.
In addition, for various reasons, oil companies have NOT invested enough into finding enough oil to meet the world’s energy needs. This spending hit a 15-year low in 2020.
Moody’s estimates that global annual upstream spending needs to increase by as much as 54% to $542 billion to avert the next supply shock.
Another reason to invest in oil over the shorter-term is inflation and possibly stagflation.
Historically, oil and inflation often go hand-in-hand. In the 1970s, skyrocketing oil prices sent inflation soaring. This forced the U.S. Federal Reserve to raise interest rates to nearly 20% to stop inflation.
Oil stocks have historically done well in periods of low economic growth and high inflation (stagflation).
How to Invest in Oil?
There are three main areas in the oil industry in which you can invest. These are:
- upstream – this is the business of oil exploration and production (E&P)
- midstream – this involves the transportation and storage of oil
- downstream – this includes the refining and marketing of petroleum products
In the upstream segment – in addition to the E&P companies themselves – there are drilling firms that contract their services to extract the oil and well-servicing companies that conduct construction and maintenance activities on well sites.
These service firms are ‘safer’ than the E&P companies themselves, which are high risk. That’s because E&P firms have high investment capital outflow, extended duration times to locate oil and drill for it. Virtually all cash flow and income statement line items of E&P companies are directly related to oil and gas production.
The midstream segment is often a safer investment. These businesses are focused solely on transporting and storing oil. Midstream companies may include shipping, trucking, railroads, pipelines, and storage tanks. The midstream segment is characterized by high regulation (particularly on pipeline transmission) and low capital risk.
The downstream businesses are the refineries. These are the companies responsible for removing impurities and converting the oil to products for the general public, such as gasoline, jet fuel, heating oil, and asphalt.
In summary, oil is a vital cog for the well-being of the global population and a necessity for economic progress. It is also essential to our daily lives. We’re reliant on oil to power our cars and trucks and so many other necessary things.
A good way to invest in the industry is through exchange traded funds (ETFs). A number of which can be found on Magnifi.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the January 7, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Governance and Transparency
More and more investors – both institutional and retail – are applying environmental, social, and governance (ESG) criteria to their evaluation of the companies they invest in.
Governance, or this case corporate governance, is the system by which businesses are directed and controlled. It involves both the board of directors and management.
Corporate governance covers the areas of environmental awareness, ethical behavior, corporate strategy, and risk management.
What Is Governance and Transparency?
The core principles of corporate governance include accountability, fairness, responsibility, and transparency. Each of these four principles are essential parts of good governance.
Perhaps the most important of these principles is transparency. Shareholders (and even outsiders) should be informed about the company’s activities, what it plans to do in the future and any risks involved in its business strategies.
Transparency means openness, a willingness by the company to provide clear information to shareholders and other stakeholders.
Disclosure of material financial matters concerning the organization’s performance and activities should be timely and accurate. This will ensure that all interested parties have access to clear, factual information which accurately reflects the financial, social and environmental position of the organization.
Transparency ensures that stakeholders can have confidence in the decision-making and management processes of a company.
After the Enron scandal in 2001, transparency is no longer just an option, but a legal requirement that a company has to comply with.
Transparency is a necessity for the whole company. However, its presence is even more important at the top where strategies are planned and all the major decisions are made. Shareholders expect that the corporate board and upper management are open about their actions; otherwise, distrust will form and the stock price will likely suffer.
Why Is Governance and Transparency Important to Investors?
The reasons governance and transparency are important are self-evident.
Poor corporate governance can cast doubt on a company’s operations and its ultimate future profitability. In fact, S&P Global research on governance factors has shown that companies that rank well below average on good governance characteristics are highly prone to mismanagement and risk their ability to capitalize on business opportunities over time.
And there are studies that show a positive link between financial performance and strong corporate ESG policies and practices.
Aaron Yoon, an assistant professor of accounting information and management at Kellogg and George Serafeim at Harvard Business School, recently examined this question by analyzing data on more than 3,000 companies. They found that stock value did tend to rise after positive ESG news about a firm emerged, but only if the news was financially material—that is, related directly to the company’s sector.
The researchers also looked at what categories of ESG news elicited the biggest reaction from investors, given that ESG covers a huge range of company activities.
In looking at both material and nonmaterial news, they found that investors didn’t respond to every piece of ESG news. But they did react strongly to news about how products affected customers, such as changes in safety, affordability, or consumer privacy. So, if companies are looking for a positive market response, it might make sense for them to invest more resources in those areas. Improving labor practices and lowering products’ environmental footprints also were linked to bumps in stock prices.
That’s why understanding in particular the “G” in ESG is critical, as governance risks and opportunities will likely increase in the future as social, political, and cultural attitudes continue to evolve.
How to Invest in Transparent Companies With Good Corporate Governance
More and more investors are seeing the connection between ESG performance, value creation, and risk reduction. It makes sense that companies with strong ESG performance tend to be more efficient and less wasteful. They enjoy greater employee commitment and higher productivity. And they are more respected and better able to build brand equity. All of that reduces operational and reputational risks.
But of course, ESG investing covers a lot of ground, including governance and transparency.
Investing in such a broad theme can be challenging for investors, even professionals. Fortunately for individual investors, a search on Magnifi suggests that there are a number of ETFs and mutual funds that can help you access this rapidly growing style of investing.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the December 22, 2021 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.