Tag Archives: asset-allocation

The Hazards Of Over-Diversification In Investment Advice

One thing I have learned over the course of my career is there are never any shortage of opinions or strategies on how you should be investing your nest egg. Everywhere you look there are hedge funds, mutual funds, ETFs, advisors, newsletters, insurance companies, and other fringe “experts” touting their methods. There is no doubt that each approach will have their own benefits and drawbacks. Opportunities and risks will be characterized by security selection, position size, timing, and costs. However, the problem that many investors run into is when they try to implement several divergent paths simultaneously. I had an investor email me the other day and say that they are subscribing to several newsletters in tandem with placing multiple accounts with different investment advisors. He wanted to know more about how we use ETFs – in effect shopping for one more opinion on what he should do with his money . I know his intentions were quite genuine. He is likely thinking that this structure is highly diversified and allows him to cover numerous bases with his investment portfolio. However, the reality is that he is trying to drink from a fire hose of information and absorbing opinions from a wide range of conflicting sources. Some questions immediately come to mind when I think about this common dilemma: How do you decide the weighting of each advisors’ opinion or strategy? What systems are you actually using and which ones are just there for “market research”? Are you increasing your overall costs by implementing all these services continually? Do each of these services enhance your total return or are they just giving you something to do? Are you just needlessly searching for the holy grail of strategists that will outperform in every market environment? (hint: they don’t exist) In any group of 4 or 5 advisors, there are probably going to be at least one that is taking a contrarian viewpoint and possibly even implementing that in their recommendations. That means you are likely absorbing opposing views that will erode your confidence in sticking with a simple and reliable plan . Let me tell you from experience what will happen. You see one guy tell you to buy bonds as a core allocation and shock absorber for your portfolio. The next guy tells you that rising rates are going to destroy the foundation of the American economy. The only reasonable course of action then is to do absolutely nothing – and you will. Sitting in cash fretting about which person to believe and then only likely implementing the correct answer long after the move has been made. The funny thing is that both of these recommendations will likely be right at some point. The problem is that we only know which one (and when) with the clarity of hindsight. Or worse, you end up going long bonds in one account and short bonds in another account, which effectively offsets both trades. There is nothing quite like the experience of paying to go nowhere. The same can be said of stocks as well. I read three articles last week talking about how consumer staples stocks were risky because of their high relative valuations. This morning I woke up to an explanation of how consumer staples are historically some of the best stocks to own during the summer months. It’s that kind of conflicting advice that permeates this industry. One argument is fundamentally driven, while the other is data-driven. Both have their own merits. Who do you believe? There Is An Easier Way My best advice is to pare down the number of advisors with a substantial influence on your portfolio. One or two professionals that have proven their worth through your experience or research should be enough to guide you through the best and worst of times. This should also include tuning out the noise of the media and allowing a specific philosophy a reasonable time to work. I’m not here to advocate for the “best strategy” because everyone has a different philosophy, risk tolerance, goals, and experience. There are many different ways you can make money in the market as long as you realize the benefits and drawbacks of your specific method. My personal view is that you should be focusing on a relatively simple framework using low-cost ETFs as core holdings. You can easily customize a well-honed list of funds to your specific needs and make small adjustments over time as conditions warrant. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: David Fabian, FMD Capital Management, and/or clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell, or hold securities.

The Fundamental Difference: Through A Lens Of Net Buybacks

By Jeremy Schwartz At WisdomTree, we believe that screening and weighting equity markets based on fundamentals such as dividends or earnings can potentially help produce higher total and risk-adjusted returns over a complete market cycle. One of the most important elements of a fundamental index is the annual rebalance process, where the index screens the eligible universe and then weights those securities based on their fundamentals. In essence, the process takes a detailed look at the relationship between the underlying fundamentals and price performance and tilts weight to lower-priced segments of the market. One way to illustrate the benefits of this approach for our earnings-weighted family is to compare the net buyback yield of the WisdomTree Earnings Index to a market cap-weighted peer universe. Below we look at how the net buyback yield changes when you screen and weight U.S. equity markets by firms’ profitability instead of market cap. Earnings Weighting vs. Market Cap Weighting Click to enlarge The WisdomTree Earnings Index consistently had a higher net buyback ratio than did a market cap-weighted universe consisting of the 3,000 largest securities by market cap. The WisdomTree Earnings Index averaged a net buyback yield of 2.2% over the period, compared to just 1.1% for the market cap peer universe. We believe that having an annual profitability screen for inclusion in the WisdomTree Earnings Index helps avoid speculative and unprofitable smaller-capitalization firms that have a tendency to raise capital by periodically issuing new shares. The earnings-weighted approach that tilts weight to more profitable firms can also be a reason the weighted average net buyback yield is higher. The chart below looks at the net buyback yield on a universe of the lowest price-to-earnings (P/E) ratio stocks within the 3,000 largest stocks by market cap and contrasts that with the net buyback yield on the highest P/E ratio stocks. Net Buyback Yield by P/E Ratio Click to enlarge If corporate America responds well to incentives, the higher-priced basket would issue more shares (given that their stocks are high priced and issuing more of them would be an effective way to raise growth capital) and the lower-priced basket would issue fewer shares or actually buy back shares to reduce their shares outstanding and thus power their earnings-per-share growth. What we see in the data is the higher-priced universe buys back fewer share, and instead issues more shares (having more companies with negative net buyback yields). Why Earnings Weight Going back to the WisdomTree Earnings Index in the first chart-weighting by Earnings Stream is essentially tilting weight from a market cap-weighted scheme to over-weight those companies with below average P/E ratios and to under-weight those companies with high P/E ratios. The Earnings Stream can be defined as earnings per share times shares outstanding or market cap x earnings yield (which is equivalent to 1/PE ratio). Tilting weight to the higher-earnings-yield stocks by earnings weighting thus is one effective way to tilt the net buyback yield balance in one’s favor. Companies reducing shares outstanding are essentially locking in earnings-per-share growth by reducing their share count, while companies that are issuing more shares are creating a higher hurdle to overcome to achieve earnings-per-share growth. There is a philosophical debate about the motivations for all the buybacks we are seeing today as well as fears that companies are failing to reinvest for future growth (or that they just see no growth opportunities, hence all the dividends and buybacks). One thing is clear to us from the data: the lower-priced stocks issue fewer shares, and the more expensive stocks issue more shares (and have lower net buyback yields). This can be especially true in the small-cap space, as we will discuss in a future blog post. The consistently greater-than 2% net buyback yields seen on the WisdomTree Earnings Index over the last five years, combined with 2% dividend yields on this basket today, provides critical valuation support and also helps explain why we think the earnings-weighted approach can add value over time. Jeremy Schwartz, Director of Research As WisdomTree’s Director of Research, Jeremy Schwartz offers timely ideas and timeless wisdom on a bi-monthly basis. Prior to joining WisdomTree, Jeremy was Professor Jeremy Siegel’s head research assistant and helped with the research and writing of Stocks for the Long Run and The Future for Investors. He is also the co-author of the Financial Analysts Journal paper “What Happened to the Original Stocks in the S&P 500?” and the Wall Street Journal article “The Great American Bond Bubble.”

The Great Temptation, Greatest Danger

“If we survive danger it steels our courage more than anything else.” – Reinhold Niebuhr I am often bewildered that what passes for analysis is really a focus on recent performance, rather than process. Yet, so little attention is given to the investor return/behavior gap, a well-documented phenomenon that proves that “on, average, investors sacrifice a substantial portion of their returns by incorrectly timing when to enter or exit investments”. In correct timing tends to come from chasing performance, getting in after a major up move has already taken place, and then, of course, exiting when the drawdown is likely near its end. The below chart sums up some of the research on this which, in my opinion, is a “must know” when considering where to put money to work. Click to enlarge The best returns in the future come from those parts of the marketplace that have not done well in the past. Yet despite the overwhelming evidence which supports this, strong recent performance is often the core catalyst to make an investment. In reality, it should be the exact opposite. High past performance and continuous visibility of that performance is a temptation too strong for many to ignore, and that temptation unequivocally results in sub-optimal returns going forward on average. Take that truism on mutual funds, and magnify it by a billion when it comes to Exchange Traded Funds (ETFs). Yes folks – I would argue to you that ETFs are the greatest danger to investors. Why? Because ETFs provide an even greater temptation to chase recent performance, day by day, hour by hour, and minute by minute. Overtrading is the ultimate source of the investor return gap, and the temptation to get “in and out” of the market has never been higher thanks to these investment vehicles. Now, don’t get me wrong here. We ourselves use ETFs to execute across our quantitative strategies in mutual funds and sub-advised separate account strategies we run. However, following a systematic, backtested, and quantitative approach using ETFs as the vehicle of choice for execution is NOT what the vast majority of ETFs “investors” do. The pattern of behavior remains the same. Assets for ETFs grow when the ETF has strong recent performance, and collapse after, with a lag, when losses have already occurred. In our case, we rotate based on leading indicators of volatility (click here to learn more). The majority rotate based on old leaders that have had continuously low volatility. The greatest danger is in using past strong performance to make an investment decision. ETFs like the S&P 500 SPDR ETF (NYSEARCA: SPY ) may be the greatest temptation of all that results in exactly that. *Join us this week for our live webcast on the 2016 Dow Award paper, hosted by the Market Technicians Association. Registration available by clicking here . This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.