Author Archives: Scalper1

Low Risk, High Return, A Dream Come True: SPLV

Most active managers fail to beat their indices. Passive management is systematic and delivers expectations over the long term. Stock-picking is lucrative, but time consuming. SPLV facts make it attractive. When it comes to investing in equities in North America, the S&P 500 is one if not the most popular index used as a guideline and benchmark. There are various exchange-traded funds that replicate the composition and the return of the S&P 500. Best known ETFs in this space are: State Street SPDR, SPY iShares, IVV Vanguard, VOO This index has delivered an annualized return of approximately 7.48% (depending on month calculated) in the past ten years with an annualized standard deviation of approximately 15.05%. This performance is certainly not rock star, but is respectable and relatively consistent. On a longer time period (since 1928), the S&P 500 has averaged around 10% annualized. So what is the S&P 500? The S&P 500 is an index composed of 500 companies in the U.S., considered leaders in their respective industries. Companies in this index are mostly of large capitalization and together they represent around 80% of the economy. Therefore, this index is considered a representation of the U.S. market. Some companies in this index are Apple (NASDAQ: AAPL ), Johnson & Johnson (NYSE: JNJ ), and General Electric (NYSE: GE ) . Knowing this index represents the U.S. market and that it has performed relatively well, we ask ourselves if we can make a better index. Like all changes, there may be something to sacrifice. Second, what do we seek in an investment? It turns out two and only two things are priority. First, we want our investment to appreciate the most be in terms of capital appreciation, income (dividend or interest), or both. Second, we want our investment to be as less risky as possible. We measure risk as continuous change in value (standard deviation) and loss of permanent capital. How do we minimize risk? Our first action is to diversity; this way we eliminate diversifiable risk known as unsystematic risk (company going bankrupt or not meeting expectations). Second, we invest in strategy that has delivered expected returns over an expected holding time period. Meet the S&P 500 Low Volatility Index. This index is a stripped version of the S&P 500, by selecting 100 constituents with the lowest volatility over the trailing 12 months from the S&P 500 and rebalancing the index quarterly. What is so great about this index? The risk-adjusted returns are impressive. Here is a graph of the index performance: (click to enlarge) As can be seen, the returns in the graph demonstrate adequate upside and safer downside risk in comparison to the S&P 500. How about the performance and the standard deviation of the index? (click to enlarge) Source: SP Indices The return table shows that on all periods except 3 years, the Low Volatility Index performs better than the S&P 500. Also, the Low Volatility Index demonstrates that it has been less risky than the S&P 500 in the trailing 3, 5, and 10 year periods. Before you get excited, I have talked about this index and the returns and risk it has provided over the previous 10 years but the index is not an instrument to invest in. So where can you invest in a fund that replicates this index? PowerShares S&P 500 Low Volatility Portfolio (NYSEARCA: SPLV ). This ETF has over $5 billion in assets under management and charges a total expense ratio of 0.25%, making liquidity and fees manageable. In terms of performance, the ETF has delivered an annualized return of 13.33% since inception versus 12.59% for the S&P 500 Index. The funds top ten holdings currently are Plum Creek Timber (NYSE: PCL ), PepsiCo (NYSE: PEP ), Republic Services ‘A’ (NYSE: RSG ), Procter & Gamble (NYSE: PG ), Campbell Soup (NYSE: CPB ), Stericycle (NASDAQ: SRCL ), McCormick (NYSE: MKC ), Paychex (NASDAQ: PAYX ), Ace (NYSE: ACE ), and XL Group (NYSE: XL ). Source: PowerShares Currently, this ETF is the only investment option in this index (per my research). There are other low-volatility ETF’s out there, but their methodology differs. It is clear SPLV is an attractive position to be considered for any portfolio.

DMO’s Year-End Distribution Brings 2015 Yield To 14%

The closed-end fund, DMO, is the best opportunity in mortgage debt. Two distribution increases and two special distributions this year bring the fund’s 2015 yield to 14%. DMO has beaten ETF, ETN and mREIT comps on 2015 returns. I have been writing recently about Western Asset Mortgage Defined Opportunity Fund (NYSE: DMO ) ( here and here ) and have made clear that, in my opinion, DMO is the best current opportunity in mortgage debt. I’ve compared it to the 2x ETN, UBS ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN (NYSEARCA: MORL ), and the unleveraged ETF, iShares Mortgage Real Estate Capped ETF (NYSEARCA: REM ). DMO’s leverage (31%) falls between MORL’s 2x and REM’s unleveraged status. Some readers have considered those comparisons invalid because DMO is more like a mortgage REIT than those ETPs, which hold (or index to) a portfolio of mREITs. So, I’ve compared it to the largest mREITs, Annaly Capital Management Inc (NYSE: NLY ) and American Capital Agency (NASDAQ: AGNC ) as well. All four of these names have been very popular among income investors on Seeking Alpha and they continue to have their defenders relative to DMO. In my view the best comparison to DMO is PIMCO Dynamic Income Fund (NYSE: PDI ). Although PDI is not a pure-play mortgage debt fund, its portfolio is typically about two-thirds mortgage debt. Here are current charts for these tickers from Yahoo Finance. (click to enlarge) The chart includes prices for all and NAV for the closed-end fund, DMO and PDI. I am writing today to note that DMO announced its year-end distribution ($0.6498, ex-dividend 28 Dec), and that distribution will bring its 2015 distribution yield to something near 14%. This will be at least the fourth consecutive year that DMO has returned a 14% yield. For 2015, total distribution is down from the two previous years and yield is down from all three. The decreases relative to past years reflect the more modest special distributions this year. Note, however, that the regular distribution is up. There have been two regular distribution increases this year, which to me indicates a vote of confidence by DMO management that the fund will continue to generate strong income in coming years. Market price, NAV and the fund’s discount status have varied over the period, as we see in this chart. For the past two years, the fund’s price has remained in a channel between $24 and $25, so capital preservation has been strong, unlike many high-yield CEFs , which have seen marked declines over the period. A recent decline has taken DMO to the mid-$23 range. But as the first chart shows, that decline is much less than that experienced by any of the comps except PDI. The discount has been closing as investors seek safer refuges in the high-yield space, but it has still been dropping to near -4% on a regular cycle. Last week’s drop to -6.1% presented a buying opportunity. I’ll continue to look for discount drops and am planning to add to my position as they occur. Total return for the fund has been excellent as we see in this 5yr (click to enlarge) and this 1 yr chart from Ycharts . (click to enlarge) High yield income has been pummeled in recent weeks. DMO has held up to this reasonably well. Much of the bearish sentiment in debt and credit is extending from apprehensions over energy company debt. Clearly this does not apply to a mortgage debt fund. I’m hopeful that DMO, and other high yield investments that are not carrying energy debt, will bounce back in 2016. The long-promised gradual upward trend in interest rates is finally begun. This may adversely impact DMO and presents the most significant risk factor for the fund. If the increases are, in fact, gradual — and there is no reason to think they will not be — mortgage credit may be well positioned to handle the rising rates better than most high-yield categories.

SAT Investing

Can investors learn something from the SATs? It may be only a few more days to Christmas, but it’s also college application season. A lot of high-school seniors are filling out the Common App, writing and re-writing essays, and anxiously awaiting their latest test scores. And there’s a test-taking technique that kids use to improve how they do on standardized tests that can help investors. It’s elimination. When they come to a question to which they don’t know the answer, they can improve their scores by eliminating what is most clearly wrong. In a multiple-choice test, someone just filling in the circles gets 20 or 25% correct by random chance. But by eliminating the obviously wrong answers, students can better their odds. They won’t guess right every time, but they’ll do better than if they had left the answer blank. In the same way, investors can do better by eliminating what’s wrong. If a company’s business model makes no sense – if you can’t figure out how they earn their money – then don’t own that business. If management seems to be focused more on politics and celebrity than capital investment and HR, don’t buy the stock. This is a variant of The Loser’s Game by Charlie Ellis. We can be smart by avoiding dumb ideas. For example, in December of 2000, Enron employed 20,000 people and claimed revenues of over $100 billion. But some analysts started looking in depth at their derivative books and couldn’t figure out how the company was earning all their money. There was a gap between what was reported and what they could confirm. We know how this story ends: Enron filed for bankruptcy in December 2001. The executives used a willful, systematic, and intricately planned accounting fraud to inflate their earnings. (click to enlarge) Enron stock. Source: Bloomberg Investors would have improved their relative performance by avoiding Enron. That was difficult to do: the company was a media darling, considered a high-flying harbinger of the new economy. It had tremendous price momentum. But it was hard to see how they could turn 2% growth in utility revenues into consistent double-digit earnings growth for themselves. By looking under the hood – understanding the business, reading the financials – investors can sometimes avoid the big flops. And just like when kids take the SATs, if you can improve your odds – in a low-return world – that just might be enough.