Tag Archives: etf

Un-Expectedly High Expected Return Of Global Equities

It seems just about everyone I talk to these days is underwhelmed by the long-term expected return of the global stock market. I too am more worried than normal about owning equities. However, my defensiveness arises from their negative momentum, not their valuation, which I see as surprisingly attractive. The valuation picture is blurred by the dramatic divergence between US and non-US equities. For the past four and half years, the US equity market has outpaced non-US equities by more than 10% a year. After that relative outperformance, US equities do appear overvalued, but the attractive valuation of non-US markets more than compensates in a global portfolio. The table below shows the cyclically adjusted earnings yields (using the past 10 years of earnings) of each regional equity market. The Baseline regional weights I’m using fall in between the weights published by MSCI and those calculated by Bloomberg using their WCAP function. 1 Click to enlarge The earnings yield of the global equity market is 6.6%. To get to an estimate of the long-term expected real return, I assume that 60% of earnings can be paid out in dividends (besides sounding like a reasonable assumption, it also happens to be the average payout ratio from 1915 to 2015 in the US), which will grow at about 1.5% above inflation in the long term. Many observers prefer the even simpler estimate of just using the earnings yield itself, which is 6.6%, but I prefer basing the estimate on cash flow to investors, which is generally more conservative. This results in 5.5% for the long-term expected real return for global equities (6.6% * 0.6 + 1.5%). 2 So how attractive is a 5.5% expected return above inflation? Here are four perspectives to consider: US equities returned 5.4% after inflation in the 50 years from 1965 to 2015, which many people view as having been a good time to be an equity investor (although not nearly as good as the 8.2% from 1915 to 1965). The chart below shows that 5.5% is well above the average expected return of 4.5%. It is in the top decile of expected returns calculated this way since 1985, a period of time longer than the careers of 80% of the people currently employed in the finance industry. 3 By contrast, other assets, such as fixed income and real estate, are currently offering low expected real returns in the bottom decile of expected returns over the past 30 years. It is difficult to come up with a simple prospective measure of expected real returns for alternatives such as hedge funds, but they certainly have been struggling recently to generate the attractive returns they produced in the ’80s and ’90s. Caution: Equities can get a lot cheaper, quickly. Just a month ago, global equities were more than 10% lower than they are now, in case we need any reminder. While 5.5% appears attractive as a long-term expected real return, we need to keep in mind that we may see much higher expected returns than that in the future. Bottom line: Global equities are pretty attractively valued, and when they enter a period of positive momentum, we’ll probably see very healthy returns. Click to enlarge Footnotes: MSCI bases its weights on strict investible market cap data while Bloomberg bases theirs on unrestricted market cap. The Baseline weights used here go beyond market cap, using other economically relevant data to compute weights. See this note for details, and here for a further comparison of weighting schemes. Based on the belief that earnings and dividends will grow at less than the rate of real GDP growth due to various slippages. For a more detailed discussion, watch this video , and read this short note . Furthermore, if we think of this as the central case in the return distribution, and if we believe the long-term return is distributed relative symmetrically around this value, then there is a convexity adjustment that makes investing in equities even more attractive. A back-of-the-envelope illustration is to note that if we thought there were two equally likely long-term (say 30 year) outcomes for the real return, of say 5.5% + 2% and 5.5% – 2%, we would see that the return associated with the expected value of equities would be 6.02%, or 0.52% higher than the 5.5% base case. From US BLS data, here . 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.

The V20 Portfolio Week #24: A Change Of Heart

The V20 portfolio is an actively managed portfolio that seeks to achieve an annualized return of 20% over the long term. If you are a long-term investor, then this portfolio may be for you. You can read more about how the portfolio works and the associated risks here . Always do your own research before making an investment. Read the last update here . Note: Current allocation and planned transactions are only available to premium subscribers . Existing holdings: CONN , SAVE , I , CALL , OTCPK:DXMM , ACCO While volatility is not something to which we should pay too much attention, it is nevertheless a possible indicator of material fundamental changes in our holdings. Over the past week, the V20 Portfolio declined by 0.9% while SPY (NYSEARCA: SPY ) rose by 0.8%. Conn’s (NASDAQ: CONN ) will be reporting earnings in a little under two weeks, meaning that the portfolio will likely experience higher than normal volatility. As investors, we look forward to earnings for guidance, to verify if our initial assumptions are correct. For Conn’s, much of the market’s concern revolves around the company’s credit operation. Despite a sound retail division, the market is still quite apprehensive about lending money to Conn’s. While improvements in the credit division has been foreshadowed by falling delinquency rates, earnings will shed more light on the details, hopefully providing more assurance to the market. Over the long term, whether the market recognizes the company’s value today or tomorrow is irrelevant, assuming that the management allocates capital correctly (i.e., seize growth opportunities, repurchase shares when conditions are favorable, etc.). Thus far, the management has been committed to their plan by buying back shares and expanding the store count. More on MagicJack Ultimately management’s actions will directly influence the company’s financial results. In MagicJack’s (NASDAQ: CALL ) case, capital allocation policy took a drastic turn (see my premium article here ). The gist of it is that the management decided to use half of the $80 million cash pile to acquire a company at 8-10x cash flow, when MagicJack itself was only trading at 2x cash flow. In previous quarters, the management did the right thing and created a lot of value by buying back these discounted shares. Unfortunately, as this acquisition has shown, the management has failed to choose the optimal method of capital allocation. Because the original investment thesis depended very much so on what the management has chosen to do with the cash (in a sense all investment thesis revolves around cash, but in this case it is particularly important as much of the value is tied to the cash at hand), it is unfortunate that things turned out the way it did. While the company itself is still extremely cheap, it is critical that we identify material fundamental changes in our holdings (such as changes in capital allocation policies) and evaluate them accordingly. As John Maynard Keynes is rumored to have said: “When the facts change, I change my mind. What do you do, sir?” As with anything in life, there is a certain degree of risk in investing. Financial results will fluctuate, but people’s thought process changes as well. While one can make an effort to understand the financials, there is no foolproof way to understand human psychology. This is why Buffett values a good management team so highly. As outsiders, the best way to analyze the quality of the management is by looking at their past actions, not their words. But as MagicJack has demonstrated, even that may not be enough. Many investors tend to focus on the result, not the process, of an investment decision. Unfortunately (and sometimes fortunately), the right decision can lead to a bad outcome, just as how a bad decision can lead to a good outcome, simply as the result of luck. Nothing frustrates a poker player more than a bad beat, yet professional players recognize that it is just a part of the game, and it is the initial decision that matters. Performance Since Inception Click to enlarge Disclosure: I am/we are long CONN, CALL, SAVE, ACCO, I, DXMM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

How To Find The Best Sector Mutual Funds: Q1’16

Finding the best mutual funds is an increasingly difficult task in a world with so many to choose from. How can you pick with so many choices available? Don’t Trust Mutual Fund Labels There are at least 242 different Financials mutual funds and at least 647 mutual funds across ten sectors. Do investors need 64+ choices on average per sector? How different can the mutual funds be? Those 242 Financials mutual funds are very different. With anywhere from 22 to 571 holdings, many of these Financials mutual funds have drastically different portfolios, creating drastically different investment implications. The same is true for the mutual funds in any other sector, as each offers a very different mix of good and bad stocks. Consumer Staples ranks first for stock selection. Utilities ranks last. Details on the Best & Worst mutual funds in each sector are here . A Recipe for Paralysis By Analysis We think the large number of Financials (or any other) sector mutual funds hurts investors more than it helps because too many options can be paralyzing. It is simply not possible for the majority of investors to properly assess the quality of so many mutual funds. Analyzing mutual funds, done with the proper diligence, is far more difficult than analyzing stocks because it means analyzing all the stocks within each mutual fund. As stated above, that can be as many as 571 stocks, and sometimes even more, for one mutual fund. Any investor focused on fulfilling fiduciary duties recognizes that analyzing the holdings of a mutual fund is critical to finding the best mutual fund. Figure 1 shows our top rated mutual fund for each sector. Figure 1: The Best Mutual Fund in Each Sector Click to enlarge Sources: New Constructs, LLC and company filings The Fidelity Select Communications Equipment Portfolio (MUTF: FSDCX ) ranks first, the Davis Financial Fund (MUTF: DVFYX ) ranks second, and the Fidelity Select Health Care Services Portfolio (MUTF: FSHCX ) ranks third. The ICON Natural Resources Fund (MUTF: ICBMX ) ranks last. How to Avoid “The Danger Within” Why do you need to know the holdings of mutual funds before you buy? You need to be sure you do not buy a fund that might blow up. Buying a fund without analyzing its holdings is like buying a stock without analyzing its business and finances. No matter how cheap, if it holds bad stocks, the mutual fund’s performance will be bad. Don’t just take my word for it, see what Barron’s says on this matter. PERFORMANCE OF FUND’S HOLDINGS = PERFORMANCE OF FUND If Only Investors Could Find Funds Rated by Their Holdings… The Davis Financial Fund (DFVYX) is the top-rated Financials mutual fund and the overall best fund of the 571 sector mutual funds that we cover. The worst mutual fund in Figure 1 is the American Century Quantitative Equity Utilities Fund (MUTF: BULIX ), which gets a Dangerous rating. One would think mutual fund providers could do better for this sector. Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector, or theme. 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.