Tag Archives: investing

Bracketology – An Investing Lesson From The NCAA

“Bracketology,” a term coined by ESPN, is the study of the annual NCAA college basketball tournament. Interestingly the art or science of filling out an NCAA tournament bracket also provides insight into how investors select investment assets. Before explaining, we present you with a question: When filling out an NCAA bracket do you A) start by picking the expected national champion and work backward or B) analyze each matchup, and pick winners starting at the earliest rounds, working toward the championship game? In A, one has a pre-determined idea for which team is the best in the country and disregards the path that team must take to become champions. Those using B’s methodology look at each game and consider the participants, compare their respective records, their strengths of schedule, demonstrated strengths and weaknesses, record against common opponents and even how travel and geography could affect performance. In a methodical, rigorous evaluation, the result is a conclusion about which team can win 6 consecutive games and become the national champion. Outcome vs Process Outcome-based investors start with an expected outcome, typically based on prior results, and select assets accordingly. How many times do we hear the gurus of Wall Street preach that stocks return 7% on average and therefore a well-diversified portfolio should expect the same thing this year? Many investors take the bait and few question the rather simple approach that drives the expected outcome and ultimately the investment selection process. Process-based investing, on the other hand, is a tactic to better determine how assets should perform. The method may be based on macroeconomic expectations, technical analysis or a bottom-up assessment of individual companies to name a few. Process investors do not just assume that yesterday’s winners will be tomorrow’s winners nor do they diversify just for the sake of diversification. They create a procedure to help them forecast which assets are likely to provide the best risk/reward prospects and deploy capital opportunistically. “The past is no guarantee of future results” is a common investment disclaimer. However, it is this same outcome-based methodology that many investment managers use to allocate their assets. Process driven investors employ thoughtful analysis to determine what investments should perform the best. Potential outcomes are the ending point of their analysis not the starting point of their work. A or B? So, why would people use a less rigorous process in investing than the one they use in filling out their NCAA tournament brackets? Starting at the final game and selecting a national champion, is similar to identifying a return goal of, for example, 10%. How that goal is achieved is subordinated to the idea that one will achieve it. In such an outcome based approach, decision making is predicated on an expected result. Considering each of the 67 possible match-ups in the NCAA tournament to ultimately determine the winner applies a process-oriented approach. Each decision is based on the evaluation of comparative strengths and weaknesses between teams. The expected outcome is a result of the analysis of factors required to achieve the outcome. Summary Very few filling out brackets this year will pick Duke solely because they won the tournament last year. Many investors, however, will select investments based on what performed well last year. The following table (courtesy invest-assist.blogspot.com and Koch Capital) is a great reminder that building a portfolio based on last year’s performance is a surefire way to ensure you are not making the most out of your portfolio. Click to enlarge Winning or losing a basketball pool has benefits like bragging rights and potentially winning some money. Managing a client’s investments deserves much more thoughtfulness. Those who apply a well thought out process-oriented approach provide their clients a much more rigorous, durable and time-tested method to consistent performance. 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.

NOBL: An ETF For Dividend Growth And The Quest For Yield

By Max Chen and Tom Lydon Investors seeking a steady yield-generating exchange traded fund to help diversify their portfolios in a volatile year can look to the ProShares S&P 500 Aristocrats ETF ( NOBL ) for quality stock market exposure and sustainable dividends. “By investing in dividend growth strategies, you not only get high-quality companies that have delivered strong total returns, you also get the potential for attractive yield,” according to ProShares . “If you look at effective yield, you’ll see dividend growth strategies have significantly outperformed the broader market.” NOBL, which has accumulated $1.39 billion in assets under management, shows a 2.03% 12-month yield and a 0.35% expense ratio. The dividend ETF has been outperforming the broader equities market. Year-to-date, NOBL rose 5.5% while the S&P 500 index was only 0.9% higher. Over the past year, NOBL increased 4.3% as the S&P 500 dipped 0.6%. NOBL’s 17.2% tilt toward industrials and 10.4% position in materials helped the ETF capitalize on the recent rally in more undervalued sectors of the market. Additionally, the fund holds large positions in more conservative or defensive sectors, including 12.9% in health care and 25.5% in consumer staples. The recent selling pressure in the equities market has also made dividend stock plays more attractive , especially as the Federal Reserve projects only two interest rate hikes this year, compared to previous expectations for four rate hikes. As the S&P 500 index experiences its worst start to a new year since 2009, yield spread between the benchmark and 10-year Treasuries widened to their largest spread in a year. The difference between U.S. equity dividend yields and government bonds can be used as a proxy for valuation comparison between the two assets. On average over the past year, the yield on 10-year Treasuries exceeded that of the S&P 500 dividends by 7.7 basis points. However, the recent volatility helped push yields on 10-year Treasury notes below 2%. NOBL, which tracks the S&P 500 Dividend Aristocrats Index, targets the cream of the crop, only selecting components that have increased their dividends for at least 25 consecutive years. Consequently, investors are left with a portfolio of high-quality, sustainable dividend payers as opposed to more high-yield focused funds that may contain companies on more precarious financial positions. High-yield equity funds can be enticing to income-seeking investors, but the higher yields come with higher the risks and are often unstable, writes Kevin McDevitt, a senior analyst for Morningstar . Alternatively, McDevitt argues that dividend growth is a more important factor for long-term dividend investors. “Dividend growth plays a big role in determining total income over the life of an investment,” McDevitt said. “As a general guideline, the higher a company’s, and by extension a fund’s, yield, the less quickly it will grow over time. Over the short run, this initial yield matters more than dividend growth. But as the time horizon grows, dividend growth has a greater impact on the overall payout.” ProShares S&P 500 Aristocrats ETF Click to enlarge 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.

On The Statistical Significance Of The Knowledge Factor

Over the last week or so we’ve been highlighting how factor investing is not as cut and dry as advertised . The traditional simple factors (value, size, momentum, quality, low volatility) sometimes work and sometimes don’t so investors are left to make educated guesses about which factors will work in any given year. Here we’re defining “work” as these factors’ outperformance, or not, of the broad equity market. But the Knowledge Factor (the Gavekal Knowledge Leaders Developed World Index) doesn’t appear to have this same limitation. As we’ve shown already two times in the last five days, the Knowledge Factor – the tenancy of highly innovative companies to realize excess stock market performance – is the only factor that delivers consistent outperformance vs the global stock market. In the first chart below we show the yearly binary relative out/under performance of each MSCI Factor index relative to the MSCI World Index itself. A blue line and a +1 represents a year of outperformance for that factor and a red line and a -1 represents a year of underperformance. The results speak for themselves as it’s clear that there is no discernible trend in the out or underperformance of the five MSCI simple factors on a yearly basis. Said differently, sometimes the factor exposures outperform and sometimes they don’t. The top line that shows the Knowledge Factor’s relative performance is as stable as it gets, returning less than the MSCI World Index only twice in 16 years. Click to enlarge This next chart shows the cumulative performance since 2000 for each of the MSCI simple factors and the Knowledge Factor (the bars) and the yearly hit rate of outperformance relative to the MSCI World Index (the stars). Over time, the stable outperformance of the Knowledge Factor has resulted in by far the highest total return of any factor over the last two full market cycles. Click to enlarge Having laid out the above, we then analyzed the performance of the Knowledge Factor to see if there were certain market environments which were not supportive of the Factor’s outperformance. We looked at bull markets and bear markets, periods of rising and falling interest rates, periods of rising and falling commodity prices, and periods of rising and falling inflation trends. We observed no market environment in which the Knowledge Factor did not outperform the MSCI World Index, leading us to conclude that the Knowledge Factor is the gift that keeps on giving . Statistical Analysis: Today we want to take a slightly different tack to try to understand the sources of performance of the Knowledge Factor (the Gavekal Knowledge Leaders Developed World Index). We’re going to decompose the return of the Knowledge Factor to see if underlying simple factor tilts are the sole reason for this factor’s outperformance. If the Knowledge Factor is just an intelligent combination of the simple factors, then the return stream could be easily replicated and the relative performance of the Knowledge Factor described above would lose significance. To test the hypothesis that the Knowledge Factor adds value (aka Alpha) even after taking into account of any underlying factor exposure, we show a multiple regression of the since 2000 return stream of the Knowledge Factor (dependent variable) vs the all the MSCI simple factors (the independent variables). Given the below ANOVA table we observe the following: This factor exposure model does a good job explaining the return stream of the Knowledge Factor (the Gavekal Knowledge Leaders Developed World Index) because the adjusted r-square is .95, meaning that 95% of the Knowledge Leaders Index return stream is explained by this model. All of the beta coefficients except the Size Factor coefficient are in the single digits and none of the individual beta coefficients are statistically significant. In other words, there are no large factor tilts in the Knowledge Leaders Index returns and any factor tilts observed in the model cannot be statistically relied upon given the low t-stats and high p-values. Said even differently, none of the MSCI simple factors, in isolation or combined, can explain the returns of the Knowledge Factor. Even after taking into account the incredibly small and insignificant factor exposures, the Knowledge Factor has a highly statistically significant unexplained annualized alpha of 3.18%. We know the 3.18% alpha is statistically significant because the t-stat is greater than 2 and the p-value is close to zero. These results indicate that the Knowledge Factor is not simply an aggregation of the simple factors. The returns of the Knowledge Factor are all-together different than the return streams of the simple factors. This goes a long way in explaining why the Knowledge Factor consistently outperforms global stocks on a yearly basis and outperforms in all the market environments studied. There are no underlying factor tilts dictating the performance of Knowledge Leaders except the Knowledge Factor itself, which is the systematic mispricing of highly innovative companies. 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.