Tag Archives: investment

2 Rising ETFs With 5% Yield

With global growth issues flexing muscles and corporate earnings falling flat, risk-on sentiments are finding it tough to sail smooth this year. Safe harbors like Treasury bonds are in demand, resulting in a decline in yields. As of May 16, 2016, yields on the 10-year U.S. Treasury note were 1.75%. As a matter of fact, the 10-year U.S. Treasury note did not see 2% or more yield after January 28, 2016. A dovish Fed, which lowered its number of rate hike estimates for 2016 from four to two in its March meeting citing global growth worries and moderation in U.S. growth, was also behind the decline in bond yields. Even Goldman Sachs cut its forecast for 10-year U.S. Treasury bond yields over the coming few years. Goldman Sachs now expects its year-end 10-year yield to be 2.4%, down from the 2.75% it projected in the first quarter. It does not expect the 10-year yield to rise above 3% to close out a year before 2018 (read: Time for Investment Grade Corporate Bond ETFs? ). Needless to say, this is a difficult situation for income investors that forced many to try out almost every high-yielding investing option. But higher yields sometimes come with higher risks. So, it is better to bet on investing areas that are better positioned from the return perspective and also offer a solid yield. One such option is preferred ETF. What is a Preferred Stock? A preferred stock is a hybrid security that has characteristics of both debt and equity. These do not have voting rights but a higher claim on assets than common stock ( Complete Guide to Preferred Stock ETF Investing ). That means that dividends to preferred stock holders must be paid before any dividend is paid to the common stock holders. And in the event of bankruptcy, preferred stock holders’ claims are senior to common stockholders’ claims, but junior to the claims of bondholders. The preferred stocks pay stockholders a fixed, agreed-upon dividend at regular intervals, like bonds. Most preferred dividends have the same tax advantage that the common stock dividends currently have. However, while the companies have the obligation to pay interest on the bonds that they issue, the dividend on a preferred stock can be suspended or deferred by the vote of the board. Preferred stocks generally have a low correlation with other income generating segments of the market like REITs, MLPs, corporate bonds and TIPs. However, unlike bond prices, these are also sensitive to downward changes in interest rates. If interest rates fall, issuers have the option to call shares and reissue them at lower rates. Investors should note that preferred ETFs have hit 52-week highs. Below we highlight two such options that are rising and also offer more than 5% yield. PowerShares Preferred Portfolio ETF (NYSEARCA: PGX ) The fund holds a portfolio of 237 preferred stocks in its basket, tracking the BofA Merrill Lynch Core Plus Fixed Rate Preferred Securities Index. It charges 50 bps in fees. Financials (85.1%) dominates this fund followed by utilities (6.5%). With the 30-day SEC payout yield of 5.72%, the fund is a solid income destination. The fund advanced 6.3% in the last three months (as of May 16, 2016). SPDR Wells Fargo Preferred Stock ETF (NYSEARCA: PSK ) The 151-securities portfolio invests 79% of the basket in the financial sector. The 30-Day SEC yield is 5.18% (as of May 13, 2016). The fund charges 45 bps in fees and added 5.7% in the last three months (as of May 16, 2016). Link to the original post on Zacks.com

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.

Dimensions Of Expected Return: Patience Is A Virtue

Giving investment advice should always aim to meet investors at their level of understanding. I do not expect everyone to have a Ph.D. in economics, so it is important to focus on big ideas that are the most crucial to understand. This can include ideas such as diversification, costs and discipline. With that said, I also recognize that many investors who have been engaged in their finances for some time or have a longstanding relationship with their wealth advisor deserve to continually learn more about investing. Today, we are going to delve further down the rabbit hole with the investment strategy that I recommend to investors. The dimensions of expected return are a finer topic that most investors are unaware of. It is hard enough motivating individuals to embrace a passive investment strategy let alone speaking about multiple regressions and time-tested data. Nonetheless, it is extremely important not only from an academic standpoint, but also from a successful investment experience standpoint. History Starting in the 1960s, financial economists began researching the behavior of stock prices. Two major events led to this particular movement in the field of economics: the development of computers and the establishment of the Center of Research in Security Prices (CRSP) at the University of Chicago. In other words, economists now had the most comprehensive dataset of stock prices and large machines that could make many computations in a reasonable amount of time. You put these two things together and all of a sudden you have an entirely new concentration in the field of economics. Decades of research and thousands of peer review academic studies into the drivers of stock market returns have led to amazing discoveries about how different types of stocks move in relation to one another. We can slice and dice the market by different factors such as market capitalization, fundamentals like book value or sales compared to market price, and region to see how different types of stocks compare to one another. From a practical standpoint, in terms of being able to translate academic findings into actual investment strategies, 4 factors or “premiums” have been found within stocks and successfully implemented (there are 2 factors that drive the behavior of bond prices): Click to enlarge That is, we know that historically stocks have outperformed bonds, small cap stocks have outperformed large-cap stocks, value stocks have outperformed growth stocks, and stocks that have high profitability have outperformed stocks with low profitability. Furthermore, we have been able to design investment strategies around these different factors. Now we are not suggesting that focusing on these “premiums” is a free lunch: quite the contrary. Traditional economic theory would suggest that higher expected returns must be associated with higher risk, which we believe for the most part is accurate. Other theories have suggested that these premiums may be associated with behavioral biases, but unfortunately, proponents of the behavioral theory have not presented an economic model to support it. Regardless, both theories still point to passive investing as the prescription. We are in essence pursuing different areas of the market that have been shown to reward investors but that involve taking risk. As we will show later on, there are periods of time where investors are not rewarded for pursuing these areas in the market, which is why they are considered to bear “risk premiums.” It is important for investors and advisors to have a healthy respect for these risk premiums when suggesting a particular asset allocation. Why These 4 in Particular? Before we go further, it is important to understand that there have been many factors found in academic research, but we stick with these particular 4 factors for the following reasons: They are sensible Persistent across time periods Pervasive across markets Robust to alternative specifications Cost-effective to capture in a diversified portfolio In other words, there is a very high degree of confidence that investors will benefit from focusing on these particular factors. From a fiduciary standpoint, it is crucial that we only do things that have been shown to be successful through rigorous scientific inquiry. Historical Performance of These Factors We now have a general understanding about dimensions of expected return. Historically, investors who have focused on these particular factors within equities have been rewarded with higher returns. Below we see the historical size, relative-price and profitability premiums for US, International/Developed and Emerging Markets using the longest dataset available for each market. Click to enlarge For example, within Emerging Markets Stocks, value stocks have outperformed growth stocks (relative price premium) by approximately 4.47% per year from 1989-2014. The highest premium has been the profitability premium in Emerging Markets, delivering 7.12% per year from 1996-2014. The smallest premium has been the size premium in the Emerging Markets, delivering 1.82% per year from 1989-2014. No Such Thing as a Free Lunch As we mentioned earlier, pursuing these different premiums in the market is no free lunch. If we want to be rewarded with higher expected return, then we have to take risk. While we should expect these premiums to be positive in any year, there are periods of time where they do not. Many clients of IFA are probably well aware that the relative price premium (value stocks) in US stocks did not deliver for the last 10-year period ending 12/31/2015. The charts below show the annual performance for each premium in the US from 1928-2014. A blue bar indicates a positive premium while a red bar indicates a negative premium. Click to enlarge As you can see, there are definitely more blue bars than red bars, but there are time periods where there are multiple years in a row where different premiums do not show up. Although the average premium observed over time has been positive, there is extreme variation around that average. For example, just looking at the relative price premium in the US, we can see that the historical average has been 3.64%. There have only been 9 years out of 87 where the observed premium was within 2% of the historical average. See the chart below. Click to enlarge The dashed line represents the arithmetic average (3.64%). The gray area around the dashed line represents the 2.00% range around that average. The dark blue bars represent the annual observations that fall within the range (1.64%-5.64%). While the average relative price premium in the US has been less than 5%, it is more likely that you will experience a much higher or much lower premium in any given calendar year. The same conclusions hold for the size and profitability premiums in the US as well as all of the premiums around the world. Patience is a Virtue While many investors are well aware of diversification in terms of investments, many people cannot fully grasp diversification in terms of time. I recommend diversifying investments as a risk control. Because we do not know with a high degree of certainty which area of the market is going to be the next winner, we hold many different types of stocks. Diversification has been shown to improve returns in terms of risk. Time diversification is the idea of following a particular investment style over time. As we mentioned before, premiums do not always show up in any given year, but the longer we hold onto them, the likelier we are to capture their benefits. If instead of looking at 1-year returns we now looked at 5-year rolling returns, how do the premiums look? Click to enlarge Each bar shows the 5-year period ending in that particular year. For example, the first red bar under the “market premium” is for the 5-year period ending 1932. The next red bar is the 5-year period ending 1933 and so on and so forth. What do you notice? Compared to the 1-year annual returns shown above, there are far fewer red bars in the 5-year rolling returns. In other words, once we move from looking at premiums from 1 year to 5 years, the probability of seeing a positive premium increases. Again, just to highlight the relative price premium in the US, below is a chart showing the historical 5-year annual rolling returns. Click to enlarge Looks like a smoother ride for the investor versus annual returns. Following the same logic, what if we looked at 10-year rolling periods, what do we expect to find? Click to enlarge As you can see, this looks even better than the 5-year rolling returns. Very few red bars across all 4 premiums. Once again, just to highlight the relative-price premium in the US, below shows the 10-year annual rolling returns. Click to enlarge As you can see, once we present the data in terms of 10-year periods, the pursuit of this premium looks very attractive. From 1941-1995, there was not a single 10-year rolling period where value stocks underperformed growth stocks. With that said, you can also see that in the 10-year period from 2005-2014, the value premium did not deliver. The table below shows the historical performance for the market, size, relative-price and profitability premiums in the US in terms of having a positive observation. Click to enlarge For example, looking at historical 15-year rolling periods for the market premium, there have been positive premiums 96% of the time. You can also see that across every single premium, the number of positive observations increases as we increase the time horizon. Things Can Turn Quickly We have already discussed the extreme variability around the historical averages for each premium. This variability means that things can quickly turn either positive or negative, highlighting the importance of long-term discipline when pursuing these risk premiums within a portfolio. The chart below shows the historical 10-year annual rolling observations for the relative-price premium sorted from lowest to highest. Click to enlarge You can see that for the 10-year period from 2005-2014, the value premium was slightly negative (-0.78%). This isn’t odd, as you can see other 10-year periods in history where the value premium was significantly negative. But if we go back just one more year and look at the 10-year period from 2004 to 2013, the value premium switches to being slightly positive (0.79%). This just emphasizes the importance of having a long-term focus when deciding to pursue these risk premiums within your portfolio. Conclusion As advisors, it is our duty to constantly educate our clients into understanding the reasoning behind their particular investment strategy. This not only allows us to be transparent, but it is crucial in building long-term discipline of the investment process. Beyond investing in index funds, academic research has found certain factors or premiums within the market that explain the variation in its returns. By pursuing these premiums we can increase the expected return of the portfolio for our investors, but this does not come without accepting a higher degree of risk or variability of returns. Because there is significant volatility around these premiums in any given year, it is important to maintain a long-term focus. Historically, the number of positive observations for each premium around the world increases as we increase the time horizon. Because I believe in a long-term approach to the investment process, I believe that pursuing these premiums within portfolios will be beneficial for investors, with the ultimate goal of creating a positive investment experience. 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: We utilize strategies from Dimensional Fund Advisors in the portfolios that we build for our clients. There are no profit-sharing arrangements between my firm, Index Fund Advisors, Inc., and Dimensional Fund Advisors, LP.