Tag Archives: management

Chalking Up Another BRIC

Summary It’s almost 15 years since Goldman Sachs coined the term “BRICs” for Brazil, Russia, India and China. Progress for the countries has been hit and miss, but it’s important to remember that we’re still less than 20% into the 21st century. Despite experiencing significant turbulence, these markets are still massive, representing 20% of the world economy. With Brazil and Russia seemingly bottoming out, there may never be a better time to get back onto the BRICs bandwagon. It’s almost 15 years since Goldman Sachs’ then chief economist, Jim O’Neill, coined the term ‘BRIC.’ The idea was that four countries (Brazil, Russia, India and China) were going to be the growth drivers for the 20th century. The idea was catchy, convincing and caught on. Soon, there were more acronyms and groups of countries doing the rounds: MINT and Next 11 were two that spring to mind, but probably none were as notorious as the BRICs. As of 2015, the BRICs aren’t nearly as popular with future gazers as they once were. True, China did experience several years of double-digit growth after the acronym was invented but you didn’t need an economist to tell you that would happen. Russia, India and Brazil have fluctuated between star performers and dunces of the class: in short, typical emerging market economies. All in all, a pass mark for the BRIC prediction but better predictions have been made. But as faddish as the term BRIC was in the middle of the last decade, it’s equally faddish now to write them off entirely. True, there hasn’t been much good news emanating from any of the BRIC countries for the past year or two but we’re not even 20% through the 21st century. Many of the fundamentals that Jim O’Neill attributed to the countries are still in place, meaning there are still opportunities for investors who are willing to ride out the inevitable storms. Furthermore, even if they’re out of vogue, the BRIC countries have a combined GDP of about 20% of the world economy. And close to a third of the world’s population. So, keeping an eye on their progress is not only of interest – it’s of importance . The iShares MSCI BRIC ETF (NYSEARCA: BKF ), which has understandably been a poor performer for the past five years. Given how the BRIC acronym has fallen from grace, there’s every chance the ETF will be removed from the Blackrock portfolio entirely over the next few years, so it may be better to watch the ETFs offered for each individual country when investing in this group is concerned. iShares MSCI Brazil Capped ETF (NYSEARCA: EWZ ) The Brazil ETF is trading at around half the level it was five years ago, and with Brazil facing into an economic abyss, it’s difficult to see this ETF recovering value anytime soon. The Brazilian real has been the biggest faller of any currency in the world in 2015, although it has stabilized in the past month and even made a minor recovery. It’s going to be a tough year or two for Brazil but markets have priced most of it in already. The component companies of this particular ETF are both well diversified (Brazil Foods, AmBev (NYSE: ABEV ), Bradesco Banking corporation (NYSE: BBD ), Vale mining (NYSE: VALE )) and not entirely dependent on the fate of the Brazilian economy. If (and it’s an ‘if’ not a ‘when’) President Rouseff finally deals with structural issues in the Brazilian economy, this ETF will almost certainly experience a bounce. iShares MSCI Russia Capped ETF (NYSEARCA: ERUS ) When Winston Churchill famously called the future of Russia ‘a riddle, wrapped in a mystery, inside an enigma,’ he may have been understating it. Sanctions against Russia in the past two years have inevitably led to a fall in its ETF, but possibly not by as much as one might expect. Vladimir Putin’s meetings with Obama in the past month that a defrosting of relations can’t be too far off – and with it, removal of sanctions, a jump in Russia’s economy and a boon to its stock market, the RTS. The Russia ETF is inevitably heavy on energy (Gazprom ( OTCPK:OGZPY ), Transneft, Tatneft ( OTCPK:OAOFY )), but also has some of the largest food retailers in Europe in its composition (Magnit). There’s one thing you can certainly say about Russia (which also goes for the other countries on this list), which should apply to its ETF: The country has weathered so many economic crises that it can surely ride out another one and come back stronger in the future. iShares MSCI India Index ETF (BATS: INDA ) And the star performer of the BRICs group is… India. Unlike the first two ETFs in this group, India isn’t going through a particularly dire economic period. Its growth is still hovering at around 4% – highly respectable in global terms. Just this week, CNBC released an article under the heading, “Why India is turning into everyone’s favorite EM.” Therein, it referred to India as “the world’s new growth engine.” Basically, what Jim O’Neill at Goldman Sachs predicted all those years ago. This ETF is trading at around 14,000, about 40% over what it was trading for three years ago. There are several familiar names in its composition, including some tech firms (Infosys (NYSE: INFY ), Tata (NYSE: TTM )), pharmaceuticals (Sun Pharmaceutical ( OTC:SMPQY )) and consumer staples (Hindustan Unilever ( OTC:HNSQY )). Industrial production in India is on an uptick, and many of these component companies will be the beneficiaries. iShares China Large-Cap ETF (NYSEARCA: FXI ) It’s hard not to detect an element of schadenfreude in the U.S. Press about China’s short-term economic demise. It would be unwise of anyone to think it’s going to be anything but short-term, though. Having dropped off a cliff at the beginning of 2015, falling by around 33% in just a few short months, the China Large-Cap ETF has already begun to rebound on the back of the Chinese Government’s aggressive economic policy. Other good news comes for China’s economy in the form that the Yuan has overtaken Japan’s yen as a unit of exchange. The China-Large Cap ETF gives investors exposure to 50 of the largest Chinese companies, and if you don’t know their names now, you soon will. There are large financials (Bank of China ( OTCPK:BACHY ), ICBC ( OTCPK:IDCBY ) and China Life Insurance (NYSE: LFC )), technology and telecommunications firms (Tencent Holdings ( OTCPK:TCEHY ) and China Mobile (NYSE: CHL )) and some energy giants (PetroChina (NYSE: PTR ) and CNOOC (NYSE: CEO )). A position on this ETF is a position on China’s future – and nearly fifteen years on from Jim O’Neill’s coining of the term BRICs, China is still the one you should invest in. With prices down 33% on last year, now is not a bad time to get involved. Conclusion Long after popular acronyms fade away, fundamentals remain. Anyone who thought investing in four of the world’s largest emerging markets and wouldn’t get a bumpy ride was fooling themselves. The BRICs provide enough evidence of that. However, with 20% of the world economy and over 30% of the world’s population, the BRICs still represent an excellent choice for anyone who wants to take a position on the long-term. There’s a maxim here which applies almost perfectly right now: Be careful when others are greedy and greedy when others are careful. In 2015 where the BRICs are concerned, too many are being careful. It may be your opportunity to be greedy.

Dividend ETFs Battle It Out: Get The Right Sectors

Summary There are three big dividend ETFs from the major low cost index providers, Charles Schwab and Vanguard. Two of the three still offer yields over 3% and all three have excellent expense ratios. Investors deciding which one to buy should look at the sector allocation. These ETFs have some major differences in their allocations. Investors seeking high consumer staples exposure should look to SCHD and VIG. Investors wanting more financial exposure should look at VYM. SCHD and VYM both offer around 10% exposure to the energy sector, but VIG has very little allocation there. If you want oil in the portfolio, SCHD and VYM make. Can you smell what the dividend ETF champions are cooking? There are a few big dividend ETFs for broad exposure to companies offering respectable dividend yields. In this article I want to compare a few of them. Let’s meet the big contenders: Name Ticker Yield Expense Ratio Schwab U.S. Dividend Equity ETF SCHD 3.02% 0.07% Vanguard Dividend Appreciation ETF VIG 2.26% 0.10% Vanguard High Dividend Yield ETF VYM 3.10% 0.10% For investors that prefer to see those numbers in graphs, I put together a couple quick charts: First Impressions Investors right away may notice that the Vanguard Dividend Appreciation ETF doesn’t have a very high yield compared with the other dividend ETFs. It may be rational for investors looking at it to ask whether it should really be considered a high dividend ETF. While the Schwab U.S. Dividend Equity ETF technically only has 70% of the expense ratio of Vanguard’s options, the difference of .03% is not material. There is no viable way to spin the difference into being material. Assuming your decision isn’t based strictly on yields, the next area to look into is the sector allocations. I grabbed the sector allocations for each ETF: (click to enlarge) (click to enlarge) (click to enlarge) Sector Analysis The first thing that I’m noticing when I look at the sectors is that two of these funds go heavily overweight on consumer staples. When it comes to dividend ETFs, I like going overweight on consumer staples. Consumer Staples The nice thing about the consumer staples sector is that they are defined by the production of products that consumers will need regardless of what else is happening in the economy. Any sector can run into problems, but the kind of macroeconomic issues that can really slam my portfolio value should have a smaller hit on the earnings (and thus dividend potential) of companies in the consumer staples category. Of course, there is no free lunch. In exchange for getting companies that should be more resilient, I have to accept that during a prolonged bull market these companies are likely to rally less than other sectors. If my focus was strictly designing the portfolio for the highest projected total long term return, it would be very reasonable to argue against going heavy on consumer staples. It is up to each investor to determine how they feel about that trade off. If the investor wants more certainty that the underlying companies can sustain their dividends because they intend to use the dividends to cover living expenses, then the importance of those dividends being sustained is more important. Having to sell off part of the portfolio during the kind of recession that sees dividend cuts across the combined portfolio would be pretty painful. Financials Where SCHD and VIG put consumer staples at the top, VYM puts financials at number one. This is very interesting because SCHD placed it at 1.99% and VIG weighted it at 6.37%. Clearly the structure of the portfolio is materially different. There are some very good reasons to like the financial sector for investments. At the top of my list would be the demographic analysis showing that Generation Y is fairly weak at understanding money . If the next generation is less capable of understanding their money, then there may be more opportunities for the financial firms to make money off complicated products that the consumers don’t fully understand. That may sound cynical, but who cares? My goal is to understand where sales and profits will be flowing. If you own shares in the banks, would you encourage the CEO to ensure they have transparent pricing even if cuts earnings and means a smaller dividend? I really doubt shareholders would be thrilled to hear “We cut the dividend to make up for a cash shortfall from lowering prices when the current pricing system was working well.” My concern about aggressive allocations to the financial sector comes from regulation. If we see more regulatory pressure or cases brought against large banks for unethical actions in the pursuit of profit, the development could represent declining margins (from regulatory pressure) or cash expenses to settle cases. Energy SCHD and VYM both put energy over 10% of the portfolio. VIG holds it as just over 1% of the portfolio. There are some fairly different kinds of companies that can be considered “Energy” companies. When energy refers to enormous companies with strong dividends like Exxon Mobil (NYSE: XOM ), I like that allocation. If it was referring to much more volatile industries like off shore oil drilling, I wouldn’t be a fan. In the case of SCHD, XOM is the heaviest single holding. The same can be said for VYM. While the energy sector has been punished with oil prices at very low levels and no clear path higher, I see those issues as being priced into the shares. As long as the issues are already priced in, I want some exposure that would benefit from higher gas prices. Lower fuel prices mean more money for consumers to spend on other goods and services. If the low fuel price trend ends, I’d like to at least have the upside from earnings going up for a big dividend payer in the portfolio. What do You Think? Which dividend ETF makes the most sense for you? Do you want to overweight consumer staples for more safety in a downturn or would you rather have more upside in a prolonged bull market? Do you want to own the oil companies, or do you foresee gas as being in a long term downtrend that makes the business model much weaker?

Why There Will Never Be Another Warren Buffett

Summary Increasing numbers of highly intelligent people have been drawn to the stock market over the past several decades. As a result, it has become extremely difficult for individual investors to gain an “edge” over the competition. This explains why it’s so hard to produce the kind of “outlier” returns investing legends like Warren Buffett achieved. In an interview in the late 1990s, Warren Buffett famously said that he could “guarantee” 50% annual returns if he was managing less money. He explained that compounding large sums of money at high rates becomes increasingly difficult over time, because it limits the investable universe to only the largest companies. A smaller portfolio would allow him to invest in smaller companies, which have historically produced slightly better returns than their larger counterparts. He further pointed out that today’s easy access to information makes it easier than ever to find such companies selling cheaply. Unfortunately, Buffett’s argument has a major flaw. It’s certainly possible that his performance would improve (marginally) if he was managing millions, rather than billions, of dollars; but to claim that faster access to more information makes it easier to find attractive investment opportunities is illogical. In reality, this actually makes the stock market more efficient (not less), which makes it harder (not easier) to find and exploit pricing inefficiencies. But there’s another equally important factor driving market efficiency: skill. Today’s investors are much better than those of earlier decades, and the difference between the best and the average investor is less pronounced. This is often called the “paradox of skill.” This phenomenon was famously observed by evolutionary biologist Stephen Jay Gould. He wanted to know why no hitter in Major League Baseball has had a batting average over .400 since Ted Williams hit .406 in 1941. He discovered that, while the league batting average has remained roughly the same throughout baseball’s history, the variation around that average has declined steadily. To put that in plain English, it means that skill of modern baseball players is better than ever, which makes outliers like Ted Williams less likely to occur. The paradox of skill is evident in other competitive sports as well. Today’s elite athletes have superior coaching, training, nutrition, and drugs/supplements. Which is why they’re running faster, jumping higher, throwing farther, and lifting heavier than ever before. But as athletes approach the biological limits of human performance, it makes it harder and harder for individuals to stand out from the competition. A perfect example of this is the men’s Olympic marathon. The winning time has dropped by more than 23 minutes from 1932 to 2012; however, the difference between the time for the winner and the man who came in 20th shrunk from 39 minutes to 7.5 minutes over the same period. In other words, the overall skill of Olympic marathoners is improving on an absolute basis but shrinking on a relative basis. We can see the same thing happening in the game of investing. Growing numbers of today’s investors (both retail and institutional) are far more sophisticated and knowledgeable than their predecessors. As a result, just as we’ve seen the disappearance of .400 hitters in baseball, we’re also seeing the disappearance of superstar investors who were once able to persistently outperform the market by large margins. The table below shows that the standard deviation of excess returns (a proxy for investment skill) has trended lower for U.S. large-cap mutual funds over the past several decades. This means that the variation in stock-picking skill has narrowed as everyone got better and the market became more efficient. Decline in Standard Deviation of Excess Returns (Mutual Funds) Note: The table shows the five-year, rolling standard deviation of excess returns for all U.S. large-cap mutual funds. The benchmark index is the S&P 500 (NYSEARCA: SPY ). Source: A North Investments, Credit Suisse (Dan Callahan, CFA and Michael J. Mauboussin) Now consider Buffett’s track record. What do we see? The same exact story as above! During the early part of his career, when the market was underdeveloped and there was less competition, Buffett was the Ted Williams of investing. He had a huge edge over the less-skilled competition. But as more and more intelligent people were drawn to the market over the years, the variation in skill narrowed, shrinking his margin of outperformance. Ironically, even Buffett’s own teacher and mentor, Benjamin Graham, realized that outperforming the market was becoming increasingly difficult over time. In one of his last interviews before he died, he recommended passive (index fund-style) investing and said that it may no longer be possible to identify individual stocks that will outperform. In recent years, Buffett has also become a fan of index funds – not surprising, considering that he’s underperformed the market four out of the last five years. Decline in Standard Deviation of Excess Returns (Warren Buffett) Note: The table shows the five-year, rolling standard deviation of excess returns for Warren Buffett’s Berkshire Hathaway (NYSE: BRK.A ) (NYSE: BRK.B ). The benchmark index is the S&P 500. Source: A North Investments, Berkshire Hathaway 2014 Annual Report The bottom line is that beating the market is becoming tougher, even for the best of the best. If Buffett started investing today with a smaller portfolio, it’s highly unlikely that he would come anywhere near the 50% annualized returns he claims he could get. In fact, over the course of his entire professional career, Buffett only accomplished this amazing feat twice (in 1968 and 1976). It should also be pointed out that even Renaissance Technologies’ legendary Medallion Fund, the most successful hedge fund ever, only managed to deliver annualized returns of 35% (that’s after a 5% management fee and a 44% performance fee). Renaissance employs scores of top PhDs who build elaborate algorithms that identify and profit from various market anomalies. If there really was a simple way to consistently earn 50% annualized returns, they would have found it by now. The reality is, as in baseball, the best hitters in money management can no longer bat .400. It’s extremely difficult to outsmart a market in which so many people have become just as smart as you are.