Tag Archives: seeking-alpha

Should You Buy Value Stocks Today?

The third quarter was abysmal for stock markets. October has proven the pain short-lived. Growth stocks have outperformed value stocks. But value has the long-term track record of outsized returns. The typical investor is a notoriously bad timer at buying and selling. A good advisor helps limit emotion-driven mistakes. The third quarter is now on the books and it was an ugly one for stocks. The S&P 500 ( SPY , IVV ) fell 6.4% while the Russell 1000 Value ( IWD ), arguably one of the best indices to benchmark “value” stock performance, was down 8.4%. We commented last month, “We concede that there are plenty of reasons to hesitate, but we’re putting capital to work. The economic landscape in the U.S. remains favorable to equities and more importantly, ample long-term investment opportunities exist. … And that’s why we’re buyers.” At least for now, the recent turmoil has proved short-lived. The S&P 500 is up over 8.0% in October and the Russell 1000 Value has posted a similar gain. For the year, the S&P 500 has delivered a 2.5% gain, while the Russell 1000 Value returned negative 1.8%. Growth stocks are up over 6.0% in 2015. Value stocks’ year-to-date underperformance of growth stocks isn’t a new trend. It’s been a tough going for value for many years now. (click to enlarge) Since Black Cypress’s inception in the summer of 2009, over six years ago, growth stocks have outperformed value stocks by 23% — about 3.0% per year. Growth’s cumulative outperformance stretches back even further, all the way to the end of 2006 before the onset of the recent financial crisis. Growth has bested value by 5% per year for almost nine years. There are only two other instances in history where growth’s dominance reigned longer: the Great Depression (another financial crisis) and the technology bubble of the 1990s. Such multi-year value underperformance is unusual. Historically, it lasts a few years at most and growth’s cumulative gains are reversed over a one or two-year period. At least that’s the historical precedent. Since 1927, value stocks have returned an average 2.5% more per year than growth stocks. Academics call this historical outperformance of value over growth the “value premium”. And yet, while the value premium is a well-documented phenomenon, most investors fail to capture it. Owning an underperforming asset taxes one’s patience. Continuing to own it requires a deep conviction in one’s research as well as the emotional fortitude to withstand the frustration that comes with being at odds with the market. Most investors have neither. And therein lays the likely reason the value premium remains despite widespread knowledge of its existence: capturing it entails suffering through occasional periods of underperformance. Individual investors buy and sell at inopportune times, fund managers fear redemptions and hug their benchmarks, and advisors chase the hottest funds. And the value premium persists. One of the best studies to illustrate such bad investor behavior and its impact on performance is DALBAR’s Quantitative Analysis of Investor Behavior. This study doesn’t address the value premium in any way, but it is illustrative of investor actions and their effects, which makes it relevant to our discussion. The 2014 QAIB stated that over the last 30 years, investors in stock mutual funds averaged annual returns of 4.0%, while the S&P 500 averaged about 11.0%. That is, the very investors that were seeking equity market performance by buying stock mutual funds underperformed stock markets by over 7.0% per year. The culprit? Poor timing decisions. Investors — including individuals, advisors, and consultants — added to their stock positions at or near stock market peaks and sold near market lows. Investors also hesitated to invest again after markets bottomed. Investors are their own worst enemy. We choose to address these topics for two reasons. First, because we’re value-oriented investors and it has been one of the more inhospitable environments in history for our investment approach. In the last two years alone, growth stocks have outperformed value stocks by 9.0%. To say the least, it has been a challenge to provide outsized returns with our currently out-of-favor approach. And yet, despite the headwind of growth over value since our firm’s inception, our strategies have held their own with broad markets. Considering what we’ve been up against, including growth’s dominance as well as no opportunity to showcase our risk management practices in this ongoing bull market, we’re pleased with our results. And today, we think our portfolio is about as well-positioned against the market as it has ever been. Broadly, we like value’s prospects over the next five years. The second reason we delved into these topics is because one of the most important functions of an investment advisor is to provide a check on emotion-driven decisions. Coaching to buy, sell, and hold, and the timing of these recommendations, often goes overlooked in an advisory relationship. But it can be more important than security selection itself. Get an advisor you can trust if you’ve found yourself buying and selling for no other reason than emotion. You’ll save yourself some well-deserved self-ridicule and probably a lot of money too. Our portfolio is well-positioned to capture the value premium and to create excess value through our carefully selected individual company holdings in the years ahead. Is yours?

The Idiot’s Guide To Asset Allocation

The finance industry constantly strives to confuse investors with new, more sophisticated and increasingly complex ways to manage risk and generate returns. But these new products and strategies generate their own risks – for example, falling prey to data mining or extrapolation. But there are simple ways to invest that can produce superior investment outcomes with a fraction of the time and effort. This article focuses on investment techniques that are so simple, it is surprising how well they work – a phenomenon that Brett Arends of MarketWatch has called “dumb alpha.” A Simpler Way to Think about the Future Let’s assume you are in your thirties or forties. You need to finance your retirement with your savings. Creating a portfolio to build retirement wealth is no easy feat, given the fact that retirement may be 30-40 years in the future. A lot can happen in that time. Who can say what the next 30 years will look like? Since it is impossible to predict which investments will do well during the next three decades, there are only two logical ways to invest. One is to keep all your savings in cash or the safest short-term bills and bonds. The problem with this approach is that you will find it impossible to keep pace with inflation once taxes and other expenses are taken into account. The alternative is to invest an equal amount of your money in every asset class that’s available in the marketplace. This makes sense, because you don’t know how stocks will do compared with bonds or real estate investments, or how Apple (NASDAQ: AAPL ) stock will do compared to Amazon (NASDAQ: AMZN ). The simplest example of this naive equal-weighted approach would be a portfolio split 50/50 between stocks and bonds. Another approach would be to invest one-quarter of your assets in cash, one-quarter in bonds, one-quarter in equities, and one-quarter in precious metals. Similarly, instead of investing in a common stock index, such as the cap-weighted S&P 500 Index, you could evenly spread your precious funds across all 500 stocks of the index. The Advantages of a Naive Asset Allocation As it turns out, this way of investing tends to work extremely well in practice. In their 2009 article ” Optimal versus Naive Diversification: How Inefficient Is the 1/N Portfolio Strategy? ” Victor DeMiguel, Lorenzo Garappi, and Raman Uppal tested this naive asset allocation technique in 14 different cases across seven different asset classes and found that it consistently outperformed the traditional mean-variance optimization technique. None of the more sophisticated asset allocation techniques they used, including minimum-variance portfolios and Bayesian estimators, could systematically outperform naive diversification in terms of returns, risk-adjusted returns, or drawdown risks. Unfortunately, naive asset allocation does not work all the time. Over the last several years, only one asset class has generated high returns: stocks. So, a naive asset allocation will not keep up with the more equity-concentrated portfolios during such periods. But it is interesting to note how well a naive approach works over an entire business cycle. Practitioners should compare their portfolios with a naive asset allocation to check whether they really have a portfolio that delivers more than an equal-weighted portfolio. You can create a better (“more sophisticated”) portfolio than the equal-weighted (“dumb”) one, but it is surprisingly hard to do. As a check, you can create an equal-weighted portfolio from the assets or asset classes used in your current portfolio. Then test whether the current portfolio is superior to this equal-weighted benchmark over time in terms of returns, risks, and risk-adjusted returns. If that is the case, congratulations: You have a good portfolio. If not, you should think of ways to improve the performance of your existing portfolio. It is also pretty clear why this dumb alpha works. Within stock markets, putting the same amount of money in every stock systematically prefers value and small-cap stocks over growth and large-cap stocks. These two effects conspire to create outperformance. There is a second effect at play, however. After all, the value and small-cap effect cannot explain why a naive asset allocation also works in a multi-asset-class portfolio. The key reason for its strong showing is its robustness to forecasting errors. Most asset allocation models, like mean-variance optimization, are very sensitive to prediction errors. Unfortunately, even financial experts are terrible at forecasting, and one follows forecasts at one’s peril. By explicitly assuming that you cannot predict future returns at all, an equal-weighted asset allocation is well suited for unexpected surprises in asset class returns – both positive and negative. Since unexpected events happen time and again in financial markets, in the long run an equal-weighted asset allocation tends to catch up with more “sophisticated” asset allocation models whenever an event happens that the latter are unable to reflect. In other words, if a naive asset allocation outperforms a more sophisticated portfolio, it might provide a hint as to why this is the case. Are there too many risky assets in the sophisticated portfolio that directly or indirectly create increased stock market exposure? What are the implicit or explicit assumptions that led to the more sophisticated portfolio that have not materialized and have led to an underperformance relative to a less sophisticated naive asset allocation? In this sense, the naive asset allocation can act as a more practical alternative to a sophisticated portfolio, and as a more easily managed risk management tool.

The Fed’s Delay On Rates Makes SDY A Good Buy

The Federal Reserve has delayed raising rates, giving a boost to dividend funds. Rates are likely to remain at historically low levels well into 2016. SDY is heavily weighted towards the financial sector, providing a nice hedge against any rising rates. The purpose of this article is to evaluate the attractiveness of the SPDR Dividend ETF (NYSEARCA: SDY ) as an investment option. To do so, I will evaluate recent market performance, its unique characteristics, and overall market trends in an attempt to determine where the fund may be headed going into 2016. First, a little about SDY. The fund seeks to closely match the returns and characteristics of the S&P High Yield Dividend Aristocrats Index. This index is designed to measure the performance of the highest dividend-yielding companies in the S&P Composite 1500 Index that have also followed a policy of consistently increasing dividends every year for at least 20 consecutive years. This is unique in that many dividend ETFs focus solely on high-yielding companies while SDY has a focus on high yield, but also a track record of a raising payment. Currently, SDY is trading at $77.04 and pays a quarterly dividend of $.49/share, which translates to an annual yield of 2.54%. Year to date, SDY is down 2.2%, not accounting for dividends, which lags the Dow Jones Index’s return of (1.5%) year to date. However, once dividends are accounted for, SDY has slightly outperformed the Dow for the year. There are a few reasons why I feel SDY is a good buy at current levels. The main reason has to do with the Fed’s unwillingness to raise rates from historically low levels. At the beginning of 2015, investors were fairly confident that rates would rise at some point this year, some believed as early as June. This negatively affected dividend ETFs, as investors had piled into funds such as SDY at record levels in search of a higher yield in a low rate environment. Because of this, SDY, along with similar funds, underperformed the Dow and other investment options. However, as we near the end of the year and an official rate hike has yet to be announced, investors are beginning to buy back into SDY as they realize that the low rate environment is here to stay for a little while longer. This is apparent in SDY’s recent rise, as the fund is up almost 7% in the last month. I believe the ETF will continue to move higher, as investors are continuously pushing back their expectations for a rate hike. According to data compiled by the Chicago Mercantile Exchange, “traders now put just a 7 percent chance of a rate move at Wednesday’s Fed meeting and a 36 percent probability for the final one of the year in December”. Traders now give a 59 percent chance of a rate hike during the March 2016 meeting, almost six months away. If that expectation turns in to a reality, SDY could be a very profitable bet in the short term. A second reason I prefer SDY over other funds has to do with its exposure to the financials sector, at roughly 25% of its total portfolio. Below is a breakdown of the sectors, by weighting, that make up SDY’s holdings : Financials 25.47% Consumer Staples 14.95% Industrials 13.54% Utilities 11.83% Materials 11.15% Consumer Discretionary 7.56% Health Care 5.92% Energy 3.41% Telecommunication Services 3.05% Information Technology 2.88% Unassigned 0.22% As you can see from the chart, financials are the top sector weighting in SDY’s portfolio. I view this as a positive, because it provides the fund with a nice hedge against rising rates, when they do eventually rise. General logic will say that these dividend funds will take a large hit once rates rise, because investors will now be able to command higher yields from less risky assets. However, SDY’s exposure to the financials sector will continue to make this fund attractive as financial companies, such as banks and insurance companies, tend to perform better in a rising rate environment. This occurs for a few reasons. One, banks will typically increase the amount they charge for loans at a faster rate than what they pay for deposits, which widens their spread and overall profit. Additionally, these firms typically have to write-off fewer bad loans, as rates generally rise during a time of economic growth. This means companies are performing better and are more likely to meet their debt obligations, and thus, no default on their loans. Therefore, SDY should experience capital appreciation from this exposure, which would cater to investors who are more concerned with the overall return, (stock price and yield), as opposed to just the yield. Of course, investing in SDY is not without risk. Investors could be wrong and interest rates could rise at a much quicker-than-anticipated pace. If this occurs, the market could move sharply lower, or investors could flee dividend funds. SDY’s yield, at only 2.50%, does not provide much of a cushion if the fund were to move rapidly lower. Additionally, SDY also has a strong weighting towards the US consumer, with weightings of 15% and 8% towards the consumer staples and consumer discretionary sectors, respectively. If the US consumer stops spending, or US job growth weakens, these sectors could be dragged lower and take SDY down with them. However, neither of these scenarios are what I expect to occur. Even if rates do rise, Yellen has made it clear that the increases will be slow and gradual. She does not intend to spook the market, and the past few years have showed investors that the Fed is being extremely cautious with regards to rates. Additionally, consumer spending continues to increase, with a 0.6 percent rise last month (September) according to the Commerce Department. Therefore, I expect SDY to perform strongly despite these headwinds. Bottom line: SDY has had a lackluster year, but has rallied recently as the Fed has delayed raising rates. With this scenario continuing, the fund continues to provide investors with an above-average yield in a low-rate environment. Until rates do rise, dividend ETFs will continue to be profitable for investors. With a fee of only .35% and exposure to the financials sector, which will serve as a hedge when rates do rise, SDY provides investors with a cheap way to profit in the short and long term. Going into 2016, I would encourage investors to take a serious look at this fund.