An ETF for the Long-Term Contrarian Investor

A number of years ago I attended a presentation at the Touchdown Club in Washington, D.C. given by a successful contrarian money manager.  In fact, his investment record was so outstanding the audience hung on every word.  After all, he was giving the secrets to beating the market using a sort of "Dogs of the Dow" on steroids approach.  As I scanned the audience, I noticed slight nods as he described his methodology.  You could almost feel the "hey, I can do this too" idea forming in the audience's brain - the same sort of thing you see when Buffett or Munger speak.

Then came the point where the golden goose pulled out a small piece of paper from his suit jacket and announced he wanted to go over some of his recent buys.  The audience edged further on its seat and pens came out of pockets, poised over napkins - ready to scarf up the golden eggs.

His first choice was General Public Utilities (GPU).  The color drained from the audience's face and pens stopped mid air.  Should they write it down or what?  As the money manager listed the metrics, including a price in the single digits that was down sharply, a low P/E ratio and all the rest, the audience reflected on the fact that GPU owned Three Mile Island - a utility in Pennsylvania that had just experienced a nuclear meltdown.

The point here is simple. Contrarian investing can be very successful, but it is not easy.  Everybody can't do it.  In fact, few have the stomach for it.  The evolution of the human brain learned quickly that walking out of the cave with a mastodon out front wasn't a good idea.

I have to admit that I walked away from the presentation chuckling.  In case you're wondering, the money manager ended up hitting a huge homerun (actually into the upper deck) with GPU.

These thoughts came to mind recently as I read a recent recommendation to buy ETFs that track European stocks by Mitch Tuchman of MarketRiders.  An example is VGK from Vanguard.  It returned -11.63 in 2011 as U.S. stocks were marginally positive.

Most investors are well aware of Europe's problems and the economic uncertainty surrounding the region.  Those who follow events closely are treated to what amounts to a daily 3-ring circus as leaders play a cat-and-mouse game, constantly meeting and presenting vague baby steps towards solving their problems.  Investors nervously eye bond auction yields as an indicator to the market's assessment of events.

In contrast, the contrarian thinks about the market years ahead.  The contrarian sees beaten down prices and a market several years in the future when today's problems will be long past.  The contrarian sees today's problems as an investment opportunity.

I agree that investors with a contrarian bent will likely profit from taking a long-term position in a well-diversified, low-cost ETF comprised of European companies.  In terms of the portfolio's overall positioning in global markets, I would limit exposure to 20%; but this would depend on individual risk preference.  As a point of reference for future tracking, VGK closed at $41.96 yesterday and SPY (S&P 500 ETF) at $129.51.

Disclosure:  The above is for educational purposes.  Individuals should do their own research or consult a professional before making investment decisions.

Target Date Fund Performance

Target date funds are, IMHO, a pretty good product for people who need to invest but don't want to invest the time to learn the basics of investing or get professional investment advice.  This article, "Target Funds Miss Their Marks - Again," by Sarah Morgan in the Wall Street Journal may cause people some pause in this regard.  Ms. Morgan reports that funds within 4 years of target date returned -0.4% for 2011, which was not good.  Most conservative funds that I have looked at returned between 2% and 4%. In her article, Ms. Morgan points out that the S&P 500 returned roughly 2% and the Barclay's Aggregate Index (the bond market) returned approximately 8%.  Thus, a 50/50 weighting would have achieved in the neighborhood of 5%.

The culprits in 2011 were basically international and small cap.  See Biz of Life for a comprehensive listing of ETF sector returns.

Also, if you were accumulating, as you probably were since you were 4 years from target, i.e. retirement, you took advantage of the strong 4th quarter in your dollar cost averaging.  In other words, systematically contributing to your 401(k) or 403(b) during the down phase in 2011 really paid off. Bottom line:  your return probably exceeded the -0.4% return on the target date fund.

Screening for Dividend Payers

Source: Capital Pixel

I'm an indexer.  I agree with Warren Buffet that most investors and individuals will do best by indexing the broad stock market.

Still, I belong to the "there is more than one way to skin a cat club" and, if an individual is willing to take the risk, has the time, expertise, emotional fortitude, and resources, he or she may outperform the market with a well-thought out/disciplined approach. Again, I would index at least 80% of the portfolio using it as an anchor for retirement assets and seek to outperform with the rest.

With this caveat in place, let's examine a popular theme and one way to approach it for investors.  The theme centers on the idea that a tsunami wave of retirees is just now beginning, and these retirees will move their assets to produce greater income, i.e. into the dividend sector.

McVey's Approach

Henry H. McVey heads up the asset allocation process at Kohlberg Kravis Roberts and incorporates this idea in what he calls his "Brave New World" thesis as described by Shirley Lazo in "Dynamic Duo."  He screens stocks according to the following criteria:  dividend yield between 2% and 5%, earnings growth between 5% and 15%, 12-month trailing return on equity rising, P/E below sector average, increasing payout ratio or a increasing dividends paid.  Thus, McVey is seeking dividend payers that should be able to increase dividends and offer value on a price basis.

Backtesting this approach achieved an average annualized  return of 11.2% versus 4.9% on the S&P 500 over the period 1/2004 - 11/2011.

The following table shows 10 of the stocks that made the screen (see the above article link for a more complete list):

Source 1/2/2012 Barron's

Click to Enlarge

I believe the approach has possibilities.  I would emphasize, however, that the results reported above were "backtested"!  Backtesting, as we know, can find the best coin flipper out of 30 people by running trials.  It doesn't help us, though, moving into the future.

A second caveat is that I am sensitive to the fact that I've seen companies implode over the past several years that I could never imagine having the problems they brought upon themselves.  These include GE, Ford, Fannie Mae, Merrill Lynch, and many others.  Some would, undoubtedly, have made this list in the past!  As a result, the backtested results suffer as well from what is called selection bias.

The bottom line is - proceed with caution.  This is an approach that has possibilities but has to be watched closely, IMHO!

Disclosure:  Post is for educational purposes only.  Investors need to do their own research before investing.  I hold some of the stocks mentioned above.

Bela Fleck in Africa

Source: Argot Pictures

Here is a belated Xmas gift to my readers- "Throw Down Your Heart" on Hulu.  Bela Fleck takes the banjo back to its origins.

If you like music, play it loud and enjoy.  Worth watching all the way through.  Hulu even throws in some commercials to give you time to replenish your wine.

Thanks to David, my music guru and son,  for giving me the link!

Dividend ETFs

Source: Capital Pixel

Anyone casually following investment markets knows that dividend stocks are the investment du jour.  After all, with the yield on the 10-year U.S. Treasury bouncing around 2%, big cap, well-known names yielding greater than 2% with a history of increasing dividends look very attractive.  Furthermore, the blogosphere has numerous bloggers who provide excellent dividend stock analyses - check out The Dividend Ninja (also see list at the end of his current post).  Thus, today investors don't have to do a lot of work digging up interesting investment candidates.


Another way to go is with dividend ETFs.  As always, they provide excellent diversification, are low fee (compared to mutual funds) and, in some instances, are commission free.

To get a take on what's available, I looked at the Schwab comparison chart shown here:

Source: Schwab

CLICK IMAGE TO ENLARGE As shown, there are 6 dividend ETFs listed including the new Schwab dividend ETF.  The following table shows the recent performance of 4 of these ETFs and their expense ratios:

CLICK TO ENLARGE  The table shows that the 12-month returns were quite attractive compared to the S&P 500 and that they varied fairly widely.  The thing to know is that there is wide variation in risk among dividend-paying stocks (and ETFs) - this is a really good reason to read dividend bloggers on an ongoing basis because they analyze this risk differential.  In particular, DVY is riskier than the other funds - its screening process will allow issues that have a higher payout ratio, lower capitalization, etc. and thus accounts for its higher performance.

I purchased some of DVY for clients who require an income stream.  Here is a history of a purchase:

Source: Schwab

CLICK TO ENLARGE  Note that it pays quarterly and that, given the dividend payments and today's price of $53.82, it is easy to calculate total return.

Disclosure:  Although the data in this post was obtained from reliable sources, it cannot be guaranteed.  I and my clients hold ETFs mentioned in this post.  This post is for educational purposes only.  Readers should consult the disclosures of the data sources as well.

How Did the Stock Pickers Do in 2011?

Source: Capital Pixel

My last post presented results on the BlackRock standard portfolio which is basically 65% stocks/35% bonds and cash equivalents.  It returned approximately 1.6% for the year.  To me, it's a good benchmark against which to measure investment performance.  After all, it is simple and very easy to exectute.  It takes very little time, is well diversified and low cost, and it is an approach recommended by many very knowledgeable long-time students of the market, including Malkiel, Ellis, Bogle, Hallam, and Bernstein.  Even Warren Buffett says that most investors, individuals as well as professionals, should use index funds.

As it happens, I am conversing with a potential client whose inherited IRA dropped 11% last year.  His broker (not a registered investment advisor) invested the IRA in funds that have a front load of 5% and expense ratios averaging 1.22%.

I gave him a cursory overview of why that was horrendous performance and why he should be in low-cost index funds.  He ran it past his broker who responded that he was in funds that had a superior 10-year record versus the S&P 500.

This brings us to a point of where there is a bit of odor in the room ,but we can't tell where it is coming from.  Down 11% but in great funds!  The potential client is a professional fireman and, unfortunately, not a professional odor spotter.  A long-term track record would seem to be obviously important, especially when presented with multi-colored graphs on glossy paper.  What isn't intuitive is that, if one has 30 funds ,it is rather easy to pick out the best 5 which probably outperformed the market. It  is sort of like having 30 people flip a coin 10 times and finding the 4 or 5 that got the most "heads."

The question most people would not know to ask is "what does the evidence show on consistency of performance."  And the evidence is clear - there is no consistency.  The best coin flippers tend not to outperform in the next round, as is the case with active fund managers.  In fact, the lack of consistency is also revealed as top investors fall to the bottom.  In recent years, we've seen Miller, Paulson, Berkowitz, and even Bill Gross humbled by Mr. Market.  Unfortunately, what people don't see are the investors whose retirement assets are put in jeopardy because they over invested with the "best and the brightest."

A related question arises as to the stock-picking ability of analysts.  Sometimes I run into people who claim " Yeah but I've got a guy...".  Here is an interesting piece written by Brett Arends, "Should you buy Wall Street's top stocks for 2012?", where he examined the top picks by analysts (paid the big bucks) out of the S&P 500.  They were - 3.5% in 2011.  The S&P 500 index was flat for the year and earned the dividend.

Imagine paying 5% up front and then 1.2% management fee to these analysts.  Sure, some will come out on top but, over the long run, the odds decreased.  You'd be better off putting your money with the top coin flippers in my opinion.

Disclosure:  Investors should do their own research and consult a professional before making investment decisions.  The information here is for educational purposes only.

2011 Performance - BlackRock Standard Diversified Portfolio

HAPPY NEW YEAR EVERYONE!!!  I had a wonderful New Year's in Ocean City, Maryland with my wife.  The weather was absolutely great.  We stayed at a fun place where the rocking chairs are comfortable and the house wine is perfect.

The view of the surfers from the deck was excellent.  I could appreciate them because I spent a day surfing in Galveston, Texas in the Gulf of Mexico years ago.  I only made it on the board once or twice, but it was fun!

Our stay in Ocean City was great place to welcome the New Year.  I hope everyone's New Year was as enjoyable.

Now, back to the real world.

A useful research piece on market performance  is the "Asset Class Returns: A 20-Year Snapshot" table produced by BlackRock and discussed at Cedar Financial Advisors.  It shows annual asset class returns, color-coded, ranked so that investors can easily see the best-performing and worst-performing sectors for each year over the 20-year period.

Similar so-called periodic tables of investment returns are produced by others, but the BlackRock table is unique in its inclusion of a diversified portfolio.  The diversified portfolio is an excellent benchmark for many DIY investors to consider, in my opinion.  It is comprised of low-cost, index exchange traded funds.  The 20-year annualized return of the portfolio was 8.89% for the 20-year period ended 12/31/2010.

2011
 
2011 was undoubtedly a challenging year for many investors.  Those swayed by their emotions had plenty of opportunities to make portfolio-busting shifts.  Most of those who had a plan and stuck with it probably came out OK.  The table shows performance achieved by various sectors as represented by low-cost ETFs and the weights of the various sectors.  Europe was the obvious drag on the portfolio as evidenced by the -12.17% return on EFA.  Once again, the overall bond market was the knight in shining armor, with AGG returning +7.58%.  Overall the portfolio returned +1.61% for the year. Although below the rate of inflation, many investors would have been satisfied with this return.  For those with the funds parked in money funds or even short-term certificates of deposit, this performance would have been acceptable.

Source:  Data from Morningstar/BlackRock Diversified Portfolio

CLICK IMAGE TO ENLARGE  As a point of reference, the S&P 500 returned 2.11% for the year.




Accumulators vs. Decumulators

My clients include both accumulators and decumulators.  Accumulators seek to take advantage of dollar-cost averaging.  They are contributing a fixed amount to their 401ks, etc.  Down markets benefit them as they buy at lower prices.  Decumulators, on the other hand, can unambiguously get hurt in a down market if they don't have a plan to draw down their nest egg.  Dollar-cost averaging can seriously harm the retiree drawing funds from their nest egg.

2011 was fairly neutral for both as long as no rash portfolio shifts were made.  The following shows the S&P 500 as represented by the SPY ETF:

Source: Yahoo/Finance

 CLICK TO ENLARGE As shown in the chart, U.S. stocks tried to trend upwards over the first half of the year and then hit a serious air pocket from which it again trended upwards.  The second half of the year was extremely volatile, as headlines out of Europe dominated even economic data showing the U.S. economy was showing some life.  In this market, dollar-cost averaging resulted in paying more for shares early in the year compared to where the market ended up.  Still, if investors held in and no shifts were made, shares were accumulated over the later half at attractive prices as the market rebounded strongly in the 3rd quarter.  In other words, dollar-cost averaging paid off over the later 6 months.

By the same token, the decumulator, drawing what is essentially a paycheck off of the nest egg, who had sufficient funds to ride out the downturn participated in the upturn.  In contrast, the decumulator who sold equities to fund cash needs during the first half of the year partially missed out on the rebound.  To stave off this negative impact, those living off their nest egg should have, at a minimum, 9 months in cash and a portfolio yield  dividends and interest) of at least 2.4% to replenish required payments.

Disclosure:  This information is intended for educational purposes.  Individuals should do their own research or consult a professional before making investment decisions.