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Re-balance Cycle Reminder

The next re-balance will be on next Monday, May 13, 2013. You can also find the re-balance calendar for 2013 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

High Dividend ETF Portfolio Construction

As we stated previously, we are fans of dividend paying stock funds. In our previous newsletter February 18, 2013: Dividend & Income Funds In Asset Allocation, we stated:

In the current extremely low rate environment, investors are turning attention to dividend paying stocks or funds.  As we pointed out many times, we are in favor of dividend paying stocks: in general, dividends don’t lie and companies that pay dividends are forced to manage their cash flow and future growth more prudently than those that are simply positioned to grow at any cost!

Dividend paying stock funds have several properties: 

• They offer comparable or even better returns in the long term. 
  
• They have better risk adjusted returns or Sharpe ratio.

In the newsletter, we further showed that dividend paying funds can be better candidate funds in a trend following portfolio than those using general broad base index funds. The following table shows the latest performance comparison between the two portfolios mentioned in that newsletter: 

Portfolio Performance Comparison (as of 5/3/2013)

**YTD: Year to Date

Again, see this link for the latest detailed comparison. 

Today’s low interest rate environment has become very hostile to regular dividend/interest income that many retirees rely upon. We have been regularly asked about portfolios that can deliver higher yields. 

In general, for a fund that can deliver high dividends or interests, it invests in following securities:

• Domestic REITs: by law, an REIT company is required to distribute at least 90% of their taxable income as dividends to investors.  REITs usually invest in commercial real estates such as office buildings and storage. Some REITs invest in residential apartment rentals. They usually rely on commercial loans to amplify their regular income. Unfortunately, recent strength in REITs has pushed an REIT fund to deliver much lower yields. For example, Vanguard REIT index fund VNQ had about 3.15% yield in the last 12 months. 
• Mortgage REITs: these REIT companies invest in commercial and residential Mortgage Backed Securities (MBS). Their main business is to borrow money in a lower rate and lend it out in a higher rate to capture the difference. After 2008-2009 mortgage crisis, many mortgage REITs have done very well by capitalizing the low rate environment (their financing cost is lower, thus yielding higher difference). They often use leverage such as 6 or 7 to 1 to amplify income. Today, mortgage REITs are still delivering very respectable yields. For example, iShares Mortgage Plus Op ETF REM had 11.19% 12-month yield. 
• International REITs: international REITs invest in oversea commercial real estates, infrastructures. They delivered higher yields than domestic REITs. For example, Vanguard international REITs index fund VNQI had 5.03% 12-month yield, as of today. 
• Master Limited Partnership (MLPs): these companies are mostly in gas and oil pipeline delivery business. With its financial leverage, they manage to deliver regular income in a relatively consistent manner. A well known MLP index Alerian based ETF AMLP had 5.7% dividend in the last 12 months. 
•  Business Development Comapnies (BDCs): these companies are really investment companies that finance and invest in other small and mid sized businesses. Again, with today’s low interest rate (and thus low finance cost) environment, they have done well in the current economic recovery. UBS E-TRACS Wells Fargo Bus Dev Comp ETN BDCS is yielding 7.13% for the last 12 months. 
• Preferred stocks: as a hybrid between stocks and bonds, preferred stock shareholders enjoy higher dividends than common stock shareholders. However, those preferred stocks that deliver higher dividends are usually in financial and/or banking sectors. PowerShares Preferred PGX has 6.3% 12-mo yield. 
• Closed end funds (CEFs): many closed end funds use leverages to amplify their investments in bonds and other businesses. One way to get exposure to this segment is through an ETF such as PowerShares CEF Income Composite PCEF that has 7.1% 12 month yield. Closed end funds should be viewed as investment businesses that use leverages that are very common in a business. 
• International and emerging market dividend paying stock ETFs: many oversea companies provide higher dividends than domestic companies. For example, SPDR International Dividend ETF DWX has 6.13% yield while SPDR S&P Emerging Markets Dividend EDIV has about 5.7% yield. 
• High yield (junk) bonds: these bonds are usually backed by projects or companies that have low credit ratings such as B or CCCs. In today’s loose financing environment, high yield bonds are increasingly becoming lower yield as many investors are crowding in this segment. SPDR Barclays Capital High Yield Bond JNK yields 5.8%. 
• Long term bonds: another way to get higher yields is to take more interest rate risk by investing long maturity bonds, similar to investing in high yield bonds that takes more credit interest risk. Long term Treasury bonds are backed by the US government, considered as a safe haven when risk asests (stocks) experience troubles. However, these bonds have very low yields by historical standard right now: iShares Barclays 20+ Year Treas Bond TLT is only yielding 2.38%, compared with investment grade long term bond ETFs LQD that has a 3.4% yield, still a record low. 

By reviewing the above high yield ETFs, one can see that the main concern in investing in these ETFs is the rising interest rate or tightening financing environment. As a result, we are not a fan in using a buy and hold strategy such as Strategic Asset Allocation – Optimal for high yield investing. We believe a tactical strategy like Tactical Asset Allocation is warranted here. The main reasons are as follows: 

In the event of rising interest rates, some or all capital are temporarily diverted to short term investments. When rates are getting more stable, the strategy will switch back to high yield investments that can deliver even higher yields than those in today’s environment. Such a strategy is even more critical for retirement income purpose as we don’t want to be tied up with investments that will rapidly lose their prices due to other higher interests/yields opportunities or higher financing cost (thus lower profits for companies like BDCs or mortgage REITs). 

We are working on portfolios that can deliver high dividends in today’s environment while protecting capital in a hostile environment. The following table shows a TAA based portfolio’s back testing result. The portfolio’s candidate funds include the ETFs mentioned above. We caution that this is still work in progress and we will not support this portfolio until we finalize our work. Furthermore, the candidate funds will be changed from time to time to reflect new opportunities and more mature ETF offerings. 

See detailed latest comparison >>

One can see that the portfolio High Dividend ETFs Liquid TAA Risk Profile 0 has done well, even compared with other dividend oriented portfolios. This portfolio currently yields 6.27%, a very high yield currently. Looking closely at the portfolio’s history, we see that it switched to cash, long term Treasury bonds in 2008-2009 financial crisis period and then gradually got back to stocks. We expect this will happen again in the future financial crisis periods. During those periods, investors should be prepared for getting lower yields. However, we don’t expect these kinds of periods will last forever and eventually, better yields will be obtained once economies are out of trouble. 

Portfolio Performance Review

It is a good time to review all weather portfolios and permanent portfolios: 

Portfolio Performance Comparison (as of 5/6/2013)

**YTD: Year to Date

*: NOT annualized

Detailed comparison >>

The permanent portfolios withstood the big gold downside recently and now they are mostly back in black year to date. Permanent Income Portfolio continues its steady performance. 

Market Overview

Market trends are now back to uniform risk on mode: all of major stock assets including emerging market stocks are now ranked above US bonds in the major asset trend ranking table on Asset Trends & Correlations (for other detailed ranking, see 360° Market Overview).  Commodities and gold are still at the bottom, indicating a weak pricing environment. 

However, we are now entering May, a month that bridges Spring and Summer. Traditionally, May signals a possible stock market (and other markets such as bond markets too) seasonality change. A ‘sell in May and go away’  Wall Street adage, coupled with over bought and stretched stock markets with weak fundamental should serve as a caution. However, we will again stick to our portfolios and respond to market conditions accordingly. 

We again copy our position statements (from previous newsletters): 

Our position has not changed: We still maintain our cautious attitude to the recent stock market strength. Again, we have not seen any meaningful or substantial structural change in the U.S., European and emerging market economies. However, we will let markets sort this out and will try to take advantage over its irrational behavior if it is possible. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

Latest Articles

• Stock ETFs with Highest Dividends
• From the Archives: Psychology That Drives Bull Markets
• Financial Repression Primer
• Emerging Market Bonds Back In Favor
• The Defensive Sector Led Stock Market Rally Continue
• Spring cleaning for your portfolio
• Being a Weather Contrarian
• CPI Inflation Rate Calculator (Experienced vs. Reported)
• April 29, 2013: Goal Based Financial Planning And Investing

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Disclaimer:

Any investment in securities including mutual funds, ETFs, closed end funds, stocks and any other securities could lose money over any period of time. All investments involve risk. Losses may exceed the principal invested. Past performance is not an indicator of future performance. There is no guarantee for future results in your investment and any other actions based on the information provided on the website including, but not limited to, strategies, portfolios, articles, performance data and results of any tools. All rights are reserved and enforced. By accessing the website, you agree not to copy and redistribute the information provided herein without the explicit consent from MyPlanIQ.