Wednesday, December 20, 2006

My Investing Christmas List

Like any investor, I wish for the next year to be full of market-beating returns.

But, rather than wish for this directly, here's my list of products or things I'd like to see that I think could help do that job over the next year:

10. A fundamentally-indexed (broad-based, not just on dividends) BRIC ETF;
9. A fundamentally-indexed (broad-based, not just on dividends) Euro ETF;
8. A fundamentally-indexed (ibid) global bank ETF;
7. Finding a wonderful proxy investment on the cusp of a major breakout;
6. More quality screening tools, like Magic Formula Investing;
5. A fundamentally-indexed (ibid) Japanese ETF;
4. A fundamentally-indexed (ibid) global small growth companies ETF;
3. A complete proliferation of fundamentally-index (ibid) EFTs;
2. Double-leveraged ETFs of all of the above and, finally;
1. More patience, so that I may reap the rewards of proper analysis, rather than falling victim, as so many have over the years, to the following saying ...
A man may see straight and clearly and yet become impatient or doubtful when the market takes its time about doing as he figures it must do… the market does not beat them… they beat themselves, because even though they have brains they cannot sit tight.
Merry Christmas to all ... may you and your loved ones have a fabulous time this holiday season ... no matter your beliefs, nationality, or any thing else for that matter ...



JW

The Confused Capitalist

Sunday, December 10, 2006

Outperformance for widows .... and others too!

I have written recently about the need to outperform the standard capitalization-weighted indices, such as the S&P500, the DJ Industrial averages and the S&P/TSX Composite. It's not only important for those folks who need to plan their retirement, but also for younger widows/widowers who may not have a grand source of income, but have received a decent inheritance.

Assuming that their home is paid off, and they end up with the tax-free equivalent of 10 years salary, they might want to look at having the equivalent of eight of those years salary invested into the stock market. All at rates intended to protect the principal from inflation (meaning that it continues to grow), but also allows a decent income to be claimed from the portfolio. The balance might be invested in money market and bond issues, and used to draw short-term living expenses from.

Again, I think using ETFs that track some type of fundamental index (in other words, a index that is based on value-type measures [eg price/book, PE ratios, free-cash flow growth, and dividend growth/payments], such as some of the RAFI indexes) offers a much greater chance for outperformance, and with enhanced safety of capital. (See video, here, on why fundamental indexation is a better mousetrap). In other words, having your cake and eating it too. What could be sweeter?

Again, I think that these type of portfolios can be very robust, and also very simple. For instance, if I was advising my wife, I would probably suggest that the stock portion of the portfolio be weighted toward dividend growth/paying ETFs (given the need for income, and the documented outperformance that these types of stocks have delivered over time) and might look something like this:

The Claymore Canadian Fundamental Index (CRQ) ETF has been designed to replicate the performance of the FTSE RAFI Canada Index, which comprises those Canadian companies with the highest fundamental weightings. The index weights constituents using four accounting factors, rather than market capitalization. These four factors include:
  • Total cash dividends (five-year average of all regular and special distributions)
  • Free cash flow (five-year average cash flow)
  • Total sales (five-year average total sales)
  • Book equity value (current period book equity value)
This index has produced a return of 13.3% since January 2000, versus only 6.5% for the TSX60 over that same period, suggesting that the ETF would have produced a parallel return, deducting only for the small MER of ETFs (instead of the giant 2.0% to 2.5% most mutual funds charge). I would suggest a 20% weighting for this ETF.

Claymore Canadian Dividend & Income Achievers (CDZ). Weighted to emphasize stocks that both have a relatively high yield, and also have a good track record of raising their dividends. It tracks the Mergent Canadian Dividend Income and Achievers (fundamental) index. Over the past five years, the index has posted a 15.1% annual gain, versus the S&P/TSX Index return of 11.1% annually. Over ten years, it posted an 18.1% annual return, versus an 11.0% return for the S&P/TSX Composite Index. The underlying holdings are around 55-60 stocks typically. I would suggest a 20% weighting for this ETF.

Claymore US Fundamental Index, C$ Hedged (CLU). This ETF also tracks another fundamental index, which tracks the top 1,000 US securities by fundamental value, using the following four factors: cash dividends, free cash-flow, total sales, and book equity. This ETF is also attractive from my point of view, in that I think the US dollar will be lower in 10 years than now, but this ETF hedges against currency changes, meaning that we'll only trap the underlying changes in the index. Over five years, this index has returned a 7.0% rate annually, versus a -3.2% S&P 500 annual return (as converted to Canadian currency). The underlying holdings are around 1,000 stocks. I would suggest a 20% weighting for this ETF.

Claymore BRIC (CBQ) is the final Claymore product, that portfolio manager Roger Nusbaum has also written about. This ETF isn't fundamentally indexed, but is designed to mirror the BNY BRIC Index, which tracks ADRs from Brazil, Russia, India and China, all powerful emerging economies. Over time, this should be a strong growth component, but one which will also be volatile in nature. This index has returned 33.2% annually over the past four years, versus the more widely known MSCI EM Index, which has returned 19.7% annually over the same period. The ETF has 75 underlying stocks with above average concentration in the first ten stocks, with about 53% of the value held therein. This isn't currency hedged or denominated in Canadian dollars, but this could be a plus if these currencies gain strength against the Canadian dollar over the next decade. I would suggest a 20% weighting for this ETF.

Finally, for the fifth ETF, I'll suggest a product that trades on the American exchanges, a Wisdom Tree ETF product that tracks the Wisdom Tree International Dividend Top 100 Index (DOO). This is also a fundamental index, based on dividend yield of large and mega cap international companies. Currently, about 80% of the companies in the index are domiciled in Europe, with about 20% in Australia, Singapore and Hong Kong. The index has returned 16% annually over the past five years, as denominated in US Dollars. Conversion to Canadian currency over that time would have considerably diminished these returns to about 8.5% annually (which is still respectable, although not outstanding). While the currency issue may be slightly negative over the next decade, I don't think it's going to weigh down returns like it did over the past five years, or like it might for an unhedged US stock situation going forward. I would suggest a 20% weighting in this ETF.

Well, that's it. A relatively simple portfolio, with ample geographic representation, and wide corporate representation. The one noteworthy thing about this portfolio is that it's definitely weighted to the financial sector, but I've never considered that a particular problem, since I consider this sector as the backbone of the entire economic system. My theory here is that if this sector suffers some sort of serious long-term decline, so will virtually every other sector of the economy.

Finally, the other noteworthy aspect is the ability of high-dividend paying stocks to resist market downturns, something that might make this particular portfolio even more attractive; certainly, it makes it easier to sleep at night.

Now, the only thing that would need to be done by your proverbial widow, is simply to "re-balance" this portfolio back to the same 20% weightings, about every three years or so. This allows the winners to run for a while, and also to take advantage of longer-term "reversion to the median" and relative underpricing in the portfolio.

Of course, the widow would want to check out other sources of fundamental ETFs, such as Claymore Investments, Wisdom Tree and Power Shares in case she prefers a slightly different weighting using fundamental indexed ETFs. Finally, she should of course take the whole idea to a fee-only financial planner for critique and tweaking.



JW

The Confused Capitalist

Monday, November 20, 2006

Outperforming the index - split shares

I recently came across a compelling paper that suggests that the good S&P 500 returns of the past are unlikely to be replicated into the future. I suggested that, for younger investors particularly, outperforming the index would be a matter of prime importance. I'd also suggest that the paper has similar implications for Canadian investors too.

I had also indicated I'd write on some relatively simple methods to outperform the index.

One that I'd like to re-visit is the idea of leveraged share structures, or leveraged funds. (Leverage: see the dangers 1, 2)

For an investor with a relatively long time line, say more than 10 years, many of these types of structures are ideal to enhance returns. They leverage underlying shares or indices and can provide a greater than average return, provided that you have sufficient time to ride out the shorter-term volatility associated with this type of leverage.

For instance, two split-shares available on the Canadian market (TSX), LSC and ALB, provide access to, respectively, the four largest Canadian life-insurers and the six largest Canadian banks. Generally, the banks and insurers have proven to be prodigious wealth-producers over time. These returns are enhanced by the leverage structure of 1.69x and 1.99x on the "capital shares", respectively, so these shares should move up or down at the underlying share rate, multiplied by that factor.

What you don't want to do is buy them when the underlying shares are over-valued. While absolute measures are somewhat subjective as to value in today's market, both corporate sectors appear to be relatively good value.

To arrive at that conclusion, I surveyed three fundamental ETFs, the IShares XCV product, a measure of Canadian value stocks. I also surveyed the Claymore Investments fundamental ETFs, CDZ (dividend-based value), and CRQ (tracks value based on four fundamental factors). In all of these three ETFs, at least four of the six banks hold a weighting in the top eight securities, while the insurers weren't too far behind, with three of the four insurers taking weightings within the top 18 spots in all those ETFs. This suggests that they are relatively cheap in the Canadian market.

Another split share, SNH.U (capital shares), tracks the Health Care portion of the S&P500; its' underlying composition is similar to the SPDRs health-care ETF, XLV. It's largest holdings are in Pfizer and Johnson & Johnson, two stocks that have recently attracted a lot of buying from the guru value set, suggesting that they too, are reasonably priced. Another recent report stated that on a historical-basis, this group is trading in the 3rd percentile of its' historical cash-flow range, indicating that valuations in the health care sector are fairly attractive at this time. But you have to be able to handle the leverage factor, in this case at 2.86x.

Therefore, using a split share structure that leverages the long-term growth and relative cheapness of these various sectors is probably a good thing for long-term performance. Which is one reason why I hold all of the above in my personal portfolio.


JW

The Confused Capitalist

Friday, November 10, 2006

Canada - Hitting the Sweet Spot

A recent Goldman Sachs study reported that Canada topped the rankings for economic growth potential of all G7 nations, surpassing both the US and Germany, and now holds 6th spot of the 170 countries tracked.

The past few years have seen a string of successes for Canada, the roots of which were formed when, in the middle 1990s, the federal government made positive strides to eliminate a seemingly perpetual bugetary deficit. Since then, the federal government has recorded its ninth consecutive budget surplus, as controlled costs and booming commodity prices have led to an enviable situation.

After a tough 1990s, it's nice to be on the right economic track. Now, if we can only do something about our productivity woes, a problem that threatens to plague a future generation.


JW

The Confused Capitalist

Sunday, November 05, 2006

Canada - Income Trusts - No Trust

The Canadian government (a Conservative minority) announced this week that existing income trusts, who pay little to no corporate taxes, would begin paying full corporate taxes in 2011. For those on the block to conversion to income trust status to eliminate paying corporate taxes, the income trust tax of 34% would be applicable immediately.

Two recently announced conversions, BCE and Telus, which themselves would have deprived the government of $1.1 billion annually in taxes, placed this in the government's "must take action" in-tray, despite a recent election promise that income trusts would be left alone. The opposition Liberals had pondered the very same move last fall when then in government, leading to a large drop in the income trust market at that time. The trust market had, however, largely bounced back since then.

A quotation from this story more or less synopsizes why the government, despite it's earlier pledge to leave the trust sector alone, felt it had to act:

Had the entire TSX converted to income trusts, it had the potential to be disastrous not just for government revenues but for Canadian productivity, although many companies would have likely gone back to the market for investment capital.

The action on the part of the government led to a 13% average drop in that sector this past week. However, many have speculated doesn't reflect the underlying valuation change due to having a significant tax burden imposed. Some experts suggest that in the weeks and months ahead, this sector, which now constitutes about 10% of the TSX Composite Index value, is slated to see further weakness.

The howling from trust-owning pensioners has been predictable, given that most trusts were bought for their income yield, typically ranging from 6-11%, which is pretty juicy in today's environment. Many of these pensioners claim to have "lost trust" in the Conservative government.

It is interesting to note that this same structure began to gain some prevalence in the US, Australia and Britain, a number of years ago, before legislators recognized the tax-shift burden that would fall to the middle class, and shut down the advantageous tax rates for them. However, they did this before these structures had gained the widespread popularity, as they have in Canada.

In this regard, Canada is simply following suit, but with many asking the question: Why did it take so long here?




JW

The Confused Capitalist

Wednesday, October 25, 2006

Why outperforming the S&P 500 must become a priority for younger investors

This is a longer than average post, but if you are in your 20s, 30s or 40s and are counting on a decent retirement based on a financial planners' estimate of a 10% market return or so, I suggest you stick with this and read it through. For many readers, this will be eye-opening to say the least.

The following diagram is from work of Steven Johnson of Simcivic.org and illustrates what he believes the future composition of the return rate (see below) of the S&P500 is likely to be (with inflation extracted): (Future returns above: Click to enlarge)

In this diagram, Mr. Johnson has outlined what he believes the constituent parts of future stock market returns are likely to be (inflation excluded). This shows a 4% return or so, compared to a historical 7% return (again, inflation excluded), which he calculates as having been historically produced by the following constituent components (see below: historical return):

(Historical returns above: Click to enlarge)

Adding inflation back into both figures, produces an anticipated future return rate of about 7%, versus a historical 10% or so. While a 3% differential doesn't sound large, over a 30 year period, this differential amounts to $10,000 being turned into $76,122 (7%) or $174,494 (10%). [Both figures now include an inflation component of an additional 3%.]

As you can see, the difference between these two figures could significantly affect your retirement planning. Mr. Johnson makes a pretty compelling case that the returns of the past cannot be relied upon as a reasonable guide for indicating the returns of the future. It's different this time he claims: this time in a negative sense!

In the paper Mr. Johnson argues that stock market returns arise from two primary sources. These are capital growth, historically accounting for about 2.3% of the 7% long-term (ex. inflation) rate; and dividends - including re-investment and share-buybacks - accounting for about 4.6% of the 7% (ex. inflation) historical return. Together, the two components produce a ~7% return (1.023 x 1.046 = ~ 7% return).

Mr. Johnson then further deconstructs the return to be able to analyze what might happen in the future, given known trends. The capital return factor (~2.3% historically) is the result of three things:
  1. Population growth in the 20th century of about 1.3% per annum;
  2. Plus rising productivity of about 2.0% per annum;
  3. Less a lag factor of about 1%
Producing a net 2.3% factor on the capital growth side.

On the dividend side, the components there are the actual dividends paid compared to the overall economy and the market capitalization of the stock market, compared to the overall GDP. Historically over the past seventy years, this has averaged 65% or so.

The ratio of dividends paid, measured by the GDP of the economy has remained relatively constant, at about 2% of the GDP. Accounting or adding for stock buy-backs, this figure rises by about 1% to become about 3%.

The 3% dividend figure is then divided by the denominator, which is the ratio that the stock market has been capitalized at compared to the GDP of the economy (historically about 65% as a long-term average), produces the aforementioned 4.6% figure.

Reiterating, the two components produce a ~7% return (1.023 x 1.046 = ~ 7% return).

Mr. Johnson argues that in the future, these underlying rates will be different (mostly lower), due primarily to two trends:

  1. Population growth is slowing, and he uses a 0.2% annual estimate (from Social Security figures) instead of 1.3%. This alone lops off more than 1%.
  2. The stock market has gradually been valued as a higher and higher percentage of GDP. This is the denominator of the dividends return portion. In fact, this appears to be on an upward trend that Mr. Johnson believes may average out at 120% of the GDP, nearly twice the historical level. Given the massive trend of the average person now investing in the market - compared to being a rich man's playground 50 years ago - it's hard to argue with this idea, even if the figures might not prove exactly right. Dividing the dividends of 3% by the average capitalized 120% ratio produces a dividend yield of about 2.5%, some 2% below what Mr. Johnson estimates this portion historically produced.
Incidentally, the falling yield portion as a value of stocks is pretty indisputable, and can be seen on one of the numerous charts within the paper that help make all this understandable, and compelling.

Hopefully, I have explained this well enough that most people can understand the basics of it, even if some of the subtly is lost. I cannot impress upon you strongly enough that you go and read the paper yourself, and try to understand the implications for your retirement planning.

I will be writing more on market outperformance in the future, and re-visiting some ideas from some of my older postings.


JW

The Confused Capitalist

Tuesday, October 24, 2006

Salute to Abnormal Returns

Disaster has struck!

Abnormal Returns, the finest investment blog in the blogosphere, has decided to take a brief break from the task of blogging. How will I get my daily fix of top-quality investment-related information?

Whether Abnormal was writing on behavioural-related investment issues; or on portfolio allocations and the need to provide advice that does no harm; or about thinking more critically sharply about positive studies you might be hearing about; or about the prospect that a commodity bubble has occurred (or least that future returns in this sector are likely to be relatively weak); or theme-oriented aggregations (such as this example on fundamental indexes/ETFs); or one of my personal favorites, a posting on "proxy investing", Abnormal brought a great deal of insight or information to our attention.

Even when I disagreed with the thesis, there was no mistaking that this was a very knowledgeable serious investor here. And a damn fine writer too.

And of course, there was the daily litany of links, many well-outside the investment world per se, that highlights an active, curious and and interested mind.

The writer of this blog and the writings herein have directly benefited from the active mind of Abnormal Returns. Abnormal Returns is, in my opinion, by a country mile the best overall investment blog out there, one that I visit daily, and cannot recommend too highly. I therefore grant Abnormal Returns the highest honor as shown here ...
May I suggest you visit or revisit Abnormal Returns for edification, erudition, and illumination?


JW

The Confused Capitalist

Saturday, October 21, 2006

I love you, I really, really, do

Are investors too much in love with stocks these days?

The reason I ask this question is obvious, given the recent Dow Jones records, but my interest was piqued by accidentally tapping a link that took me to the msn money web-site.

The so-called "Stock Scouter" on the site purports to show that in three categories of a) sector type, b) investing styles, and c) market capitalization ranges which is "in favor", "neutral", or "out-of-favor". Guess what?!

In all three categories (sectors, styles and capitalization ranges), there isn't a single thing that is "out of favor". Is this one of those contra-indicators, suggesting that the market is priced to perfection, with nowhere to go but down?


JW

The Confused Capitalist

Wednesday, October 18, 2006

Learning, ever learning

One thing I love about the markets, is that there is so much to learn. To become a better investor, you must want to learn more and then put that knowledge to use.

Stockcoach recently wrote a great posting about one of his favorite sites to learn from, CXO Advisory. I too enjoy the insights that this site affords.

To become better in the markets necessarily involves continuous learning, both about strategies that can better the market, and also your own inner human psychology.

Many strategies to beat the market are fairly simple, straightforward, and well known. Studying these things for a while, allow you to come to know them. Further incremental improvement is possible, by learning more advanced techniques. However, many market-beating strategies, it has often been said, can be written on a matchbook cover.

Buying low book-to-value stocks, for instance, is a perenial winner on the whole. As is buying low PE stocks. As is buying stocks with a record of increasing dividends. All well-known, market-beating, strategies.

Implementing and sticking with those strategies is something else altogether, for many, many people.

Two quotations I recently posted on my site relate to fundamental reasons for market underperformance. In my view, most underperformance can be traced to poor emotional control, particularly patience. Both sayings touch on the subject ...

Most of man's troubles come from his inability to sit and be quiet for 20 minutes.
- Pascal (b. 1623, d. 1662)

A man may see straight and clearly and yet become impatient or doubtful when the market takes its time about doing as he figures it must do… the market does not beat them… they beat themselves, because even though they have brains they cannot sit tight.
- From Reminiscences of a Stock Operator, published 1923.

Most investors would do well to ponder these sayings, both before they set their strategy, and after. Just as I have, and continue to do so - to improve my performance.


JW

The Confused Capitalist

Sunday, October 15, 2006

Completed labelling

I have completed back-labelling all my posts, so if you had turned off an RSS etc. feed, you now will only be getting new posts and could turn it back on without fear of a tidal wave of old postings.


JW

The Confused Capitalist

Thursday, October 12, 2006

You got a problem with that?

Have your good intentions of investing perhaps turned into something else, something else you fear has become a gambling addiction?

With the rise of the internet, discount brokers and the rapid fire world we live in, it's all too easy for some investors to turn into gamblers, in the world biggest casino - the world's stock markets.

According to psychologist Paul Good, if you exhibit five of the following 11 traits, you most likely have a gambling addiction:
  1. You engage in high volume trading, where "action" is more compelling than the objective of the trade;
  2. You are constantly preoccupied with your investments;
  3. You need to invest more and more money or increase your leverage to feel excited;
  4. You have repeatedly tried to stop or control your market activity and failed;
  5. You become restless and irritable when you try to cut down or stop investing;
  6. You invest to escape problems, relieve depression, or distract yourself from painful emotions;
  7. You sometimes have to increase your position in an investment after a loss - chasing your losses;
  8. You have lied to conceal the extent of your involvement in the market;
  9. You have committed an illegal act to finance your market activity;
  10. You are jeopardizing significant relationships or your job because of excessive involvement in the market;
  11. You have relied on others to bail you out when you got into desperate financial situations.
Tally up your score. For those who scored five or higher, why not check out a Gambler's Anonymous meeting near you?



JW

Adapted from Canadian Business.

The Confused Capitalist

Tuesday, October 10, 2006

ETFs - Blow your horn

I've read a few articles around the net yakking it up about how many ETFs are, essentially, replicas of other ETFs already out there. And that the 200 or so, should be enough for anyone, right? Many have really puckered up to that trumpet, and are blowing hard.

There's about 8,000 mutual funds out there, and people think that 2.5% of that in ETFs is enough? Pulleeze!

I don't hear too many financial advisor's saying that the doors should be shuttered on the 90% of mutual funds which are essentially replica's of each other AND underperform the market. Would their silence on this issue be because of the juicy trailer fees that accrue with mutual fund recommendations, and their squawking about ETFs due to the limited to no trailer fees?

Before you believe those puckered up to blow on the "200 is too many" sheet music, check their knowledge, motives and whether they're protesting the outrageous number of mutual funds.

When I see an ETF for every industry type, for every single country, for every capitalization size, and for every type of outperforming back-tested fundamental and enhanced indexing style there is, using rules-based entry strategies, and virtually every combination thereof, TIMES TWO, then I might start to agree with those already puckered up on the "there are too many" trumpet.

Until then, ETFs, until then, blow your own horn baby. Blow sweetly and with all the range of melodies available in the investment world.


JW

The Confused Capitalist

Monday, October 09, 2006

Blog Quality Continues to Impress This Blogger

Just been taking a recent tour around many new (or new to me) stocks/investing/market commentary blog sites. The quality even from so-called amateurs is amazing, as is the explosion of blogs.

It's getting hard to see all the new stuff, there's so much of it coming on so often ... all good for the consumer ... makes Jim Cramer's crap seem more like, well ... crap ...

I'll probably be adding numerous links to my site fairly soon, based on my travels to some of these great blogs ...



JW

The Confused Capitalist

The Value Blogs

There's a new blog aggregator in town, The Value Blogs. They intend to aggregate some of the best value postings from around the internet. I've already found them useful, with interesting new contributors.

You may want to take a look around there ...


JW

The Confused Capitalist

Festival of Stocks #5 - as hosted at Value Discipline

The most recent Festival of Stocks is up at Value Discipline. May I suggest you check out some of the postings and authors highlighted there?


JW

The Confused Capitalist

Sunday, October 08, 2006

Informants in the investment process - rating and ranking

Separating good leads from bad is crucial in assessing investing leads. Avner Mandelman of Giraffe Capital has a method to do so.

Essentially, it's from a page stolen from spy agencies. In order to be able reliably assess information coming from a variety of informants, some sort of ranking system had to be devised.

These agencies rate their information from informants in two ways:

  1. Based on the past track record of the informant, and,
  2. Based on the informant's confidence in this particular piece of information.
Similarly, in assessing investing leads, whether they come from brokers, analysts, industry sources, customers, etc. we can assign a letter grade rank to each of the above. For instance, an industry source who has proved highly reliable in the past might be assigned a letter grade of "A", under point 1 above. Secondarily, they provide you with a particular piece of information that they claim they are highly certain is accurate (another "A", but under point 2, above).

This can provide you with a certain level of confidence in using this information as part of your investment process. For instance, an "A" ranked informant with an "A" piece of information would play higher in your investment process than a "B" informant, with "C" level information.

Mr. Mandelman even suggests that those so poor at any type of accuracy, can eventually become "A" level informants, by being contra-indicators. In other words, you studiously avoid their recommendations.

Of course, all of the above pre-supposes that you start tracking and rating your own informants, and keep those in your investment scrapbook. A worthwhile idea, in my view. By the way, I rate Mr. Mandelman as an "A" source.



JW

The Confused Capitalist

Saturday, October 07, 2006

Moving on over to eTrade Canada

Although I've been with the Royal Bank for a long time, the new low trading fees at eTrade Canada, of $9.95 vs $28.95 is enough to cause me to move my account.

This should help me to put some more dollars in my own pocket every year. I think this (eTrades new fee schedule) is the first serious challenge to the banks oligopoly of $28-$30 fee charges on discount brokerage accounts. It'll be interesting to see what they do in a year or two from now to stem the tide of accounts leaving ...

JW

The Confused Capitalist

Friday, October 06, 2006

Proxy Investing - ETFs

Given what I believe will be phenomenal growth in ETFs over the next decade, particularly those specializing in some sort of fundamentally-based ETFs (or enhanced ETFs), would an investment in Wisdom Tree Investments (the stock) as a purveyor of fundamental ETFs be a wise proxy investment decision?

The industry probably has a huge tailwind, as ETFs generally, and fundamental ETfs in particular, begin rapidly draining money away from both mutual funds and, perhaps, to some extent, individual stocks (which themselves were often previously used as an industry proxy).

Unfortunately, there are no recent SEC filings, so by buying this pink-sheet stock, you're buying a bit of a pig in a poke. Nontheless, given the heavy hitters joing this company (Siegel, Levitt) as owners and advisors, one has to think they wouldn't want to sully their reputation on a business without a viable future. Undoubtedly, provided this stock is at a reasonable valuation now, its return will be a leveraged bet on the ETF market generally.

Value, as always however, remains the key to a decent return.

JW

The Confused Capitalist

Thursday, October 05, 2006

Apologies

Apologies to anyone on an RSS etc. feed to the site, but Blogger has released a new version with the ability for tags or labels. Given that I've found their internal seach engine weak when looking for my own postings (yes, I know this is odd, but I know it's also missed postings I've done), I've decided to go back and tag all my postings, before the task becomes overwhelming.

If you're on an RSS feed you might want to turn it off for a week or so, while I do this. Otherwise, I suspect you'll be getting many repeats as I do this task.


JW

The Confused Capitalist

Tuesday, October 03, 2006

Fundamental Indexes & ETFs

Release the hounds! The hunt for positive alpha [or avoidance of negative alpha]).

I have just finished watching a presentation to the Toronto CFA society by Robert Arnott, Chairman of Research Affiliates. For anyone wanting a complete 60 minute education on new fundamental ETFs and indexes, I suggest that that you link up and watch the following two segments (only if you have broadband access however):

Claymore Investments 1
Claymore Investments 2

Mr. Arnott has many fascinating things to say, and many fascinating Power Point slides, all of which reinforce the superiority of fundamental indexing. For those in doubt, or those who'd just like to know more, I highly suggest this presentation.

Just one of the little nuggets he throws out there (and there are indeed, many), is that simply investing in the S&P 490 (don't invest in the 10 biggest S&P companies), would have produced an average outperformance over the S&P 500 (over the last 80 years), of about 55 to 60 basis points annually.

Even if you're a believer in the strength of fundamental indexes, as I am, there's still lots of good stuff here. Visit once, and you might be on your way to investing products from three of the larger fundamental ETF providers (Power Shares, Wisdom Tree, Claymore [USA or Canada]). Any strategy that produces 200+ basis points better annually than a conventional index, with lower risk, certainly gets my attention!

The one other fascinating thing to me, is the potential for these fundamental indexes to get a short-term boost over their usual outperformance, as more and more capital begins flowing into these companies over the next decade or so. I suspect the outperformance will be even starker over the next while, as this phenomenon unfolds.

John Bogle, thanks for the ride, but move over, the next great investment train is arriving!

JW

The Confused Capitalist

Sunday, October 01, 2006

Emerging Markets

I was recently forwarded a paper written by Goldman Sachs reseachers in October 2003 relating to the potential of the BRIC emerging economies. I have written on emerging market potential outperformance many times (and here, and here too) before.

The paper projects that, given favorable growth regimes in those countries, that these economies will be one-half the size of the G6 by 2025, and larger than them, as measured in USD, by 2040. In fact, the world's largest economy in 2041 is predicted to be China.

The paper has obvious implications for any forward-looking investor. They also suggest that one expectation is that average currency appreciation for BRIC nations will be by about 2.5% annually for these currencies over the next 45 years. That's a pretty good tailwind alone, for investment results.

As the paper points out, things could obviously go wrong over that time period, but these results have reasonable potential to occur. Under the assumptions laid out in the paper (and with their model checked against history in other nations), it suggest that the largest economies in 2050 will be as follows:
  1. China
  2. US
  3. India
  4. Japan
  5. Brazil
  6. Russia
In other words, BRICs will have four of the top six spots. I think long-term investors should pay attention here, and try to understand why your particular investment advisor might be suggesting emerging market investment ratios of below 15% or 20% of your portfolio (which is actually below their current world GDP share in US$, at roughly 25%).

What also brought this issue into sharp relief for me, again, was a recent Economist magazine special on the world economy, that focussed on the emerging economies of the world. To an investor that wants growth at a reasonable price, these economies are growing their GDPs over the past five years at 5.6% annually, versus 1.9% for the developed world.

A forward-looking investor can't afford to ignore these reasonably-priced markets, and excellent growth prospects going forward. Are you such an investor?


JW

The Confused Capitalist

Sunday, September 24, 2006

Single Best Investment - some of the rules

I recently reviewed the book, The Single Best Investment, which provided a framework for investing in stocks likely to outperform the market over lengthy periods of time.

I am going to provide a synposis of some of the rules that the author suggests to find suitable candidates using this dividend-and-value-oriented approach:


  1. Company has to be financially strong, minimum B+ Value Line rating, or BBB+ S&P credit rank;
  2. Dividend yield at 150% of the S&P500, but hopefully at 200%+;
  3. Yield has to be expected, and shown to have grown over 5-10 years, at at least 5% annually (twice the expected inflation rate);
  4. Dividend payout ratio less than 50% (except for utilities and REITs);
  5. Company should have at least moderate earnings growth of 5-10% annually (both historically and going forward);
  6. Price/Sales ratio below 1.5, and hopefully less than 1.0;
  7. Price/Earnings ratios lower than the market, AND must less than the reciprocal of the long-term bond rate;
  8. Book value ratios should be lower than the market, and;
  9. Growth of cash on the balance sheet is a big positive.

There are, of course, other rules and suggestions, but I'd suggest to you that these encompass the heart of the book and suggested technique.

Since almost all of these rules as stand-alone situations have been shown by various academic studies to produce some level of market outperformance, combining them is obviously going to provide a platform for outstanding results with enhanced safety of capital.





JW

The Confused Capitalist

Saturday, September 23, 2006

A low-maintenance simple portfolio

I am advising an older person on their portfolio allocation for the stock market portion of their investments. Although he's not as old as the still long-term investor, 105 year old Albert Gordon, he's still looking to the future.

And that's smart, because, given his heredity, he may well have another 20-30 years left. And the only thing that'll provide adequate long-term growth over that time, is participation in the markets. I've convinced him that mutual funds aren't the best ticket today, but he still needs broad diversification at his age. So we're looking to some ETFs to fill his ticket.

Readers here know my belief in the power of dividend-paying stocks to produce out-sized market returns, with lower volatility and risk. This has been well-documented in a variety of books, large and small market studies over lengthy periods of time, covering a variety of market conditions. Thus, most of the selections I suggest for this Canadian investor, will fit the mold of having dividend-paying attributes as prime amongst their selection criteria.

Because of potential tax implications, we'll seek suitable Canadian products where available.

We are going to use just four ETFs, a quartet, but this will provide ample diversification by geography and will eliminate individual stock risk. Given that they are ETFs, they will also eliminate so-called "style drift". Finally, we'll use products that use rules-based fundamental indexing where possible, to enhance returns and reduce risk.

Claymore Investments has three of the four products we'll need. Because he's Canadian, it's suitable to try and get returns denominated in Canadian funds if possible, on the basis that cost of living swings might mirror market activity. So here are the products I've suggested:

Claymore Canadian Dividend & Income Achievers (CDZ). Weighted to emphasize stocks that both have a relatively high yield, and also have a good track record of raising their dividends. It tracks the Mergent Canadian Dividend Income and Achievers (fundamental) index. Over the past five years, the index has posted a 15.1% annual gain, versus the S&P/TSX Index return of 11.1% annually. Over ten years, it posted an 18.1% annual return, versus an 11.0% return for the S&P/TSX Index. The underlying holdings are around 55-60 stocks typically. I'm suggesting a 40% weighting for this ETF.

Claymore US Fundamental Index, C$ Hedged (CLU). This ETF also tracks another fundamental index, which tracks the top 1,000 US securities by fundamental value, using the following four factors: cash dividends, free cash-flow, total sales, and book equity. This ETF is also attractive from my point of view, in that I think the US dollar will be lower in 10 years than now, but this ETF hedges against currency changes, meaning that we'll only trap the underlying changes in the index. Over five years, this index has returned a 7.0% rate annually, versus a -3.2% S&P 500 annual return (as converted to Canadian currency). The underlying holdings are around 1,000 stocks. I am suggesting a 20% weighting for this ETF.

Claymore BRIC (CBQ) is the final Claymore product, that portfolio manager Roger Nusbaum has also written about. This ETF isn't fundamentally indexed, but is designed to mirror the BNY BRIC Index, which tracks ADRs from Brazil, Russia, India and China, all powerful emerging economies. Over time, this should be a strong growth component, but one which will also be volatile in nature. This index has returned 33.2% annually over the past four years, versus the more widely known MSCI EM Index, which has returned 19.7% annually over the same period. The ETF has 75 underlying stocks with above average concentration in the first ten stocks, with about 53% of the value held therein. This isn't currency hedged or denominated in Canadian dollars, but this could be a plus if these currencies gain strength against the Canadian dollar over the next decade. I am suggesting a 20% weighting for this ETF.

Finally, for the fourth ETF, I'll suggest a product that trades on the American exchanges, a Wisdom Tree ETF product that tracks the Wisdom Tree International Dividend Top 100 Index (DOO). This is also a fundamental index, based on dividend yield of large and mega cap international companies. Currently, about 80% of the companies in the index are domiciled in Europe, with about 20% in Australia, Singapore and Hong Kong. The index has returned 16% annually over the past five years, as denominated in US Dollars. Conversion to Canadian currency over that time would have considerably diminished these returns to about 8.5% annually (which is still respectable, although not outstanding). While the currency issue may be slightly negative over the next decade, I don't think it's going to weigh down returns like it did over the past five years, or like it might for an unhedged US stock situation going forward. I am suggesting a 20% weighting in this ETF.

Well, that's it. A relatively simple portfolio, with ample geographic representation, and wide corporate representation. The one noteworthy thing about this portfolio is that it's definitely weighted to the financial sector, but I've never considered that a particular problem, since I consider this sector as the backbone of the entire economic system. My theory here is that if this sector suffers some sort of serious long-term decline, so will virtually every other sector of the economy.

Finally, the other noteworthy aspect is the ability of high-dividend paying stocks to resist market downturns, something that might make this particular portfolio even more attractive; certainly, it makes it easier to sleep at night.

In summary, I consider that these four components will produce robust and relatively reliable returns over the medium to long haul, all with overall reduced risk because of the weighting towards the various fundamental indexes.



JW

The Confused Capitalist

Monday, September 18, 2006

More low PEs and sweet dividends

Portfolio sweetness: a well above average chance for portfolio outperformance!

With the number of articles I've written over the past while about dividends and low PE ratios, I thought I'd continue the trend.

A fairly recent report issued by RBC Dominion Securities identified a list of stocks that met a trifecta of tests for outperformance: relatively low PE ratio, relatively high dividend yield, and positive dividend growth over the past five years. The following S&P 500 companies were included in the report:

  • Bank of America, BAC
  • Pfizer, PFE
  • KB Home, KBH
  • Cincinnati Financial, CINF
  • Fannie Mae, FNM
  • Conoco Phillips, COP
  • DR Horton, DRI
  • Home Depot, HD

Note that these stocks all have a dividend yield above 1.5%, with most above 2.5%, and a PE below 20 (but most are below 13).

The report also included some Canadian TSX-listed stocks, including:
  • Russel Metals, RUS
  • Reitman's Canada, RET.A
  • Teck Cominco, TCK.B
  • National Bank, NA
  • Rothmans, ROC
  • Power Financial, POW
  • Bank of Nova Scotia, BNS
  • Encana, ECA

An investor could do a lot worse than look at these stocks as a great starting point for core holdings in a conservative stock portfolio.


JW

The Confused Capitalist

Saturday, September 09, 2006

Book Review: The Single Best Investment

I recently completed reading The Single Best Investment: Creating Wealth with Dividend Growth, by investment manager Lowell Miller. The dust cover additionally describes the book as "The Classic/Revised & Updated".

The subtitle describes how the wealth is to be created: by finding reasonably-priced (perhaps even so-called "cheap" stocks), reasonably-yielding dividend-paying stocks, that have a history of raising their dividends over time.

As readers to this blog know, I am a fan of both buying stocks with below average PE ratios, and with good (and rising) dividend yields as a way to outperform the market (which is the essense of the approach recommended in this book). This is also something I've written about here, here, and here. So this is an approach that I personally recommend as suitable for practically any type of stock-market investor.

This book is useful for both beginning investors and those with more experience, particularly experienced investors weary of the "next great stock" approach. Mr. Miller does teach the keys to finding the right kind of stocks, that will allow an investor to "sleep easy", knowing that the stocks chosen using this approach are likely to be far less volatile than the market in general, and to have great staying power over the longer term. All with the likelihood of achieving achieving above-market-average rates of return. What more could most investors want?

Of course, this also provides the opportunity to hold these stocks outside of tax-sheltered accounts for long periods of time, thereby reducing both transaction costs, and capital gains. Another wonderful benefit.

Finally, the book isn't filled with lots of technical jargon and is a nice easy read.

However, having sung the praises of this book I also have to note a few a warts with the book. Although it's stated as an "updated" version, there are places in the book where it's not clear what time frame is being talked about: now, or examples which were current when the orginal version was published (about 10 years ago). Also, some of the examples are also dated, and it could have been very useful for the author to show how, for instance, five or ten stocks recently purchased in the portfolio he manages, fits into this approach. A few changes to the book could have resulted in a great book showing a a great approach, rather than just a good book with a great approach. Overall though, these warts aren't enough to really detract from the overall content and message of the book.

In the end, this is a book I definitely recommend this as a good addition to any investors library, with a very solid approach, and with very high off-the-shelf usefulness. I'll definitely be lending this book to my teenagers to read and for them hopefully to practice the approach!

Finally, I would like to thank and acknowledge the publicist (Jo Treggiari of The Print Project) for providing me with a complementary copy of the book.


JW

The Confused Capitalist

Monday, September 04, 2006

Distill Your Investment Choices

A recent story from the excellent Avner Mandelman of Giraffe Capital reminded me, once again, of one of the reasons I became a "focus" investor.

Mr. Mandelman relates a story of a old classmate asking for Giraffe's top ten stocks in 2003. Although Giraffe already ran a focussed portfolio of just 25 stocks, Mr. Mandelman agreed. One year later, the former classmate sent back the results of just those 10 stocks: those ten stocks actually doubled the overall performance of the already focussed portfolio (see link for overall 2003 performance).

Mr. Mandelmans point is to dive into your own stocks to both cull the weaker positions, and to add to those positions holding the best promise.

In fact, I also had a virtually identical experience when I ran the Global Walkers Investment Newsletter in the mid-to-late 1990s. I had two model portfolios, one of which ("The Top Ten"), which was a subset of a moderately larger (typically 20-25 stocks) portfolio. While both portfolios trashed the TSX index (its benchmark) over the two year period I ran them, the Top Ten, like Mr. Mandelmans experience, also doubled the broader model portfolio.

So I concur with Mr. Mandelman: don't be afraid to look in your own backyard for some of the best stock ideas out there. After all, there's already been considerable distilling (hopefully) of your ideas to arrive at those. Just a little further distillation can yield fabulous results!

A foolish diversification is the hobgoblin of little minds, adored by mutual fund managers, brokers and fitful investors alike.

(With all due apologies to Ralph Waldo Emerson)




JW

The Confused Capitalist

Saturday, August 26, 2006

Insider Ownership & Long Management Tenure

When management and insiders have significant economic ownership and management has longer tenure ... (see illustration, left).

I recently recieved one of those ubiquitous The Motley Fool ads in my hotmail box recently, and I found the message they conveyed worth contemplating ...

10-Bagger Tenures
By Tim Hanson (TMF Mmbop)

More than 700 CEOs have already resigned this year, putting 2006 well ahead of pace to break the record (set in 2005) of 1,322 CEO exits in one year. That statistic, published in Fortune, should be worrisome for investors. Why? Because companies that do not have steady leadership at the top get lapped by companies who do.

Seriously. It's true ...
Need evidence? I found that of the 100 top-performing small caps from 1996 to 2005, 84 of them had either a founder at the helm or a CEO with more than five years of experience at the company -- far greater than the market average.

And the trend continues across the best-performing stocks of any size. Fully 164 of the 308 stocks that returned more than 20% annually, from June 1996 through June 2006, continue to have insider ownership of more than 5% today. That's 53% frequency. Now let's compare that to the broader market. According to Capital IQ, there are 21,959 companies trading on U.S. exchanges. Of that enormous number, just 3,550 have insider ownership of 5% or more -- a measly 16%.

Clearly, then, there's correlation between long-term shareholder rewards and insider commitment to the company they're running.
While I sometimes find the frequency of these ads irritating, it's worth thinking about this.

In fact, this is one of the things that I look at, when I analyze a stock in my small and microcap blog: a consideration of insider ownership. Perhaps I'll start considering the tenure of the CEO hereafter too ...


JW

The Confused Capitalist

Wednesday, August 23, 2006

Investing via themes ... or via financial statements

Over at Random Rogers, (Roger Nusbaum), a fellow blogger I read nearly every day, he's really big on investing in themes.

Given that Roger is a big proponent of ETF investing, that stands to reason. Roger's forte is obviously trying to enhance returns by not just investing in low-cost investment vehicles like ETFs, but then trying to sweeten those returns by looking at other big sweeping factors that'll influence values: investment themes.

I've learned a considerable amount from Roger and using his ideas to broaden my own thinking, portfolio holdings, and returns; in fact, my propensity to recommend emerging markets as a huge, long-term and reasonably-priced theme, owes much to Roger's thinking style.

Having said that, however, I also think that thematic investing requires a certain amount of patience and isn't necessarily suited to every investor. For instance, being right about the theme of commodities being underinvested in, in the late 1980s and early 1990s, would have been completely right, but far too early to make any money from it.

Sometimes, the theme is right, but the market is wrong: a situation of theoretical low risk, but also of low/no/negative returns. By the time the market realizes you were right - you could well have exited the theme: who's got the patience to wait ten years to be proven right?

For some investors with the appropriate skill set (an ability to read financial statements chief amongst them), an idea needing less patience is investing by value situations. What "value" means is finding the right combination of value and growth, at a favorable price. In fact, at a price that you think is completely unfair to the seller. Hence, you become a buyer.

When you can find appropriate situations like that, you don't have to wait around for the theme to unfold.

For instance, the legendary value investor Marty Whitman discusses in his book, The Aggressive Conservative Investor, investing in Japanese non-life insurance companies for years during the brutal Nikkei decline from 1997 to 2004 (a decline in the index that cut the index value in half). Yet, because of his ability to ferret out value, his Third Avenue fund was able to earn an annual 10% compound return on those Japanese assets over that period. No need for the "Japanese" theme to unfold. Instead, a hunt for value provided a decent return, without requiring the patience of Job.

At times, value investors are able to combine the idea of thematic investing with ordinary value investing to achieve extraordinary results.

So don't forget to check your own toolbox as an investor, and attempt to put more tools in there that you can use during your investing years. Thematic and value investing: a potent (but infrequent) combination.



JW

The Confused Capitalist

Monday, August 21, 2006

Will this high dividend, low PE stock portfolio outperform?

I have used the Globe Investor stock screen to come up with a group of TSX-listed common stocks that have both a high dividend yield, above 4% and a a relatively low PE (15 or lower). To make sure I'm not getting ones that have dubious cash-flow/earnings issues or accounting practices, I've also added a cash-flow filter, ensuring that the price/cash-flow is also 15 or lower.

Of the 1,075 common stocks that this screen picks up without any defined parameters (except for common stocks), the aforementioned screening yields some 15 securities, meaning this screen is picking up well under 2% of those common stocks. I'm going to track over the next while, so see if they outperform the broader index, the S&P/TSX60 index, which is currently at 12,044.83. We'll track the performance of this model portfolio, over time.

Here is the list of the 15 stocks, name, followed by symbol, and latest price (market close August 18, 2006):
  • Amerigo Resources, ARG, $2.26
  • BCE Inc., BCE, $27.48
  • Circa Enterprises, CTO, $1.30
  • Destiny Resource Services, DSC, $9.90
  • Goodfellow Inc., GDL $26.50
  • MCAP, MKP, $10.05
  • Norbord, NBD, $9.09
  • Pacific Northern Gas, PNG, $17.44
  • Revenure Properties Company, RPC, $14.00
  • Rothmans, ROC, $20.10
  • Russell Metals, RUS, $27.88
  • Seamark Asset Management, SM, $6.50
  • Taiga Building Products, TBL, $2.03
  • Viceroy Homes, VLH.A, $5.17
  • Weyerhaeuser, WYL, $65.63
We'll check back in anywhere from a month or longer, to see how they're all doing ..


JW

The Confused Capitalist