Author Archives: Scalper1

Looking For Value From Vanguard

My article last week looked at the long-term benefits to holding a diversified portfolio that included a tilt to large cap and small cap value stocks globally. To illustrate the results, I used the structured asset class mutual funds from Dimensional Fund Advisors (DFA) as my proxies for the value stock categories, unlike the market indexes, where I substituted Vanguard index funds. Why not use Vanguard results across the board? Vanguard has an obvious expense ratio advantage over DFA and just about everyone else, and investors have voted with their wallets – Vanguard has more assets than any other mutual fund company. The issue is, when you look to Vanguard for value, they either don’t measure up or don’t even offer strategies for a given asset class. Take a look at the table below. FUND/Index 3/1993-12/2015 6/1998-12/2015 1/1995-12/2015 DFA US Large Cap Value fund (MUTF: DFLVX ) +9.8% Vanguard S&P 500 fund (MUTF: VFINX ) +9.0% Vanguard Value Index (MUTF: VIVAX ) +8.8% DFA US Small Value fund (MUTF: DFSVX ) +9.1% DFA US Small Cap fund (MUTF: DFSTX ) +8.5% Vanguard Small Value Index (MUTF: VISVX ) +8.1% DFA Int’l Value fund (MUTF: DFIVX ) +6.0% MSCI EAFE Index +4.7% MSCI EAFE Value Index +5.3% DFA Int’l Small Value fund (MUTF: DISVX ) +7.4% MSCI EAFE Small Cap Value Index +7.0% Vanguard manages index funds in the US covering large and small value stocks. But they don’t capture as much of the value “premium” as the asset class funds from DFA do. Since 1993 (DFLVX inception), the DFA US Large Value fund outpaced the Vanguard Value Index (net of a higher expense ratio) by 1% per year. Since 1998 (VISVX inception), the DFA US Small Value fund outpaced the Vanguard Small Value Index (net of a higher expense ratio), again by 1% per year. Surprisingly, the Vanguard value funds even underperformed the S&P 500 and small cap “market” funds, despite the fact that these “neutral” (holding both growth and value) funds obviously have less exposure to value stocks than the Vanguard value indexes. This should dispel any myth that the Vanguard underperformance is due solely to “less exposure to the value factor.” Things get considerably more challenging with Vanguard once we leave the US market. Vanguard doesn’t offer an index fund that buys international large value stocks or small value stocks. You’re stuck with a plain-vanilla market index like the MSCI EAFE. The chart above finds, since 1995 (DISVX inception), the DFA Int’l Value fund bested the EAFE Index (before expenses associated with an actual index fund that buys EAFE stocks) by 1.3% per year. The DFA Int’l Small Value fund did 2.7% per year better. Clearly, there’s a significant cost (return drag) to investing only in international market indexes that doesn’t show up in simplistic expense ratio comparisons. But what if Vanguard did offer large and small value indexes in foreign markets? Would they be worth a look? Here I’ve reproduced the returns on a likely index provider – the MSCI EAFE Value and EAFE Small Value Indexes – for comparison purposes ( source: DFA ReturnsWeb ). These indexes don’t have any fees, and any index fund or ETF that tracks them would likely trail the index return by 0.2% to 0.3% or so. Even still, the apples (net of fee DFA fund return) to oranges (gross of fee index returns) comparison shows a clear advantage to DFA : The DFA Int’l Value fund did +0.7% per year better than the EAFE Value Index while the DFA Int’l Small Value fund did +0.4% per year better than the EAFE Small Value Index. The lack of value stock indexes from Vanguard in non-US markets isn’t just a return issue, either. Large and small foreign value stocks also have lower correlations to US asset classes and have provided an additional diversification benefit. What accounts for these significant net-of-fee differences that are consistent across geographical regions over meaningfully long periods of time? First, as previously mentioned, DFA does hold a deeper subset of the lowest-priced value stocks, about the cheapest 30% compared to the cheapest 50% for Vanguard. And the small cap funds hold almost purely small and micro cap stocks compared to small and mid cap stocks for Vanguard. DFA screens out stocks with low-to-negative profitability and when buying and selling, they do so patiently throughout the year, hanging on to companies with positive momentum while waiting to buy stocks with the strongest negative momentum. And, finally, DFA is a more active security lender, earning a few more basis points on average from lending out stocks overnight and earning a return (that gets credited back to the fund) for doing so. All of this adds up to much purer asset class exposure with noticeably better long-term returns that is not isolated to just one area of the market. I like Vanguard . T hey’ve done a good job of educating investors on the importance of broad diversification and minimizing fees. But given the option, in the crucial asset classes that belong in a “core” diversified portfolio*, I just don’t see the value in using Vanguard. *I would add that the DFA US Large Cap Equity fund (MUTF: DUSQX ) and DFA Five-Year Global fund (MUTF: DFGBX ), which cover the other two core asset classes not discussed in this article, represent superior options to the Vanguard S&P 500 fund and the Vanguard Short-term Bond Index fund as well, but the reasons are beyond the scope of this article. Past performance is not a guarantee of future results. Mutual fund performance shown includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. This content is provided for informational purposes and is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services. Disclosure: I am/we are long DUSQX, DFLVX, DFSVX, DFIVX, DISVX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Random Ideas: Buy Global Defence And American Transport Shares

Two sectors deserving your investing scrutiny. Defence Has it struck you that whilst global economic and thus earnings growth is slowing, defence spending is accelerating? This is logical: “All politics are local”, as Tip O’Neill quipped years ago. Thus, politicians are rallying the masses against the “bad foreigner” who is to blame for the mess that politicians keep making at home by not structurally reforming their economies. Investment implication : keep buying shares (or a credible sector ETF), particularly in the defence sectors of America, Europe, Japan, South Korea and Australia (who want to increase defence spending by 80 per cent over the next decade). Transport Is economic growth really as terrible as all that? (Or are large investment banks merely using some flicks of bad news in order to drive profits by driving trading turnover, now that margins have collapsed?) Were economic growth so dire? Then why has America’s Dow Jones Transport Sector been gaining for the past six weeks? According to the Financial Times (FT) of 27th February, p. 15, ” The rebound for the closely watched sector, which includes 20 companies such as United Parcel Service (NYSE: UPS ), railway Norfolk Southern (NYSE: NSC ) and Delta Air Lines (NYSE: DAL ), is seen as a sign that the broader US equity market can gain further momentum.” All of this lends credibility to our long-held view that slowly, America’s Economic Time® is improving ; indeed, this is why the Fed has started raising rates, albeit gingerly. Investment implication : Buy cheap American transport stocks or an appropriate American transport sector ETF.

Irrational Pessimism – Throwing The Baby Out With The Bath Water

Since first publishing kortsessions.com in February 2013, I have tried not to get into the weeds on individual stocks ideas. We are all about the media and the adverse outcomes in store for those who rest their investment policy on their pronouncements. When I did mention a name for illustrative purpose, I did my best to make certain that I acknowledged my fallibility and ownership position (if I had one), and to advise all readers consuming my work to make certain companies mentioned were suitable to their own investment circumstance and tolerance for risk before they considered purchase… caveat emptor. Today’s post is going to sound like a recommendation. But because of the irrational pessimism surrounding a certain segment of the market, the securities covered have great illustrative value. Nonetheless, I urge you refer to the admonition in paragraph one before rushing out and buying any of the two names that I will refer to. I own positions in both names. Background of the craziness My example today comes from a former client, Tortoise Capital Advisors . As their name implies, “Slow and steady wins the race.” They are not trying to hit the ball out of the park every time they come to the plate. Singles do just fine. Tortoise manages both separate accounts, closed-end, exchange-traded funds and open-ended funds (AUM $13 billion), the majority of which specialize in the shares of Master Limited Partnerships (MLPs). I have owned their shares in the past, and recently initiated positions in their flagship fund, the Tortoise Energy Infrastructure Corporation (NYSE: TYG ), and the Tortoise MLP Fund (NYSE: NTG ). These two funds, in particular, are midstream (processing, storage and pipelines – not production ) oriented. They are conduits and not terribly sensitive to commodity prices. The management at Tortoise is very conservative. I can vouch for this from personal experience. As an institutional broker with both A.G. Edwards and Wells Fargo, I had the opportunity to bring managements in for meetings with their PMs and analysts. I will attest that they were an extremely tough sell. They have scrupulously avoided commodity risk and the risk of anything questionable in financing plans/needs and capitol structures (excessive leverage). They looked for simple businesses with long-term repeatable revenue streams. They did their homework. Both TYG ($23.58, yielding 11%, a/o-2/26) and NTG ($15.20, yield 11%, a/o- 2/26), after making all-time highs in 2013 ($50.64 and $30.18 respectively), began precipitous declines in 2014. Interestingly, TYG, because it had the word “Energy” in its name, began to plummet first; even though none of its MLP investments owned oil and gas reserves or production. Its holdings were all fee-based conduits, storage or processors, whose prices had collapsed due to oversupply issues in commodities that they transported, but whose demand (ergo, fee-generating capacity) continued to grow. This was crazy, but par for the course for the stock market. Linn Energy LLC (NASDAQ: LINE ) and Kinder Morgan, Inc. (NYSE: KMI ) exacerbate matters In the case of Linn, it is an upstream (ergo, highly exposed to commodity risk via owned oil and gas production) MLP that came under bear attack for its hedge accounting (completely unwarranted). The company made a large acquisition, with the idea that it could swap out pieces for lower-risk producing assets and sell equity to finance the rest. It did this on the credit card. The crude market turned. Linn Energy could not sell or swap assets. When oil collapsed, its stock price collapsed. The company could not sell equity to pay down debt. Linn’s stock, which at one time traded as high as $42, is now less than $.50 per share. Importantly, Linn and the upstream partnerships are outliers. Though midstream MLPs, for the most part, have little commodity exposure, investors did not want to be confused with the facts and sold. KMI was another case of a bear attack on what was considered at one time “best of breed” in the midstream MLP space. It was also a situation where an acquisition was made in a market that was not sympathetic to financing MLPs. Ergo, to put itself back on sound financial footing (which it did – see here ), the company slashed its dividend 75%, proving the naysayers correct and causing further group-wide liquidation… throwing the babies out with the bathwater. The Elephant in the Room: Is the MLP model broken? According to Tortoise portfolio manager, Matt Sallee …Looking at the facts, midstream MLPs, their fundamentals are not broken. Our portfolio has average cash flow growth of 20% year over year looking at EBITDA, 10% per unit. And while not every company has announced their 4th quarter distributions, north of half of our portfolio has, and that weighted average distribution as I mentioned previously is up about 3% over the prior quarter, so we feel pretty good about that. Along with that, our MLP portfolio companies, have not experienced any distribution cuts. You read that? Over half their portfolio companies in the last year increased distributions with no distribution cuts! Source: Transcript of Tortoise first quarter 2016 conference call (Additional context: Video presentation by Tortoise CEO, Kevin Birzer) How irrational has the pessimism been in the MLP space? My favorite recent example came on January 20, 2016. In the wake of a horrific (pardon my sarcasm) 1/4 point increase in the Fed Funds rate, a continuing collapse in the price of oil, the Chinese market in free fall, a potential European banking crisis (punctuated by rumors of problems at Deutsche Bank AG (NYSE: DB )), the market opened and fell almost immediately by 550 Dow points. During the panic selling that ensued, TYG hit a low of $18.50 (yielding 14%) and NTG fell to $11.60 (yielding 14.5%). Don’t confuse us with the facts! We can’t stand this anymore! Get us out! The above panic is a descriptive of what one normally sees at a market bottom, not at a top … an example of – “… nameless, unreasoning, unjustified terror … (- Franklin D. Roosevelt ).” It is Irrational Pessimism of the highest order. I believe that the MLP space is a good proxy for much of the craziness afoot in today’s market… healthy babies being tossed out with the bath water. What is your take? Disclaimer: The information presented in kortsessions.com represents my own opinions and does not contain recommendations for any particular investment or securities. I may, from time to time, mention certain securities for illustrative purpose, names where I personally hold positions. These are not meant to be construed as recommendations to BUY or SELL. All investments and strategies should be undertaken only after careful consideration of suitability based on the risks, tolerance for risk and personal financial situation.