Tag Archives: capital-gains

5 Ways To Spring Clean Your Portfolio

Click to enlarge If you have a ritual to turn your house upside down for a thorough spring cleaning, you may want to do the same for your portfolio. If a lot of dust has settled on your investments over the years, it may be time to size things up and evaluate your holdings. Below are five tactics to help you see – and optimize – your portfolio in the new light of spring. 1. Sweep your house into order When was the last time you assessed your portfolio allocations and rebalanced its exposures? Let’s start from the top and assess whether your asset allocation still makes sense. If you want to maintain your original allocation but it is drifting, you can rebalance it by redistributing the weightings among each asset class. While rebalancing does take work, the alternative is a portfolio with out-of-balance allocations that could very well change the portfolio’s overall risk level and performance. Rebalancing the motifs in your account takes only a few mouse clicks. For more, check out the importance of rebalancing a portfolio over time. 2. Is it time to dust off old strategies and look forward? Does your portfolio need a fresh start? While you’re sizing up your portfolio, it could also be a good time take stock of the macro environment and see whether your investment thesis still makes sense. In the current climate where a strong U.S. dollar is putting the brakes on inflation and consumers are pocketing greater purchasing power, you may want to consider plays that take advantage of the appreciating greenback and shed exposure to foreign currencies. After all, of the major central banks, only the Fed has signaled rate hikes this year. In Europe, central bankers are still keeping rates around zero while Bank of Japan has kept rates below zero. So, consider strategies like investing in shares of companies that rake in their earnings from the U.S. domestic market or trim your holdings in foreign bonds. To get some ideas going, check out the All-American motif. 3. Time to part with low performing funds and high cost? Spring cleaning is about letting go – like that old sweater you’ve clung to but have not gotten any wear out of it for a decade. Have your investment returns met your expectations? For instance, if your mutual funds have underperformed, you may want to consider replacing them with ETFs. ETFs track an index, specific asset or basket of assets and can cover sectors, commodities, currencies, bonds, and other asset classes. On the performance front, the latest research from S&P Dow Jones Indices, Does Past Performance Matter , shows that relatively few active managed funds can outperform year after year. Of the 678 U.S. equity funds that made the top quartile as of September 2013, only 4 percent managed to stay in the top quartile after two years. ETFs also tend to be more transparent. While mutual funds are only required to disclose their holdings every quarter, you can usually verify your ETF’s daily positions. On the cost front, ETFs tend to have lower cost because as passive investments that track indices, they do not require high-priced investment professionals to look after them; the passive nature of these vehicles also means fewer trades, which translates to lower commissions. For cost, performance and transparency reasons, it is no wonder that last year ETFs drew a record $2.2 trillion, according to data from Fund Distribution Intelligence and Investment Company Institute. If your mutual funds have underperformed and command high management fees, keep in mind that ETFs are a popular alternative. 4. Pruning your holdings Think about harvesting your gains and cutting your losses. Take a look at the winners and losers in your portfolio. If you have accumulated a few winners over the years and believe their themes have played out, or if the company is fully valued, consider cashing them in and realizing your long-term gains. After all, we have had a strong bull run of the last seven years and taking profits would be a wise move as the climate is now more uncertain. By selling your positions now, you get to reinvest your gains while delaying the payment of your taxes for 12 months. You are also taxed at the long-term capital gains of 15 percent, which is significantly lower than the rate at which short-term gains are taxed (this would be your normal income tax rate). If, on the other hand, you have accumulated some losers and no longer believe in them, ditching them now may be as good a time as any. Your losses can also reduce your capital gains and soften the tax blow. 5. De-cluttering and streamlining your portfolio Do you have multiple retirement accounts? Do you have duplicate holdings in your brokerage accounts? If you are someone who has hopped from one workplace to another, you may have built a nice collection of 401(k) and IRA accounts. If that is the case, you may want to consolidate them because you can probably better manage your retirement accounts and track your assets when your funds are not all spread out among different accounts. Having fewer accounts will help you better size up your net worth, assets and liabilities. So, there you have it. We encourage you to pick one of these spring cleaning tips and get to work. A word of warning: once you dig in, it may be hard to stop because the act of spring cleaning and getting into your portfolio’s nooks and crannies does something to induce satisfaction and put a spring in your step. Happy cleaning!

International Treasury ETFs: Winners Amid Gloom

Recent developments in the domestic and global markets have led to a rise in volatility across all asset classes. None of the economies around the world are looking up with the most developed economies facing recessionary threats. The U.S. is also losing momentum and the emerging economies, mainly China, is facing hard-landing fears. Developed market inflation remains abysmally low while emerging markets, normally known for sky-high inflation, have also been seeing price level abating. The major reason behind this weakening in price level goes to the energy sector rout as crude prices lost around 75% in the last two years. Moreover, most of the commodities are slouching on lower global demand and ample supplies. Central banks across the board are striving to beef up asset values, charge up their sagging economies and boost inflation. Following the European Central Bank, Bank of Japan recently introduced negative interest rates. A reduction in rates would spur activities in economy which in turn should translate into higher growth. All these sparked-off a rally in international treasuries and the related ETFs. First, risk-off trade has led investors to flee the risky asset classes and seek solace in the so-called safer bond segment and then rock-bottom interest rates dragged down the Treasury bond yields giving a push to their prices. Yields on Decline Yields on Japan’s benchmark 10-year government bond recently slid to below zero ( negative 0.007% ) for the first time. The dropdown in yields mainly came in the wake of a negative interest rate policy adopted by BoJ. In fact BoJ chief indicated a slash in the Japanese interest rates – deeper into the negative territory if needed. However, as investors rushed toward a safe refuge following global market sell-off on February 8, which was triggered by the European banks’ sell-off, global government bonds came under the spotlight. The 10-year German and U.S. government bond yields also slid to multi-month levels lately. The benchmark U.S. treasury yields fell to as low as 1.75% on February 8, 2016, down 49 bps from the start of this year. More than $7 trillion of government bonds – accounting for 29% of the Bloomberg Global Developed Sovereign Bond Index – offered negative yields globally as of February 8, 2016. If the trend of negative interest rates continues, the negative-yielding bonds load is likely to increase. Given this, the International Treasury ETFs could provide investors with an opportunity of capital gains and safer bids. ProShares German Sovereign/Sub-Sovereign (NYSEARCA: GGOV ) The fund looks to track the performance of the Markit iBoxx EUR Germany Sovereign & Sub-Sovereign Liquid Index. The fund has a weighted average maturity of 5.86 years and a modified duration of 5.52 years. It charges 45 bps in fees and yields 0.17%. The fund is up 4.6% so far this year (as of February 8, 2016). SPDR Barclays Capital International Treasury Bond ETF (NYSEARCA: BWX ) BWX measures the performance of investment grade sovereign debt securities located outside the U.S. The ETF targets the longer end of the yield curve and has an average maturity of 9.48 years. The ETF is more sensitive to interest rate movements as indicated by an average duration of 7.77 years. From a holdings perspective, BWX allocates 23.32% of its total assets in the Japanese Government bonds. The fund allocates more than half of its assets in European nations. BWX is up 3.3% in the year-to-date frame. iShares S&P/Citigroup International Treasury Bond (NASDAQ: IGOV ) The ETF tracks the S&P/Citigroup International Treasury Bond Index Ex-US which measures the performance of foreign currency denominated treasury bonds issued by developed countries other than the U.S. Like BWX, IGOV also mostly places its bets on the Japanese government bonds which account for almost 22.6% of its total assets. The ETF has a weighted average maturity of 9.44 years and effective duration of 7.66 years. IGOV yields 0.1% annually and has added 4.3% so far this year (as of February 8, 2016). iShares S&P/Citigroup 1-3 Yr International Treasury Bond ETF (NASDAQ: ISHG ) This product targets the shorter part of the yield curve. Its weighted average maturity is 1.74 years and effective duration is 1.71 years. From a weightings perspective, the ETF holds 23.08% in Japanese short-term bonds and around 65% in the European nations’ near-dated securities. ISHG yields 0.09% annually and has added 2.6% so far this year (as of February 8, 2016). DB 3x Japanese Govt Bond Futures ETN (NYSEARCA: JGBT ) JGBT focuses on the triple-leverage performance of a long position in the 10-year Japanese Government Bond Futures. The assets of 10-year JGB Futures are Japan-government issued debt securities with a remaining term to maturity of not less than 7 years and not more than 11 years as of their date of issue and the futures contract delivery date. The fund is up 7.2% so far this year. Original post

The Two Sides Of Total Investment Return

By Quan Hoang I spend about 10-15% of my time crunching data. That sounds tedious but I actually enjoy this task. It forces me to pay attention to details, checking any irregularity I see in the numbers and trying to tell a story out of the numbers. My recent work on Commerce Bancshares (NASDAQ: CBSH ) led me to ponder the relationship between ROIC and long-term return. Over the last 25 years, Commerce Bancshares averaged about a 13-14% after-tax ROE, and grew deposits by about 5.6% annually. Over the period, share count declined by about 1.9% annually, and dividend yield was about 2-2.5%. Assuming no change in multiple, a shareholder who bought and held Commerce throughout the period would receive a total return of about 9.5-10%, which is lower than its ROE. Why is that? Chuck Akre once talked about this topic: ” Mr. Akre: What I’ve concluded is that a good investment is an investment in a company who can grow the real economic value per unit. I looked at (what) the average return on all classes of assets are and then I (discovered) that over 75-100 years that the average return on common stock is around 10%. Of course this is not the case for the past decade but over the past 75-100 years, 10% has been the average return of common stocks. But why is that? Audience A: Reinvestment of earnings. Audience B: GDP plus inflation. Audience C: Growing population. Audience D: GDP plus inflation plus dividend yield. Audience E: Wealth creation. Audience F: Continuity of business. Akre: …what I concluded many years ago, which I still believe today, is that it correlates to the real return on owner’s capital. The average return on businesses has been around low double digits or high single digits. This is why common stocks have been returning around 10% because it relates to the return on owner’s capital. My conclusion is that (the) return on common stocks will be close to the ROE of the business, absent any distributions and given a constant valuation. Let’s work through an example. Say a company’s stock is selling at $10 per share, book value is $5 per share, ROE is 20%, which means earnings will be a dollar and P/E is 10 and P/B of 2. If we add the $1 earning to book value, the new book value per share is $6, keeping the valuation constant and assuming no distributions, with 20% ROE, new earnings are $1.2 per share, stock at $12, up 20% from $10, which is consistent with the 20% ROE. This calculation is simple and not perfect, but it has been helpful in terms of thinking about returns on investment. So we spend our time trying to identify businesses which have above average returns on owner’s capital.” The restriction in Akre’s explanation is ” absent any distributions. ” In general, there are two sides of total return: the management side, and the investor side. Management can affect total return through ROIC, reinvestment, and acquisitions. Investors can affect total return through the price they pay and the return they can achieve on cash distributions. The Problem of Free Cash Flow Reinvestment into the business usually has the highest return (this post discusses only high quality businesses that have high ROIC). Problems arise when there’s free cash flow. Management must choose either to return cash to shareholders or to invest the cash themselves. Both options tend to have lower return than ROIC. Cash distributions don’t seem to give investors a great return. Stocks often trade above 10x earnings so distributions give lower than 10% yield. In my example, Commerce Bancshares wasn’t able to reinvest all of its earnings. It retained about 40% of earnings to support 5.6% growth and returned 60% of earnings in the form of dividends and share buyback. The stock usually trades at about a 15x P/E, which is equivalent to a 6.67% yield. The retained earnings had good return, but the cash distributions had low underlying yield. The average return was just about 10%. Unfortunately, many times returning cash to shareholders is the best choice. Hoarding cash without a true plan on using it destroys value. Expanding into an unrelated business for the sake of fully reinvesting doesn’t make sense. Similarly, acquisitions often don’t create a good return. The problem with acquisitions is that they’re usually made at a premium so the underlying yield is likely lower than the yield that would result from share buybacks. The lower underlying yield can be offset by either sales growth or cost synergies. Studies show that assumptions about cost synergies are quite reliable while sales growth usually fails to justify the acquisition premium. To illustrate this point,let’s take a look at 3 of the biggest marketing services providers: WPP, Omnicom, and Publicis. Omnicom is a cautious acquirer. It spends less and makes smaller acquisitions than peers. Its average acquisition size is about $25 million. Over the last 10 years, Omnicom spent only 16% of its cash flow in acquisitions while WPP and Publicis spent about 44% of their cash flow in acquisitions. Publicis is a stupid acquirer. It makes big acquisitions and usually pays 14-17x EBITDA. WPP is a smart acquirer. Like Omnicom, it prefers small acquisitions. When it did make big acquisitions, it paid a low P/S and took advantage of cost synergies. For example, it paid $1.75 billion or a 1.2x P/S ratio for Grey Global in 2005. That was a fair price as WPP was able to integrate Grey and achieve WPP’s normal EBIT margin of about 14%. To compare value creation of these companies over the last 15 years, I looked at return on retained earnings, a measure of how much intrinsic value per share growth created by each percent of retained earnings. As these advertising companies have stable margins, sales per share is a good measure of intrinsic value. Retained earnings in this case is cash used for acquisitions and share buyback, but not for dividends. As expected, Publicis created the least value: It’s interesting that the smart acquirer WPP didn’t create more value than Omnicom. That’s understandable because acquisitions aren’t always available at good prices. So, it’s very difficult for management to generate a great return on free cash flow. Therefore, the value of a high-ROIC business is limited by the capacity to reinvest organically. Free cash flow tends to drag down total return to low double-digit or single-digit return. The Investor Side of Total Return It’s very difficult to make a high-teen return by simply relying on management. The capacity to reinvest will dissipate over time and free cash flow will drag total return down to single digit. However, there are two ways investors can improve total return. First, investors can shrewdly invest cash distributions. When looking at capital allocation, I usually calculate the weighted average return. For example, if a company invests 1/3 of earnings in organic growth with 20% ROIC and 1/3 in acquisitions with 7% return on investment, and returns 1/3 to shareholders, how much is the total return? It depends on how well shareholders reinvest the money. If we shareholders can reinvest our dividends for a 15% return, the weighted average return is 20% * 1/3 + 7% * 1/3 + 15% * 1/3 = 14%. This number approximates the rate at which we and the management “together” can grow earnings (actually if payout rate is high, combined earnings growth will over time converge to our investment return on cash distributions.) Second, an investor can buy stocks at a low multiple. The benefit of buying at a low multiple is two-fold. It can help improve yield of earnings on the initial purchase price. It also creates chance of capital gains from selling at a higher multiple in the future. Warren Buffett managed to make 20% annual return for decades because he was able to buy great businesses at great prices and then profitably reinvest cash flow of these businesses. Small investors can mimic Buffett’s strategy as long as the stock they buy distributes all excess cash. They can reinvest dividends for a great return. In the case of share buybacks, they can take and reinvest the cash distribution by selling their shares proportionately to their ownership. That’s how Artal Group monetizes Weight Watchers (NYSE: WTW ). Share Repurchase at Whatever Price This discussion leads us to the topic of share repurchases. I think many investors overestimate the importance of share buyback timing. It’s nice if management buys back shares at 10x P/E instead of 20x P/E. But what if share prices are high for several years? Would investors want management to wait for years – effectively hoarding cash – to buy back stock at a low price? Good share buyback timing can help build a good record of EPS growth but EPS growth doesn’t tell everything about value creation. It’s just one side of total return. What investors do with cash distributions is as important. So, I think management should focus more on running and making wise investments in the business and care less about how to return excess cash. I would prefer them to repurchase shares at whatever price. By doing so, management effectively shares with investors some of the responsibilities to maximize total return. Share buyback gives investors more options. Investors must automatically pay tax on dividends but they can delay paying tax by not selling any shares at all. If they want to get some dividends, they can sell some shares and pay tax only on the capital gain from selling these shares instead of on the whole amount of dividends. Or they can simply sell all their shares and put all the proceeds into better investments if they think the stock is expensive. Conclusion I do not believe in buying a good business at a fair price. If the management does the right things, holding a good business at a fair price can give us 10% long-term return. But great investment returns require a good job of capital allocation on the investor’s part: buying at good prices and reinvesting cash distributions wisely.