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General Mills (GIS)

On Friday, I sent out an e-mail to our e-mail subscribers, like we always do whenever we are about to have a transaction in our portfolio. I don’t usually address our portfolio transactions on the blog, but I thought I should clear something up. Some readers have been questioning why we recently sold out of certain stock positions, specifically General Mills (NYSE: GIS ) and Procter & Gamble (NYSE: PG ). These sales have been several months in the making honestly. Over the past two months, I have written a couple of posts about changes to our Portfolio Allocation and the ETFs that will make up the core of our future portfolio. Part of the focus of our portfolio has been to generate income from the dividend growth in our portfolio, but the other part of our focus is to grow our portfolios’ value by investing in undervalued business… that will prosper over the long term. Part of that concept means that we do need to take profits when the value of some of our assets become overvalued. A while back we sold out of our utility company investments, for instance. At that time (and currently), we felt that the valuations and growth prospects that the market was assuming did not justify our continued investment. Something similar has occurred over the past several months, in regards to consumer staples companies. While I consider General Mills a good company, it’s a mature business and its model is dependent on consumers continuing to pay a premium for the company’s name brand products and agricultural commodities remaining low. Therefore, I don’t believe it has the characteristics of a company we should own over the next 30 years. Profits over the past couple of years have been goosed by unusually low agricultural input costs, low transportation costs, and good consumer demand. Will these trends continue? I don’t know, but given the company’s current metrics, I am happy to book our profits. The other part of why we took our profits, is I am not particularly optimistic about the global economy. That outlook, which may or may not be justified, and our desire to shift our core holdings over to passive index investments… encouraged us that some of our capital was better in cash for the time being. While I never expect to time our portfolio’s transition from mostly individual stocks… to mostly passive index investments… perfectly, it makes sense to me to do some selling while those assets are at elevated levels. For the past few years, dividend growth investments have been very popular with investors…largely as a result of the current (artificially) low interest rate environment. Therefore, some consumer staples and utility companies are trading at price to earnings ratios approaching 30. That wouldn’t concern me at all if the underlying businesses were growing at a rapid pace, but instead, many are only growing (revenues and profits) at 2%-6% annually. At some point, the companies will likely need to grow faster, or the share prices will need to come down. The exception being if we are entering a sustained period of mild deflation, but that situation comes with its own problems. I have been called everything from a contrarian to a “nut” on this blog, but I have found most readers receptive to our ideas. I don’t know that I am really a contrarian and I don’t strive to invest the opposite of how most people invest. I just try to think independently, and follow the path that’s best for me and my family. So our portfolio is largely in cash and we’re happy to remain that way for the near term. I think we will have dramatically better investment opportunities within the next year. If I can leave you with a concept, without going on about all the virtues of cash, it’s that in the current economic environment Cash is Not Trash! In round numbers, our sale of General Mills freed up $11,500 in capital. We had owned the shares for about 2 years and enjoyed capital appreciation of 20.5%, as well as 2 years’ worth of dividend income. The cash has been added to our growing “war chest”. We will reinvest this capital in the global equity markets as soon as we see a great long-term opportunity, but we also invest a small portion of our portfolio in deep value investments. Time will tell what our next investment will be, but for now, I am happy to hold plenty of cash and wait for the proverbial “fat pitch”. Do you ever book profits, or are you strictly a “buy and hold” investor? Disclosure: I do not currently own shares in GIS or PG. This article is for informational purposes only and should not be considered a recommendation for anyone to buy, sell, or hold any equities. I am not a financial professional.

Is Volatility A Useful Signal For Dynamic Currency Hedging?

By Jeremy Schwartz WisdomTree and Record Currency Management Ltd. 1 partnered to create a family of dynamic currency-hedged Indexes that utilize three factors to determine the dynamic hedge ratio on each individual currency: interest rate differentials, momentum and value. In the field of currency hedging one oft-debated question is whether there are other effective signals and, in particular, whether volatility could also be a useful signal. We have, of course, carefully considered which signals we believe to be most optimal, and although we recognize that volatility in currency markets can show patterns of behavior, we are convinced that it is not an appropriate independent signal to use in a hedging strategy, for the simple reason that volatility is by definition non-directional. Volatility Does Not Dictate Direction What do we mean by non-directional? Simply that rising (or falling) volatility tells us something about the size of observed movements in a currency pair, but nothing about the direction of those movements. Knowing that the standard deviation of exchange rate movements has become wider or narrower could be consistent with either one currency strengthening or the other-or, indeed, neither. In a dynamic currency-hedging strategy, which is naturally long equities, the only trade available is to be currency hedged (e.g., long U.S. dollar and short euro, or yen, or another currency)-or not. Since the purpose of dynamic hedging is to seek greater exposure to hedges that are expected to be profitable, and less exposure to hedges that are expected to be loss-making, it is essential for each signal to have some explanatory power as to which currency in any pair is expected to appreciate, i.e., to be directional. An example may serve to illustrate the point. We have tried to create a signal hedging strategy that is as widely applicable within developed market currencies as possible, without having been ” curve-fitted ” to one particular domestic currency or set of foreign currencies. Volatility seems to defy this. If, for example, one investor was looking for a strategy that worked well for hedging euro exposure into dollars, and another wanted to hedge dollar exposure into euros, then rising volatility in the euro/dollar exchange rate might tell both of them to hedge more. Since the exchange rate will only go one way, only one of these hedges will be profitable, while the other will be loss-making-so the signal will have worked for only one of the investors. Interest Rates, Value and Momentum Are Directional Hedging Signals By contrast, higher U.S. interest rates, or the momentum of the U.S. dollar, or an undervalued dollar, will all signal to U.S. investors to hedge their euro exposure, while also being a signal to euro-based investors to not hedge their U.S. dollars. These three signals are thus consistent by virtue of being directional. Looking for Volatility Reduction? Adopt Full Passive Hedging Finally, there’s the question of whether an investor wouldn’t always want to hedge more in a more volatile environment, simply because currency movements are at risk of being bigger. To this we would respond that bigger movements can come in both positive and negative directions, so once again the directionality of the signal is vital. If an investor is concerned about currency volatility, a full currency-hedged strategy may be most appropriate, as the long-term results showing currency exposure in a broad international framework has historically increased the volatility of international investments. 2 This is why WisdomTree has long suggested that fully currency-hedged strategies could serve better as core, strategic long-run allocations. Dynamic Hedging Can Help Returns The goal of the dynamic hedged Indexes WisdomTree and Record created were to tactically add value and return potential above fully hedged and fully unhedged offerings by incorporating the dynamic signals. Our signals were designed to be directional, so while they do lower volatility compared to unhedged benchmarks, they are likely to see a small volatility pickup over a fully hedged strategy. But our research leads us to believe that higher returns could compensate investors for this small pickup in volatility. Sources No WisdomTree Fund is sponsored, endorsed, sold or promoted by Record Currency Management (“Record”). Record has licensed certain rights to WisdomTree Investments, Inc., as the index provider to the applicable WisdomTree Funds, and Record is providing no investment advice to any WisdomTree Fund or its advisors. Record makes no representation or warranty, expressed or implied, to the owners of any WisdomTree Funds regarding any associated risks or the advisability of investing in any WisdomTree Fund. WisdomTree, Bloomberg, as of 12/31/2015. Important Risks Related to this Article Hedging can help returns when a foreign currency depreciates against the U.S. dollar, but it can hurt when the foreign currency appreciates against the U.S. dollar. Jeremy Schwartz, Director of Research As WisdomTree’s Director of Research, Jeremy Schwartz offers timely ideas and timeless wisdom on a bi-monthly basis. Prior to joining WisdomTree, Jeremy was Professor Jeremy Siegel’s head research assistant and helped with the research and writing of Stocks for the Long Run and The Future for Investors. He is also the co-author of the Financial Analysts Journal paper “What Happened to the Original Stocks in the S&P 500?” and the Wall Street Journal article “The Great American Bond Bubble.”

Q1 2016 Style Ratings For ETFs And Mutual Funds

At the beginning of the first quarter of 2016, only the Large Cap Blend style earns an Attractive-or-better rating. Our style ratings are based on the aggregation of our fund ratings for every ETF and mutual fund in each style. Investors looking for style funds that hold quality stocks should look no further than the Large Cap Blend and Large Cap Value styles. These styles house the most Attractive-or-better rated funds. Figures 4 through 7 provide more details. The primary driver behind an Attractive fund rating is good portfolio management , or good stock picking, with low total annual costs . Attractive-or-better ratings do not always correlate with Attractive-or-better total annual costs. This fact underscores that (1) cheap funds can dupe investors and (2) investors should invest only in funds with good stocks and low fees. See Figures 4 through 13 for a detailed breakdown of ratings distributions by style. Figure 1: Ratings For All Investment Styles Click to enlarge Source: New Constructs, LLC and company filings To earn an Attractive-or-better Predictive Rating, an ETF or mutual fund must have high-quality holdings and low costs. Only the top 30% of all ETFs and mutual funds earn our Attractive or better rating. The Vulcan Value Partners Fund (MUTF: VVPLX ) is the top rated Large Cap Blend fund. It gets our Very Attractive rating by allocating over 61% of its value to Attractive-or-better-rated stocks. Oracle Corporation (NYSE: ORCL ) has long been one of our favorite stocks held by VVPLX and earns a Very Attractive rating. Over the past decade, Oracle has grown after-tax profit ( NOPAT ) by 15% compounded annually. The company’s earns a top quintile 23% return on invested capital ( ROIC ). Oracle has grown into a cash machine, generating over $40.7 billion in free cash flow over the past five years. Unwarranted concerns about the company’s ability to adapt to new cloud technologies have created a great buying opportunity. At its current price of $37/share, ORCL earns a price-to-economic book value ( PEBV ) ratio of 0.9. This ratio means that the market expects Oracle’s NOPAT to permanently decline by 10% from current levels. If Oracle can instead grow NOPAT by just 5% compounded annually for the next decade , the stock is worth $57/share today – a 54% upside. Neuberger Berman Small Cap Growth (MUTF: NSNAX ) is the worst rated Small Cap Growth fund. It gets our Very Dangerous rating by allocating over 48% of its value to Dangerous-or-worse-rated stocks. Making matters worse, it charges investors total annual costs of 5.37%. Brunswick Corporation (NYSE: BC ) is one of our least favorite stocks held by NSNAX and earns a Dangerous rating. Over the past decade, Brunswick’s NOPAT has fallen by 1% compounded annually. Over the same time, the company’s ROIC has declined from 9% in 2004 to 8% over the trailing-twelve months. Despite the continued deterioration of the business, the stock remains overvalued. To justify its current price of $44/share, Brunswick must grow NOPAT by 10% compounded annually for the next 16 years . This expectation seems rather optimistic given Brunswick’s inability to grow profits over the prior decade. Figure 2 shows the distribution of our Predictive Ratings for all investment style ETFs and mutual funds. Figure 2: Distribution of ETFs & Mutual Funds (Assets and Count) by Predictive Rating Click to enlarge Source: New Constructs, LLC and company filings Figure 3 offers additional details on the quality of the investment style funds. Note that the average total annual cost of Very Dangerous funds is almost five times that of Very Attractive funds. Figure 3: Predictive Rating Distribution Stats Click to enlarge * Avg TAC = Weighted Average Total Annual Costs Source: New Constructs, LLC and company filings This table shows that only the best of the best funds get our Very Attractive Rating: they must hold good stocks AND have low costs. Investors deserve to have the best of both and we are here to give it to them. Ratings by Investment Style Figure 4 presents a mapping of Very Attractive funds by investment style. The chart shows the number of Very Attractive funds in each investment style and the percentage of assets in each style allocated to funds that are rated Very Attractive. Figure 4: Very Attractive ETFs & Mutual Funds by Investment Style Click to enlarge Source: New Constructs, LLC and company filings Figure 5 presents the data charted in Figure 4 Figure 5: Very Attractive ETFs & Mutual Funds by Investment Style Click to enlarge Source: New Constructs, LLC and company filings Figure 6 presents a mapping of Attractive funds by investment style. The chart shows the number of Attractive funds in each style and the percentage of assets allocated to Attractive-rated funds in each style. Figure 6: Attractive ETFs & Mutual Funds by Investment Style Click to enlarge Source: New Constructs, LLC and company filings Figure 7 presents the data charted in Figure 6. Figure 7: Attractive ETFs & Mutual Funds by Investment Style Click to enlarge Source: New Constructs, LLC and company filings Figure 8 presents a mapping of Neutral funds by investment style. The chart shows the number of Neutral funds in each investment style and the percentage of assets allocated to Neutral-rated funds in each style. Figure 8: Neutral ETFs & Mutual Funds by Investment Style Click to enlarge Source: New Constructs, LLC and company filings Figure 9 presents the data charted in Figure 8. Figure 9: Neutral ETFs & Mutual Funds by Investment Style Click to enlarge Source: New Constructs, LLC and company filings Figure 10 presents a mapping of Dangerous funds by fund style. The chart shows the number of Dangerous funds in each investment style and the percentage of assets allocated to Dangerous-rated funds in each style. The landscape of style ETFs and mutual funds is littered with Dangerous funds. Investors in Small Cap Value have put over 38% of their assets in Dangerous-rated funds. Figure 10: Dangerous ETFs & Mutual Funds by Investment Style Click to enlarge Source: New Constructs, LLC and company filings Figure 11 presents the data charted in Figure 10. Figure 11: Dangerous ETFs & Mutual Funds by Investment Style Click to enlarge Source: New Constructs, LLC and company filings Figure 12 presents a mapping of Very Dangerous funds by fund style. The chart shows the number of Very Dangerous funds in each investment style and the percentage of assets in each style allocated to funds that are rated Very Dangerous. Figure 12: Very Dangerous ETFs & Mutual Funds by Investment Style Click to enlarge Source: New Constructs, LLC and company filings Figure 13 presents the data charted in Figure 12. Figure 13: Very Dangerous ETFs & Mutual Funds by Investment Style Click to enlarge Source: New Constructs, LLC and company filings D isclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.