Tag Archives: portfolio

3 Income Funds You Should Hold In 2016

Summary If 2015 has taught us anything it’s that there is a high degree of risk in individual high yield sectors such as master limited partnerships and junk bonds. My top income themes for 2016 are centered around large, diversified, and proven investment vehicles that circumvent the hit-or-miss proposition of individual sectors. I think you will find these actively managed mutual funds and low-cost ETFs offer attractive characteristics as core holdings for nearly every style of income investor. Forecasting where the market will end up in 2016 is a very difficult task, as innumerable variables will intercede over the course of the next twelve months. The actions of the Federal Reserve in particular are going to be a heavy influence on income investors as they seek to position their portfolios for capital preservation and dependable dividend streams. If 2015 has taught us anything it’s that there is a high degree of risk in individual high yield sectors such as master limited partnerships and junk bonds. These groups have erased years of accumulated gains in a manner of months as credit headwinds weigh on investors’ minds. In addition, the trendless direction of interest rates will likely lead to above-average volatility in high quality fixed-income holdings as well. My top income themes for 2016 are centered around large, diversified, and proven investment vehicles that circumvent the hit-or-miss proposition of individual sectors. That may seem boring to those who like to tempt fate with the glory of a turnaround story or make assumptions in continued strength of momentum names. Nevertheless, I think you will find these actively managed mutual funds and low-cost ETFs offer attractive characteristics as core holdings for nearly every style of income investor. Vanguard High Dividend Yield ETF (NYSEARCA: VYM ) If you are looking for an essential equity income fund to own in 2016, then VYM should near the top of your list. This exchange-traded fund houses 435 U.S. stocks with characteristics of consistently high dividend yields. Top holdings include well-known names such as Microsoft Corp (NASDAQ: MSFT ), Exxon Mobil Corp (NYSE: XOM ), and General Electric Co (NYSE: GE ). VYM has exposure to virtually every sector of the stock market, which means that it is a highly diversified and transparent investment vehicle. I like to think of this fund as the “S&P 500 of dividend stocks” because of its market-cap weighted structure and broad index construction methodology. Currently VYM has a 30-day SEC yield of 3.25% and income is paid quarterly to shareholders. The embedded expense ratio of this fund is just 0.10% and it has over $11 billion in total assets. I have owned this ETF as a core holding in my Strategic Income Portfolio for several years and expect that it will continue to add value in 2016 as well. It’s simply difficult to find a better investment vehicle for those that crave a low-cost, dividend-focused stock fund. PIMCO Income Fund (MUTF: PONDX ) Most bond investors have their core holdings in passive indexes such as the Vanguard Total Bond Market ETF (NYSEARCA: BND ). However, in my opinion, an over allocation to a passive fixed-income basket may lead to weak performance over the course of the next several years. One of my favorite actively managed bond funds to supplement or replace existing passive strategies is PONDX. This portfolio is governed by Daniel Ivascyn and Alfred Murata of PIMCO, who were named MorningStar’s 2013 U.S. Fixed-Income Managers Of The Year. The PONDX strategy is built on the foundation of a flexible, multi-sector approach with the goal of income and long-term capital appreciation. It takes a global slant by incorporating themes from overseas markets and has been known to use hedges to control risk and limit interest rate sensitivity as well. The effective duration of PONDX is just 3.09 years and it has a current 30-day SEC yield of 3.03%. This fund has an admittedly higher expense ratio than a comparable ETF at 0.79%. However, the performance over the last several years has well compensated investors for the superior security selection and risk management techniques. PONDX has gained 2.81% versus 0.81% in BND on a year-to-date basis in 2015. Over the last three years, PONDX has returned 17.02% versus just 4.02% in BND. The fund is rated 5-stars by Morningstar and has been consistently ensconced in the top of its peer group over the last 3 and 5-years. I own this fund in my own account alongside my clients and feel that the managers’ expertise navigating credit and interest rate volatility will make for a solid bond holding in 2016. Note: Larger investors or those working with an advisor may benefit from the institutional share class PIMIX, which charges an expense ratio of 0.45%. Vanguard Wellesley Income Fund Admiral Shares (MUTF: VWIAX ) For those seeking a conservative multi-asset income fund with a solid track record and low fees, look no further than VWIAX. This fund is one of the few actively managed offering from Vanguard that has been in existence for over 40 years. Yet true to the Vanguard approach of minimal cost, the expense ratio of VWIAX is only 0.18%. The fund invests in a mix of income generating assets that fluctuate between 35-40% stocks and 60-65% bonds. The stock allocation consists of 59 large-cap names such as Wells Fargo Inc (NYSE: WFC ) and Merck & Co (NYSE: MRK ) to name a few. The bond sleeve consists of high quality corporate and government securities with an average maturity of 6.5 years. VWIAX has a current 30-day SEC yield of 2.83% and dividends are paid quarterly to shareholders. In a world filled with aggressive income strategies trying to position themselves as high yield standouts, this stalwart mutual fund aims for a quality and dependable asset allocation mix that has survived the test of time. This helps keep volatility low and risks in an acceptable range that retirees or other capital preservation-focused investors can appreciate. Furthermore, it has been rated 5-stars by Morningstar over 3, 5, and 10-year time horizons. The bottom line is that these three income funds offer solid value in 2016 by sticking with investment themes that have historically provided dependable results. They can also be supplemented with tactical or alternative investment themes to enhance the overall yield of your portfolio or capitalize on a relative value opportunity.

Capturing The Move Higher In 3-Month Deposit Rates

Summary What we’re trading and how. Full disclosure of trade entry, objective and strategy. If the Fed’s expectations for rates are right this position will appreciate from $2,050 at 0.82% to $5,000 at 2.00% by December 19, 2016. Linked is an interactive risk/reward spreadsheet enabling you to experiment with any potential outcome for this trade or your own trading criteria. I’ve included instructions on how to use the interactive risk reward spreadsheet. Three-month deposit rates outside the Treasury system (Eurodollars) are the most liquid futures contract on the board. Open interest (contracts outstanding) is greater than the Dow, S&P, Gold, Silver, Crude Oil, Gasoline, Euro-FX, Yen, Pound, Canadian and Australian dollars combined. (6.9 million versus 11.3 million) Click here if you’re not familiar with what this rate is, how it’s set and the underlying futures contract. Capturing the move higher This simple trade runs through December 19, 2016. Short the December 2016 ( GEZ16 ) 3 month rate futures contract at 99.18, trading this rate higher from 0.82% contract value $2,050. Objective = 98.00, rate 2.00% contract value $5,000 consistent with the lowest of the Fed’s disclosed expectations . Click here to enlarge the rate, price valuation chart below A short 99.18, B objective 98.00. (Video 1:59) Last objective guidance of where Fed Chair Yellen sees the Fed funds rate and when. Source: Federal Reserve Correlation between the Fed funds and 3-month deposit rates (Eurodollars) the average for the 3 month is +.25% to Fed funds. (click to enlarge) Qualify risk/reward by experimenting with any potential outcome for this trade and match it to your current risk investments. Click here and open the December 2016 risk/reward spreadsheet. When the spreadsheet opens enable it. Click here for current quotes and charts (December 2016) enabling you to track this trade or experiment with any potential outcome for this trade using the data on the Exchange’s site. How to use the spreadsheet 1) Entry Price = short December 2016 at 99.18 (B-9) 2) Enter any contract price in cell B-3 3) C-3 Shows the rate the contract price represents 4) D-3 Initial investment 5) E-3 Net profit or loss 6) F-3 Net liquidating value 7) C-4 Deposit per contract Any entries can be changes to experiment with your own criteria. Click to enlarge Click here for the CME Fedwatch for rate expectations

Assessing The Utility Of Wall Street’s Annual Forecasts

It’s that time of year when everyone starts preparing for the New Year and Wall Street makes its 2016 predictions. I’ll get right to the point here – these annual predictions are largely useless. But it’s still helpful to put these predictions in perspective, because it highlights a good deal of behavioral bias and some of the mistakes investors make when analyzing their portfolios. The 2016 annual stock market predictions are reliably bullish. Of the analysts that Barrons surveyed, they found no bears and an expected average return of 10%. This is pretty much what we should expect. After all, predicting a negative return is a fool’s errand given that the S&P 500 is positive about 80% of the time on an annual basis. And the S&P 500 has averaged about a 12.74% return in the post-war era. So, that 10% expected return isn’t far off from what a smart analyst might guess, if they’re at all familiar with probabilities. There is a chorus of boos (and some cheers) every year when this is done. No analyst will get the exact figure right, and there will tend to be many pundits who ridicule these predictions despite the fact that expecting a positive return of about 10% is the smart probabilistic prediction. In fact, if most investors actually listened to these analysts and their permabullish views, they’d have been far better off buying and holding stocks based on these predictions than most investors who constantly flip their portfolios in and out of stocks and bonds. But that’s the reason why these predictions exist in the first place. Because every year, investors perform their annual check-ups and evaluate the last 12 months’ performance before deciding to make changes. And of course, Wall Street encourages you to do exactly that, because turning over your portfolio means increasing the fees paid to the people who promote these annual predictions. But when we put this analysis in the right perspective, it becomes clear that this mentality is misleading at best and highly destructive at worst. Stocks and bonds are relatively long-term instruments. The average lifespan of a public company in the USA is about 15 years.¹ And the average effective maturity of the aggregate bond index is about 8 years.² This means an investor who holds a portfolio of balanced stocks and bonds holds instruments with a lifespan of about 11.5 years. When viewed through this lens, it becomes clear that evaluating a portfolio of long-term instruments on a 12-month basis makes very little sense. What we do on an annual basis with these portfolios is a lot like owning a 12-month CD that pays a one-time 1% coupon at maturity and getting mad that the CD hasn’t generated a return every month. But this annual perspective makes even less sense from a probabilistic perspective. As I’ve described previously , great investors think in terms of probabilities. When we look at the returns of the S&P 500, we know that returns tend to become more predictable as we extend time frames. And the probability of being able to predict the market’s returns increases as you increase the duration of the holding period. While the probability of positive returns becomes increasingly skewed as you extend the time frame, there is still far too much randomness inside of a 1-year return for us to place any faith in these predictions. The number of negative data points is only a bit lower than the number of positive data points, even though the average return is positively skewed: (click to enlarge) So, at what point do returns become reliably positive? If we look at the historical data, we don’t have reliably positive returns from the stock market until we look about 5 years into the future, when the average 5-year returns become positively skewed. A 50/50 stock/bond portfolio has a purely positive skew, with an average rolling return of 3 years. Interestingly, this stock market data is just as random even though it’s positively skewed. So, trying to pinpoint what the 5-year average returns will be is probably a fool’s errand (even though stocks will be reliably positive, on average, over a 5-year period). (click to enlarge) All of this provides us with some good insights into the relevancy of making forecasts about future returns. When it comes to stocks and bonds, we really shouldn’t bother listening to or analyzing predictions made inside of a 12-month period. The data is simply too random. As we extend our time horizons, the data becomes increasingly reliable with a positive skew. But it still remains a very imprecise science. The bottom line – If you’re going to hold stocks and bonds, it’s almost certainly best to plan on having at least a 3-5 year+ time horizon. Any analysis and prediction inside of this time horizon is likely to resemble gambling. As Blaise Pascal once said, “All of human unhappiness comes from a single thing: not knowing how to remain at rest in a room”. The urge to be excessively “active” in the financial markets is strong; however, the investor who can take a reasonable temporal perspective will very likely increase their odds of making smarter decisions, leading to higher odds of a happy ending. Sources: ¹ – Can a company live forever? ² – Vanguard Total Bond Market ETF, Morningstar