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One Investment… Three Ways To Profit

$150 billion is a lot of money. And due to some planned changes the makers of S&P and MSCI indexes are making, that’s the amount of money that is likely to flow into shares of real estate investment trusts (REITs) over the next few months. You see, up until now, REITs have been considered “financials” for the purposes of sector weighting. Well, that’s just crazy. A landlord that owns a portfolio of rental properties really has little in common with a bank or an insurance company. Yet, that’s where REITs have historically been lumped. But now that the index creators are fixing their mistake, there are going to be a lot of mutual fund managers and other institutional investors who will be pretty dramatically out of balance. According to recent research by Jefferies, that $150 billion is how much would need to be reallocated to REITs so that mutual fund managers can meet their benchmark weightings. I expect that the real number will be a decent bit lower than that. A lot of managers will be content to be underweight REITs relative to their benchmark. But even if it ends up being half that amount, that’s a big enough inflow to seriously buoy REIT prices. The entire sector is only worth about $800 billion. I’m telling you this now because we’ve been mentioning REITs in Boom & Bust of late, and so far, the results have been solid. But what I want to mention today is potentially even better. If you believe in the REIT story and expect REIT prices to go higher, and someone told you that you could buy a portfolio of REITs for 90 cents on the dollar, wouldn’t you jump at the opportunity? Well, that’s exactly the situation today in the world of closed-end funds. And in Peak Income , the new newsletter I write with Rodney Johnson, I recently recommended a closed-end REIT fund trading for about 90% of net asset value. Out of fairness to the readers who pay for that information, I can’t share the specific stock with you. But I can definitely tell you how I chose this fund and what you should look for when evaluating closed-end funds on your own. With most mutual funds, you can really only make money one way: the stocks in the portfolio must rise in value. Sure, dividends might chip in a couple extra percent. But for the most part, you only make money if the stocks the manager buys go up. That’s not the case with closed-end funds. In fact, you can make good money in three ways with this particular investment vehicle: #1 – Current dividend is generally a large component of returns. Unlike traditional mutual funds, closed-end funds are specifically designed with an income focus in mind, so they tend to have some of the highest current yields of anything traded on the stock market. This is partially due to leverage. Closed-end funds are able to borrow cheaply and use the proceeds to buy higher-yielding investments. This has the effect of juicing yields for you. #2 – Returns delivered via portfolio appreciation. Just as with any mutual fund, you make money when the stocks your fund owns rise in value. #3 – You have the potential for shrinkage of the discount or an increase in the premium to net asset value. That sounds complicated, so I’ll explain. Because closed-end bond funds have a fixed number of shares that trade on the stock market like a stock, the share price can deviate from its fundamentals just like any stock can. Sometimes, you can effectively buy a good portfolio of stocks, bonds or other assets for 80 or 90 cents on the dollar … or even less from time to time. But often, that same dollar’s worth of portfolio assets might be trading for $1.10 or higher on the market. Well, I’m not a big fan of paying a dollar and 10 cents for just a dollar’s worth of assets… no matter how much I might like those assets. But I do rather like getting that same dollar’s worth at a temporary discount. And when that discount closes, your returns outpace those of the underlying portfolio. The ideal closed-end fund investment should have solid potential from all three factors. It will pay a high current dividend, will have a portfolio poised to rise in value, and will be trading at a deep discount to net asset value. Be sure to look for those three things when you research closed-end funds. This article first appeared on Sizemore Insights as One Investment… Three Ways to Profit . Disclaimer: This article is for informational purposes only and should not be considered specific investment advice or as a solicitation to buy or sell any securities. Sizemore Capital personnel and clients will often have an interest in the securities mentioned. There is risk in any investment in traded securities, and all Sizemore Capital investment strategies have the possibility of loss. Past performance is no guarantee of future results. Original Post

These Funds And ETFs Are Now Poised To Outperform

For several years now, I have been recommending that investors put a somewhat higher emphasis on two categories of stock funds/ETFs, namely Large Value and International, along with a lower emphasis on domestic Large Growth and Small-/Mid-Cap. The reason is straightforward to me although less than obvious for most: While the former two categories have consistently trailed US broad stock benchmarks over the last several years, the latter two have at times exceeded them. In the sometimes upside down world of fund investing, there is a tendency, usually after a considerable number of years, for underperforming and relatively weak performing categories to switch places with the well-performing ones. The same is true for ETFs. Finally, after some trepidation that the approach was not working as expected, except in the case of Small-Cap funds which have indeed gone from being stellar performers to among the weakest over at least the last year, it now appears that the strategy may be beginning to pay off. However, it has been a frustratingly long wait, although an interval of one or two years for such an expected turnaround should not be regarded as particularly unusual. Large Value I believe the long expected rotation to value stocks may now be underway. So far this year, all three value stock category averages, Large, Mid-Cap, and Small, are running well ahead of their three growth stock brethren categories. The average Large Cap Value fund is outperforming the average Large Cap Growth fund by over 4%. While such a short spurt may not in itself seem significant, on a quarterly basis one has to go back consecutive 29 quarters, to the third quarter of 2008, to see an outperformance by Large Value over Large Growth that is that large. Note: Performance figures cited are through Apr. 20 unless otherwise noted. If Large Cap Value funds continue to outperform Large Cap Growth at the same pace for the rest of the year, there would be a huge 12% spread by year’s end. While such a large disparity might seem highly unlikely, it cannot be totally dismissed. If you compare the performance of two Vanguard index funds, Vanguard Index Value (MUTF: VIVAX ) and Vanguard Index Growth (MUTF: VIGRX ) as proxies for each of these categories, you will see that over the last 9 years, going back to May 1, 2007, Value has gone from a NAV (Net Asset Value) of 27.85 to only 33.03 for a cumulative gain of 18.6% (not annualized, excluding dividends). Growth, on the other hand, has gone from a NAV of 31.44 to 55.64 for a gain of 77.0%. The difference is a whopping 58.4%. When averaged out over the 9 years, VIGRX has exceeded VIVAX by about 6.5% per year. You would find the same discrepancies if you looked at the ETF equivalents of these funds, Vanguard Value ETF (NYSEARCA: VTV ) and Vanguard Growth ETF (NYSEARCA: VUG ), since they encompass the identical portfolios as these mutual funds. Since Large Value has been so far behind, merely gaining back one year of this outperformance for the rest of this year would bring it close to an 11% outperformance of Large Growth. However, it seems far more likely that the category will see smaller outperformances over quite a few of a number of upcoming years to enable it to eventually catch up to Large Growth. I, for one, believe such an equalization is reasonable to expect. In fact, history shows that value stocks tend to be better long-term performers than growth stocks, supporting the potential for a big upcoming turnaround. What else might argue for my suggested Large Value overweighting? Evidence suggests that as the Fed raises interest rates which they already have begun to do, value stocks tend to get stronger. (For a further discussion of this, see the following article .) Further, with growth stocks having reached a greater degree of overvaluation in the recent past than value stocks (although each category is more fairly valued now), Large Growth stocks would seem more likely to suffer if and when investors become unnerved and decide that they need to protect their profits. International Stocks Even more severe than the long-term underperformance of value stocks has been that of International funds/ETFs. When one compares the performance of the average International category fund with that of the S&P 500 index over the last 10 years (thru Mar. 31), one finds an annualized total return for the foreign category of 1.8% vs 7.0% for the US-only index. Emerging Market funds have done only slightly better at 2.5%. Is there any sign of a possible turnaround here? While only tentative given the short time period, a proxy for the entire International category, the Vanguard Total International Stock Index Fund (MUTF: VGTSX ), has gone from a NAV of 12.87 on 01/20/2016 to 14.98 on 4/20 for a 16.4% gain over 3 mos. Looking back over its quarterly returns, one has to go back to the 3rd quarter of 2010 (21 consecutive quarters ending this past Dec.) to find a gain that big. The same can be said for emerging markets. Looking at the Vanguard Emerging Mkts. Index Fund (MUTF: VEIEX ), the NAV has gone from 18.06 on 01/21/2016 to 22.38 on 4/20 for a gain of 23.9%. To find a closely comparable quarterly gain, one would need to go back to the 3rd quarter of 2009 (25 consecutive quarters, ending this past Dec.). Once again, you would get essentially the same results as above with Vanguard Total International Stock ETF (NASDAQ: VXUS ) and Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ). For both Large Value and International stocks, while not proof that a longer-term turnaround will be forthcoming, the data seem to be possibly suggesting that these categories of funds/ETFs will be better places to emphasize within a diversified portfolio over the next few years. With International stocks, and especially emerging markets relatively undervalued, these categories of funds/ETFs would appear more appealing than US-only stock funds when looking at annualized return potentials over at least the next several years. Still, there can be many “false dawns” where a category seems to be making a comeback but, not much later, falls back again. And, even if the outperformances I expect occur, it may not mean excellent absolute returns but only relatively better returns than the aforementioned competing categories. But especially when viewed over the longer term, an approach that incorporates the notion of comebacks by underperforming categories often seems to be an effective strategy when deciding which funds to emphasize within portfolio whenever considering periodic changes. But turnarounds don’t just happen because one “thinks” they should happen. The necessary ingredient is typically that the category in question has either become under-/overvalued, or, a major and usually unexpected development occurs within the markets that creates a nearly totally new mindset in investors, or both. While the second of these conditions is almost impossible to predict and is relatively rare, the first can be recognized by investors who are willing to pay close attention to relatively extreme over- or under-performance within the category averages. Disclosure: I am/we are long IN ALL OF THE MUTUAL FUNDS MENTIONED. 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.

The Future Of Beta – Slip Sliding Away…

Value, momentum, size, quality, volatility, etc., as factors in investing are quite popular. They’ve produced significant outsized returns relative to benchmarks. Now, we even have Smart Beta funds and ETFs popping up all over to make taking advantage of factors super easy. That brings up the critical question every investor interested in taking advantage of factors in their portfolio should ask – will the outperformance of factor investing continue in the future? Here I’ll take a look at a recent post from Alpha Architect that addresses this question. In short, investors should expect past outperformance to decrease in the future. Basically, there are two reasons why outperformance could go away; data mining (the factor is not real and just an artifact of the data) and arbitrage (basically investors becoming aware of the anomaly, investing in it in a big way, and thus it disappears). The Alpha Architect post references a study that looked at out of sample performance of factors. Below are the results. Basically, out of sample returns are lower than what the historical results had shown. The returns were about 40-70% of what they were in the past. Sobering. But as I’ve discussed on the blog in the past, some factors are better than others. In another post , a bunch of factors are analyzed and the only two sustainable ones are value and momentum. This is the reason all the strategies I use are primarily focused around these two factors. But one of the reasons that value and momentum work is that they come with periods of awful performance, absolute and relative, and drawdowns. All of which make them very difficult to stick with over the long term. And if history is a guide, investors should expect their relative outperformance to decrease going forward as more investors become aware of them. In a way, these factor strategies are even harder to stick with than just simple buying and holding of traditional index products. When you’re indexing at least you’re doing no worse than the index! There is no FOMO (Fear of Missing Out). If you’re not willing or able to tolerate underperformance, potentially for long periods of time, then you won’t be successful with factors. But I think the are a several things investors can do to increase their chances of success going forward. Reduce expectations: I always reduce potential outperformance by at least half when I look at implementing a strategy. Diversify: Use multiple strategies – buy and hold indexing, TAA, smart beta, individual stocks. There’s a very strong chance at least one of the strategies will be outperforming, thus increasing your chances of sticking with your program. It doesn’t and shouldn’t be all or nothing. Stick with what works – Value and momentum strategies have stood the test of time… at least so far. Dampen portfolio volatility with bonds. Reduce noise – There is a lot of noise in markets today. Investors need to work hard to tune it out. Try and go 1 month without looking at the market. Most investors I know can’t go a week. Have an investing process – Investing your money shouldn’t be haphazard and random. As with many things in life, having a system and process will help you achieve success. What are your goals? How does your portfolio match those goals? When do you rebalance? What strategies are you implementing and why? Do the same things at the same times on a regular schedule, etc… In summary, factor outperformance could very possibly decrease in the future. But they are still likely to be very powerful wealth building strategies if investors can stick with them and not expect the future to be exactly like the past.