Alternative Beta

July 22, 2013

…has been discovered by the Wall Street Journal.  Recently, they wrote an article about better ways to index—alternative beta—and referenced a study by Cass Business School.  (We wrote about this study here in April.)

Here’s the WSJ’s take on the Cass Business School study:

The Cass Business School researchers examined how 13 alternative index methodologies would have performed for the 1,000 largest U.S. stocks from 1968 to 2011.

All 13 of the alternative indexes produced higher returns than a theoretical market-cap index the researchers created. While the market-cap index generated a 9.4% annualized return over the full period, the other indexes delivered between 9.8% and 11.4%. The market-cap-weighted index was the weakest performer in every decade except the 1990s.

The most interesting part of the article, to me, was the discussion of the growing acceptance of alternative beta.  This is truly exciting.

Indeed, a bevy of funds tracking alternative indexes have been launched in recent years. And their popularity is soaring: 43% of inflows into U.S.-listed equity exchange-traded products in the first five months of 2013 went to products that aren’t weighted by market capitalization, up from 20% for all of last year, according to asset manager BlackRock Inc.

And then there was one mystifying thing: although one of the best-performing alternative beta measures is relative strength (“momentum” to academics), relative strength was not mentioned in the WSJ article at all!

Instead there was significant championing of fundamental indexes.  Fundamental indexes are obviously a valid form of alternative beta, but I am always amazed how relative strength flies under the radar.  (See The #1 Investment Return Factor No One Wants to Talk About.)  Indeed, as you can see from the graphic below, the returns of two representative ETFs, PRF and PDP are virtually indistinguishable.  One can only hope that relative strength will eventually gets its due.

The performance numbers above are pure price returns, based on the applicable index not  inclusive of dividends, fees, commissions, or other expenses. Past performance not indicative of future results.  Potential for profits accompanied by possibility of loss.  See for more information.  

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Relative Strength Dividend Investing

July 22, 2013

Dividend investing is all the rage these days.  It can be a valuable investment strategy if it is done well—and a very negative experience if it is done poorly.  The editor of Morningstar’s DividendInvestor, Josh Peters, recently penned a great column after his model portfolio collected its 1000th dividend payment.  The article involves the lessons he learned in his foray into dividend investing.  It is a must-read for all dividend investors.

One interesting thing, to me, was that many of the dividend investing problems that he experienced could have been avoided with a relative strength screen.  (We use just such a screeen for the First Trust dividend UITs we specify the portfolios for.)  Allow me to explain what I mean.

Morningstar’s first lesson was that quality was important in dividend investing.  Mr. Peters writes:

The dividend cutters occupy a land of agony: We lost money on 13 of the 16 portfolio holdings that cut their dividends, and the 3 that have been profitable–General Electric (GE), U.S. Bancorp (USB), and Wells Fargo (WFC)–only pulled into the black long after their dividends began to recover.

One of the first things we noticed when screening the dividend investing universe by relative strength was this: companies that cut their dividends overwhelmingly had negative relative strength.  In fact, when I looked through the list of S&P Dividend Aristocrats that cut their dividends in the middle of the Great Recession, I discovered that all but two of them had negative relative strength before the dividend cut.  Some had had poor relative strength for many years.  Pitney Bowes (PBI) is just the most recent example.  You can see from Morningstar’s chart below that most of their losses came from dividend cutters.

Source: Morningstar  (click on image to enlarge)

In other words, screening for good relative strength is a pretty good insurance policy to avoid the land of agony.

Morningstar’s second lesson was that many of the best dividend stocks were not fundamentally cheap.

I’ve always believed dividends were the most important aspect of our investment strategy, but I’ve always been something of a cheapskate, too. I don’t like paying full price for anything if I can help it. In the first year or two of DividendInvestor’s run, I brought this impulse to my stock-picking, but I was often disappointed. In the banking industry, for example, I originally passed on top performers like M&T (MTB) and gravitated toward statistically cheaper names like National City and First Horizon (FHN).

Guess what top performers have in common?  You guessed it—good relative strength.  A relative strength screen is also a useful way to avoid slugs that are cheap and never perform well.

The third lesson is just that time is important.  If you are doing dividend investing, a lot of the benefit can come from compounding over time, or perhaps from reinvesting all of the yield.

If you choose to use the Dorsey Wright-managed First Trust UITs, we always recommend that you buy a series of four UITs and just keep rolling them over time.  That way you always have a current portfolio of strong performers, screened to try to avoid some of the dividend cutters.  If the portfolio appreciates over the holding period—beyond just paying out the dividend yield—it might make sense when you roll it over to use the capital gains to buy additional units, in an effort to have the payout level increase over time.

Even if you never use our products, you might want to consider some basic relative strength screening of your dividend stock purchases.

Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  See for more information.

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Weekly RS Recap

July 22, 2013

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile and then compared to the universe return.  Those at the top of the ranks are those stocks which have the best intermediate-term relative strength.  Relative strength strategies buy securities that have strong intermediate-term relative strength and hold them as long as they remain strong.

Last week’s performance (7/15/13 – 7/19/13) is as follows:

ranks 07.22.13

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