High Yield Bonds & Large Moat Dividend Growers

[MachineGhost]

Does anyone have any thoughts on carving out a portion of the equity allocation to allocate towards short-to-intermediate term high yield bonds and large moat dividend growers?  I am already nearly evenly split between domestic and foreign growth stocks but find this unsatisfactory as they are not going to deliver outsized long-term returns at current valuations.

Specifically, I'd like to know how valuable the volatility capture is for this asset, especially as HB started to favor the less-volatile broad index funds over the high beta mutual funds that he recommended in his earlier books.  How much gain was given up due to his switch and how much gain would be given up to carve out in favor of less volatility but more consistent income?

I think the issue about stock alternatives are going to become more and more important over time if the PP flounders sideways during an extended Japanese-style deflation that we seem to be experiencing.  There must be a sweet spot where the reduced volatility is not offset by the increase in steady income.

[D1984]

MG, holding low volatility blue-chip dividend growers as part of a "slice'n'dice of the stock portion of a PP isn't a bad idea IMO but if you are worried about lack of volatility capture pair it with an SCV fund and a leveraged large growth fund; these assets aren't too strongly correlated with "stable" stocks as a whole so that will provide a chance for some rebalancing volatility gains even within the 25% stock portion itself plus will help make the stock portion overall as much or more volatile than holding the TSM.

My main concern about high-yield bonds would not be lack of volatility (although IIRC they are less volatile than equities at about 60-70% of the volatility level on average); what would worry me would be what would happen if we had another period like 1979-1980 (stocks did well but bonds of all stripes-whether junk or Treasuries or anything in between-of all but the shortest maturities got creamed by rising rates) or 1998-1999 (stocks take off but junk bonds perform in a merely OK to mediocre manner-in this case due to the 1998 LTCM mini-crash and rising rates in 1999). This wouldn't be such a problem if one had junk bonds as a significant part of one's portfolio but in a PP the equities are there for a very specific reason-prosperity-and gold WILL fall during non-inflationary prosperity and LTTs will do so as well if rates are rising enough as the Fed tries to cool a hot economy.

I would also urge you to consider that junk bonds come in two main "flavors"; these are "original issue" i.e. issued with a below BBB rating and "fallen angels" i.e. bonds that originally were investment grade but have been downgraded one or more times or there is a worry the issuer may default and the bond's price reflects this. Swedroe (he of FTM portfolio fame) had a link on his SeekingAlpha page about two studies that showed how the "original issue" junk bonds actually underperformed the junk market as a whole (they only provided about 6% nominal return if I remember correctly) and actually provided NEGATIVE alpha vs a comparable Treasury benchmark; the only reason high-yield bonds as a whole provided the supposed "equity-like returns with less risk than equities" was because the "fallen angel" junk bonds did well enough to provide positive alpha and offset the poor risk-adjusted returns of the original issue junk.

Were you planning on buying individual junk bonds or a bond fund? If you were considering a fund what about FAGIX? It is known for scraping the bottom of the junk bond garbage pail-it holds a good bit of B, B-minus, and CCC (and even unrated) debt that got that way after being downgraded-and as such typically loses more in bad times or periods of economic distress and high default rates (look at 2000-late 2002 and 2008 and early 2009 and how it did vs the ML junk bond master index) but makes up for it in years like 1993, 2003, and post-March 2009. I know it's not an index fund and is actively managed but so far as I am aware there are no junk bond funds that are passively managed but that only focus on "fallen angels" and not original issue. As far as duration and maturity are concerned, almost 90% of the bonds it holds mature in ten years or less (almost 55% mature in seven years or less).

Finally, if all of this is in preparation for a Japanese style-deflation do you have any studies or evidence showing that Japanese junk bonds or "stable" blue chip dividend growers outperformed Japanese equities as a whole during the 1990-2011 bear market; if you do I'd certainly be interested in seeing it?

[Pointedstick]

FAGIX appears to have a beautiful inverse correlation with TLT. Fascinating.

[MachineGhost]

Great stuff, D1984!  Thanks.

Finally, if all of this is in preparation for a Japanese style-deflation do you have any studies or evidence showing that Japanese junk bonds or "stable" blue chip dividend growers outperformed Japanese equities as a whole during the 1990-2011 bear market; if you do I'd certainly be interested in seeing it?

Data availability is an issue.

So, I have no clue if Japanese junk bonds outperformed Japanese stocks.

Here's a limited comparison of small cap dividend payers to the non-dividend indexes:

http://finance.yahoo.com/echarts?s=DFJ+ ... =undefined;

[MachineGhost]

Guggenheim BulletShares has come out with a bunch of high yield corporate bond ETF's.  They are defined-maturity and have a low expense ratio of <.50%.

However, the underlying index that the ETF's use is just beta exposure and passively managed, so these ETFs serve very little purpose in terms of acquiring capital gains in selective, discounted corporate bonds with very low risk.  See the current paltry yields: http://www.accretiveasset.com/daily_hy_ ... mmary.html

Doing this yourself would require 5% of the equity allocation to be $50K-$100K to keep the expense ratio <1.5%.  Just not practical for anyone but who isn't at least a PP millionaire. 

This situation continues to frustrate me.

[MachineGhost]

I am now leaning towards using a ladder of the Bulletshares HY ETF's in lieu of any stocks at all.  While I won't sell off my existing PP equity position, the fact is stocks are not currently priced to deliver long term returns worth current risks.  So it feels pointless to throw more good money after bad, especially with bonds in a similar situation.  At some point, stocks will go down to increase long-term returns and it seems a gamble to me whether or not Treasury bonds will go up enough to compensate...  it would depend on the nature of the crisis (i.e. sovereign debt or not) and potentially going into negative nominal rates.  I think Europe is a good, recent example of what can happen where both stocks and bonds collapse.  It seems stupid to me to incur capital losses when at least half of it is avoidable by not being risk seeking.

For those unaware, the advantage of corporate bonds is you don't have capital gain losses (if you don't pay above par) as you do with stocks as you are guaranteed to get back 100% of your principal on the maturity-date.  The failure rate for HY is only 3% and recovery rate of that 3% in bankruptcy is about 50%.  The comparable duration of stocks is 50+ years compared to a short term bond ladder which would be about 2.5-5 years duration.  As long as you stay below a 7 years maturity with bonds and ladder, rising inflation would have a non-disastrous impact and wouldn't be much different than how equities respond to rising inflation (i.e. muddling).

Any criticisms or hole pokes?

[D1984]

MachineGhost,

It seems to me that you are essentially looking for a "placeholder" in lieu of a portion of your equity allocation because you do not think equities are attractive right now on a risk-return basis and have concluded that HY bonds are the best (in terms of risk vs return) such placeholder available. A few questions/concerns:

One, HY bonds may only have an average default rate of 3% but averages can be deceiving; what typically will happen will there will be several years with almost no defaults and then you get a year like 1990 or 2008 with 8-9% default rates. If the default was the only loss this inflicted it would be one thing but the fact that defaults are so high above average in years like these means that HY bonds get oversold and can lose 15-20% or more in addition to the loss just from the defaults (see 2008 for an example of this).

Two, what happens when you get a year (or two) when junk bonds underperform equities very badly or even that they lose money in real terms when stocks are gaining money? Something like one of those two happened several times before (1979-80; 1989-90, 1998-99, etc) and there's nothing to say it couldn't happen again. What if this is also a year when all the other PP assets are slightly down or flat and stocks would've saved your PP's bacon if only you had owned them instead of junk bonds? Can you stick with HY bonds through that?

Three, what about hyperinflation.....in any country that experiences hyperinflation but at least still has a functioning economy (in other words Zimbabwe in the late 2000s or Japan after WWII don't count) stocks have typically gotten mauled (in real inflation-adjusted terms) at first but then recovered enough so that when all is said and done they've nearly held their own with inflation (so you have huge nominal gains albeit little or no real gains or maybe even a small real loss but at least you didn't lose everything like you would've in fixed income) while anything that is bonds or FI (unless it's floating rate, tied to a commodity index or foreign currency, or VERY short duration like a MM fund) gets obliterated. Some of those Bulletshares ETFs have durations and maturities of greater than five or six years. In a hyperinflation getting your money back in five years is as good as never getting it back.

Four, what about tax-efficiency? Almost all of the return from HY bonds of the type in the BulletShares ETFs comes not from capital gains (as you said yourself: "these ETFs serve very little purpose in terms of acquiring capital gains in selective, discounted corporate bonds with very low risk" ) when the bonds are bought at a discount in the market and redemeed at par by the issuer (or alternately, are bought at a discount when spreads relative to Treasuries are high and sold back into the market when spreads relative to Treasuries are low) but from coupon payments. Coupon payments are interest and are taxed as ordinary income every year whereas much of the return on equities comes from capital gains (which are taxed at a lower rate-or may not even be taxed at all if Romney wins...who knows) and are tax-deferred until the stock is sold, and from dividends which are also taxed at a preferential rate (and even if Obama wins the preferential rate should continue for anyone making less than $150K or maybe $200K a year) vs ordinary income. This is not an issue if the assets are held in an IRA or 401K but if you hold any in an ordinary brokerage account it will be.

I understand what you are trying to do (although I don't agree 100% that stocks can't provide any more good returns from current levels....US stocks were already "expensive" on a PE and dividend yield  level when Greenspan made his "irrational exuberance" comment and they only continued getting more expensive for the next 3-4 years; Japanese stocks in 1986 were the same way and only peaked in late 1989; US stocks aren't at PE ratios near either of the preceding right now) but question whether owning only high-yield bonds is this best way to do it. If you think owning an S&P 500 or TSM fund is too risky at current levels, why not a fund like BERIX or ICMBX that owns HY bonds but can also own equities or investment-grade bonds or cash if they are at attractive levels? Or a convertible bond fund so you could get much of the upside of stocks (if we get a year like 1999 or 2009) with a good bit less of the downside (if we get another year like 2008)? Or a stable dividend oriented fund like TWEIX or BEGIX? Or a consumer staples fund like VDC or FDFAX? How about one of the Powershares low volatility/low beta funds (or take a page from the Tangent 20 strategy and make your own low beta fund by combining consumer staples, energy, health care, and utilities stocks as these are traditionally the least downside volatile sectors of the market)? Maybe a partially cash-holding (or at least willing to go somewhat into cash/bonds when markets get expensive so as to have dry powder to rebalance when they get cheaper) fund like Valley Forge, Copley, Cook and Bynum, Yacktman, Sequoia, or PRWCX? Or a Swedroe-style SCV-tilted 70/30? Or a market neutral merger-arbitrage fund like ARBFX, MERFX, or Gabelli ABC?

If one just wanted to stay out of the markets altogether until equities are cheaper, one could always put part of it into the BulletShares ETFs and the other part into something like RiverPark's Short Term High Yield fund (holds HY bonds and "orphaned" called bonds with maturities of from 1-180 days...think of it like a MM fund made up of junk bonds) in order to reduce duration/maturity/inflation/interest rate risk, or into an absolute return fund like HSTRX with a long history of stable returns or perhaps even into TIAA's stable value products based on its general account (their Intelligent Life Survivorship VUL pays 4.75% APR currently on its fixed account with a guarantee that it will never pay less than 3%, carries no sales load or surrender charge whatsoever, can be liquidated any time after it has been held for more than one month, and if funded at or just below the MEC level and with two fairly young insureds on a last-to-die policy COI will be almost nothing so the returns won't be affected too much by it).

To sum it all up: I don't happen to think (as Craig does) that holding HY bonds is an entirely bad idea per se, but if I was looking for something to replace some or most of my current equity allocation in a PP until stocks were "cheaper", I wouldn't hold ONLY high-yield bonds but diversify into some of the abovementioned options as well as holding HY.

[D1984]

I think Europe is a good, recent example of what can happen where both stocks and bonds collapse

Europe is not really a fair example to use because HB assumed (when coming up with the PP) that treasury bonds might decrease in value due to higher rates or inflation but would not decrease in value due to perceived risk of default. However, this assumption was based on a country being a sovereign issuer of its own currency and of bonds denominated in said currency such that if no one else would buy its bonds the treasury and/or central bank could always monetize the debt and buy the bonds or bills themselves (this would of course cause inflation but that's what the stocks and gold were there for). This cannot happen in, say, Greece or Italy because they are forced to issue bonds in someone else's currency (the Euro) and they can't simply print up Euros to buy the bonds so there IS a perceived default risk which leads to their debt being marked down and being sold at lower prices (and higher yields) which leads to more speculation that they can't pay their debts off which leads investors to demand even higher yields which leads....and so ad infinitum in a vicious, self-reinforcing cycle of ever more unaffordable and eventually unpayable yields (unless the ECB steps in as a buyer of last resort or simply converts the debt to Eurobonds).

With that said, if one had bought the Euro-denominated bonds of the most stable and historically the "hardest-money policy" member of the Eurozone (that would be Germany) as the "next-best" (next-best since there are no such things as actual Eurobonds yet) option for the bond portion of a PP and held an all-Europe stock index would one have done that badly from, say, 2007 to the present when compared to a PP that held Greek or Italian stocks and those respective countries' bonds? How would such a PP (German bonds and a pan-European stock index for the LTTs and stocks, plus gold for the gold portion and German day-bonds or schatzanweisungen bubills for the STTs) have fared compared to a US PP?

[MachineGhost]

Thanks for the valuable feedback.  You've helped crystalize my thoughts more as to what I'm trying to do. 

Essentially, I want the upside of stock-equivalent capital gains but without the downside risk.  That's obviously not possible in the long-term at the current valuations of stocks, but its clear that beta-exposure, defined-maturity HY ETFs isn't going to provide that either.  I could live with a 8-9% failure rate; after all, that is only 1 bond out of 10 and half of the assets may be recovered.  That's still light years ahead of stocks which aren't a claim on anything legally.  I did not consider hyperinflation, but I consider that historically as unlikely as worrying about Treasury bonds defaulting in a core economy.

So I think its clear to do what I want to do right, I'll have to do it myself so I can have defined-maturity, short-to-medium term duration, a ladder and to be able to buy only discounted bonds.  That's the only way I can see to preserve the upside capital gains without the duration risk of equities.  I wasn't willing to allocate more than 5% of the equity allocation, but I will have to do so to get the "expense ratio" reasonable.  This will all just be a temporary "placeholder" until stocks are actually undervalued again and/or we actually have an economic recovery after fundamental restructuring.

I will investigate some of the alternatives you mentioned that I was not aware of.  Although I'm generally skeptical that the managers have any practical market timing skill to cap downside loses in an "infinite maturity" fund, but there may be some surprises waiting to be uncovered.

[stone]

Machine Ghost, stocks might be very good  value now if from now on earnings and dividends grow at 20% per year for the next couple of decades due to some magical discovery/ economic solution to all our ills/ whatever that is about to become apparent over the next couple of years/ next couple of months/ next couple of days. Basically we don't know what is going to happen. IMO stocks are  held in case things turn out much better than sensible analysis suggests is likely and that is true whatever things seem like.

[D1984]

Machine Ghost, stocks might be very good  value now if from now on earnings and dividends grow at 20% per year for the next couple of decades due to some magical discovery/ economic solution to all our ills/ whatever that is about to become apparent over the next couple of years/ next couple of months/ next couple of days. Basically we don't know what is going to happen. IMO stocks are  held in case things turn out much better than sensible analysis suggests is likely and that is true whatever things seem like.

What he said. 100% agree.

If we DO get a bull market in the next few years high-yield bonds (probably) won't do badly but stocks will beat them maybe three to one. If gold is declining during this time and LTTs are slightly falling due to rising rates (since if the economy picks back up due to some new discovery/discoveries the Fed can raise rates sooner and/or bonds will have to compete with stocks for money driving rates up) then you'll need those stocks to offset losses in your other PP assets that are falling (although if the carefully selected HY bonds are for the variable portfolio and not your PP then this is a moot point).

Also, I don't know how many issues of discounted or HY bonds you intend to buy but if it's something like 20 or 25 then that is nowhere near adequately diversified IMO. What if there are maybe 1,000 potential choices of discounted bonds and (let's hypothetically say) a 6% default rate but you can't know for sure which ones will default. What if half of the ones you picked default? What makes you absolutely certain that you can pick HY and discounted corporate bonds that will not be the ones to default or end up in BK? Granted there are situations (Hilltop Holdings comes to mind....they had some preferred a few years back that was more than covered by the cash in the bank...in fact their whole company was trading for about what the cash on their books was worth; the preferred was discounted because everything was on sale in early 2009 but it was perfectly safe because of all the cash on their books; anyone who bought this preferred made a good bit when it got called) where the margin of safety is huge but these are few and far between from what I've seen.

I do admit that (assuming your security analysis and picking skills are exactly equal to theirs) you have at least something of an advantage over the big funds when it comes to security picking simply because you have so much less money (let's say a million dollars for you vs a billion for a mutual fund) that you are investing with and thus can go into situations they couldn't touch (say maybe a bond or preferred where the total float is only a few million and perhaps 1,000 shares trade a day on average) because they'd move the market and drive the price of the bond sky-high if they tried to use, say, 3% of their total cash to buy into this issue whereas you probably wouldn't since you'd be investing a thousandth of what they would....I'm just not sure if this is enough to offset the "lack of diversification risk" if you only buy twenty or thirty issues. Perhaps I am wrong and you will be buying several hundred different securities?

[clacy]

MG,

I backtested 50/50 split between VWEHX (Vanguard high yield mutual fund) and XLE (energy sector) with the following results from May 24, 2001 forward:

50/50

Total Return:  +146%
CAGR:  +8.4%
Sharpe: 0.42
Max DD:  -42.73%

100% VTI

Total Return:  +49.9%
CAGR:  +3.7%
Sharpe:  0.15
Max DD:  -55.45%

That was rebalancing quarterly, but the results were almost identical if you rebalanced yearly.  Substitute IJS (small cap value) and the results were very similar to XLE.  In fact, a 50/50 split between VWEHX and VTI were still considerably better than VTI alone.

However, some of the improved results obviously come from volatility capture because of rebalancing between the two assets.  However, that volatility capture within the stock (prosperity) portion, might negatively affect the volatility capture between the other asset classes (gold, LTT, STT).

[MachineGhost]

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[D1984]

MachinGhost,

I take it a "Perptual Dividend Raiser" is someone's (Lichtenfeld's perhaps?) fancy marketing name for a Dividend Aristocrat or the like? If not, what exactly makes them differ from Dividend Aristocrats?

Also, what about stocks like Tiffany or like Molex's "A" shares that haven't raised dividends every year but haven't cut them either? I'm not suggesting these are good (or for that matter, bad) stocks to buy but I am using them as examples of stocks that haven't actually cut their dividends (ever..even in 2008-9) and have an average 5, 10, 15, and 20-yr dividend CAGR that stomps inflation? Do stocks like these not deserve consideration as much as a Dividend Aristocrat or Acheiver....especially if the particular Dividend Aristocrat/Achiever/Champion has a CAGR that barely beats or even loses to inflation (certain water utilties come to mind) but still technically maintains its status by increasing the dividend, however slightly (even a 0.1% increase could theoretically qualify)?

Of course, OTOH a stock like Visa (again, not a buy or sell recommendation, just a good example of this type of dividend grower) with a stunning dividend CAGR but pathetic current yield might not be exactly a good idea either.

[MachineGhost]

I take it a "Perptual Dividend Raiser" is someone's (Lichtenfeld's perhaps?) fancy marketing name for a Dividend Aristocrat or the like? If not, what exactly makes them differ from Dividend Aristocrats?

Its likely just the Champions.  The table was to highlight the performance under higher tax dividend rates that we are facing, but I found it more interesting for the sustained outperformance vs the S&P500.  Typically, we all tend to think of volatility as random noise but in actuality the volatility would either be an sustained uptrend or a downtrend in any one of the assets to trigger a rebalance band.  So, there should be no loss of "volatility capture" if the upside is enhanced as any downside would be more than covered by the LT bonds (as we are relying on economic environments not tenous asset class correlations).  It seems to me a downside rebalancing band trigger may not be a very common thing so that the lower volatility of Dividend Growers is not such a bad thing after all?

I think doing this strategy wold optimally require it to be a relative Dividend Grower, i.e. momentum.  Gotta replace the deadwood.  It would be an interesting backtest.  Here's the top 20 dividend growers by weighted dividend growth rate:

Code: Select all

Name	                Symbol	Score	1-yr	3-yr	5-yr	10-yr
Walgreen Company	WAG	25.0 	28.0 	24.5 	22.9 	18.9 
Target Corp.	        TGT	24.9 	31.0 	22.4 	20.1 	17.5 
Parker-Hannifin Corp.	PH	22.8 	33.6 	15.8 	17.0 	11.5 
Lowe's Companies	LOW	22.5 	25.0 	14.9 	25.6 	29.6 
W.W. Grainger Inc.	GWW	18.7 	21.2 	17.6 	17.8 	13.7 
Wal-Mart Stores Inc.	WMT	16.8 	18.4 	14.4 	16.5 	17.9 
McDonald's Corp.	MCD	16.4 	11.9 	15.9 	20.4 	27.4 
Family Dollar Stores	FDO	15.7 	20.0 	13.7 	11.9 	11.8 
Hormel Foods Corp.	HRL	15.6 	21.4 	11.3 	12.7 	10.7 
Raven Industries	RAVN	13.7 	12.9 	11.9 	15.5 	18.8 
Stanley Black & Decker	SWK	13.6 	22.4 	9.2 	6.8 	5.7 
T. Rowe Price Group	TROW	13.6 	14.8 	8.9 	17.2 	15.2 
Donaldson Company	DCI	13.3 	17.2 	9.2 	11.3 	14.5 
Medtronic Inc.	        MDT	12.9 	8.7 	14.4 	17.8 	15.8 
Helmerich & Payne Inc.	HP	12.8 	18.2 	11.0 	8.5 	5.7 
Air Products & Chem.	APD	12.6 	16.1 	9.5 	10.7 	11.1 
Colgate-Palmolive Co.	CL	12.5 	11.8 	13.3 	12.7 	12.9 
Becton Dickinson & Co.	BDX	12.5 	10.8 	12.9 	13.8 	15.7 
Franklin Resources	BEN	12.4 	13.6 	7.7 	15.8 	14.4 
Sigma-Aldrich Corp.	SIAL	12.3 	12.5 	11.5 	11.4 	15.9 
Nordson Corp.	        NDSN	11.4 	17.9 	8.0 	6.5 	5.1 

I could sleep at night with pretty much any of those.  Of course, given the extreme durations of stocks, overpaying above the equivalent of par value would be quite deadly.

[D1984]

Typically, we all tend to think of volatility as random noise but in actuality the volatility would either be an sustained uptrend or a downtrend in any one of the assets to trigger a rebalance band.  So, there should be no loss of "volatility capture" if the upside is enhanced as any downside would be more than covered by the LT bonds (as we are relying on economic environments not tenous asset class correlations).  It seems to me a downside rebalancing band trigger may not be a very common thing so that the lower volatility of Dividend Growers is not such a bad thing after all?

MachineGhost, the upside OVERALL may be enhanced by using Achievers/Aristocrats/Champions as the stock portion of the PP but the upside in a sustained uptrend probably would not be and this would hurt volatility capture. By way of explanation:

Most of the "enhanced upside" (which I agree is real) of of the Aristocrats comes NOT from doing better in a strongly and sharply rising market but from simply not getting pummeled as badly during a downturn. This does not matter in a retirement income portfolio that is mostly or entirely in equities (not a good idea IMO but to each their own) but it most certainly will matter in a volalility capture one like the PP.

I have annual performance data for the S&P Aristocrats Index from 1990 to the present. It outperformed (in the bad years) of 1990 (not a hot time for the S&P 500 at -3.13% but the Aristocrats were up 1.25% on the year), 2000 (S&P 500 down 9.10; Aristocrats up 6.65%), 2001 (S&P down again...by 11.89% but Aristocrats up 10.62%), 2002 (S&P 500 and Aristocrats both down but 500 far worse at over 22% while Aristocrats lost just over 10% or less than half what the broader index lost), 2008 (S&P 500 killed...it lost 37% while the Aristocrats lost just 21.75%), and 2011 (S&P 500 nearly flat for the year after the debt downgrade drubbing and woes in Europe but Aristocrats up over 8%). In 2009 and 2010 the Aristocrats and broader index were virtually neck-and-neck both years.

The flipside of the above "bad year" outperformance was how (relative to the S&P 500) it did in the good years, and that's where things get messy. It managed to perform well in 1991 (by about 2% more than the broad S&P), barely outperformed in 1992, and then (with the exception of 1997 when it outperformed by a measly percent and three quarters) managed the ignonimous feat of spending every single year from 1993 to 1999 underperforming the S&P 500 including 1998 where it basically returned a little over half what the 500 did and 1999 where it actually LOST five and a half percent when the index was up 21%; this was probably due to everyone in 1999 (with the possible exceptions of Barton Biggs and Warren Buffet) chasing tech stocks and not wanting anything to do with a company like Coca-Cola or Kimberly Clark....BRK-A,TWEIX and FDFAX-Berkshire Hathaway, the most stable blue chip dividend fund I know of, and Fidelity's excellent consumer staples fund respectively-lost money as well as did a backtested Powershares low-beta index so it's not the Aristocrats' fault per se for being "bad stocks" which they were anything but, but the fact that everybody and his brother wanted dotcoms and more dotcoms that year and no one wanted to show any love to plain old "boring" dividend growers.

Again, this would be a non-issue (and even a plus since underperformning in good time as a tradeoff for outperforming in bad ones means better or equal returns with lower volatility and max drawdown) in a portfolio that relied mostly on equities but the fact of the matter is that the PP would have needed something in all of the 90s but 1993 to counter gold and would also have needed a boost in 1996 and 1999 to counter rising LTT rates. WIthout stocks proving 20% plus returns in those years I don't think anyone could stick with the PP (heck, the PP might even have LOST money in 1999 if it used an Aristocrats index fund for its"prosperity" portion) when their friends, family, and coworkers were bragging about doubling their money every month day trading dot-coms.

If you wanted to counter the above lack of upside volatility in the good years, add equal weights of an SCV fund and a very large and growthy-tilted growth fund to your Aristocrats (33/33/33) and set wide rebalance bands or even rebalance only annually. IIRC these should have correlations of less than 0.70 which is actually quite good for being technically all part of the same asset class and does provide some additional opportunity for volatility capture. This should help make the returns in periods like the 90s better than the broad index and probably not much worse in years like 2001-2002 or 2008.

Also, what about something like SDOGX in lieu of the Aristocrats/Achievers for the "boring sleep-at-night dividend stock" portion? If you look at the backtests it has lower volatility than the broader index, made an impressive recovery from 2008 (back to its peak by 2010), lost less from October 2007 to the March 2009 lows, and did much better than the index in 2000-02 as well. It tilts (well, relative to DOTD anyway) to size by using a modified "Dogs of the Dow" strategy on not just the Dow but the whole S&P 500. It focuses on yield moreso than dividend growth-it equal weights the five highest yielding stocks from each of 10 equally weighted sectors so it doesn't end up overweight in traditional income sectors like utilities, REITs, and banks. The focus on yield also means that it somewhat tilts to value by buying the most "beaten down" stocks every time it rebalances. I am aware that the current expense ratio is horrible but they've waived much of it and I presume it will (hopefully) fall anyhow as they gether more assets under management as more people invest in their fund (which just started out this year). I don't know how well it would work in a true depression (although 2008 was one hell of a battle-test even if it didn't lead to said depression) but if you check out http://www.investingdaily.com/10908/the ... end-stocks and http://investment-fiduciary.com/2008/10 ... depression it seems that high dividend yielders help a portfolio recover rather more quickly than the market at large by buying stocks at depressed prices through reinvestment of those fat dividends.

[MachineGhost]

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[D1984]

MachineGhost,

What was the universe of stocks they chose dividend payers vs non-payers from? The S&P 500? Also, by "dividend payers" I take it they mean ALL the dividend paying stocks from the chosen sample and not just the ones with multi-year (or sometimes multi-decade) dividend increasing histories like the Achievers/Aristocrats, correct?

Were the returns for the payers vs non-payers net of taxes or gross of taxes (i.e. were they before-tax or after-tax)?

[MachineGhost]

MachineGhost,

What was the universe of stocks they chose dividend payers vs non-payers from? The S&P 500? Also, by "dividend payers" I take it they mean ALL the dividend paying stocks from the chosen sample and not just the ones with multi-year (or sometimes multi-decade) dividend increasing histories like the Achievers/Aristocrats, correct?

Were the returns for the payers vs non-payers net of taxes or gross of taxes (i.e. were they before-tax or after-tax)?

I assume it was all universe and its all stocks paying a dividend, not just growers.  Returns seems pre-tax to me.

[MachineGhost]

The excess return for growers sure seems small.  I do not think it is going to beat value or momentum.

Ned Davis Research found that over the past 30 years, dividend growers have returned an average of 10.4 percent annually, compared with 9.4 percent gains for basic dividend payers and 1.5 percent for nonpayers. (06/12)

Dividends have played an important role in offsetting the effect of inflation. Since 1947, total dividends across S&P 500 companies have grown by an average of 5.6% per year, while the average inflation rate in that period has been about 3.7%. (03/12)

[align=center] (03/12)[/align]

[align=center] (06/10)[/align]

Recently, the Wall Street Journal reported the results of research published by the highly respected Ned Davis organization. According the article, data from Ned Davis Research showed that, since 1972, stocks in the S&P 500 Index that had consistently increased their dividends generated average total returns that were 2.2 percent greater (on an annualized basis) than stocks that didn’t raise their dividends. (08/08)

[stone]

One thing I've wondered about is how relevant this is within the context of a PP. I do suspect that a selection of profitable companies is better than just taking on anything BUT some good companies don't pay dividends. I'm struck by how studies such as those you describe above entirely ignore volatility capture oportunities. There was something on the GMO site showing that holding volatile stocks and selling calls on them ending up being the same as holding low volatility stocks.
As an example compare BHP bulliton and Rio Tinto. Those are both iron ore miners listed in London. BHP bullition and Rio Tinto prices move pretty much in lockstep except Rio Tinto has more volatility and no dividend (because it has more debt). A buy and hold strategy with just one stock shows BHP bulliton to be much superior  but in the context of a PP perhaps the volatility of Rio Tinto would get captured.

[stone]

Clive, what strikes me about minimal dividend stocks is that earnings typically DONT get translated into durable capital gains but instead get translated into volatility. A stock holder captures the earnings only if she/he captures that volatility by rebalancing or selling call options or whatever. I think you'd like:

http://www.gmo.com/America/GMOInsights/

Re-Thinking Risk: What the Beta Puzzle Tells Us about Investing
David Cowan and Sam Wilderman - Published 11/17/2011
Convex and concave payoffs play a central role in the performance of many investment strategies. In considering a range of applications, including high and low beta stocks, options, levered ETFs, and hedge funds, the authors show how understanding these payoffs can have important consequences for understanding asset pricing and making investment decisions.

[MachineGhost]

Re-Thinking Risk: What the Beta Puzzle Tells Us about Investing

What an illuminating article!  At one time I called dividend paying stocks a "poor man's way to hedge".  Now I see why.  Same as why market timing "works", for its merely shifting the market risk between convexity and concavity.  So logically, the optimal risk/reward any strategy would be to maximize both curves, i.e. sell puts on high beta stocks.

Two minor quibbles.  The article doesn't consider that puts are chronically overpriced relative to calls post 1987.  And that increasing concavity correlates to a shortening of time frame.

I'm pretty sure the PP has a concavity structure since the downside risk is rather large relative to the upside on a yearly basis.  I think the innate economic hedging is a stronger factor for returns than volatility capturing.  Its not like 15/35 rebalances happen all that often.

[MachineGhost]

In the virtual portfolio I started for the Dividend Growers (top 10 based on last 10 years weighted to more recent dividend growth), the stocks are classified as 50% growth, 40% blend and 20% value.  Not what I expected.  I suppose if a company has the ability to keep increasing their dividends at a relatively high rate, they must be growing by default.  Since growth stocks are typically conflated with technical momentum in the literature and strategies (CANSLIM, Navellier, etc.), dividend growers may represent a "purer" growth factor.

[MachineGhost]

[align=center]1982-2010
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