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Six years of low interest rates has created a host of problems for investors, who are being forced into finding more and more creative ways of replacing lost income. One of the most popular strategies is the use of high-dividend investment ETFs. But Larry Swedroe points out that the popularity of a strategy, can sow the seeds of poor future returns.
Swedroe, principal director of research of Buckingham Asset Management, says that this occurs because cash flows impact valuations, and valuations are the best predictor of future returns.
Swedroe has carried out research into how relative valuations have changed over time. “The bottom line is that the popularity of high-dividend strategies has driven their valuations to levels that are no longer value-oriented.” Swedroe said, “This changes the nature of the fund in terms of what investors should expect in returns. Unfortunately, it’s almost a certainty that most investors are unaware of this impact.”
The bottom line is, if or when interest rates rise to levels that provide more competition for the yields on high-dividend stocks, investors who moved assets from safe bonds into a high-dividend strategy may try to exit at the same time.
This is crucial to note because the correlation of Treasury bond yields to the relative valuation of high-dividend payers has been about 80 percent since 1986. When yields go down, dividend payers get more expensive and vice versa. You never want to be the owner of investments in “crowded trades.”
The exits, when they happen, can get ugly.
Todays Other Top Stories
Learn Bonds: – Is investing in bonds risky? – So, is investing in bonds, risky? Just like any other security with a fluctuating market value, bonds do have risk – However, some bonds possess more risk than others.
WSJ: – Some European banks sell holdings of Detroit bonds. – Two European banks have sold hundreds of millions of dollars of Detroit municipal bonds after prices rose from lows reached when the city went bankrupt last year.
Businessweek: – SEC says California school district misled bond investors. – The U.S. Securities and Exchange Commission charged a California school district with lying to bond investors.
Businessweek: – Franklin muni fund declines to record low on Puerto Rico losses. – A Franklin Templeton Investments municipal-bond fund with the industry’s biggest allocation to Puerto Rico has sunk to the lowest in its 29-year history as prices on the struggling commonwealth’s debt set record lows.
FT: – Puerto Rico casts shadow on muni market. – A move by Puerto Rico to allow some public companies to restructure their debt last month sparked a credit downgrade, and brought a rally in debt sold by the US commonwealth to a halt.
Bloomberg: – Stockton judge tells Calpers to justify bankruptcy claims. – The California Public Employees’ Retirement System may not be a creditor with collateral rights over a city’s assets, the judge overseeing Stockton’s bankruptcy said today during a court hearing.
Zacks: – Zacks #1 Ranked government bond mutual funds. – We share with you 5 top rated government bond mutual funds. Each has earned a Zacks #1 Rank (Strong Buy) as we expect these mutual funds to outperform their peers in the future.
ValueWalk: – Why the Fed needs you to sell your bonds: Treasury shortage. – Today I will attempt to explain why longer-term interest rates have fallen significantly this year when almost everyone expected rates to rise. This discussion focuses on the fact that there is a shortage of Treasury securities in the marketplace today, especially in maturities of 10 years or longer. The shortage is due to a combination of factors that I will discuss below.
WSJ: – Fed sets October end for bond buying. – Federal Reserve officials agreed at their June policy meeting to end the central bank’s bond-buying program by October, closing a chapter on a controversial experiment in central-banking annals with results still the subject of immense debate.
Investment Grade Bonds
Donald van Deventer: – Bank of Nova Scotia and Goldman lead 20 best value bond trades for maturities of 1 to 5 years. – We rank the “best value” trades by the ratio of credit spread to matched maturity default probability.
Donald van Deventer: – Hewlett-Packard company bonds: Default risk continues to drop. – Fixed income veteran Ian Spreadbury has trimmed his exposure to investment grade corporate bonds, warning the sector is showing signs of deterioration.
Marketwatch: – Smaller issues in the U.S. corporate credit market offer opportunities that many equity investors may miss. – Even Sophisticated Investors Often Overlook Corporate Bonds as a Vehicle for Steady Returns, Lower Risk and Opportunities to Invest in Solid, Middle-Market Companies, According to Scott’s Cove Management.
Emerging Market Bonds
CNBC: – What taper tantrum? EM bonds return to peaks. – Emerging market bonds have been a hot trade this year as prices fell in the wake of convulsions following last year’s “taper tantrum,” but some analysts say the rally may have run its course.
WSJ: – Investors need not cry for Argentina. – A high-profile default is never good news. But Argentina, which may default unless it can strike a deal with creditors who have refused to accept previous restructuring deals, seems unlikely to cause big problems for most emerging-market investors.
FT Global Markets: – The long term play of emerging markets: time on their side. – Driven by accelerating growth in capital raising activities over the next one-and-a-half decades, emerging nation capital markets are expected to capture a more proportionate share of the global capital market universe relative to their economies, closing the gap with their developed peers, according to the Credit Suisse Research Institute’s Emerging Capital Markets: The Road to 2030 report.
Businessweek: – Wall Street clashes over emerging-market bonds as UBS says sell. – Two of the world’s biggest banks have come out with very different takes on emerging-market debt.
PIMCO: – Consider longer-maturity TIPS as core fixed income holding given mkt complacent about long-term inflation risk. – Given the lack of inflation risk premium in the market and the Fed’s continued dovishness, we think longer-maturity TIPS are an attractive investment for core fixed income portfolios.
Market Realist: – So what’s an investor to do in a rising rate environment? – If you have a bond portfolio that’s heavy with long-term bonds, you can potentially reduce your interest rate risk by rebalancing your portfolio to increase exposure to short-term bond ETFs.
About.com: – The bright side of U.S. Federal Reserve rate hikes. – Do interest-rate increases by the U.S. Federal Reserve necessarily have to be a bad thing?
Reuters: – Don’t believe predictions of low interest rates. – Will the new normal for interest rates be lower than the old? It is rapidly becoming conventional wisdom that years of near-zero overnight rates will be succeeded by an indefinite period in which borrowing costs remain low by the standards of the last few decades. The new consensus is reflected in financial markets: the yield on 30-year U.S. Treasury bonds has fallen from 4 percent to 3.4 percent this year. But it is built on unsound foundations.
David Fabian: – Not all short-term bond ETFs are cut from the same cloth. – The popularity of short-term bond ETFs has continued to gain steam in 2014. In the wake of Federal Reserve taper fears and rising interest rates last year, many fixed-income investors flocked to these low duration funds in an attempt to shelter their portfolios from decline.
In developed markets over the last year yields on 10yr govt bonds have fallen in every country except New Zealand (+11) and the UK (+22)
— David Schawel (@DavidSchawel) July 9, 2014
Worrying about money never helps. Take a deep breath. Focus only on those things you can control. Let go of the rest.
— Carl Richards (@behaviorgap) July 9, 2014
Fed set to wrap up QE in October, minutes show. Rate hiking timing? That’s a whole other question.
— Pedro da Costa (@pdacosta) July 9, 2014