WTF? Not one but Two ETFs?

I’ve always felt the active versus passive investing debate has been overdone. There is no such thing as pure passive investing, rather differing distributions of investment decision-making along the spectrum of possible decision points between fund manager, index compiler, algorithm constructor, rebalance operator, end investor.

That said, unlike many in the online Financial Independence community - notably Monevator and such luminaries as Lars Kroijer (see his Investing Demystified videos) Warren Buffett, at least in his advice to other investors, if not his own practice; see for example page 20 of his 2013 annual letter:

“The goal of the nonprofessional should not be to pick winners — neither he nor his “helpers” can do that — but should rather be to own a cross section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.”

- I’ve been instinctively averse to passive funds for fear of ending up as a ‘mannequin’ investor; trapped inside an investment black-box until the next rebalance whilst the model on which the passive fund is based stops working in the face of a geopolitical shock or paradigm shift in market sentiment.

So why have I recently invested in not one but two ETFs? In a word, evidence.

Reviewing the performance of a few funds I was intending to retain whilst switching to a lower-cost platform confronted my intuitive distaste for so-called passive funds with the evidence of their superior past performance, but also the possibility of tilting my holdings in a [possibly] more yield-friendly direction.

Both the ETFs I’ve recently invested in are with Wisdomtree.

Established for more than a decade in the US, Wisdomtree has begun to make its offerings available in Europe, including direct listings on the LSE.

My first investment stemmed from a desire to finally invest directly in a US-focused fund. For several years I’ve been wary of the elevated valuations in the US market, and for several years have missed out on the upward progress of various US indices (although not completely as I have some biotech and global dividend fund exposure to US companies).

Trump’s recent victory and the potential return of fiscal activism prompted an exploration of how to invest in US small cap stocks whilst gaining some dividends. Even allowing for the historically lower payout ratios in the US market, the active funds on offer (e.g. Legg Mason IF Royce US Smaller Companies; Schroder US Smaller Companies) seemed to offer low or non-existent yields.

This is where ETFs come in. Searching for small cap ETFs on justetf.com, 

not only did Wisdomtree’s US Small Cap Dividend ETF outperform other small cap ETFs in the last 12 months, it also outperformed the above mentioned OEICS even before taking the dividend into account.

The fund’s most recently quarterly distribution announcement implies an annual yield of about 2%, not huge, but about as much as a US fund is likely to yield without option-generated income enhancement.

That same justetf.com search on “small caps” led me to Wisdomtree's Emerging Markets Small Cap Dividend ETF.

Like its US Small Cap Dividend stablemate, this Wisdomtree ETF is also dividend-weighted rather than market-capitalisation weighted.

In this version of ‘smart beta’, rather than share price performance driving the index weighting of individual stocks within the proprietary index through which the ETF’s holdings are calibrated, Wisdomtree weights each holding according to its contribution to the overall dividend stream and rebalances with that dividend tilt once a year.

Again in terms of capital value (excluding dividends) the Wisdomtree Emerging Markets Small Cap Dividend ETF has outperformed the OEIC I’d been holding in this area in the last 12 months: Newton Emerging Income (37.51% versus 24.65% for the Newton Emerging Income W Inc unit class).

With this ETF having switched to a twice yearly dividend payment pattern it’s hard to judge how comparatively income-generative it will be, but I’m prepared to experiment.

I still have some reservations:

- The dividend payment policy of ETFs is a little opaque: do they pay out all the dividends received like OEICs? Do they have revenue reserves like investment trusts?

- Each of these ETF portfolios being so market-embracing (709 stocks in the US Small Cap ETF and 592 stocks in the emerging small cap ETF) means the portfolios doubtless contain some of last year’s successes and next year’s relative failures until the next rebalance.

It is impossible to know in advance whether the recent outperformance in these two cases will persist, but the combination of lower charges, the absence of platform fees, and the liquidity of immediate trading on the open market merit at least this experimental foray.

Indeed my ongoing search for ‘value’ investments in what will become the small ‘growth’ portion of my post-retirement portfolio is leading me towards the ETF offerings in this area, which will be the subject of a future post.

Polar Opposites? A Fund Management Firm and an ETF

I read too much – an occupational hazard of a soon to be ex-academic. Although famed investors like Warren Buffett and Charlie Munger regard deep and wide reading as fundamental to sound investment decisions, too many ideas can spur too much trading.

I may have committed this error in recent days as frustrated by my current account turning from 1-2-3 to 1-2-1.5 I’ve committed a very small amount of incremental capital in search of yield.

To my surprise, my disparate reading prompted me to make my first ever investment in an ETF (to be discussed in a future post). It also alerted me to an intriguing test case of the value opportunity versus value trap question that haunts many investment decisions.

Another recent investment I’ve made is in the shares of Polar Capital  (LSE ticker POLR) a small(some might say ‘boutique’) fund management company. I can’t deny that the current yield of over 8% was a major attraction.
However the shares may be a longer-term recovery prospect with a clear potential catalyst for re-rating emerging in early 2017.

One of several frustrations of 2016 was the sudden departure of George Godber and Georgina Hamilton from Miton, and thus from managing their successful Miton UK Value Opportunities Fund, in which I’d invested with some success.

It quickly became apparent that they were headed for Polar Capital, although both had to serve long notice periods of 12 and 6 months respectively.

The recent interim results from their new employer confirmed that Georgina Hamilton will be running the new Polar Capital UK Value Fund due to launch in January with Godber joining in April.

It might seem rather speculative to base an investment case on two relatively young fund managers operating in a new institutional context. Yet not only is the macro-investment climate arguably more favourable to their style of value investing today than when they launched their Miton fund, there is more to Polar Capital than this new fund.

The steady decline in the Polar Capital share price from a peak of over £5.50 in early 2014 to just under £3.00 today mirrors a decline in assets under management, some of which stems from the relatively poor performance of a Japan fund, and related outflows, as well as “difficult industry conditions” in the first half of 2016 as the active fund management industry as a whole suffered outflows.

Yet according to the December 2016 results a number of the company’s funds, Biotechnology, Healthcare and the long/short UK Absolute strategy experienced inflows in more recent months.

Most of the Polar Capital funds are in the first or second quartile of their respective sectors since inception, and their Technology investment trust recently reported strong benchmark-topping results.

Admittedly the stated intention to hold the full year dividend for the current year at 25p (implying a 19.5p final dividend) may outstrip cashflow and the 2018 dividend could well come under pressure.

The interim results presentation describes the 2018 dividend as “expected to be defended, even uncovered" subject to: Evidence of return to growth and imminent EPS coverage anticipated; a strong balance sheet (although ‘strong’ is not defined) and there being no compelling alternative use of cash.
Reading between the lines potential investors should steel themselves for a dividend cut. But even if the 2018 full year dividend became 15p, this would be a yield on current share price of 5%.

Both profits and earnings per share in the half-year to September 2016 were down by around 20%, but the chief executive ended the interim results on an optimistic note: “Overall we have become somewhat more positive on the outlook for our business over the second half of the financial year.” In addition, although not at the forefront of my thinking, it’s easy to think of a number of larger fund management firms who are weak in the specialist niches (biotech, health, technology) where Polar Capital seem strong, making Polar Capital a possible takeover target.

So there is more to this investment than depending on the success of two ‘value’ fund managers to increase the underlying value of the company.

As ever, the following disclaimer applies: the above is an attempt to explain my investment strategy, not to be taken as advice suitable for anyone reading this site.

From Biotech to...erm...Biotech

The closer I get to leaving full-time work the more yield-hungry I become.

Yet like many investors I've learnt the hard way that eschewing 'growth' investments in favour of high current yield can impair the real terms rise in portfolio value which is a necessary condition of long-term prosperity (one day I will document here some of my ill-fated flirtations with high yield shares).

I've also suffered in relative terms in recent years from having very little exposure to technology companies among my fund and equity holdings.

Given that the Office for National Statistics life expectancy calculator estimates I will live for another 37 years I'm starting to ponder the wisdom of jettisoning all my zero-dividend paying 'growth' funds for income-generating vehicles.

In 2013 I invested in the much-vaunted biotech sector with a small 'punt' - and it was only ever a speculative adventure - in the Biotech Growth Trust (BIOG). Over the next three years the share price bounced from my entry point of 378p to nearly 900p in 2015, then to below 600p, before settling near 700p in September 2016.

Amidst concerns over a possible Clinton presidency clamping down on pharmaceutical pricing, in September 2016 BIOG's rival investment trust, International Biotechnology Trust (IBT) announced the introduction of a 4% dividend starting in early 2017, paid out of capital, and calculated on the trust's Net Asset Value of the previous August 31st.

Comparing the recent capital performance of the two trusts, if anything IBT has the edge over BIOG (e.g. over 3 years to 2nd December 2016 share price growth was 88% for IBT versus 65% for BIOG).

Some familiar biotech companies are common to each trust: e.g. Celgene, Biogen. The differences lie in BIOG's more concentrated, large-cap focus, with IBT having 14% in unquoted companies, against just 1.2% in unquoted for BIOG.

I recently switched my BIOG holding for IBT and look forward to receiving the first dividend in early 2017.

Of course paying a 4% dividend from capital may impair capital growth, but the opportunity to retain exposure to the biotechnology sector whilst earning a relatively attractive yield is too good to overlook.