The Investment Scientist

Archive for October 2008

In his book “Unconventional Success: A Fundamental Approach to Personal Investing,” David Swensen prescribes for retail investors an asset allocation markedly different from his management of Yale Endowment.

  • Domestic Equity (30 percent) – Stocks in U.S.-based companies listed on U.S. exchanges.
  • Emerging Market Equity (5 percent) – Stocks from emerging markets across the globe. Brazil, Russia, India, China, etc.
  • Foreign Developed Equity (15 percent) – Stocks listed on major foreign markets in developed countries, such as the UK, Germany, France, and Japan.
  • REITs or Real Estate Investment Trusts (20 percent) – Stocks of companies that invest directly in real estate through ownership of property.
  • U.S. Treasury Notes and Bonds (15 percent) – These are fixed-interest U.S. government debt securities that mature in more than one year. Notes and bonds pay interest semi-annually. The income is only taxed at the federal level.
  • TIPs or U.S. Treasury Inflation-Protection Securities (15 percent) – These are special types of Treasury notes that offer protection from inflation, as measured by the Consumer Price Index. They pay interest every six months and the principal when the security matures.

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Warren Buffet: “Price is what you pay, value is what you get.

The value of a stock is its dividend stream. (Also see Dividends to rescue in a “Great Depression”.) So far in this bear market, the S&P 500 has tumbled close to 50%. Does that mean dividends will fall by 50% … permanently?!

During the Great Depression, the S&P 500 fell by more than 80%, and yet the discounted value of the subsequent dividend stream barely declined (See Chart). In fact, the detrended value of the S&P 500 dividend stream was fairly stable throughout history while the index itself gyrated wildly. This led Yale Professor Robert Shiller to conclude:

Stock prices move too much to be justified by subsequent changes in dividends.

Chart: Price volatility compared to “value” volatility, from Robert Shiller’s 1981 paper “Do stock prices move too much to be justified by subsequent changes in dividends?”

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This is the complete list of US dividend oriented ETFs.

Symbol Asset (mm) Expense Yield* Name
DVY 4782 0.40% 4.67% iShares DJ Select Dividend
VIG 402 0.28% 2.20% Dividend Achievers Select
PFF 308 0.48% 11.21% iShares S&P US Preferred Stock
DLN 288 0.28% 3.61% WisdomTree LargeCap Dividend
SDY 230 0.35% 4.40% SPDR S&P High Yield Dividend Aristocrats
DTN 145 0.38% 4.82% WisdomTree Dividend 100
PEY 139 0.60% 5.69% Mergent Dividend Achievers 50
FVD 137 0.70% 3.20% First Trust Value Line Dividend
VYM 120 0.25% 3.72% FTSE High Dividend Yield
DHS 120 0.38% 5.50% WisdomTree High-Yielding Equity
DES 80 0.38% 4.73% WisdomTree SmallCap Dividend
DTD 80 0.28% 3.71% WisdomTree Dividend
DON 78 0.38% 4.31% WisdomTree MidCap Dividend
PFM 53 0.60% 2.72% PowerShares Dividend Achievers
CVY 50 0.60% 7.61% Claymore Yield Hog
FDL 45 0.45% 5.52% First Trust Morning Star Dividend
PHJ 23 0.61% 2.70% PowerShares High Grow Rate Dividend Achievers
LVL 7 0.60% 11.21% Claymore High Income

* Yield information is according to Yahoo Finance as on 9/30/08.

The high-dividend-yield ETFs could come to the rescue of your retirement if we have a prolonged recession.

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Yale Endowment, as an institution investor, has to disclose to SEC its public equity holdings every quarter. This allows us to get a glimpse of David Swensen’s direct stock investments. Since Yale Endowment does not have to disclose its private equity investments and its allocations to money managers, this is not the complete picture of its asset allocation.

The author is president of MZ Capital, a RIA serving DC/MD/VA. Get his monthly newsletter in your mailbox or get to the directory of his past articles.

Table: David Swensen’s stock portfolio

Ticker % weight of portfolio Name
OEF 1.24% iShares S&P 100 Index
INFN 0.12% Infinera Corp
EFA 13.82% iShares MSCI EAFE Index
EEM 37.42% iShares MSCI Emerging Market Index
AKR 7.12% Acadia Realty Trust
XTXI 1.39% Crosstex Energy Inc.
WWW 0.07% Wolverine World Wide
CELG 0.05% Celgene Corp
DEI 29.47% Douglous Emmett Inc.
CXO 8.39% Concho Resources Inc
SPY 0.9% SPDR S&P 500 Index

“This sucker could go down!”

That was what President Bush said during the recent $700 billion bailout plan meeting with congressional leaders at the White House. The market has gone down another 20% and talk of another Great Depression has filled the airwaves ever since.

If you are a listener of Jim Cramer, you would have heard his advice: Sell, sell, sell! He constantly reminds his listeners how the Dow went down 83% during the Great Depression; and never fully recovered until 1954.

Cramer forgot to account for dividends. If dividends from the Dow stocks were reinvested, then investors would have been able to recoup all losses by 1945. That’s a full nine years sooner! Think about this: what if investors held only high-dividend stocks? Would they have recovered their investments even sooner?

To find out, I examined the following four portfolios’ performance from 1929 onwards:

  1. Portfolio A: stocks with zero dividends.
  2. Portfolio B: stocks with bottom 30% dividend yields.
  3. Portfolio C: stocks with middle 40% dividend yields.
  4. Portfolio D: stocks with top 30% dividend yields.

All four portfolios peaked in August, 1929. With the exception of portfolio B, all portfolios bottomed in May, 1933. Portfolio B bottomed in June, 1933. For each of the four portfolios, the total peak-to-trough decline (drawdown) and the number months it took to recover are presented here:

Buy at the top and hold during Great Depression
Drawdown 89% 86% 85.4% 84%
Months to recover 132 154 144 44

Data source: Kenneth French Data Library

It is probably not surprising that the highest dividend-yielding portfolio D fell a little less than other portfolios. It’s striking that portfolio D recouped all losses in just three-and-a-half years – eight to nine years before other portfolios.

Why did high dividend-yield stocks performed so well?

During the Great Depression, stock prices on average fell more than 80%. Dividends fell only about 11%. (See Chart below) As Yale University professor Robert Shiller has found, historically dividend volatility was about 15% of price volatility (meaning dividend declines were a fraction of price declines in recessions.) Stable dividend payments quickly made up for losses in price.

If the price gyration makes you dizzy, focus on dividends instead. They don’t gyrate and ultimately, they will sustain your retirement.

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Since President Bush declared that if the Congress does not give Secretary Paulson the $700 billion blank check, “the sucker could go down!” the talks of another Great Depression have filled the air waves.

So how much today resembles the Great Depression that lasted from 1929 to 1933?

It doesn’t take a lot to bring together data from various government sources to present a comparison in the table below.

Table: Comparison of the Great Depression and today

Factor Great Depression Today
GDP growth -27% +1%
Unemployment rate 25% 6%
US exports -66% +15%
Inflation -27% +4%
Stock market -83% -43%

Data source:

Granted, the situation today could get a lot worse before getting better, it simply does not resemble the Great Depression. However, the stock market already have priced in half the chance of that.

Did President Bush and Secretary Paulson scare us so much, we not only handed over the $700 billion blank check, but we pee our pants as well?

Today, the VIX index reached all-time high of 56 and closed at 52. To give a measure of how fearful investors are, in 9/11/01 during the terrorist attach the index only reached a lowly 39.

In days like this, it helps to remember Warren Buffet’s mantra: “Be greedy when others are fearful!”

In a recent ABC news piece, Dr. David Swensen, manager of $34 billion Yale Endowment had this to say about Jim Cramer:

On ‘Mad Money,’ Cramer promotes a mindless short-term approach to markets by encouraging frenetic trading of individual stocks. Such a high-cost, tax-inefficient strategy almost guarantees failure.

In the same article, my view on Jim Cramer was also mentioned:

Zhuang is no fan of Cramer. Like Swensen and Ehrenberg, he argues against frequent trades and says Cramer may be influencing investors to overreact to financial news.

(For Swensen’s stellar track record, click here.)

8/11/08 Mad Money:

I called the bottom in the financial stocks on July 15. Since that call, many of the banking stocks are up, and up big. Wachovia Bank was $8.90; now $18.60 a share. WaMu was $3; now $4.08 a share. Incredibly AIG was $20; now $24 a share. Even the troubled Fannie Mae is up from a low of $6.90 a share to $8.30 a share today.

9/5/08 Lightning Round:

I like (Wachovia) CEO Bob Steele, so this stock is a buy.

9/10/08 Lightning Round:

Consider buying Wachovia on any weakness.

9/18 Mad Money:

Investment banks, like Goldman Sachs just cannot be owned …The time has come to put the investment banks, like Goldman, on the back burner, and instead focus on the deposit banks, such as Wells Fargo, US Bancorp, Bank of America, Wachovia and JPMorgan Chase.

9/25 Mad Money:

Wachovia will also benefit from the bailout. With CEO Bob Steel’s previous government experience, he will be able to take advantage of the plan by splitting Wachovia into good and bad components and sell off the bad parts quickly to the government.

9/29/08 Mad Money:

Wachovia was toast.

Note: Jim Cramer is a vivid example of investing by a hunch, a gut feeling and hearsay. The opposite is Harvard and Yale style of investing, which is rigorous and disciplined.


Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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