Home WBI Intelligence BALANCE RISK AND RETURN- “FOLLOW THE MONEY”

BALANCE RISK AND RETURN- “FOLLOW THE MONEY”

by Don Schreiber, Jr.

By Don Schreiber, Jr. – WBI Founder and CEO

Risk and return go hand-in-hand when it comes to investing, it’s important to balance both risk and return when making investment decisions. It seems everyone wants to know what comes next for the equity markets. Will the almost 11-year bull market run come to an end? Or will the bull continue its historic run? If it corrects, what will be the cause, and will the correction be small or large? If I knew the answer to these questions with certainty, I would have a world-class crystal ball or maybe be able to walk on water. I assure you I don’t. However, I have been an avid student of market cycle history for the past four decades. Currently, it seems pretty clear there is no magic wand to improve economic and corporate trends enough to justify what I believe to be today’s massively overvalued markets.

Signs of the Next Market Trend

The Federal Reserve’s attempt to normalize post-Financial Crisis interest rates in 2017 and 2018 reduced an already anemic GDP growth rate, pushing the economy toward recession. This caused investors to have a rate normalization “temper tantrum,” which moved popular indexes down 20% or more in the fourth quarter of 2018. The Fed quickly reversed course in 2019 to stabilize the economy and markets. With a refreshed “Fed Put,” investors cheered the attempt to keep the asset bubble and consumer spending intact, and the S&P 500 Index inked a 30% return for the year. We believe price trend is one of the few clear indicators that are reliable in telegraphing the markets’ next move. Based on year-to-date trends, it looks like equity markets will continue to move higher until some unknown exogenous event causes investors to reassess the current risk/return balance.

A venerable Wall Street adage is to “follow the money” because significant capital flows into a segment of the market typically causes outperformance. We look for a reversion in price trend followed by a revision in market psychology. For the past ten years, the growth, momentum, and tech trades have ruled supreme, providing stunning returns. When bull markets turn bearish, institutional investors who have to maintain equity exposure have historically turned to defensive and deep-value oriented, high-yielding dividend stocks. This is one of the reasons why value stocks have historically outperformed growth stocks by a large margin. But that has not been true in the elongated bull market run off the March 2009 bottom. I find it interesting and compelling that this has been the only ten-year period in history where growth stocks have outperformed value. Because of that, I’d bet the pendulum is going to swing firmly in favor of value and dividend stocks in the next major correction. Many investors have a fear of missing out on the growth trade if it continues to run. However, we think there is an increasing probability that a reversion to value and high-yield dividend stocks may be closer than investors believe.

Case Study: Solactive Power Factor High Dividend Index*

With that in mind, let’s take a look at the Solactive Power Factor High Dividend Index (SOLWBIYT) to see what the risk and return trade-offs are relative to the growth-centric S&P 500 Index. Over the past ten years, the S&P 500’s top capitalization-weighted stocks, commonly referred to as “FAANG” stocks, have been responsible for driving a large percentage of the index’s return. The SOLWBIYT Index uses a multi-factor, smart beta approach to provide investors with consistent exposure to the “Top 50” U.S. domestic, high-yielding stocks as ranked by WBI’s advanced, quantitative Power Factor® process. In an effort to provide higher returns with lower volatility, the Index employs a quarterly rebalancing and reconstitution process. High-yielding, dividend-paying stocks tend to exhibit a deep value bias, demonstrate lower volatility, and provide faster recoveries from market declines.

The potential benefits of “following the money” on a reversion trade from growth, momentum, and tech stocks to high-yielding, dividend-paying, value stocks are relatively easy to see over the past 20 years in the statistical analysis of SOLWBIYT vs. the S&P 500 below. Lower volatility and risk is an attractive characteristic if you don’t have to give up too much return to pay for it. The Worst Quarter (-14.44 vs. -21.94), Max Drawdown (-25.69 vs. -45.80), Down Market Capture Ratio (30.00 vs. 100.00), and Beta (0.71 vs. 1.00) all providing what we feel is strong confirmation of material risk reduction through two of the worst bear markets in modern times. We believe the most powerful aspect of providing risk reduction is helping clients stay comfortably invested during large bear market events. Studies show that most clients fail to buy and hold when exposed to full down market volatility and loss.

balance risk and return
Source: Morningstar, Total, Quarterly Return 2020.

The Solactive Power Factor High Dividend Index launched on 06-Dec-2016. All information, including index levels, provided for any date or time period prior to the launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. *Please see important additional disclosure at the end of this piece relating to the Solactive index calculation and construction.

Equally as important as risk reduction is return capture because most investors are hyper-focused on either beating or keeping up with passive index returns. That means any strategy employed must compete favorably with the S&P 500 Index. The statistical analysis in the chart above shows how the Solactive Power Factor High Dividend Index compares favorably on the key return metrics of Best Quarter (24.33 vs. 15.93), Up Capture Ratio (109.18 vs. 100.00), Alpha 10.60 vs. 0.00, and last but not least, Average Annualized Rate of Return (15.27 vs. 6.06).

For investors, the rubber really meets the road in bear market declines. High-yielding dividend-paying stocks have historically softened the blow to capital that bear markets can cause investors. If we take a look at the risk events that have occurred over the past 20 years (2008 Financial Crisis and 2000-2002 Dot.Com) in the table below, it becomes easy to recognize the potential dividend advantage during market declines as capital flows favor the more defensive nature of dividend stocks with high yields.

balance risk and return
Source: Morningstar, Total Return, 2020

The Solactive Power Factor High Dividend Index launched on 06-Dec-2016. All information, including index levels, provided for any date or time period prior to the launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. *Please see important additional disclosure at the end of this piece relating to the Solactive index calculation and construction.

We feel one of the most powerful statistics in favor of positioning now for a reversion trade is how quickly a high-yielding dividend approach can recover from Max Drawdown period market events. The Max Drawdown Recovery Period statistic measures the number of months it takes for an investment to recover from a peak to trough decline. The SOLWBIYT Max Drawdown Recovery Period is two quarters, which compares very favorably to the 12 quarters it took for the S&P 500 to recover from the Financial Crisis market cycle. 

Why Dividends?

Dividend-paying stocks tend to have a short-term volatility profile similar to other stocks in the first stage of a bear market decline but tend to recover quickly as institutional and individual investors seek a more defensive value-oriented investment posture. They are attracted to the steady stream of dividends that provide a source of return that is independent of the return provided by price appreciation. 

To be successful, we believe investors have to put up with some short-term volatility pain, six months historically, with dividend stocks for above-average long term gain. The increasing trend of sustaining income from dividends has been more than enough to help investors stick to their investment plan. It’s time clients stay comfortably invested during large bear market events. We can’t tell for certain what will come next for equity markets, but we believe it’s time to “follow the money” by following dividend-paying stocks. Are you focused on keeping up with index returns? The goal of many investors is to beat the return of the S&P 500. Chasing returns doesn’t always get you very far, this is why risk reduction is key. 

IMPORTANT INFORMATION

This presentation contains backtested hypothetical returns for the Solactive Power Factor High Dividend Index, which do not represent actual results, and are provided for illustrative purposes.

*The Solactive Power Factor High Dividend Index launched on December 6, 2016. All information, including index levels, provided for any date or time period prior to the launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same or fundamentally the same methodology that was in effect when the index was launched. A back-test calculation means that no actual investment which allowed a tracking of the performance of the Index was possible at any time during the period of the back-test calculation and that as a result any comparison is purely hypothetical. The methodology and the model used for the calculation and back-test calculation of the Index were developed with the advantage of hindsight. In reality, it is not possible to invest with the advantage of hindsight and therefore this performance comparison is purely theoretical. Solactive Power Factor High Dividend Index (SOLWBIYT) is constructed by scoring each ordinary dividend paying, common stock constituent from the 3,000 largest U.S. companies both directly and relative to industry peers using the three Power Factors and ranking those securities in descending order according to their dividend indicated yield. The 50 companies with the largest dividend indicated yield are chosen as Index components. Performance is not indicative of the skill of the advisor. Investors may experience loss. For more information, please visit https://www.solactive.com/indices/?index=DE000SLA2T42.

Solactive has performed the calculations included and adviser does not represent that the hypothetical returns would be similar to actual performance had the adviser managed the index or accounts.

Past performance does not guarantee future results. Indices are unmanaged and may not be invested in directly.

The views presented are those of Don Schreiber, and should not be construed as investment advice. Don Schreiber, or clients of WBI may own stock discussed in this article. All economic and performance information is historical and not indicative of future results. This is not an offer to buy or sell any security. No security or strategy, including those referred to directly or indirectly in this document, is suitable for all accounts or profitable all of the time and there is always the possibility of loss. Moreover, you should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice from WBI or from any other investment professional. To the extent that you have any questions regarding the applicability of any specific issue discussed to your individual situation, please consult with WBI or the professional advisor of your choosing. This information is compiled from sources believed to be reliable, accuracy cannot be guaranteed. Information pertaining to WBI’s advisory operations, services, and fees is set forth in WBI’s disclosure statement in Part 2A of Form ADV, a copy of which is available upon request. 

Although a company may pay a dividend, prices of equity securities – including those that pay dividends – fluctuate. Investing on the basis of dividends alone may cause an investor to buy or sell certain securities when circumstances may or may not be favorable.

Alpha: measure of risk-adjusted excess return. Positive Alpha indicates the portfolio has performed better than its level of risk (measured by Beta) would predict. Beta: measure of volatility relative to an index; Beta above 1 is more volatile than the index; Beta less than 1 is less volatile. Up and Down Capture Ratios: used to evaluate how well a manager performed relative to an index during periods when the index is up or down. Maximum Drawdown: measures peak-to-trough loss of an investment, indicating capital preservation. Standard Deviation: measure of volatility; greater STD indicates a more volatile strategy or index during a given time period. S&P 500 TR Index: includes a representative sample of large-cap U.S. companies in leading industries where all cash payouts (dividends) are reinvested automatically. Solactive Power Factor High Dividend Index (SOLWBIYT) is constructed by scoring each ordinary dividend paying, common stock constituent from the 3,000 largest U.S. companies both directly and relative to industry peers using the three Power Factors and ranking those securities in descending order according to their dividend indicated yield. The 50 companies with the largest dividend indicated yield are chosen as Index components.

You are not permitted to publish, transmit, or otherwise reproduce this information, in whole or in part, in any format to any third party without the express written consent of WBI Investments, Inc.

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