Radio Interview Saturday

I”m going to talk about dividend investing on The Big Money Show with Steve Cordasco on Saturday morning, tomorrow, at 8:30 a.m.

The show will be on The Big Talker, WPHT, 1210 AM in Philadelphia. It will also air on WTKK FM in Boston, 96.9 FM.

Boomers Likely to Focus on Dividend Stocks

Dividend Stocks for Dummies gets some notice in Canada.

Baby boomers, those born starting in 1946, will reach the traditional retirement age of 65 in 2011. Jonathan Chevreau of the Financial Post writes that without pension plans “boomers won’t abandon their love affair with stocks, despite being jilted by two market crashes in the past decade. However, they will flock to certain types of stocks: those that pay dividends — the juicier the better.”

Why? Dividend-paying stocks offer the promise of growing their dividends at or beyond the rate of inflation.

He says, and so do I, that, such a move to dividend stocks will reap an unexpected bonus: unsought capital gains for the stocks boomers choose — merely because of a growing demand for a finite number of decent-yielding stocks.

“All of which is good timing for a useful new book on this topic: Dividend Stocks for Dummies, by American financial journalist Lawrence Carrel. The title notwithstanding, I’d say dividend investing is for smart investors, not dummies. The book is U.S.-centric but not entirely so. It contains a chapter on international investing but some chapters focusing on the major economic sectors also list some well-known Canadian names.”

Investors are advised to “spread their money across the major economic sectors. Conveniently, those sectors each get a chapter in Part III of the book: Exploring Income-Generating Industries. This is the most interesting section, with chapters devoted to each of utility stocks, energy, telecommunications, consumer goods, and financial stocks (in which he lumps in REITs).

“Each ends with a list of stocks Carrel suggests should be “considered,” complete with ticker symbol, dividend and annual yield as of the end of 2009, listed in descending order by yield. Carrel explains the ins and outs of cyclical stocks and how they behave as the economic cycle progresses, and under different interest rate scenarios.

His 13 financial stocks include four of Canada’s big banks: all but BMO. His list of 12 telecom stocks includes BCE, whose dividend is 6.3%. In addition, a half-page sidebar is devoted to Canada’s royalty trusts and income trusts. Because they’re losing their tax-free status in 2011, Carrel’s recommendation is to “pass” on royalty trusts.

But it’s the sectors NOT represented in Canada, such as consumer goods, that Canadians should focus on. He lists 26 consumer goods firms, with yields from a low of 2.5% for Hasbro to a high of 11.4% for Vector Group.

To read the full story, click here.

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New ETF to Hold Closed-End Shares

Invesco PowerShares launched the first ETF whose portfolio consists of closed-end funds last month. The PowerShares CEF Income Composite Portfolio (PCEF) tracks the S-Network Composite Closed-End Fund Index.

Like mutual funds and ETFs, closed-end funds are diversified portfolios, but they differ in the way they sell and price their shares. Mutual funds and ETFs are open-end funds because they can sell as many shares needed to satisfy investor demand. In addition, they’re priced each night at their net asset value, or NAV. However, a closed-end fund sells a limited number of shares on the stock exchange in an initial public offering. Because closed-end fund shares trade on the stock exchange, demand for the shares determines price not the NAV. Thus, most closed-end funds sell at a discount or premium to the fund’s NAV.

PCEF is a “fund of funds,” as it invests its assets in the common shares of funds included in the underlying index. The index selects constituents from a universe of 350 U.S. closed-end funds with a concentration in one of three sectors: taxable fixed income, which includes corporate bonds, government bonds and mortgage back securities; high-yield emerging market debt and bank loans, and option-income funds. Unique to close-end funds, option-income funds buy high dividend yield equities and sell options to create high current income.

The fund of funds concept is an interesting one. Essentially, the fund sponsor says there are a lot of great funds out there and we’re going to give you one-stop shopping and create a portfolio of the best so you don’t have to do the research. Since the cost of buying many closed-end funds would be huge, you get the ETF benefit of diversification within a minimal investment. But since, each closed-end fund is already a diversified portfolio, how many does one investor really need?

The key advantage to this kind of ETF is dividend yield, which can get pretty sizeable with closed-end funds.

“PowerShares wanted high maximum current yield and to be well diversified,” says Paul Mazzilli, senior advisor to S-Networks Global Indices. “Because ETFs invest in the most liquid high-yield bonds, they don’t have the highest yield, but do have significant tracking error. Since, closed-end funds can hold illiquid securities, high-yield closed-end funds will have a higher yield than high-yield ETFs.”

Dividends and yield have become hot topics as people look for some guaranteed returns in a market full of uncertainty. Yield is the rate of return you receive from the dividend. While the dollar amount of the dividend payment remains the same, yield moves daily in an inverse relationship to price. When the share price of a closed-end fund falls, the yield percentage rises. When prices rise, yield falls. Currently, the index has a composite yield of 8.66%, which is double the 10-year Treasury note.

Up to now investors have had only one choice it they wanted to track closed-end funds in an exchange-traded product. Two years ago, the Claymore CEF GS Connect ETN (GCE) launched. Unlike PCEF, which actually holds closed-end funds, GCE is an exchange-traded note, an unsecured subordinated debt instrument that promises to pay the index’s return without actually holding assets. The GCE currently yields 8.3%, but since it has not funds, it receives no dividend, so their are no payouts. The yield is merely factored into the total return of the index. With only $3 million in assets under management, it hasn’t garnered much enthusiasm.

One especially nice thing about PCEF is that dividends are paid out monthly. This ETF expects to go ex-dividend on March 15, which means you need to buy before then to get this month’s payout.

Currently, the index holds 71 closed-end funds, of which 27 invest primarily in taxable investment-grade fixed-income securities, 15 invest primarily in high-yield fixed-income securities and 29 primarily use an equity option writing (selling) strategy. The index bases its weightings on a value-based rules approach, instead of market-capitalization. Market-cap weightings give additional weight to richly valued funds and underweight the undervalued funds, which is the opposite of what an investor wants.

“During the quarterly index rebalancing, we look at the average discount of all the funds,” says Mazzilli. “The funds with a wider discount get their weighting increased, while the funds with as wider premium get their weight decreased. Like fundamental indexing, the index focuses on value, selling the expensive funds and buying the cheaper funds.”

This approach enhances the fund’s return because it’s focused on securing the highest yield over price appreciation. It addition, you avoid capital gains inside the fund because closed-end funds and ETF’s have more tax efficient structures than mutual funds.

However, there are some serious negatives here. High yields are not just a function of shares being discounted, but typically signify a higher level of risk in the underlying securities, especially high-yield emerging market debt. The multiple layers of diversification within the closed-end funds and the ETF itself should lower that risk. However, closed-end funds have the transparency requirements of mutual funds. They only need to tell you what they own every six months. So, you never really know the level of risk of each fund’s holdings.

Then there’s the cost. While PCEF charges an expense ratio of 0.5%, a reasonable rate, each closed-end fund in the ETF also charges an expense ratio which will be paid out of the underlying funds. And while the ETF won’t hold any funds with an expense ratio higher than 2%, this duplicate level of fees significantly increases the cost of the investment and it’s not specified by how much, but it looks like 1.8%.

Dave Nadig of IndexUniverse calls it “the worst of all possible worlds – zero transparency, high costs, and unreliable pricing.” I’m not sure I would go that far, but I am concerned by the fact that PowerShares hasn’t posted a factsheet yet on the fund.

In the comments section, Mazzilli debates Nadig over the funds transparency, pointing to the white paper detailing the fund’s workings. In addition, on the S-Network Web site you can find the constituent list for the index as of Dec. 31, 2009, which would have been the holdings when the fund launched. You can also find the fund holdings on the PowerShares Web site. You could make the effort to find out what the closed-end funds hold, but that’s a layer of research the ETF tries to help you avoid.

Personally, I like the idea of a high-yielding investment that pays monthly. But I’ve always been bothered by the duplicate level of fees found in every fund of funds product and how it will take a significant bite out of that dividend payment. The big benefit seems to be the ability to invest in closed-end funds with a much lower level of risk than you would have when you put a lot of money in a single fund.

Second Book Put to Bed

Whew!! Okay, I’m back on the ETF beat.

I feel like I’ve just run two marathons with very little sleep in between. I just finished the final edits and put my second book to bed. Dividend Stocks for Dummies will hit the bookstores in April. I expect I will be taking a closer look at dividend focused ETFs now.

 But in the meantime, check out my first book and the inspiration for this blog, ETFs for the Long Run.

WisdomTree Now Offers Growth

Nice ticker symbol.

WisdomTree on Thursday launched the LargeCap Growth Fund (ROI) on the NYSE Arca. ROI is usually the symbol for “return on investment.” Nice score on WisdomTree’s part.

The new ETF is designed to track the WisdomTree LargeCap Growth Index. This fundamentally-weighted index measures the performance of approximately 300 domestic large-cap growth companies. Each company’s weighting is set annually and based on the earnings generated during the prior four fiscal quarters. The ETF has an expense ratio of 0.38%.

WisdomTree, the market leader in fundamentally-weighted indexes, is best known for its family of ETFs based on dividends-weighted indexes. This isn’t the firm’s first earnings-based ETF, it launched a few others earlier in the year. But it is a radical departure for WisdomTree. It’s the first growth-oriented fund in this value-oriented firm. Not only is this WisdomTree’s first fund focused on growth stocks, but it’s the first growth-oriented ETF among all the Fundamentalists, those fund families with indexes based on fundamental metrics.

One big disadvantage of dividend-based ETFs is that they ignore strong companies that refuse to pay out dividends, such as technology companies. Earnings-based indexes, and especially growth funds, have the potential to expand WisdomTree’s customer base by offering an ETF with some of the fastest growing companies in the world, such as Google.

Jeremy Siegel, famed professor of the Wharton Business School and a senior advisor to WisdomTree, said in a written statement, “I devoted the first chapter of my book, The Future for Investors, to what I call the ‘Growth Trap,’ the long-standing problem of investors paying too much for the future prospects of growth companies.”

One assumes the new ETF digs itself out of the “Growth Trap”, but WisdomTree didn’t elaborate. The company did say, “growth’s historic underperformance may have more to do with how the major growth indexes are constructed, than with growth stocks themselves.”