In my last post, I discussed about how I dealt with my existing position in some of the dividend cutters. I received a question that “can your post be interpreted as a recommendation to buy BAC and WFC because they are cheap”, and “what about GE, doesn’t it have wide moat, you ignored GE and did not mention anything about it”.
To begin with, this blog is not about recommending any stock or advising what do with individual’s investment. I have mentioned this in my disclaimer. This blog is a chronicle of my quest to build an income portfolio. I do not recommended or advise buying any stock on this blog. The premise of the post was how I dealt with the dividend cutters in my portfolio. It was about risk management process for my own dividend growth portfolio. It demonstrates my thought process with reference to my principle of objective based investing approach. I added to my original position based on my personal risk profile. I did not initiate a new position. continue reading rest of the article….
The continued challenges and slow down in various sectors of the economy is putting stress on dividends paid by many corporations. During year 2008 and so far in 2009, investors have had to experience dividend reductions and/or dividend cuts, thereby affecting their continued dividend income. My dividend portfolio was also affected by dividend elimination/reductions by C, BAC, and PFE. In order to minimize the risk of dividend reduction/elimination from each stock, I have been using the pre-determined maximum limit of 5% of total dividends. This method does not provide a means to measure the changes in risk-to-dividend on continued basis. Therefore, I have come up with the method that I have started using for my dividend portfolio. Here I am discussing a measure of risk-to-dividends, which can be used by individual dividend investors. continue reading rest of the article….
The expected dividend growth can be defined as the rate at which the common share dividends will grow over a period of time.
In order to determine the expected dividend growth for a given stock, one needs to look at the financial statements of the corporation. The three financial statements are income statement, cash flow statement, and balance sheet. It can surely be argued that cash flow is the only statement that is possibly real while other two statements can be engineered by financial wizards. However, I believe that looking all three together is a prudent approach. In context with dividend growth, my viewpoint about these three statements is discussed below. continue reading rest of the article….
Let me open today’s post with a question. How do we decide what is an effective asset allocation for us?
As individual investors we all know that we need to maintain a diversified asset allocation in our portfolios. We are also aware of different types of asset class and investment vehicles. Unfortunately, for most of us individual investors (note: individual investors) that’s where we hit dead end on asset allocation discussions. We really do not know how to engineer a portfolio that has optimum asset allocation for our risk profile.
Theoretically, asset allocation is a risk management methodology driven by relationship between expected return and risk. Can we use this classical approach of asset allocation to dividend investing? It can be argued that the inclusion of dividends in ‘expected return’ captures the dividends, and hence, it can be applied. My viewpoint is, these asset allocation methodologies are driven by expected return on capital. We dividend investors know that in short (3 to 5 years) to intermediate (5 to 8 years) term the dividends have a small contribution to the total return. The significant contribution of dividends starts to accelerate after 10 to 12 years. In addition, the dividend investors would find that asset allocation becomes very challenging, particular with reference to foreign (developed and emerging) asset classes.
In this context, I looked at David Swensen’s work with Yale Endowment Fund (source). This is an institutional fund, therefore, may not have a direct bearing on individual investors. I am including it in this discussion to highlight how the fund’s asset allocation is managed by using ‘expected real return’ and ‘standard deviation of the returns’. The table below shows the different asset classes with expected real return and standard deviations.
In this table, we can see that every asset class has its own expected return and its corresponding standard deviation. In general, I was quite surprised by the single digit expected real return and higher percentage of standard deviations (in 20s). The expected real return excludes inflation, but still it appears to be quite different than the generally purported value of approximately 10% (domestic equity) and 10+% (foreign equity).
The interesting point in this asset allocation methodology is the use of concept of expected return. Keeping with this methodology, as a dividend investor, I have recently started doing following:
Looking at my asset allocation from the viewpoint of risk-to-dividend (referenced in Dividend Tree Holdings)
Use of ‘expected dividend return/growth’ instead of expected return (will discuss in future posts).
How do you decide what is a good asset allocation for you?
I had initiated a started position in WisdomTree International Basic Materials Sector Fund (DBN) in middle of October 2008 at $22.13 per share. At the time of purchase, my yield on cost was 1.16%. This index-based ETF is derived from the WisdomTree’s DEFA Index. It is based on dividend-paying companies in developed markets outside US and Canada. The companies in this index are weighted based on regular cash dividends.
My primary reason for investment in this fund was exposure to international developed countries and material sector. Investing in one index-based ETF provided me exposure to two different aspects. The secondary reason was that the fund is over weighted to top 15 companies. The top 15 companies have close to 55% weight in the index fund.
Since October 2008, the funds value has declined to $16.15 per share (from $22.13). Conversely, the cash dividend paid for year 2008 increased to $1.094 per share (from $0.26 per share). My YOC is now at 4.86%. Now let us look at funds performance in context of my portfolio?
Risk analysis of DBN in my portfolio
This fund continues to meet my buying objective of exposure to international assets and materials sectors.
The fund being top heavy is a two edge sword. This fund does not provide true diversification one would expect from an ETF. On the other hand, it provides concentrated investment in top 15 dividend paying companies from developed international market. In essence, the dividend performance of the top 15 companies will drive the performance of this fund.
At least for the first year, the fund had a growing dividend. Although I do believe that this will not be case in future years. I fully expect that dividends from this fund will be erratic at best.
The fluctuation of US dollar vis-à-vis other currencies is another aspect that will affect the dividends paid by this fund.
Dividends from DBN are only 2% of my total dividends, while the capital allocation is only at 4% or less. With is small position, any dividend cuts or volatility does not have a significant effect on my total dividend portfolio.
The issue that I have with this fund is that it provides dividend only once a year. I am not happy about this characteristic of the fund. It slows down my dividend compounding machine.
My plan with DBN
I will continue to hold DBN in my dividend portfolio. It continues to meet my buying objective. Since I have small position, my expectation is it with not have significant effect on my performance. My expectation is over the next 3 to 5 years, this fund will aid in my capital appreciation. However, I will not be adding any new capital in this fund because of only one dividend per year and expected lack of consistency in dividend growth.
This fund does not fall in the dividend growth classification. It only provides international materials exposure with cash dividends still being the criteria.
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