Posted on | January 4, 2012 | 3 Comments
As you may be aware, I am not the only investment or financial blogger on the web! The web has provided such a great resource for everyone interested in investing; the collaboration is incredible. The Financial Blogger has a yearly contest in which other bloggers develop portfolios of four stocks that they think will outperform the market in that calendar year. Last year’s winner was Dividend Growth Investor (DGI), who has an awesome 15.36% return. Dividend Growth Investor’s performance highlights the power of strong, international, dividend-paying companies. DGI kept the same four stocks for the 2012 contest—what conviction! I believe this also shows that stocks of companies that increase their dividends are truly an investment (as opposed to a trade).
Since I do not want to promote individual stocks on this blog, I am going to propose a diversified portfolio of four ETFs in my contest entry. This contest has simple rules; they are as follows:
- Four stocks picked at the beginning of the year
- No trading allowed (buy and hold)
- Canadian or USA stocks
- Dividends count in end-of-year yield calculation
1. I am big fan of dividend-paying stocks. They provide income (and “free” shares if the dividends are reinvested, lowering your cost per share) and can have a “floor” to their prices. If the price drops too much (for example, because of bad news from Europe), the yield increases. As the yield increases, the stock becomes more and more attractive to buyers. The financial sector is still too risky for me, especially when it comes to dividends. Some banks are reinstating dividends and some are actually increasing their dividends, but it just takes one act of Congress (during an election year) or a new regulation to reverse the positive dividend trend.
ETF: WisdomTree Dividend ex-Financials Fund
WisdomTree Dividend ex-Financials index measures the performance of high dividend-yielding stocks outside the financial sector. The index consists primarily of large- and mid-capitalization companies listed on major U.S. stock exchanges that pass WisdomTree Investments market capitalization, liquidity and selection requirements.
2. Next it is time for some diversification. Typically, different sectors or asset classes act independently of each other (this is referred to as correlation, or lack thereof). Last year, everything was correlated. All sectors and/or asset classes would go up or down together. I hope some of the correlation goes away this year. Typically, real estate investment trusts (REITs) have a low correlation to stocks. I like their income, and as the economy slowly improves, the sector should improve.
ETF: Vanguard REIT Index Fund ETF Shares
The fund employs a passive management or indexing investment approach designed to track the performance of the MSCI US REIT Index. The MSCI US REIT Index, a free float-adjusted market capitalization index, consists of equity REITs that are included in the MSCI US Investable Market 2500 Index, except for specialty equity REITs that do not generate a majority of their revenue and income from real estate rental and leasing operations.
3. As mentioned previously, I am a little cautious of the financial sector. There is one niche sector that I do like, even though it is a little more risky: business development companies (BDCs). BDCs are typically closed-end management investment companies that make long-term private investments. For tax purposes, they are commonly structured as regulated investment companies (RICs), which means that the companies have to pay much of their taxable income out to shareholders as dividends. These companies focus on making business loans to lower- and middle-market companies. They provide long-term debt as well as equity capital. Most BDCs will also offer managerial expertise to assist the companies they invest in, as needed. I like BDCs because they are filling in the void left by regional banks, which, since the financial crisis, have stopped or limitied thier lending to small and midsized companies.
ETF: ETRACS Linked to the Wells Fargo Business Development Company Index
The ETRACS Linked to the Wells Fargo Business Development Company Index due April 26, 2041 is designed to track an investment in the Wells Fargo Business Development Company Index (“Index”), and may pay a variable quarterly coupon linked to the cash distributions associated with the underlying BDC constituents, less investor fee. The Wells Fargo Business Development Company Index is a float adjusted, capitalization-weighted Index that is intended to measure the performance of all Business Development Companies (“BDC”) that are listed on the New York Stock Exchange (“NYSE AMEX”) or NASDAQ and satisfy specified market capitalization and other eligibility requirements. To qualify as a BDC, the company must be registered with the Securities and Exchange Commission (“SEC”) and have elected to be regulated as a BDC under the Investment Company Act of 1940 (“1940 Act”).
4. Finally, my fourth pick. As mentioned in my previous post, inflation can be a killer. I would like some inflation protection. Typically, dividend-paying stocks can keep up with inflation over time. A short-term spike in inflation can dampen profits in the short term, though. I am guessing the inflation we will see over the next year will be either food or energy related. One way to invest would be through Treasury Inflation-Protected Securities (TIPS), which are special bonds from the U.S. government. The TIP ETF from iShares currently has a nice yield around 4%. There is one other risk I would like to hedge against over the next year, and that is geopolitical tensions. Any issues in the Middle East could upset energy prices and drive down stock prices; I would like a hedge against that. I decided to go with a commodity ETF that follows the energy sector. I hope to get some inflation protection and a hedge against geopolitical tensions.
ETF: PowerShares DB Energy Fund
The PowerShares DB Energy Fund (Fund) is based on the DBIQ Optimum Yield Energy Index Excess Return™ (Index) and is managed by DB Commodity Services LLC. The Index is a rules-based index composed of futures contracts on some of the most heavily traded energy commodities in the world: Light Sweet Crude Oil (WTI); Heating Oil; Brent Crude Oil; RBOB Gasoline; and Natural Gas. The Index is intended to reflect the performance of the energy sector.
Here is a final summary of my ETF portfolio for 2012:
|DTN||WisdomTree Dividend ex-Financials||0.38%||~4.0%|
|VNQ||Vanguard REIT Index||0.12%||~4.4%|
|BDCS||ETRACS Business Development Company Index||0.86%||~7.5%
|DBE||PowerShares DB Energy||0.80%||0%(ouch)|
I will provide quarterly updates and track the dividend reinvestments. For a benchmark, I am going to use Vanguard S&P 500 Index ETF, ticker: VOO. Here are my starting positions for each ETF:
|ETF||Jan. 3, 2012 price @ open|