Weekend Reads

One quick follow-up to my CEF article from earlier this week – you can run NAV and momentum screens at CEF Connect for free. Investment News also published an article on recent value opportunities in the CEF space.

Claim You’re MarketClub Trial – It’s Already Been Paid For!

Single Best New Site For Investors – Mebane Faber

Under the Hood: Wisdom Tree’s Managed Futures ETF – Attain Capital

From Alpha Architect: Backtesting 13 AAII Value Strategies: What Wins? Plus, Smart Beta is More Expensive Than You Think. and Digging into the Enterprise Multiple Factor.

Valueshares also announced the launch of the ValueShares U.S. Quantitative Value ETF (QVAL), which is advised by Alpha Architect. The strategy is detailed in Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (Wiley Finance)

From ETF.com – Swedroe: Are You Prepared To Face A Bear? and Valuations And Asset Allocation

Facts (and Minds) are Stubborn Things – Above the Market

A Value and Momentum Strategy for Closed-End Funds

Closed-end funds (CEFs) are an often overlooked corner of the market. They are publicly traded investment companies which raise a fixed amount of capital via an IPO by issuing a fixed number of shares. They are actively managed, often employ leverage, and typically represent a specific segment of the securities market.  They trade throughout the day on exchanges, just like a stock or ETF, with their share price determined by market demand. However, a key component of CEFs is that they issue a fixed number of shares which represent an interest in the underlying securities of the CEF, which means the CEF not only has a share price but also a Net-Asset-Value (NAV). The value of the underlying securities held by the CEF determines its NAV, while the daily trading prices of a CEF are determined by the market – buyers and sellers of stock in the CEF.  Thus, it is possible for a CEF to trade at a discount or premium to its NAV.

The CEF universe is often inefficient and investors can exploit these inefficiencies by purchasing CEFs trading at discounts to their NAV.  I consider this a potential “value” play – by purchasing a CEF at a discount to its NAV we are essentially purchasing the underlying securities held by the CEF at a discount to their price.

I am not concerned with “why” CEFs may trade at a discount or premium. If there is a dollar laying on the street, I am going to pick it up rather than worry about why nobody else has already done the same.  I want to know if the discount can be systematically exploited over time.

Using Portfolio123 I first created a ranking system which ranked CEFs based on their discount or premium to NAV (a value-only strategy). CEFs with the highest discount to NAV received the highest ranking. The test below sorted CEFs into 20 buckets and as you can see the bucket with the highest discount to NAV produced the highest average annual returns with a fairly consistent decrease in annual returns as the discount to NAV decreased:

Note: All of the subsequent tests were run from 1/2/99 – 10/22/14.



Next, we employ a momentum overlay to the strategy.  Regular readers of my site, Scott’s Investments, know I am a proponent of momentum and trend following strategies. I created a rank system which ranked CEFs based on both their discount to NAV and their 6 month total return, giving us a value and momentum system. CEFs with a high discount to NAV and high 6 month total returns (share price returns, not NAV returns) received the highest rank:

CEF Value and Momentum

We see similar results as the value-only strategy but with even higher returns in the top ranked buckets.

How do these strategies perform real-time, with real securities and turnover? Below is a backtest of the value and momentum system. The first test held 20 CEFs and they were required to have 20-day average share volume of 5000 shares or greater and a closing price greater than $2.  It also assumed 0.5% slippage to account for bid/ask spreads and made transactions at the next day’s closing price to help give a realistic execution of a live strategy. The strategy ranked CEFs every 4 weeks, and those no longer rated in the top 20% were sold and replaced with the highest rated CEF. I chose the 20% threshold to help reduce turnover, thereby limiting expenses. The results:




The next test used the same parameters as above with one addition. CEFs were required to have positive 6 month total returns. CEFs were sold when their 6 month total returns dropped below 0%.  This filter helped during 2008 to reduce portfolio drawdowns:




I have two CEF portfolios currently available on Portfolio123 (search “CEF Value Momentum ” and “CEF Value Momentum 20 “, which will be available in 14 days). They use similar parameters to the ones presented here.

A word of caution on the data presented here. Fifteen years feels like a really long time, but does not give us robust results when backtesting strategies. Secondly, data-snooping is always a concern. Changing parameters of the system impact results and the more complex a system the more susceptible it is to data-snooping. Thus, I tried to keep the systems presented here simple. Finally, taxes and other trading costs will impact results.

Book Review: Dual Momentum Investing, An Innovative Strategy for Higher Returns with Lower Risk

I was fortunate to obtain an advance copy of Gary Antonacci’s Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk, which is set to release in hardcover at the end of October.  I frequently cite Antonacci’s momentum research and his Optimal Momentum website on Scott’s Investments so I was excited to dive into the book.

The book begins with a brief history of modern finance. To summarize modern finance in a few pages is a daunting task, but overall the book does a good job of providing historical context for the development of momentum investing. The efficient market hypothesis (EMH) is taken to task by Antonacci, laying the groundwork for Chapter 2 which explores the the history and evolution of momentum investing. It may surprise some readers that momentum investing is not a new phenomenon, and Antonacci provides several historical examples of successful momentum investors, one of the most famous being Jesse Livermore.

We are warned at the start of Chapter 3 “This and the next chapter are a bit wonkish. Some readers may wish to skip them and move on to Chapter 5.” This is an accurate warning, although I found value in the overview of modern finance and its relationship to dual momentum. Chapter 3 gives a history of mean-variance, the Capital Asset Pricing Model (CAPM), the Fama/French 3 factor model and the 4 factor model. This was a much deeper history than I expected, but also a very good synopsis of modern finance. Chapter 4 provides hypotheses on potential reasons why momentum works, such as herding, anchoring, and the confirmation bias, while acknowledging that ultimately we do not have a definitive explanation for why momentum is so prevalent. Chapters 3 and 4 are very accessible for those with a background in finance or economics. However, the layperson may have difficulty with Chapter 3 and 4 and may want to skip ahead.

Chapters 5 and 6 focus on asset selection and “smart beta” strategies. Antonacci is skeptical of many of today’s popular investment strategies and asset classes. He makes intelligent arguments against hedge funds, private equity, active mutual funds, managed futures and other alternative strategies. He is skeptical of “smart beta” but acknowledges there may be some room for low-cost alternatives to traditional cap-weighted index based strategies.

The last three chapters of the book put the “Dual Momentum” strategy together. In Chapter 8 the reader is presented with a simple strategy rooted in both relative and absolute momentum that can be implemented with three ETFs. Readers are warned against replacing or modifying the strategy with something new. However, Chapter 9 provides some alternative momentum strategy implementations which have historically strong results.

Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk is a must-read for individual investors and financial professionals. I was struck by the volume of references and citations. Antonacci has done the heavy lifting for his readers by thoroughly researching the history and data behind momentum investing. The result is a well-researched and overwhelming argument for momentum investing. Readers are rewarded with a simple, robust strategy that anyone can implement.

Weekend Reads

I will be posting a review of Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk this weekend – stay tuned!

Below are some shorter reads for the weekend (although the list is longer than usual!):

Global Diversification: Accepting Good Enough to Avoid Terrible – A Wealth of Common Sense

Buybacks: The Rationale and the Evidence – Greenbackd

From ETF.com: Swedroe: Targeting Liquidity As A Style / Swedroe: Measure Value In Different Ways / ProShares Debuts Alts Fund

The Reformed Broker: “Stocks and bonds aren’t good enough anymore” – Wall Street / The Single Most Important Thing To Know About Stocks This Year

Alpha Architect: Avoid High Beta Stocks. Period. / Buy the Cheapest, Highest Quality Value Stocks / Afraid of Market Risk? Stop. Be Afraid of Bias. / The Fascinating Relationship Between Low Volatility and Value

Optimal Momentum, Giving Investors a Chance

O’Shaughnessy Asset Management: The Power of Share Repurchases (pdf)

Mebane Faber: Omaha, Process, & Skin in the Game

Sea Change (pdf) – John Mauldin

Graham Value Stock Portfolio October Update

In January 2012 I announced a new portfolio, a Benjamin Graham “inspired” value stock portfolio.  The Graham portfolio is an attempt to add a value strategy to Scott’s Investments, which is otherwise focused on momentum, trend, income and market timing strategies. The portfolio tracks returns for a portfolio of 15 stocks selected based on a variety of valuation metrics.

The criteria used to select the stocks are listed below.  The tool used to perform the screen and backtests are courtesy of  Portfolio123 (“P123″).

The actual screen factors are below:

  • Liquidity filter: No OTC Stocks
  • Market capitalization > $100 million
  • Eliminate companies classified in the Miscellaneous Financial Services Industry, most of which are investment companies and funds and not the kind of stocks this all-star tended to seek
  • Current ratio must be at least 1.5
  • Long-term debt must be no higher than 10% above working capital
  • EPS must be above breakeven in each of the last four quarters and in each of the last five annual periods
  • Trailing 12 month EPS most be above EPS in the latest annual period
  • EPS in the latest annual period must be above EPS in the prior year and five years ago
  • The company must have paid common dividends in the last 12 months

The ranking system used as a basis for selecting the top 15 based among those stocks that pass the Graham screen are below:

  • Valuation – 60% of total
  • Trailing 12 month P/E (15% of this category)
  • Price-to-Book (15% of this category)
  • Price-to-Tangible Book Value (35% of this category)
  • Operating P/E, defined as Market Capitalization divided by Business Income, which is Sales minus Cost of Goods sold minus Selling, General & Administrative Expense and omits unusual items (35% of this category)
  • Earnings – 40% of total
  • 5-year EPS Growth Rate (50% of this category)
  • EPS Stability, defined as the standard deviation of EPS over the past 16 quarters, lower being better (50% of this category)

Stocks will now be sold when they drop below the 75th percentile ranking based on the ranking system above. Improvements in the screening and testing platform (via Portfolio123) allows a change in the sell/turnover rule from previous updates.   I originally intended to update the portfolio monthly; however, in the spirit of creating a lower turnover, value-driven portfolio it is now updated less frequently.

I began tracking this portfolio real-time on January 13th, 2012. As of October 15th, 2014 it is up over 34%. A real-world application of this portfolio could also utilize stop losses in order to prevent large drawdowns in single positions. However, for the purposes of tracking the portfolio results, all positions are bought and held until rebalancing.

Below is a 14+ year backtest results for this screen  using a quarterly rebalance and .50% slippage to help account for bid/ask spreads. Backtests include the 75th percentile sell rule (stocks will only be sold when they drop below the 75th percentile ranking):

(test data courtesy of Portfolio123)


The stocks being sold 10/16/2014 are listed below:

Symbol Name Purchase Date Cost Basis Current Value Percentage Gain/Loss
CHRM Charm Communications 1/15/2014 $9,622.36 $10,658.26 10.77%
HUM Humana 1/15/2014 $9,615.87 $12,447.27 29.45%

The current portfolio is listed below:

Current Positions Symbol Name Purchase Price Purchase Date Unadjusted Percentage Gain/Loss Current Price
Hold BGFV Big 5 Sporting Goods Corp 15.32 4/15/2014 -33.88% 10.13
Hold BWC The Babcock & Wilcox Company 33.85 4/15/2014 -16.51% 28.26
Hold HFC HollyFrontier Corp 45.9 4/15/2013 -8.98% 41.78
NEW ALG Alamo Group 39.72 10/15/2014 0.00% 39.72
Hold CLMS Calamos Asset Management Inc. 12.67 4/15/2014 -6.31% 11.87
Hold CSH Cash America International 47.35 4/15/2014 -9.52% 42.84
Hold CTCM CTC Media, Inc 9.26 4/15/2014 -45.90% 5.01
NEW UFPI Universal Forest Products Inc. 46.06 10/15/2014 0.00% 46.06
Hold JST Jinpan International 7.77 1/15/2014 -2.45% 7.58
Hold SWM Schweitzer-Mauduit Intl Inc 33.61 10/15/2012 11.40% 37.44
Hold WMK Weis Markets Inc. 38.69 1/15/2013 5.17% 40.69
Hold RCKY Rocky Brands 15.37 1/15/2014 -8.59% 14.05
Hold SCVL Shoe Carnival Inc. 24.82 1/15/2014 -23.81% 18.91
Hold DDS Dillard’s Inc. 91.08 4/15/2014 13.35% 103.24
Hold KALU Kaiser Aluminum Corporation 73.01 4/15/2014 1.11% 73.82

Dual Momentum ETF Portfolio for October

Scott’s Investments provides a free “Dual ETF Momentum” spreadsheet which was originally created in February 2013. The strategy was inspired by a paper written by Gary Antonacci and available on Optimal Momentum.

Antonacci has a new book coming out in November, Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk. I will be reviewing an advance copy of the book in the coming week, so stay tuned!

My Dual ETF Momentum spreadsheet is available here and the objective is to track four pairs of ETFs and provide an “Invested” signal for the ETF in each pair with the highest relative momentum. Invested signals also require positive absolute momentum, hence the term “Dual Momentum”.

Relative momentum is gauged by the 12 month total returns of each ETF. The 12 month total returns of each ETF is also compared to a short-term Treasury ETF (a “cash” filter) in the form of iShares Barclays 1-3 Treasury Bond ETF (SHY). In order to have an “Invested” signal the ETF with the highest relative strength must also have 12-month total returns greater than the 12-month total returns of SHY. This is the absolute momentum filter which is detailed in depth by Antonacci, and has historically helped increase risk-adjusted returns.

An “average” return signal for each ETF is also available on the spreadsheet. The concept is the same as the 12-month relative momentum. However, the “average” return signal uses the average of the past 3, 6, and 12 (“3/6/12″) month total returns for each ETF. The “invested” signal is based on the ETF with the highest relative momentum for the past 3, 6 and 12 months. The ETF with the highest average relative strength must also have an average 3/6/12 total returns greater than the 3/6/12 total returns of the cash ETF.

Portfolio123 was used to test a similar strategy using the same portfolios and combined momentum score (“3/6/12″).  The test results were posted in the 2013 Year in Review.

Below are the four portfolios along with current signals:


Return data courtesy of Finviz
Equity Representative ETF Average of Quarterly/Half/Full Year % Returns Signal based on 1 year returns Signal based on average returns
US Equities VTI 4.47 Invested Invested
International Equities VEU -5.43
Cash SHY 0.51
Credit Risk Representative ETF Average of Quarterly/Half/Full Year % Returns Signal based on 1 year returns Signal based on average returns
High Yield Bond HYG 0.23
Interm Credit Bond CIU 2.37 Invested Invested
Cash SHY 0.51
Real-Estate Risk Representative ETF Average of Quarterly/Half/Full Year % Returns Signal based on 1 year returns Signal based on average returns
Equity REIT VNQ 5.97 Invested
Mortgage REIT REM 5.38 Invested
Cash SHY 0.51
Economic Stress Representative ETF Average of Quarterly/Half/Full Year % Returns Signal based on 1 year returns Signal based on average returns
Gold GLD -6.4
Long-term Treasuries TLT 11.48 Invested Invested
Cash SHY 0.51

As an added bonus, the spreadsheet also has four additional sheets using a dual momentum strategy with broker specific commission-free ETFs for TD Ameritrade, Charles Schwab, Fidelity, and Vanguard. It is important to note that each broker may have additional trade restrictions and the terms of their commission-free ETFs could change in the future.

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High Yield Dividend Champion Portfolio – October Update

The High Yield Dividend Champion stock portfolio has been updated for October. The portfolio is tracked publicly as a continuous hypothetical portfolio with a starting balance of $100,000 on Scott’s Investments.

There is turnover in one position this month.  Altria Group (MO) has been a long-term holding but was sold for a capital gain of 34.27% and an original purchase date of 3/5/2013. The proceeds were used to purchase Helmerich & Payne (HP), which currently yields 3.04%.

The High Yield Dividend Champion Portfolio uses a small number of historically relevant ideas to create a simple, yet powerful investment plan. As I previously detailed, “Some studies have shown that the, highest yielding, low payout stocks perform better over time than stocks with higher payouts and lower yields.”

The High Yield Dividend Champion Portfolio attempts to capture the best high yield, low payout stocks with a history of raising dividends. There are numerous ways to rank high yield/low payout stocks. The screening process for this portfolio starts with the “Dividend Champions” as compiled by DRIP Investing. The list is comprised of stocks that have increased their dividend payout for at least 25 consecutive years.

To date the portfolio is up nearly 90% including dividends.  I mentioned in the 2013 year in review that valuation of high yield stocks was a concern. In January’s update I noted that “I have lowered my expectations for future returns of US equities and high yield stocks.”

I added a valuation filter to the portfolio starting in 2014 in an attempt to mitigate concerns over valuation.  We still begin with the Dividend Champion list, which is first sorted by yield and the lowest 50% yielding stocks are eliminated. Eliminating the lowest yielding stocks ensures only stocks with a relatively “high” yield make the portfolio.

The remaining stocks are then assigned a rank based on their yield (the higher the yield the higher the rank), payout ratio (the lower the payout ratio the higher the rank), 3 year dividend growth rate, and price-earnings (P/E) ratio.  Extra weight is given to yield and payout ratio rankings.

I have also created a second portfolio using similar metrics as the High Yield Dividend Champion portfolio. The primary difference is it only requires 10 years of dividend increases and it also hedges the portfolio during unfavorable market conditions. Hedging requires margin, but the portfolio can also be implemented without the hedge. The portfolio is available on Portfolio123 and backtested results were posted in the June update.

The top 10 stocks based on the new ranking system make the portfolio. Stocks will be sold at the re-balance date (generally around the 5th of the month) when they drop out of the top 15 (to limit turnover) and are replaced with the next highest rated stock.

The top 15 stocks based on my ranking methodology are below and displayed in order of their overall ranking (figures are September month-end):

Name Symbol Yield
Chevron Corp. CVX 3.59
Old Republic International ORI 5.11
Tompkins Financial Corp. TMP 3.63
AT&T Inc. T 5.22
ExxonMobil Corp. XOM 2.93
Eagle Financial Services EFSI 3.21
McDonald’s Corp. MCD 3.59
Community Trust Banc. CTBI 3.57
Mercury General Corp. MCY 5.04
Helmerich & Payne Inc. HP 2.81
First Financial Corp. THFF 3.17
AFLAC Inc. AFL 2.54
Universal Corp. UVV 4.60
Consolidated Edison ED 4.45
Weyco Group Inc. WEYS 3.03

As previously stated EFSI is not purchased due to its low liquidity.

The current portfolio is below:

Position Initial Purchase Date Percentage Gain/Loss Excluding Dividends Current Yield Current Allocation
CVX 12/6/2012 9.28% 3.62% 8.55%
MCD 1/3/2014 -2.80% 3.62% 8.22%
ORI 4/4/2014 -11.34% 5.08% 8.64%
MCY 9/5/2014 -2.78% 4.99% 9.16%
TMP 8/6/2014 -0.11% 3.60% 10.00%
CTBI 5/5/2014 -7.36% 3.54% 12.12%
XOM 4/5/2013 6.19% 2.92% 9.72%
HP 10/6/2014 0.00% 3.04% 11.31%
T 3/6/2014 9.74% 5.18% 12.35%
THFF 7/7/2014 -2.37% 3.13% 9.58%

Below is the portfolio charted against three benchmarks:

Dividend Champion

Sunday Reads

No football distracting me today since the Vikings already got walloped on Thursday night. Below is my Sunday investment reading list:

Bonds – The fourth quarter trade of 2014 – The Gold and Oil Guy

World’s Greatest Stock Picker® – The Big Picture

Is the Stock Market Cheap? Doug Short

3 Int’l ETFs With Huge Diversification – ETF.com

Exclusive: Schwab ready to unveil free ‘robo-broker’ service – Reuters

Forget active vs. passive. It’s all about factors. Gestaltu

Why the Yield Curve Matters – The Reformed Broker

Be Careful Where you get your Financial Advice from…. Pragmatic Capitalism

ETFReplay.com Portfolio for October

The ETFReplay.com Portfolio holdings have been updated for October 2014.  I previously detailed here and here how an investor can use ETFReplay.com to screen for best performing ETFs based on momentum and volatility.

The portfolio begins with a static basket of 15 ETFs. These 15 ETFs are ranked by 6 month total returns (weighted 40%), 3 month total returns (weighted 30%), and 3 month price volatility (weighted 30%). The top 4 are purchased  at the beginning of each month. When a holding drops out of the top 5 ETFs it will be sold and replaced with the next highest ranked ETF.

Bring Your Portfolio Into The 21st Century
Free Access – INO.com Special Report

In addition, ETFs must be ranked above the cash ETF SHY in order to be included in the portfolio, similar to the absolute momentum strategy I profiled here. This modification could help reduce drawdowns during periods of high volatility and/or negative market conditions (see 2008-2009), but it could also reduce total returns by allocating to cash in lieu of an asset class.

The top 5 ranked ETFs based on the 6/3/3 system as of 9/30/14 are below:

LQD iShares iBoxx Invest Grade Bond
TLT iShares Barclays Long-Term Trsry
PCY PowerShares Emerging Mkts Bond
VTI Vanguard Total U.S. Stock Market
SHY Barclays Low Duration Treasury

The portfolio maintains positions in TLT for October. Vanguard MSCI U.S. REIT (VNQ) was sold for a gain of 1.58% and a purchase date of 2/28/14.  iShares MSCI Emerging Markets (EEM) was sold for a loss of 5.67% and a purchase date of 8/1/14.  SPDR DJ International Real Estate (RWX) was sold for a loss of 6.21% and purchase date of 5/30/14.  The proceeds were used to purchase LQD, PCY, and VTI.

Beginning in 2014 we track both the 6/3/3 strategy (same system as 2013) as well as the pure momentum system, which will rank the same basket of 15 ETFs based solely on 6 month price momentum. There is no cash filter in the pure momentum system, volatility ranking, or requirement to limit turnover – the top 4 ETFs based on price momentum will be purchased each month. The portfolio and rankings will be posted on the same spreadsheet as the 6/3/3 strategy.

The top 5 six month momentum ETFs are below:

6 month Momentum
TLT iShares Barclays Long-Term Trsry
VTI Vanguard Total U.S. Stock Market
PCY PowerShares Emerging Mkts Bond
LQD iShares iBoxx Invest Grade Bond

The 6 month momentum system maintains positions in PCY and VNQ. EEM was sold for a loss of 5.67% and a purchase date of 8/1/14. RWX was sold for a loss of 5.61% and a purchase date of 8/1/14. The proceeds were used to purchase TLT and VTI.