Here’s an unorthodox investing strategy that’s super tax-efficient and could boost returns by nearly 50%: Avoid dividend stocks to improve “dividend investing.” Really.
Research scientist-cum-money manager Meb Faber – the witty, popular blogger with an independent and systematic approach to investing – in early March emerged with the idea as a way to increase returns – and reduce taxes. With it, he is questioning one of the most hallowed strategies of investing.
But sure enough, Faber’s research found that, by removing the dividend and using a value approach instead, investors can add another 50 to 100 basis points to after-tax returns, he told ThinkAdvisor in an interview.
The quant blogged his unconventional replacement strategy half-expecting to draw heckling emails and prickly comments from the financial blogosphere. After all, what he suggested was to replace a sacred cow – investing in dividend stocks – with his “better mousetrap” “non-dividend” strategy in order to reap similar returns.
Well, Faber reports no such bashing and trashing to date. That’s probably because the co-founder, chief investment officer and portfolio manager of Cambria Investment Management, 38, has already demonstrated a panoply of proven good ideas. It’s not for nothing that his own publishing imprint is called “Idea Farm.”
Newest of Faber’s five books is “Global Asset Allocation: A Survey of the World’s Top Investment Strategies,” released in March. It is available for free on the blog.
With about $320 million in assets under management, Cambria’s main goal is to provide low-cost alternatives to traditional buy-and-hold portfolios. The El Segundo, California-based firm’s quantitative research process is global, tactical, trend-following and multi-asset in approach. What chiefly impacts the global focus are price trends and valuations.
Faber, who started in the industry as a biotech stock analyst, saw early signs of the global financial crisis: in January 2008, his tactical computer models exited U.S. stocks; likewise, foreign equities the following month.
The models “won’t be long in bear markets,” Faber noted in a 2009 interview with this reporter. Cambria’s Global Tactical Moderate composite was even up slightly, 0.11%, in 2008.
The following year, Faber and co-author Eric Richardson, Cambria co-founder and chair-CEO, published “The Ivy Portfolio: How To Invest Like The Top Endowments and Avoid Bear Markets” (John Wiley).
This year, while on a February skiing trip in Japan, Faber blogged a white paper, “Finding Yield in a 2% World.” It laid out what he calls a better strategy for investing in global bonds. With today’s low, or even negative yields, he wrote, “a value approach could add a source of income to a diversified portfolio … Much like investing in stocks, one can apply a value methodology to global bonds.”
The Cambria ETF Trust and Cambria Investment Management are behind the first – and still only, according to Faber – U.S. market ETF that charges a 0% management fee. Launched two years ago, the passive Cambria Global Asset Allocation ETF (GAA) seeks to replicate a true global market portfolio, investing in a basket of U.S. and foreign equities, bonds, real estate, commodities and currencies. The portfolio tilts toward value and momentum factors.
All of Cambria’s seven funds – most of which are active and tactical – have been available for less than three years.
ThinkAdvisor recently spoke with the cerebral Faber, a Denver-born aerospace engineer’s son, who graduated from the University of Virginia with a double major in engineering science and biology.
With no traditional background in financial services, he has found that his objective view of market data is a major plus: “I don’t just believe what’s fed to you,” he says. Here are highlights from our conversation:
THINKADVISOR: What are your thoughts on buy-and-hold investing?
MEB FABER: It’s fine, but there are certainly many approaches that can be better: income strategies, global income strategies, global value strategies. Where do you see most of the opportunity in the market right now?
Foreign equity markets. We’re more positive on a basket of cheap ones than anything else, particularly the really cheap markets and emerging markets, which are a much better opportunity than the U.S.
That’s going against the grain.
Yes. [Those markets] have done very poorly since the global financial crisis, but it’s one of the reasons they’re set up for great returns going forward.
What’s the level of risk there?
We think it’s low.
Tell me about your provocative paper, “What You Don’t Want to Hear About Dividend Stocks.”
Historically, dividend stocks have outperformed the broad market any way you look at it. But what most people don’t know is that “dividend” is just a substitute for “value” – and not a very good substitute, at that. Dividend is simply another way of doing value investing. And if you’re going to do value investing, there are better ways to do it. You can come up with a basic value strategy that will do similarly or even better than dividend stocks.
What’s the biggest benefit?
The really important thing [to remember] is that dividend stocks are highly tax inefficient. So if you do a value approach and completely avoid them, you can add another 50 to 100 basis points to after-tax returns.
Is this a good time to use that strategy?
Yes. Right now dividend stocks are expensive – more expensive than the broad market. So you’re getting a sort of triple-whammy by investing in individual stocks. It’s particularly timely for people to avoid them.
Talk about the argument you present in your paper, “Finding Yield in a 2% World.” You examined a global value approach to sovereign bonds in 30 countries going back to 1950.
Most U.S. investors have no exposure to the largest asset class in the world, which is foreign bonds. If they do have exposure, they have it through a market cap-weighted index, which allocates more to countries that issue more debt. Something like 70% of the global bond indexes are invested in just five countries: the U.S., France, Germany, the U.K. and Japan.
So, what, specifically, do you propose?
A value approach to bonds, which is similar to a value approach to stocks. Bond yields in the U.S. are under 2%, and a lot of Europe is flat to negative. So you can get a basket of, say, the top 25% of the highest yielders, and the yield will be closer to 7% or 8%, which is a lot better position than being in the very low-yielding U.S.
At the end of 2014, you told me, in an interview, that your forecast for the coming decade was for stocks to do about 3% a year in the U.S., based on long-term valuations. Are you sticking with that?
Yes, the same low digits – maybe 5% now. Long-term valuations haven’t changed that much. The U.S. market is up some but not too much.
Your new book, “Global Asset Allocation,” tracks 13 assets and their returns since 1973. You found that, with a few exceptions, the allocations have similar exposures.
That’s right. This goes beyond a limited stock-and-bond portfolio to consider a more global allocation that also takes into account real assets. The book is a simple route to following star stock-pickers and their investing ideas. It takes you through [the strategies of] a lot of famous star managers, like Warren Buffett, Ray Dalio, Rob Arnott and Marc Faber [no relation]. It’s a fun read.
How are the Cambria funds performing?
Fine. [But] we don’t like to get into the game of talking about performance because all funds go through cycles of outperformance and underperformance, and all our funds are less than three years old. So we’d be talking about the performance of this year or the last six months. That’s usually not too helpful.
On your blog, you publish your personal holdings and allocation. This year’s article is titled: “Take Lots of Risk, or None At All? My Portfolio Allocation for 2016.” You wrote, “I think it’s important to have skin in the game.”
Right. All of my [liquid assets] are in funds that I manage.
— Check out Meb Faber: Should Investors Buy, Hold or Hedge? on ThinkAdvisor.