Dividends have accounted for 40 percent of total returns in the market since 1940. Some investors are concerned about recent stock price increases, but there still is room to invest in dividend-paying stocks, especially for the long term, says Sonia Mintun, vice president and portfolio manager at Ancora Advisors LLC.

“For the long term and at current valuations, particularly given historically low payout ratios, dividend-paying stocks can see strong relative and absolute performance. The outlook is enhanced by near all-time low U.S. Treasury yields and the Federal Reserve’s extended dovish position on interest rates,” she says.

Although the upcoming election and global economic environment are areas for concern, Mintun says an emphasis on high-quality dividend-paying stocks at low valuations should cushion investors from volatility and provide real returns over the long term.

Smart Business spoke with Mintun about the current stock market and how dividend-paying stocks remain a smart investment.

With the recent run-up in equities, is the dividend-paying strategy overvalued or a crowded trade?

Over the last year or more, the dividend theme has been the popular trade and the market has run up. There are a number of ways to evaluate if the market — and therefore dividend-paying stocks — is overvalued. You can examine whether it is trading at lower-than-average yields, or higher-than-average valuation ratios such as price-to-earnings (P/E), price-to-book (P/B) or price-to-cash flow.

The current market’s value is dependent on an investor’s time frame and risk tolerance. Is it overvalued for the next several months? It is possible we could see some pullback, but looking over the long term, it is our view that dividend stocks are not overvalued. The trailing P/E ratio of the S&P 500 index is around 14, which is lower than its historical norm and nowhere near where it was during the tech bubble when P/E ratios were closer to 50. While you can argue that the economic growth outlook is sluggish, companies have become operationally leaner, which has helped boost profit margins. They have better positioned their balance sheets by refinancing debt at extraordinarily low interest rates and have historically high cash levels. Lastly, with regard to dividend payers in particular, yields are at close to seven-year highs, while payout ratios are low, suggesting current yields are well supported by earnings. So overall, our opinion is that dividend-paying stocks remain attractive for long-term investors, especially in comparison to fixed-income yields.

What sectors have performed better and may be perceived as overvalued?

Defensive sectors such as consumer staples, health care and utilities have attracted a lot of capital and could be perceived as overvalued. Their P/E multiples compared to the overall market are trading at premiums to their five-year averages, but it is not a significant premium. Utilities, for example, are the most correlated sector, with 10-year treasury yields that have an 80 percent correlation since 1990. If you think that rates are going to stay low for some period, utilities may not be overvalued based upon the five-year averages.

What dividend-paying sectors have underperformed?

Economically sensitive stocks, such as energy, industrials and materials, have fared the worst, largely due to fears about slower growth in emerging markets and from concerns in Europe. However, many stocks in these sectors are trading at attractive discounts to their historical valuation ratios. They have ample cash on their books, generate consistent cash flows and could see improving profitability with higher commodity prices and demand if global stimulus takes hold.

What impact will the potential tax changes have on dividend-paying stocks?

A potential dividend tax increase has concerned some investors about owning dividend-yielding stocks. In 2001 and 2003, dividend tax cuts were put into place that reduced the dividend tax rate to 15 percent from 35 percent. These cuts are set to expire at the end of this year unless Congress extends them or passes new legislation. If no legislation is passed, taxes return to a top marginal rate of 39.6 percent. This tax increase may be a short-term negative for stocks and high-yielding stocks.

However, history has shown that tax increases do not have a long-term negative effect on dividend-paying stocks, as stocks typically recover after six months or so following an increase. This may be because an estimated 50 percent of equity held is owned by tax-exempt entities — such as qualified plans, foundations and foreign investors — all of which are somewhat indifferent on taxes. In addition, when tax increases are anticipated, it has typically not been problematic over the long term. For example, beginning in 2013, a new Medicare contribution tax of 3.5 percent will be imposed on investment income. This proposed tax increase has had minimal effect on the stock market so far.

What is the long-term outlook for dividend-paying stocks?

Longer-term dividend-paying stocks remain an attractive option for risk-averse, equity-oriented investors. Dividends provide a cushion during poor equity markets and are relatively stable over time. Consequently, by being less volatile and being more disciplined with capital because of the dividend policy, dividend-paying companies have outperformed non-dividend-paying companies for more than 80 years. Additionally, with dividend payout ratios near historical lows and weighty cash balances, companies may return more cash to shareholders in a low-growth environment. Given today’s low interest rates and continued global economic turbulence, we see dividend paying stocks as attractive now and for the long term.

Sonia Mintun is a vice president as well as an Investment Advisor Representative of Ancora Advisors LLC (an SEC Registered Investment Advisor). In addition, she is also a Registered Representative of Ancora Securities, Inc. (Member FINRA/SIPC).  Reach her at (216) 593-5066 or sonia@ancora.net.

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Published in Cleveland

Is there a pipeline in your investment future? Master limited partnerships (MLPs) are a type of publicly traded holding structure employed widely in the natural resources energy infrastructure space, which includes pipelines, storage facilities and anything in the transportation chain, from the wellhead to the market consumer.

“Yield-starved investors are dying for ideas, so here’s an idea of a niche asset class that has high current income, growth potential and some tax-deferred characteristics,” says John Micklitsch, CFA, director of wealth management with Ancora Advisors LLC. “They bring some diversification to a portfolio because they have a low correlation with stocks and bonds, and they have the potential to hold up well in an inflationary environment because they are a hard asset and their distributions are growing.”

Smart Business spoke with Micklitsch about the advantages of MLPs and why this might be a smart investment for you.

How do MLPs work?

MLPs trade on major stock exchanges such as the New York Stock Exchange or NASDAQ like any corporate stock, but instead of being a common shareholder of a corporation, you are a unitholder in a limited partnership. Like stocks, there are no liquidity or minimum purchase requirements. Some MLP examples include Kinder Morgan Energy Partners (KMP) and Energy Transfer Partners (ETP).

Ninety percent of a MLP’s income must derive from natural resources production, transportation or storage, real estate, dividends or interest income. As it turns out, the majority of publicly traded MLPs are in the natural resources production, transportation and storage sectors. Basically, the government decided in order to have a strong energy infrastructure in this country, it would give companies participating in that infrastructure a subsidy by not taxing them, provided they distribute their income out to unitholders.

Why are they potentially attractive investments?

MLPs have the highly sought after characteristics of strong current income and future growth potential. The business model is very predictable and simple to follow, as MLPs are paid fees, based on long-term contracts, for the natural resources that go through their pipelines or storage facilities. Generally, midstream MLPs take no ownership of the underlying commodity and therefore have little or no exposure to commodity price volatility. This fee-based, steady income stream allows them to pay out high distributions.

The Alerian MLP Index, which represents the universe of publicly traded MLPs, showed yields above 6 percent as of June 30. Comparatively, utilities were around 4.1 percent, real estate investment trusts near 3.9 percent, the Dow Jones Industrial Average was 2.7 percent and the S&P 500 was 2.2 percent.

In addition, MLPs are predicted to grow because energy production is transforming due to the technological breakthroughs associated with horizontal drilling and the exploration and production of the country’s shale resources, known as fracking. Whether the newfound natural gas and oil is consumed in this country, as is likely, or exported, those resources are too valuable to sit in the ground and will find their way to market to the benefit of these volume-based infrastructure providers.

The distributions a given MLP would be able to pay are expected to grow 5 to 7 percent over the next several years. When added to current yields, you could be talking about potential low double-digit returns.

What else might impact MLP performance?

Many people are currently worried about inflation, but MLPs are hard assets. In addition, their distributions, which are not fixed and are expected to grow, stand a better chance of preserving people’s living standards in an inflationary environment.

When purchased directly, there are some potential tax-deferral benefits for investors, making MLPs and the income they produce potentially a tax-advantaged asset. However, it is important to work with an adviser to find the best ownership fit for you, direct or through a fund, as both have certain considerations.

One other advantage the MLP universe has exhibited in the past is a relatively low correlation with both the stock and bond markets, making them a good diversification tool. For example, in 2008 and 2009, MLP prices fell, but importantly, MLPs not only met their distributions but many of them continued to increase those distributions. MLP business models are very resilient to economic and commodity volatility.

What does the future look like for these investment vehicles?

The future is extremely bright for MLPs based on domestic energy production, led by this horizontal drill, shale/fracking revolution and simple demographics. The aging population will be starved for yield; interest rates are at an all-time low. MLPs’ combinations of high current yield plus distributions that should keep pace with inflation put them in a very attractive position for the key baby boomer demographic over the next five to 15 years.

In addition to yield-starved individual investors, institutions — endowments, foundations, defined benefit plans — are becoming more aware of MLPs and their benefits. Institutions could increasingly become involved in the MLP space over the next decade as they search for sources of return that allow them to hit their long-term actuarially driven targets. Even though they face the hurdle of unrelated business taxable income, it can be solved by a variety of ownership structures.

What should investors remember about MLPs?

MLPs are a very interesting asset class that’s growing in stature and awareness, due to the attractive combination of high current yields and growth potential of distributions, but MLPs do have several nuances that make their incorporation into your overall portfolio best accomplished with the help of an experienced adviser well versed in the space.


John Micklitsch, CFA, is the director of wealth management with Ancora Advisors LLC. Reach him at (216) 593-5074 or johnmick@ancora.net.

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Published in Cleveland

When investors are seeking a financial adviser, they often make their decision based on price, figuring that everyone offers the same products. But that could be a mistake, says Frederick D. DiSanto, CEO of The Ancora Group.

“Instead of looking for the least expensive adviser, look for someone you can work with, with whom you feel comfortable and who has a real interest in helping you achieve your goals and objectives,” says DiSanto. “Pricing is always a concern and it should be commensurate with what is out there in the marketplace, but building that relationship with someone you trust is critical.”

Smart Business spoke with DiSanto about what to look for in a financial adviser and how to get the most out of the relationship.

What are some important traits of a good financial adviser?

The first thing to make sure of is that you are comfortable with that person, because it is all about the relationship. Is this someone with whom you feel that you can build a strong, solid working relationship — and friendship?

When looking for someone to manage your assets, that relationship is so important. You have to believe that once you set your goals and objectives and make that asset allocation, the adviser can execute. If issues arise, are you comfortable enough to call them in good times and bad? The stronger your relationship is, the better and the higher the probability will be that you will meet your goals and objectives.

The adviser should help you define your goals and risk tolerance, then provide solutions to meet your individual needs. There is no one-size-fits-all solution. An adviser should get to know you and your needs and not simply try to sell you products. Advisers should take the time to address a total risk management solution and take into consideration issues such as the riskiness of your career and your business and incorporate them into the risk profile of your investments.

This is not a five-minute conversation. It is an ongoing conversation in which the adviser helps you assess your goals, objectives and your stomach for risk to create an investment road map. Forming this type of relationship can really differentiate advisers.

The best advisers are not trying to push a product but are working to provide the best solutions to their clients. Your adviser needs to understand that not everyone is the same and that he or she has to mold, develop and create a total solution to accommodate your individual needs.

How would you define the adviser/client relationship today?

There is much more transparency because of the volatility we have seen in the market in the last few years, and there is much more communication between adviser and client.

Asset allocation is one of the most critical elements to understanding a client’s risk exposure. Throughout the past four years much more attention has been paid to a portfolio’s asset allocation. As the markets go up, people tend to be more aggressive and lose sight of their risk tolerance. Today, the focus is more on developing the right asset allocation, which will help investors weather any market conditions.

How often should investors meet with their advisers?

Every client is different, but an investor should meet with his or her adviser at least once a year, if not more, to review performance and determine if goals, needs or risk profiles have changed.

If there is going to be a life-changing event — for example, you want to retire in three years — you need to be communicating with your adviser about your goals and objectives so he or she can work to help you meet them.

How important is it for your financial adviser to work with your tax and legal advisers?

It is critical. Investors often have multiple investments, so having your financial, legal and tax advisers working together will help them better understand your total tax liability, gains and losses to create the most tax-efficient scenario. Your financial adviser should be providing your CPA with information about what your gains and losses have been on a quarterly basis to make sure nothing gets overlooked. And from an estate planning point of view, there is a lot of coordination to be done with legal advisers to ensure assets are held in the appropriate name, title, etc.

How should investors approach the issue of fees with their adviser?

The first thing an investor should look at is whether he or she can work with this adviser. Do you feel comfortable calling on Saturdays when you have a question or concern? If you believe you can work well together, then look at fees to determine how they compare to the marketplace and have a conversation about the discrepancies. If the adviser’s fees are slightly higher than the market that should not really dissuade somebody if the relationship fit feels right.

Is it fair for clients to ask their advisers for help with networking or other services for which the advisers don’t get paid?

Absolutely. Your adviser should go the extra mile to help you network. Having an adviser who can help clients build centers of influence and relationships outside their own network and help them grow professionally and personally is extremely important. It does not come out in the performance of your assets, but it comes out in your relationship. If you have a great relationship, your adviser will want to help you, whether it is with investments or business. It is not strictly what investments you make in your portfolio, it is also all those variables that you cannot put a hard number on.

Frederick D. DiSanto is CEO of The Ancora Group, as well as an investment advisor representative of Ancora Advisors LLC (an SEC Registered Investment Advisor).  Reach him at (216) 825-4000 or fred@ancora.net.

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Published in Cleveland

Volatility in the marketplace can have a significant impact on investors’ accounts and psychology.

But while many people think of volatility as a negative, there is an upside, says John Micklitsch, CFA, director of wealth management at Ancora Advisors LLC.

“For those who are still accumulating and investing in the market on a regular basis, volatility to the downside can create buying opportunities and the ability to buy shares on weakness,” says Micklitsch. “However, if you’re at a point in your life where you’re done adding to your account, volatility can be very frustrating and emotionally challenging.”

Smart Business spoke with Micklitsch about why the markets are so volatile right now and how to approach the market in this environment.

What is volatility?

Like everything there is a technical and a practical definition of volatility. To most people, however, volatility is a change in the value of their investment accounts from one measurable period to the next. Generally speaking, volatility is associated with risk.

Why are today’s markets so volatile?

It goes back to the globalization of the world economy. It used to be that what happened in a small country such as Greece, stayed in Greece. But today, everything is linked. Financial institutions hold sovereign bonds to facilitate worldwide trade and then hedge positions with other global financial institutions and incur counterparty risk. Corporations generate earnings from all over the world and now investors can trade in just about any market with the click of a mouse or tap of a smartphone. It’s all linked and it is in our face all the time with the 24 hour news cycle. For a long time, globalization has been a good thing, but lately it seems we are only as strong as the weakest link. Add in the uneasiness associated with huge, unresolved global debt levels and you can begin to see why markets have been so volatile.

Is volatility the new normal for investors?

Volatility in many ways, is the norm for now. We are in a period of relatively low returns in both the equity and fixed income markets due to sluggish economies. Buy and hold investors are frustrated. As a result there is tremendous pressure on managers to generate returns for clients with many now resorting to trading in an attempt to generate returns. There are inverse and leveraged vehicles that allow investors to turn risk ‘on’ and ‘off’ in their portfolio throughout virtually every minute of the day. Until we get sustained improvement in the economy this in and out activity is going to be the norm. The IRS and brokers will be happy, but it is less clear how investors will fair.

How should investors approach a volatile market?

The best way to approach today’s volatility, like anything, is to have a plan. Every investor should know how much of their portfolio they want to have in a given asset class and the potential volatility of their overall asset allocation. Then, when volatility soars they can dial into that plan to see just how much their actual allocations have deviated from their target percentages and whether reallocating or rebalancing is necessary. By having that plan in place, a touchstone if you will, investors are more likely to stay the course, as opposed to falling into that ‘just sell everything’ mentality. We think it is best to work with a financial professional to create long-term targets that are appropriate for your risk tolerance and your stage in life because they have the tools to help you model risk.

How often should that plan be reviewed?

The plan should be a living, breathing reflection of your goals and objectives at any particular moment in time. You should work closely with your advisers to update them on your changing risk profile and needs. If your risk profile changes and it is not reflected in your investment allocation, your portfolio might be more volatile than is appropriate. That could lead to making poor decisions at a market cycle bottom or in a period of particularly high volatility. Taking a few minutes to regularly review your plan can reassure you just enough to avoid making a 100 percent move to the sidelines, because then the challenge becomes deciding when to get back in, an error that could compound the situation.

What advice would you give to investors in this market?

There is a tendency for people to find safety and security in a stock market characterized by high prices. Although it is counterintuitive, the lower the stock market goes the safer it becomes from a margin of safety standpoint.

To reverse that basic decision-making apparatus and embrace lower prices is really the key to long term investing success. The only time volatility is not something to take advantage of is when you are done accumulating shares. At that point in life, you should probably have a more conservatively positioned portfolio that is not as highly impacted by market swings. All of this can seem overwhelming, which is why it is important to work with a professional adviser who can help you plan for and manage volatility in your portfolio.

John Micklitsch, CFA, is the director of wealth management, as well as an Investment Advisor representative, of Ancora Advisors LLC, an SEC Registered Investment Advisor. Reach him at (216) 593-5074 or johnmick@ancora.net.

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Published in Cleveland

Many companies offer their employees bundled 401(k) products from mutual fund or insurance companies, but if the organization is unhappy with any component of the plan, it is forced to physically move the plan’s assets and start over by selling them and then repurchasing them elsewhere because the individual plan components cannot be “unbundled.”

However, an open architecture plan allows employers to change any of the silos of the plan — the registered investment adviser, the third-party administrator, the record keeper — without having to move the plan itself, says Peter Mooney, CEO of Source Companies LLC, a subsidiary of The Ancora Group.

“The strength of open architecture is that you can custom build your plan to meet your needs and those of your work force,” says Mooney. “You can change any of the components of the plan without having to start over.”

Smart Business spoke with Mooney about how open architecture can ensure that you never have to move your plan again.

What are the disadvantages of bundled products?

When you use a bundled product, that plan is not owned by you, the employer. Instead, it is owned by the investment company, which negotiates each of the components and their fees, and then sells them bundled together.

As a result, you are tied to whatever the investment company has negotiated. If you are not happy with some component of the plan, you must sell all the assets, move the entire plan to another investment company and then repurchase the assets. That also requires terminating the relationship with your third-party administrator and setting up a relationship with a new one.

What is changing in the 401(k) industry?

Instead of the insurance or mutual fund company owning the 401(k) plan, companies are moving toward having a direct relationship with a custodian through open architecture. Then if, for whatever reason, you are not happy with an investment, for example, you can just change the investment. The same would be true with your third-party administrator, your record keeper or the performance of your investment adviser. The employer has control and can change out any of those components without ever having to change that core custodial account because your company owns that relationship.

With the recent requirements of full disclosure of 401(k) plan fees and more thorough reporting, there is an increasing trend toward open architecture. People are tired of physically moving their plan from company to company. It is disruptive to employees to have to sell everything and then repurchase it, requiring them to fill out forms and re-elect how their money is being allocated.

Open architecture makes everyone’s lives easier, allowing you to have a direct relationship with the custodian and giving you control over that relationship. You can replace your investment adviser, the third-party administrator or the record keeper, but you do not have to replace the base of what you started with.

Is an employer qualified to make decisions about changing components of the plan?

If your investment adviser is doing his or her job properly, you should be educated enough to make those decisions. There should be checks and balances of what to look for and to make sure that other people are doing their jobs. It sounds like it puts more onus on the employer, but it really does not.

As long as the plan sponsor and the advisor establish a proper investment policy statement, there is no more burden on the employer. In fact, it actually makes their life a lot easier in the long run.

What would you say to an employer who doesn’t want to be involved in those decisions?

Your investment adviser can take a fair amount of the responsibility off of the employer, but ultimately, you are still responsible for the plan. You need to be educated about the issues, and if you do not want to be involved in it at all, I would recommend that you do not offer a retirement plan.

What does a company need to be aware of regarding 401(k) fees?

Previously, many advisers claimed to sell 401(k) plans but were not really in the 401(k) industry. They may have sold two or three plans but were not advising them properly. Fees at that time were very, very high.

Over the years, the industry has consolidated and the surviving organizations that are in the business really understand 401(k) plans and make them their focus. The good ones are trying to drive down fees for employees as well as the employer while educating the trustee on the changes in the industry.

Most important, regarding fees, an employer must understand the value of the services being delivered by each of the service providers to ensure it is getting what it is paying for.

Employers should drill down to find out what each of the fees are. What are the investment adviser fees? What are the third-party administrator fees? What are the record keeper fees? And what are the custodian fees? Those are the biggest areas of fees associated with a 401(k) plan, outside of the expense ratio for mutual funds. What questions should a company be asking to ensure that they have the right 401(k) plan to meet their needs?

The plan sponsor should ask every service provider: How are you going to help my employees meet their retirement needs? What type of education do you provide me and my employees? Do you have a product that can grow with me as my business expands and changes? Can you provide me three references of similar companies to mine in size and industry?

Then make your decision based on what you learn.

Peter Mooney is CEO of Source Companies LLC, a subsidiary of The Ancora Group.  He is also a Registered Representative of Safeguard Securities, Inc. (Duly Registered Member FINRA/SIPC and an SEC Registered Investment Advisor). Reach him at (216) 593-5095 or pmooney@sourcecompanies.ws.

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Published in Cleveland

If investors hold several different mutual funds in their portfolios they are probably pretty well diversified, correct? Not necessarily, says John Micklitsch, CFA, director of wealth management at Ancora Advisors LLC.

“The sheer quantity of holdings in a portfolio is largely irrelevant in terms of diversification, if the funds you hold all behave the same way at the same time. A more useful diversification plan looks at your portfolio in a way that, regardless of the environment, inflationary or deflationary, bull or bear, you hold some investments that have the potential to step up and provide positive returns,” says Micklitsch. “Not only can this approach be good for your long-term investment results, but it can be good for your emotional well being,as well. With potentially less volatility, you’ll be less likely to sell out at market lows and therefore be more likely to reach your long-term goals.”

Smart Business spoke with Micklitsch about correlation and how to build potentially more diversified portfolios.

What is correlation?

Correlation is the tendency of two investments to move in tandem with each other. It is measured on a scale of +1.0 to -1.0. If two investments move in perfect tandem with each other, their correlation is +1.0. If they move perfectly opposite each other, their correlation is -1.0. But it is never that perfect unless it is the exact same asset. In practice, correlations are almost always somewhere between +1.0 and -1.0.

Why is correlation important to investors?

Let’s face it, most investors focus on picking funds or securities with the highest recent returns. This leads to a portfolio of holdings that share common characteristics. The risk is that when the market environment that led to them all doing well changes, there is nothing in the portfolio to step up and take their place.

One way to measure this crowding effect is through a correlation analysis of your portfolio’s holdings.

How can investors assess the correlation in their portfolios?

Online correlation calculators are available that allow investors to see how their holdings behave relative to each other. If you use one of these calculators and see that your assets have correlations all in the .8 to .9 range, you probably don’t have the diversity you might think you have because your holdings are likely to rise and fall pretty much at the same time.

If you don’t feel like doing this sort of calculation yourself, you can ask your advisor to do it for you.

Is this approach to analyzing portfolio diversification unique?

It is not a unique approach in the institutional world of investing, but it is a fairly new concept with individual investors. The market crash in 2008 was a watershed event, when many traditional diversification models that focused on spreading assets across the lines of small versus large and growth versus value, did not protect investors from significant losses. As a result, investors are looking for different approaches to protect their assets.

How can investors begin to build lower correlation portfolios?

You should start by making sure you have core stock and bond positions. This is the starting point. Then look at adding asset classes that bring return streams with potentially lower correlation to these two core holdings. Gold, international fixed income, real estate, commodities, MLPs and alternative investments such as hedge funds, private equity and venture capital all have the possibility of having a low or lower correlation to core stock and bond positions.

With the growth of Exchange Traded Funds (ETFs), a diversifying asset such as gold, for example, can be purchased as easily as shares of IBM.

What are the negatives of correlation?

Intuitively, it makes sense and appeals to investors to protect their assets throughout a variety of market environments. The problem is that this strategy will not outperform in every market environment.

By definition, an asset with a low or even negative correlation with equities, for example, is a hedge against equities. If equities are going up, then this is going to cause a drag on the portfolio and lead to underperforming an all-equity benchmark. The idea is that slow and steady really does win the race in the long run.

How often do investors need to revisit their allocation?

That is a key question. When you have multiple, different asset classes, there is the eventuality that some are going to perform better than others. When certain assets classes do better than others, they become a larger percentage of the overall portfolio than they were originally intended.

As a result, from time to time, you should evaluate your holdings relative to your original plan and rebalance back to target levels. This can remove some unintended risk that lies from hot asset classes dominating the portfolio. The tech and housing bubbles are both good examples.

John Micklitsch, CFA, is the director of wealth management, as well as an Investment advisor representative of Ancora Advisors LLC (an SEC Registered Investment Advisor).  Reach him at (216) 593-5074 or johnmick@ancora.net.

Insights Wealth Management & Investments is brought to you by Ancora.

Published in Cleveland

Many investors avoid microcap stocks, thinking that companies in that category are too small or too risky.

However, the term “microcap” is misleading and stocks in that sector can provide a good return on investment, says Denis Amato, CFA, chief investment officer at Ancora Advisors LLC.

“There is a misperception of microcap stocks being this crazy, wild area, so a lot of people shy away because they think this is a terribly risky area,” says Amato. “But by focusing on the value component, you will normally get good results over time, and if you put a microcap mutual fund in your portfolio, as opposed to buying individual companies, your risk is not as great as people’s perception of the area.”

Smart Business spoke with Amato about how to invest in microcap stocks.

What are microcap stocks?

Microcap stocks are generally those with market capitalization of $500 million and below, generally corresponding to the smallest 20 percent of the stock universe.

Many times, when people think of microcaps, they think of a new IPO or a penny stock. But that is not always the case.

There are two categories of microcaps. First is growth oriented microcap stocks, which may only have a few million dollars in revenues but market caps in excess of several hundred million dollars. Not always a good combination from a risk perspective. The better area to focus on, in our opinion, is microcap value stocks. These are stocks that often have several hundred million or even $1 billion plus in revenue, but market caps of just a couple hundred million dollars. This represents much better risk-reward to us than a company with low sales and high market cap. The price could be down because of the sector the business is in; it could have stumbled in some way or it may have had an earnings problem and the stock has been driven down because of it. And sometimes it is just a matter of the market ignoring the stock or the industry, or that the company is being followed by so few analysts that the stock is inefficiently priced. So the opportunities are real.

In fact, studies have shown that over a 50-year period, returns for microcap value stocks have exceeded the microcap growth category by a factor of almost four to one. That is why it is better to focus on microcap value stocks.

For what kinds of investors can microcaps be a good investment?

Microcap stocks make sense for a lot of people, but because it is a more volatile area, it makes the most sense for investors willing to take some risk and who have a large enough portfolio to make this a component.

How can an investor get involved in microcaps?

You can invest in microcaps through individual ownership of stocks, but to do that, you have to have a pretty broad portfolio because you need diversification to lessen the single company risk factor. Because they are smaller, they are riskier, so you need to have more than a handful of companies so you do not get stuck with the one or two that run into trouble.

Microcap index funds and exchange traded funds are also options, but studies have shown that the lack of Wall Street research devoted to these companies, makes microcaps an area where an actively managed fund has a good chance of outperforming passively managed strategies over time.

What timeframe should investors in microcaps be looking at?

Two to four years is reasonable because it can take several quarters to turn a company around and change the fundamentals that might be hindering the stock. Even after a company changes its fundamentals, sometimes it takes longer for the market’s perception of it to change. If you are going to get a really good return on a stock, it takes not only earnings going back up but also price earnings multiples to start reflecting that better result. The combination of those things generally takes two to four years.

What criteria should an investor look for in microcap stocks?

First, because microcap value stocks are where the better returns are, we always look for stocks that are undervalued in this sector. The financial condition of the company and its balance sheet also must meet strict criteria.

Finally, look for insider buying which is especially significant with small companies. With a large company, there may be 100 vice presidents, and five are buying and three are selling, so what does that really mean? With smaller cap companies, there are fewer insiders, and they tend to know what the real value of the company is. Management in small companies can be more aware of positive catalysts and this frequently gets reflected in insider buying.

A good microcap fund manager will take note of this and incorporate it into their decision-making process, especially with regard to the timing of the fund’s purchases. It is easy to find microcap stocks, but finding those stocks that are a good value and have other characteristics that will enable them to provide a good return are best left to professional managers.

What percentage of a portfolio, in your opinion, should be invested in microcap value stocks?

Studies have shown that 5 to 10 percent of an equity portfolio can be put into this sector. These stocks have a diversifying effect relative to an all S&P 500 oriented portfolio so investors can actually increase their returns without significantly increasing risk.

Denis Amato, CFA, is chief investment officer as well as an Investment Advisor Representative of Ancora Advisors LLC (an SEC Registered Investment Advisor). In addition, he is also a Registered Representative of Ancora Securities, Inc. (Member FINRA/SIPC).  Reach him at (216) 825-4000 or denis@ancora.net.

Insights Wealth Management & Investments is brought to you by Ancora.

Published in Cleveland

The investment market has been rocky the past few years, and there is no indication that volatility is going to change any time soon.

But current market conditions make it an excellent time to invest in dividend-paying stocks, says Sonia Mintun, CFA, vice president with Ancora Advisors LLC.

“Given the historically low bond yield environment, dividend-paying stocks are an attractive alternative,” says Mintun. “Right now, you can assemble a portfolio of quality stocks with a yield of 3 to 3.5 percent, in comparison to the 10-year Treasury yield of approximately 2 percent. Dividend-paying stocks also offer downside protection, providing a cushion during negative equity markets, while also allowing for the capture of upside potential.”

Smart Business spoke with Mintun about why dividend-paying stocks are a smart investment in today’s economy.

Why does dividend-oriented investing make sense in today’s markets?

There are several reasons: Dividend-paying stocks are less volatile than non-payers and they have been proven to have a lower standard deviation, which is a measure of risk. Dividends have accounted for 40 percent of total returns in the market since 1940, and dividend-paying stocks have outperformed non-dividend-paying stocks over the last 80 years. These stocks tend to be relatively stable over time because dividends are a component of earnings that are less subject to speculation. In addition, dividends are sticky, and tend not to fall, as companies are reluctant to cut them. Dividends allow investors to collect some income while they’re waiting for the fundamentals of the company to improve.

Furthermore, payout ratios are hovering at extremely low levels historically. They tend to revert to the mean over periods of two to three years. The current payout ratio is 30 percent, compared to a historical rate of 52 percent. With increased confidence and economic stabilization, we will likely see deployment of large cash balances on companies’ balance sheets toward higher payouts.

Dividend yields are also below long-term averages of 2.8 percent. Currently, yields are about 2 percent, despite cash balances being at record highs. Moreover, earnings are recovering from the financial crisis and balance sheets are healthy, so there is good potential over the next year or two that yields will rise due to increased payout ratios.

Last, given today’s bond yields, the S&P earnings yield — which is the inverse of the price/earnings ratio — is pretty attractive relative to the 10-year Treasury on a historical basis.

How does inflation impact dividend-paying stocks?

Historically, dividends have grown faster than the rate of inflation in the U.S. With 3 percent inflation now, short-term, high-quality, fixed-income instruments are losing purchasing power. You can get a 3 or 3.5 percent dividend yield on a diversified portfolio of good quality stocks, and have potential for income growth relative to the fixed coupon on bonds.

The average dividend income from a portfolio of S&P indexed stocks has grown at a rate of 5 percent per year since inception in 1957, which is one full percentage point over the rate of inflation in the same time period. As a result, dividend stocks offer both the potential for capital appreciation and income growth. Dividends increased more than 10 percent in 2011, on top of a 10 percent gain in 2010. Also, dividend-paying stocks have outperformed more often in higher inflationary times.

What vehicles can be used to implement a dividend-paying strategy?

Investors can buy individual equities in portfolios that are sizable enough to diversify the risk of one particular issue or sector. While dividend-paying stocks tend to be less volatile, it’s prudent to make sure your portfolio is not too concentrated in one sector or company.

Investors can also buy exchange traded funds, or ETFs, that concentrate on dividend-paying stocks. ETFs are a cost-effective way to invest in dividend payers while achieving diversification in smaller accounts. There are also mutual funds that focus on dividend-paying companies. These typically have higher expense ratios than exchange traded funds, but the fund manager can trade them more tactically than ETFs, which are passively managed and based on an index.

Are all dividend-paying stocks the same?

All dividend-paying stocks are not the same. It’s very important to do your homework on the company when you are buying individual stocks. Higher yield stocks are associated with better subsequent performance, but only to a degree. Those in the 3 to 6 percent dividend yield bucket have outperformed their peers, both those with higher dividend yields and those with lower yields.

Stocks with yields in the 6 to 9 percent range and above tend to have a higher standard deviation, or risk. Sometimes investors fall into the yield trap, buying troubled companies that cannot sustain high payouts, leading to cuts in their dividends.

Investors should seek stocks in which the dividend can be sustained, potentially evidenced by a low payout ratio and ample net cash or share buybacks. Look for companies that have consistent cash flow, a healthy balance sheet for their industry and that increase their dividends consistently.

Given today’s historically low bond yields, the potential for inflation down the road, as well as the other reasons I detailed, investing in dividend-paying stocks makes sense. With the expectation that volatility is going to continue due to our upcoming election and events in Europe, investing in less volatile stocks paying dividends is a sound strategy. Furthermore, based on price/earnings ratios and the potential for improving earnings, the disparity between the earnings yield on the S&P relative to 10-year Treasury bonds make dividend stocks an attractive investment.

Sonia Mintun, CFA, is a vice president as well as an Investment Advisor Representative of Ancora Advisors LLC (an SEC Registered Investment Advisor). In addition, she is also a Registered Representative of Ancora Securities, Inc. (Member FINRA/SIPC). Reach her at (216) 593-5066 or sonia@ancora.net.

Published in Cleveland

Bonds have historically been an investment of choice for those looking to diversify their portfolios. Today’s market is no different, but the challenge comes in determining what types of bonds to invest in and the length of time to invest, says Jim Bernard, CFA, senior vice president and director of fixed income portfolio management at Ancora Advisors LLC.

“A prudent move right now in our opinion is to focus on bonds maturing within a three- to seven-year time period,” says Bernard. “Interest rates are very low right now, so it may be tempting to go out to longer dated bonds to get yield. But most investors should be very careful about locking their money up for too long a time. If interest rates increase, the value of existing long dated bonds will likely decrease materially in value. It would then be a long time until maturity before investors get their money back at par value.”

Smart Business spoke with Bernard about the value in U.S. fixed incomes markets and the primary risks faced by investors.

Can you put today’s interest rate environment into historical perspective?

Interest rates have been historically low for three years, and that low interest rate environment is probably going to last another three years, possibly longer. If you keep money in short-term CDs, you will get what you are getting today, which is close to nothing.

Interest rates will begin to increase when the economy and/or market improve. Or, if those things don’t occur, but commodity prices or inflation spiral up, then interest rates will also go up. However, we don’t see a materially better economy for the next few years, and although there may be slight job growth, we think the job market will remain very difficult.

What are the primary risks fixed income investors face today?

First, how can you get any legitimate return on your money without buying long-term bonds or bonds of questionable quality? If you buy a low-rated bond, the probability of getting your all money back at maturity declines.

To get a decent yield, you have to go to long maturity bonds that are going to be due in 15 to 30 years. The risk is that if interest rates were to go up materially in the future, then the value of your bond declines materially.

For instance, if today, you buy a good, AA 15-year corporate bond that yields 4.5 percent, that is great for today. But if in four years interest rates go up and an 11-year bond is trading at a yield of 8.5 percent, the face value of your bond would go down to about 65 cents on the dollar to be yield competitive in the higher interest rate environment.

At that point, you have a decision to make. You are earning 4.5 percent, but you could buy a new bond to earn 8.5 percent. However, the only way to do that is to sell your bond at 65 cents on the dollar. Do you want to take a loss to get more income, or are you going to continue earning 4.5 percent while others earn 8 percent? That’s the dilemma.

That’s why three- to seven-year bonds may be the best move today. If you construct a portfolio of these bonds, for an average maturity of five years, interest rates may go up in three or four years. In that instance, you may not be happy in the short term, but you’re going to have access to your money at face value in the next one to three years, which is better than 10. The price of those bonds will go down but they will mature at face value, and you will know what the future value is and know when that is coming back to you.

How do you view the current municipal bond market?

We like municipal bonds and think they are a good value, but people have to be very careful of what they buy.

We recommend bigger rather than smaller issuers in this uncertain market. There may be municipal defaults on the smaller end of the spectrum over the next few years, as opposed to states and larger issuers.

If a $15 million sewer district bond were to fail, the state of Ohio would survive, even if bondholders didn’t get back all of their money. However, if a multibillion dollar issuer were to fail and not pay back bondholders 100 cents on the dollar, that would have huge ramifications. Issuers with significant size may be too big to fail, but every municipality may not be bailed out.

Are non-U.S. dollar denominated sovereign bonds a good investment?

U.S. currency has been weak against other currencies over the last decade or so. Our view is that until we adequately address our fiscal problems here in the U.S., the dollar will continue to do worse than currencies of countries that are more fiscally disciplined.

We don’t know what the ultimate outcome is going to be with the euro, but we are very concerned. The yen is also uncertain. But we have identified five to seven currencies that we believe are better fiscally positioned and have been more responsible from a budget perspective. We would rather own their government debt than ours because we believe their currency will do better than ours.

We recommend buying three- to seven-year non-euro zone bonds in countries with solid economic positioning and finances.

What are the keys to being an effective long-term fixed income investor?

You have to understand the structure of the bonds you are looking to buy. Is this a bond in which you have a high degree of confidence that you will ultimately get all of your money back? With stocks, you want growth and higher earnings, but with bonds, you care a lot about the issuer’s balance sheet and less about their income statement, because the balance sheet will ultimately determine whether you are going to get your money back.

Jim Bernard, CFA, is senior vice president and director of fixed income portfolio management as well as an investment advisor representative of Ancora Advisors LLC, (an SEC registered investmentadvisor). In addition, he is also a registered representative and a registered principal of Ancora Securities, Inc. (Member FINRA/SIPC). Feel free to contact him at jb@ancora.net or (216) 593-5063.

Published in Cleveland