A heatwave struck London the week I decided to revamp my home office. I usually enjoy assembling flat pack furniture. Less so in a DIY sweatshop.

Perhaps the resultant lethargy is one reason why I’ve been lingering over the paperwork the rearrangement brought to the surface.

Bundles of old bank statements. Letters confirming the opening of savings accounts that paid 7% interest. A document I’d kept confirming my entitlement to 228 HBOS shares when Halifax turned itself into a bank. A decade and a half of summaries of Legal and General tracker funds.

I’m going to shred and recycle most of this stuff. But I have mixed feelings about doing so.

Unreal returns

Investing can be such an ephemeral thing.

When you first put money into funds or shares and see it fluctuate like a statistic in a video game, the pounds and pennies you’re winning and losing seem entirely concrete.

But soon enough it’s not real money anymore. It’s ‘halfway to a house deposit’ or ‘not enough yet to compound to retirement’ or ‘thirty swanky holidays you could have had instead’ money. It’s ‘doing well’ or ‘must try harder’.

I’ll often smile as I pounce on a yellow sticker-ed bargain in Waitrose, delighted to save 50p on some fancy soup. But I no longer bat an eyelid when my portfolio fluctuates by thousands over lunchtime as I eat it.

Different rules apply to that money. For now it has become a score or a staging post towards a goal, or a marker against a market that as an active investor I’m always trying to beat.

Other people talk about paper profits, or losses not being losses until you sell. Such mental accounting may be a trick or a trap, depending, but in any event it can only happen once you can stop seeing your portfolio as entirely real money.

I believe most of us who are natural savers – grown-up children who could easily forgo eating a marshmallow – are good at abstracting money like this.

In contrast, people who can’t save even when on healthy incomes are probably bad at compartmentalizing. They only see real money they could be spending.

Similarly, people who struggle with risky assets are perhaps too prone to seeing their ‘pension pot cut in half’ and ‘tens of thousands wiped out’.

Such things rarely cut so deeply when your portfolio is – in some abstract sense – not real money. When, rather, it’s in this special universe of long time horizons, distant goals, and where volatility that would have you calling the police if it happened to your bank account or in your wallet is expected and welcomed for giving you the chance to buy more cheaply.

We evolved as hunter-gatherers. At most, our ancestors might have salted away a bit of woolly mammoth jerky for the hard times.

Those of us who happily tuck away multiples of our income for a future we may never see are probably the weird ones.

Paper assets

Maybe back in the days of beautiful share certificates people felt less disconnected from their investments?

You can read old stories of investors carefully inspecting their shareholdings before returning them to their bank’s safety deposit box. Once upon a time you had to physically carry your certificates into a broker’s office to complete a transaction.

It’s easy to see how things change in a world where you can sell a six-figure holding via your smartphone in a few seconds.

Which is probably why these old letters and statements have struck a nerve. As a (naughty) active investing junkie, I’m used to knowing my portfolio’s value up to the last second. So it’s a melancholy feeling to find an old note from a broker confirming I’ve opened an account that’s now as familiar to me as doing my teeth – but that was once a leap of faith for a 20-something version of me.

I’ve got more options now because of the decisions he made. In truth, I’m well ahead of most of the goals he set.

But equally a bit of me wants to go back in time, take £200 from the savings he invested, and instead send my young self out into the turn-of-the-century night to have fun when nothing hurt the next morning and most of my friends were single and fancy free.

Intangible assets

As I said, I’ll probably shred most of this stuff. I’m not even sure I like the feelings they’ve brought up. Besides, a few key documents should deliver a Proustian moment without taking up several feet of London living space.

Filing them has little practical justification, either. Most of my accounts are paperless now, so this random repository is not comprehensive. I know brokers urge you to print and store everything, but whenever I’ve had a query, I’ve solved it online. That’s how this forgotten and neglected stuff got forgotten and neglected.

Also I keep a (very irregular) investment log that reminds me of the arc of my story, if not every detail. So most of this ephemera is surplus to requirements.

Yet I have mixed feelings about destroying the paper trail. Maybe because even far from Wall Street, investing so easily feels like a fugazi…

Note: The title of this article refers of course to Alice Schroeder’s biography of Warren Buffett, The Snowball. It’s well worth a read.

What caught my eye this week.

Passive investors who dabble with the value factor and wannabe Warren Buffetts alike know that every few years, the ‘value is best’ mantra gets kicked into the long grass.

Value investing – basically buying cheap companies and ideally shorting expensive ones – has a great long-term record. However sometimes it performs like an elephant on LSD, crushing your returns.

Indeed, one theory for why value investing works is that these periods of under-performance are so miserable, few people can stick through them.

The years after the financial crisis were not kind to value investors. Slow growth and low inflation among other things made growth stocks the place to be.

But that changed in 2016, particularly in the US as this rather beautiful graph from a new GMO PDF demonstrates:

Source: GMO.

The market got giddy about Trump going on a spending spree, it looked like interest rates were headed higher and faster, and outside of Brexit-blighted Britain, growth accelerated.

However it wasn’t to last, as GMO demonstrates in the following graph:

Source: GMO.

Value players might have expected a few years in the sun after their years in the – um – desert, but the market has turned around and undone the progress they made in 2016.

But the authors’ urge value disciples to hang tight:

It’s an interesting paper if you’re an active investor like me.

If you’re a passive investor who includes value funds in your portfolio, though, then arguably you shouldn’t be reading stuff like this.

You’ll probably do better to keep plugging money into your lagging value funds year in and year out, and trust in the long-term charts that led you to tilt to value in the first place.

[continue reading…]

Recently it struck me that I’ve been writing about dividend investing for more than ten years. (Here’s my first article, if you’re interested – apologies for the sales pitch at the end.)

With the benefit of hindsight, I can’t imagine a better ten year period for covering the topic.

When I started out in 2006, the traditional view of dividend-paying shares – that they are reserved primarily for income-dependent investors – reigned supreme. Shortly after, the dividend world was turned upside down by the financial crisis. Not since the Great Depression had dividend cuts occurred at such frequency or magnitude.

As quickly as dividends fell under the knife, however, they became hugely popular in the post-crisis, low-interest rate environment.

Whether or not you agree this has been an exciting decade for dividends, it’s been an educational one at the very least.

The cycle turns, as ever

In a previous article on Monevator, I noted that a distaste for dividends seems to be taking root once more.

There are multiple explanations as to why this is occurring. At the risk of repeating myself, buybacks have increasingly been seen as an alternative means of returning shareholder cash. Investors might also look at the immense success of younger, non-dividend paying companies like Facebook or a Google, and wonder why they should instead invest in 100-plus-year-old businesses that aren’t changing the world.

To illustrate this trend, I recently spoke with another investor, also in his mid-30s, who told me: “My goal is to invest in high growth businesses until I retire. Then I’ll switch to dividend stocks.”

Logical, yes, but easier said than done. Credit Suisse HOLT’s research, for example, found that:

“…cumulative shareholder returns to stocks with high growth expectations frequently lag shareholder returns to firms with much lower anticipated growth.”

Indeed, Credit Suisse looked at the largest 1,000 U.S. companies, excluding financials and utilities, and broke them into the following four categories:

• Cash Cows: Firms with high CFROI (cash flow return on investment) and low market growth
• Dogs: Low CFROI and low market growth
• Stars: High CFROI and high market growth
• Question Marks: Low CFROI and high market growth

The bank’s researchers then back-tested the performance of these four groups of companies to 1976. The results are quite telling, and perhaps surprising:

Source: Credit Suisse

Why would cash cows and dogs do better than star companies?

The Credit Suisse research is a good reminder that an investment’s performance is ultimately a function of expectations and what actually happens. Too often, investors mistakenly extrapolate recently strong performance from high growth companies, thinking the good times will continue. The problem is, many other investors are likely doing the same.

In some cases, the good times do indeed keep rolling – or even exceed expectations, as has been the case with Facebook and the like. Competitors, however, are attracted to high growth and high profits like flies to honey.

Unless the growth company has a durable competitive advantage (an ‘economic moat’), it’s more likely that their margins will be competed away and fall short of original expectations. There’s also greater risk that management will mis-allocate capital in their effort to keep up with the competition. Ultimately, these sort of shares will be re-rated lower, which reduces returns to investors.

On the other hand, expectations for companies in the lower growth cohorts – the Cows and Dogs – in which we’ll find most dividend payers, are often too pessimistic.

Slow asset growth, for instance, could indicate a consolidating industry where survivors will benefit from improving margins and more rational competition. Low earnings expectations for well-run businesses are eventually corrected and the shares are often re-rated higher.

What does this mean for me?

It’s easy to look at some of the modern growth stock success stories, the massive wealth being created in Silicon Valley and elsewhere, and want a piece of that for yourself. It’s far less satisfying in the short-run to own a basket of slower-growth companies that may not operate in exciting industries.

You won’t exactly endear yourself to dinner party guests with a rousing discussion on the global containerboard market. [Editor’s note: I can confirm Todd speaks from experience. He tried to talk to me about packaging for over an hour on Skype once…]

What matters in the long-run – and isn’t that what we’re after? – is how well your companies perform relative to expectations. And based on evidence found in the Credit Suisse report and elsewhere, if you’re a stock picker then your research time is probably best spent in the slower growth areas of the market.

Remember that it’s in a dividend investor’s best interest to invest when dividend-paying shares are out of favor. I think that we’ll have plenty of chances to do that in the coming years.

Todd Wenning, CFA is an equity analyst based in the United States. Opinions shared here are his own and not those of his employer. A full disclaimer can be found here. For compliance purposes, Todd cannot reply to comments below, though he welcomes any correspondence sent by email. You can read Todd’s expanding collection of dividend articles here on Monevator or check out his book, Keeping Your Dividend Edge.