2015 July Newsletter

Paul Sutherland, CFP®
By: Paul Sutherland, CFP®

Dividends Don't Lie

This month I’d like to discuss dividends. I’ll highlight a few stats that Swiss Bank UBS put out in a recent riveting 50-page report titled “Safe dividends in times
of financial repression.” Before that, though, let’s briefly go over some dividend basics and our team’s recent thinking on dividend payers. I should also point out that Zach writes on
one dividend-heavy sector for our managed accounts, real estate,
later in this newsletter.

First, the Basics

A dividend is simply a shareholder distribution that a company makes from a portion of its earnings. Management teams and board directors have a myriad of options when it comes to utilizing a firm’s profits. They can reinvest these earnings back into the company, make acquisitions, reduce debt, buy back stock or pay investors a dividend. Most earnings-generating companies do some combination of these things, and many include dividends as part of the mix. Some set a transparent policy for shareholders (for example, targeting a stable absolute dividend or a target payout ratio of earnings), while others choose to stay less committed and offer only the occasional “special” dividend. 

For investors, total returns on a stock are simply a combination of any dividends received and price appreciation over a given holding period. If a stock is foreign, changes in exchange rates can add or subtract from the U.S.$ dividends and price gains. Because the price appreciation portion of total return often depends as much on the sentiment and motivations of other investors as it does on a company’s fundamentals, many investors (like us, especially in our strategies geared for clients with regular portfolio cash needs) prefer to own stocks where a meaningful part of the expected return is projected to come from dividends. 

In fact, nearly all of the stocks held in our Balanced Conservative and Yield Income strategies pay dividends. This steady stream of dividends can be a real help during periods of general market stress as it allows us to avoid selling positions to meet cash needs when market prices are irrationally low. The annual yields that our dividend payers produce (in combination with the yields from the bond investments held in these portfolios) are expected to cover most of the 3%-6% sustainable withdrawal rates we advise for clients in these strategies. 

Dividends Don’t Lie (But Watch Out for Sucker Yields)

The old Wall Street saying, “dividends don’t lie” has often been cited by dividend-loving investors. There was even a book written back in 1990 by Geraldine Weiss and Janet Lowe titled Dividends Don’t Lie: Finding Value in Blue-Chip Stocks. Cash dividends, unlike accounting earnings, are pretty much impossible to fake, although they can certainly prove to be unsustainable. Remember that the fundamental value of a stock can be simplified down to the company’s expected future stream of dividends (discounted back to today’s dollars). In most cases, the majority of a company’s fundamental value comes from expected dividends years and even decades into the future. Losing sight of this and focusing only a tantalizing dividend yield based on current dividends, can lead to ugly “sucker yield” outcomes should dividends end up being reduced or eliminated because of weakness in a company’s cash generation capability.

Our investment team spends significant time analyzing the sustainability of dividends in our portfolio companies. We look at a broad array of drivers behind the cash flows that ultimately support a dividend payment. These drivers encompass most of a company’s “funda-mentals,” including its business model, competitive position, management team and balance sheet strength. 

Our analysis of dividend stocks (and all stocks for that matter) also looks hard at valuation. It is one thing to find a solid dividend-paying company and quite another to find an attractively priced dividend-paying stock. This is especially so after years of exceptionally low interest rates that have forced conservative investors to leave the comfort of bond-land to find the yield they seek elsewhere. As the herd has crowded into “blue chip” dividend-paying stocks, the prices of these stocks has risen considerably, leaving many such stocks vulnerable to any change in investor sentiment.

Taking Advantage of Short-Term Mood Swings

Fortunately, our team has the flexibility to invest globally and across a variety of sectors and company sizes. Lately, we continue to find good values in select dividend-paying stocks both here and abroad. By staying focused on long-term fundamentals, we can exploit short-term changes in investor sentiment. For example, we continue to find excellent value in Europe as concerns of Greece’s future in the Eurozone weaken investor appetite for Europe-listed shares. We are also finding certain stocks deemed “bond-like” or “interest rate-sensitive” in areas like utilities and real estate quite interesting of late, as they tend to trade cheaper when investors get nervous about the prospect for higher interest rates. We are comfortable holding these high current dividend/modest future dividend growth names as part of the portfolio mix given our belief that global economies will stay sluggish at best and that the deflationary pressure from longer-term global trends in debt and demographics will keep a lid on interest rates for the foreseeable future. 

Looking ahead, we expect that investor demand for dividends will remain strong. As Baby Boomers continue to enter retirement, they will likely desire more of the “bird in the hand” that dividends offer versus the much less certain “two in the bush” potential of non-dividend payers. This will especially be the case if large parts of the bond market continue to offer far more risk than reward (negative yields after inflation and significant loss potential should rates normalize). Key for our team’s success will be our disciplined analysis of dividend sustainability and our willingness to exploit the temporary shifts in sentiment that drive market prices apart from fundamental value.

In closing, I’ll share just a few snippets from the UBS report that gives statistical support to dividend-loving investment approaches. The Swiss Bank looked at total returns at the 1,000 largest U.S. companies from 1974-2014. The combined annual return for the 1,000 companies that paid dividends was 3.2% higher for the dividend payers and 4.2% greater than the non: dividend paying equites over that 40 year period.

The study also found consistent outperformance for the high-dividend yield group through the 40-year period, especially over longer holding periods. As Figure 1 shows, for 10-year holding periods, the high dividend yield subset outperformed the market nearly 90% of the time, while the no dividend group outperformed only 20% of the time. While the often repeated disclaimer that past performance is not indicative of future returns should always be heeded, we believe there is good potential for the continued outperformance of dividend payers into the future. We expect that high-quality dividend payers will remain a significant part of our portfolio mix.

What is risk to a professional investor? It depends on the seat the investor occupies. When I was at BlackRock managing a Large Cap Growth fund, my risk was always versus a benchmark. Specifically, my job was to consistently beat the Russell 1000 Large Cap Growth benchmark on a 1-, 3- and 5-year basis. That seemed like a noble goal, but it was not always aligned with the long-term goals of the average investor and sometimes was actually fraught with considerable risk. At BlackRock, absolute return was not a consideration; we concerned ourselves only with relative returns. Whether my portfolio was up 50% or down 50%, BlackRock management and many of my institutional investors were not concerned as long as I beat the benchmark. 

This focus on the benchmark often led to herding behavior and an actual hidden increase in risk from an absolute return standpoint. For example, at the height of the tech bubble in 2000, the technology sector was about 65% of the benchmark. Believe it or not, the way the risk was defined, it was considered risky not to have a full weighting to the benchmark in technology stocks. Suppose in 2000 I felt that technology stocks were going to implode and I went to a zero weighting in sector. Well, the risk police of the firm would flag me and want to have a chat about the risk I was taking for my clients and the firm by making such a bold bet. The firm did not care that tech stocks were trading at 100 P/Es or that it was 65% of my portfolio because it was too much risk to take versus the benchmark. And herein lies the distortion. Risk to much of Wall Street is relative, not absolute. At the end of the Bull Market in the 1990s, everyone owned tech stocks because they were perceived as “not risky.” The risk models that Wall Street uses are static and not forward-looking. 

Today, we see history repeating itself. If you manage a Large Cap Growth portfolio today, Apple is 7.00% of your benchmark and has a market cap of $750 billion. Clearly Apple is an amazing company and has been a fantastic stock. Everyone owns it because, by Wall Street’s measures, it is a risky stock not to own. However, how does it look on an absolute return out five years? I would argue that we have seen most of Apple’s best days. When I look to the future I see slowing growth as smartphone penetration looks to have peaked this year globally. Margins are at peak and competition will intensify. Never in the history of consumer electronics has a company been able to keep margins sustainably high for more than a few years. Granted Apple has lasted longer than most, but the mobile phone business is brutally competitive. To put Apple’s stock into perspective, the market cap is currently larger than the entire market cap of the Russian stock market. In the dot-com bubble we saw similar comparisons … and we all know how those returns looked five years out. 

In the vein of  looking forward, certain Russian stocks have presented a unique opportunity for the patient investor with the ability to withstand some short-term volatility. Russia is in the midst of a deep recession due to E.U. and U.S. sanctions. One stock that we have purchased in Russia is Yandex (YNDX), the Russian equivalent of Google with 60% market share and sizable growth prospects. Last year, the stock was trading at a high of $45, and we have been able to purchase it for $16. The company has a market cap of $5 billion and a normalized three- to five-year growth rate of 25%. Due to the recession, growth has slowed and valuation of the stock now trades at a significant discount to its long-term growth rate. If I look out three years, this stock can definitely get back to $45 and likely exceed these levels as Internet penetration and e-commerce are much lower than in the developed world, giving a growth runway for years to come. The sanity check is simply this: does a $5 billion market cap seem excessive for a search engine with 160 million Russian-speaking people as a market? To me the answer is simply “no.” 

Currently Mr. Market loves Apple because it is too risky not to own even though the price is at a high and its prospects are as well. Mr. Market hates Russia and Yandex, and it’s too risky to own even though prices are much lower than a year ago. The way the sausage is made on Wall Street is definitely strange and sometimes insane. I like the way we do things at FIM Group and is one of the major reasons I joined the firm.

Zach Liggett, CFA®
By: Zach Liggett, CFA®

Hunting for Real Deals

Real estate has long been a popular asset class for investors worldwide. Today is certainly no exception, with options ranging the gamut from buying and flipping a local fixer-upper to letting professional managers do all the work via property-themed mutual funds. In between these extremes are specialty “non-traded” real estate limited partnerships, new crowdfunding real estate portals like, and publicly listed real estate companies that specialize in niche real estate segments like Asian hospitals and U.S. data centers. 

Our team at FIM Group is constantly on the hunt for compelling real estate investments. We seek companies with significant competitive advantages trading at great prices. These advantages include strong existing property positions in high-demand areas (impossible to replicate given finite land supply and regulatory hurdles to new development) and seasoned teams with deep development and deal sourcing expertise. Our search for real estate deals generally falls into two broad categories: publicly listed REITs and publicly listed property developers and operators. While some see the volatility that accompanies public market investing as a negative (which, by the way, drives a very lucrative market for those selling non-traded REITs), we use such volatility to our advantage and look for temporarily suppressed investor sentiment as a great source of future returns. Before I discuss some examples of our portfolio holdings, let me first make a few quick observations on one popular segment of the property investment universe: U.S.-listed real estate investment trusts (REITs).

Caution Warranted in REIT-Land

Recall that REITs are companies that provide investors of all sizes the ability to invest in large-scale property portfolios, not unlike the way a mutual fund allows investors the means to own a diverse group of stocks. REITs assemble portfolios of income-generating property and are required to pay at least 90% of their taxable income in the form of dividends to shareholders. This makes them attractive to yield-oriented investors who appreciate their generally stable cash flow streams. And unlike most bonds, which carry a fixed coupon and therefore face price risk during periods of rising market interest rates, REITs have the potential to grow their dividends over time by raising rents, improving occupancy and making accretive acquisitions. 

As Figure 1 shows, U.S. REITs (green line) have generally performed quite well over the last 30 years, with total returns in line with the broader S&P 500 stock index. Resilience through the tech bubble implosion of the early 2000s gave investors the confidence to pile into REITs right until the global financial crisis. Many of these latecomers to the REIT party faced substantial losses during the 07-’09 period, although since then the sector has bounced back along with the general stock market. Today, prices for U.S. REITs, in aggregate, are not far from all-time highs. Valuations are rich, as investors scramble to find “safe yield” in a world of ultra-low interest rates. U.S. REIT dividend yields, for example, are currently bouncing near their all-time lows (Figure 2). 

Taking a Selective Approach 

Given this generally high-priced environment for REITs, we’ve taken a very selective approach to our REIT exposure in managed accounts. Rather than accept valuation risk by owning the most popular REITs at high prices, we’ve accepted different risk factors instead that we feel more comfortable with. 

Take, for example, one of our larger REIT positions, Government Properties Income Trust (ticker: GOV). GOV is a REIT which, as you might expect, owns a $1.9 billion portfolio of 71 properties leased back to primarily federal and state government tenants. We were able to buy GOV at a discounted price to its peer group (and at a higher, 8%+ dividend yield) primarily because of complexity in its ownership and management structure. A recent deal announcement that proposes to better align the management company with shareholders is a step that should bring more transparency to this structure and with it improved investor sentiment over time.

Lippo Malls Indonesia Retail Trust (ticker: LPMDF) is an example of a REIT where we are accepting the risks one faces when investing in emerging markets. Lippo owns 17 high-quality retail malls and an assortment of other major retail spaces across Indonesia. Retail fundamentals should be solid for years to come in Indonesia, given strong demographic and urbanization trends (Figure 3). At recent prices, Lippo pays an 8% dividend yield, or two to three times the dividend offered by shopping mall REIT leaders in the U.S. like Simon Property Group (3.4%) and General Growth Properties (2.5%).

One of the potential drawbacks with REITs is that their corporate structures require paying most cash flow back to shareholders via dividends (rather than retaining for future use). While this can lead to better dividend yields, the structure does create a dependency on capital markets (equity and debt) that at times can be counter-productive.

Unlike most bonds, which carry a fixed coupon and therefore face price risk during periods of rising market interest rates, REITs have the potential to grow their dividends over time by raising rents, improving occupancy and making accretive acquisitions. 

Looking Beyond REITs

While many REITs carry much more resilient balance sheets today than they did back in 2007, the high cash payout requirement can still be a headwind to shareholder-accretive growth. This is especially the case should the positive cycle of 1) strong share prices, leading to 2) attractive equity raises, and then 3) further property acquisitions, reverse course. For that reason, we look beyond REITs when hunting for real estate deals.

Atrium Real Estate (ticker: ATRBF) and Immofinanz: (ticker IMMZF), for example, are both Austrian-listed real estate companies held in managed accounts. These companies combine properties leased for income with development projects and land banks for future growth. Atrium, which focuses on food-anchored shopping centers in Central and Eastern Europe, currently pays a dividend. Immofinanz, with income-generating assets and develop-ment projects across European office, retail and logistical assets, expects to resume dividends in the next year or two. 

Over in Asia, we also have positions in several very high-quality property companies. CapitaLand (ticker: CLLDF), for example, is a Singapore-based property developer primarily focused on mixed developments (residential, retail, office) in Singapore and China. In addition to these development activities, CapitaLand holds stakes in eight publicly listed property units (mostly REITs). CK Hutchison (ticker: CKHUY) is a Hong Kong-based global conglomerate with one of the largest property portfolios in Asia. A recently completed deal where the company spun off this property portfolio into a separately traded unit should give investors better visibility into these prime assets.

Responsibly managed real estate investments can be a strong addition to any investment portfolio. While our team is concerned with the current state of valuation across the most popular U.S. REITs, we continue to find significant value in several lesser-known REITs and property developers. The publicly listed nature of these positions exposes us to temporary sentiment shifts and price volatility, but in return we expect that our collection of real deals will generate a compelling mix of dividend growth and price appreciation in the years ahead.

Retirement Income and its Impact on Social Security

For some retirees, selecting when and which accounts to draw from to meet their retirement income needs can have an impact on the taxability of their Social Security benefits. Social Security taxability is based on your provisional income and falls into three inclusion brackets. Provisional income is your Modified Adjusted Gross Income plus half of your Social Security benefit.

If your provisional income is less than $25,000 for single filers or $32,000 for joint filers, your Social Security benefits are not taxed. However, if your provisional income is between $25,000 and $34,000 for single filers and $32,000 and $44,000 for joint filers, up to 50% or your benefits can be taxable. Above those amounts, you reach the top inclusion of benefits at 85%. According to a recent report by the Congressional Budget Office, about half of all Social Security beneficiaries owed some tax on their benefits in 2014. 

If you estimate that you will likely fall in or around the income levels in which your Social Security benefits will be taxable, there are planning strategies that might reduce how much of your Social Security benefits will be taxed.

One strategy that could make sense is spending down your IRAs or retirement plans in early retirement to delay claim-ing Social Security until later. Two benefits of this strategy are that delaying Social Security can result in higher monthly payments for life, and also your Required Minimum Distributions (RMDs) will be smaller in the future due to lower year-end balances. As a result, your combined income will be lower, potentially resulting in a smaller amount of Social Security benefits being taxable. Drawbacks to this strategy are that there is no guarantee you will live long enough to see the benefits of delaying Social Security payments, and IRA assets remaining at your death can pass to beneficiaries, whereas Social Security benefits cease at your death.

A second strategy to consider is converting a portion of your IRA to a Roth IRA in early retirement prior to taking Social Security. The primary benefit of this strategy is that this will reduce the size of your IRA subject to RMDs, and distributions from Roth IRAs in the future can be taken without subjecting Social Security to increased taxation. One of the drawbacks that needs to be considered is that it may be more tax-efficient to have Social Security benefits included in your income rather than paying the taxes on the Roth conversion. 

In addition, the Roth conversion is particularly appealing when you expect to have a year where you have a much lower taxable income (temporary or permanent). Now that your taxes are more than likely complete for 2014, it would be a great time to review the total of your taxable income listed on your 1040 to identify if you might be in one of those unique situations where you have zero taxable income, or if you anticipate that your income for this year or in the next few years will be significantly lower than 2014. If so, this would be a great time to review your portfolio with one of FIM Group’s advisers if accelerating your income, such as a partial Roth conversion, might be appropriate. Numerous factors can influence the success of a Roth conversion, but doing one in a low-tax year is a great first step.  

For those who estimate that their incomes from other sources, such as pensions, rents and investment income, are going to be far greater than the top thresholds mentioned above, you will likely be stuck paying tax on 85% of your Social Security benefits. If you have estimated retirement income closer to the top inclusion threshold or flexibility in estimated retirement income sources and you would like to review any of these strategies further, please give us a call to review your situation. 

Accell Group

Accell Group (Ticker: ACGPF,

Share Price | Market Capitalization

Company Description: Accell Group NV is a Dutch designer and manufacturer of bicycles as well as a wholesale distributor of bicycle accessories and parts. Head-quartered in Heerenveen, Netherlands, Accell is active throughout Europe as well as the United States. Assembly facilities are in six countries, and Accell employs nearly 3,000 people across 18 countries. Some of Accell’s better-known brands include Batavus, Sparta, Loekie, Ghost, Haibike, Winora, Raleigh, Diamondback, Lapierre, Tunturi, Atala, Redline, XLC and Nishiki. 

Investment Thesis: We believe that in Accell Group we have found an entity that through market cycles can consistently grow a few percentage points above GDP. Additionally, Accell has historically been good at returning capital to shareholders; today, Accell
is yielding roughly 3.63% (06/12/15). Given Accell’s exposure to the booming e-bike marketplace and alignment with key demographic trends, we expect Accell to continue its current
growth trajectory. 

Accell is aligned with two demographic trends that we believe are important for investors to heed. Urbanization continues to increase globally, and as more people are living closer together, traditional methods of transportation are becoming less efficient. Even in countries traditionally light in bicycle commuting, there is a shift occurring (e.g., France relative to Netherlands). Health and wellness are the second demographic trend at play here; people are becoming more active (think the “experience economy”). Interestingly, urbanization
is helping this, as people
have shorter commutes
they have more time to
spend on activities. 

For Accell, brands tend to be country-specific, with occasional cross-selling/market testing; this allows country-level teams to tailor the product as well as the marketing to fit pertinent demographics. Considerable discretion is given to each brand division; however, efficiency programs are occasionally exacted at a company-wide level (e.g., combining assembly/painting operations). With countless channels to distribute through, Accell takes unique tacks, helping smaller retailers with their logistics, creating experience centers, and helping these retailers to manage their inventory as efficiently as possible. 

While the product cycle spans a year, as with many other industries, the timing is unique covering a fall-to-fall time period. This seasonality is something to keep in mind as summer is very important (as well as the weather). Looking at Accell’s geographic footprint (i.e., weather exposure), an investor should ascribe greater uncertainty to any one-year’s expectations. Over longer periods, we expect solid management can continue to smooth out any bumps caused by a single year. Here, Accell’s scale and broad geographic footprint have helped them to weather years where summer was less than ideal. 

Accell has consistently proven that, regardless of economic malaise or inclement atmospheric conditions, they can grow efficiently. Their product mix spans the entire value chain: from high-end luxury road bicycles (e.g., Lapierres ridden by le Tour de France’s team Francaise des Jeux – FDJ), sturdy commuters (where differentiation is admittedly challenging), e-bikes (less popular in the U.S. but growing handily in Europe), to the more stable parts and accessories distribution business. 

Data Source: Company Filings, Bloomberg


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