With help from central banks, markets remain nicely higher seven months into 2019. Of course, what has happened is less important than what will happen and the purpose of this note is to add context to the economic update (linked here). We want to connect the dots between what we are seeing out there and how that is directly influencing portfolio construction.
A quick summary: We are focused on increasing yield and reducing risk.
The emphasis of this note is a simple reminder of how returns are generated. An
understanding there will provide rationale behind the portfolio adjustments we are making. The big
question we try to continually answer is: Where will returns come from? Let’s take a look…
Returns can be generated in one of three ways: 1. Yield 2. Growth 3. Valuations Rising. Here’s a simple example of each…
You buy a share of company ABC for $10. Company ABC generates $2 a share of earnings. You paid a valuation of 5x (5 times) earnings for your investment. Remember this is a simple example but hopefully helpful to illustrate the ways in which the investment can create return for you as an investor.
Valuations Rising – There are rumors floating around about Company ABC and its potential over the next year or so. Nothing has changed their financials today, but it hasn’t stopped people’s expectations from rising. The rising expectations have caused the stock price to adjust to $12 a share. You bought in at a valuation of 5x earnings and now, the same company with the same 2 bucks of earnings, is trading for 6x earnings – a valuation change that generated a 20% return for your investment.
Growth – Let’s revisit your investment and go back to our starting valuation of 5x earnings. Recapping, you paid $10 a share with company ABC generating $2 a share in earnings. Well, good news. Company ABC just landed their biggest customer – earnings are now $3 a share. If valuations remain the same (5x earnings), Company ABC now trades at $15 a share – a 50% return on your initial investment, not bad.
Market Note: Growth has been solid but there's enough evidence pointing to a higher level of uncertainty (again, more detail in the linked update). Hopefully we are wrong, but we anticipate growth to have less of an impact than it has recently.
We are through 2 of the 3 ways to generate return and both are looking to be a lesser influence on overall return than recent past. That leaves us with the 3rd avenue: Yield.
Yield – This is the easiest to quantify as it’s simply the return of capital on your investment. Again, sticking our example, if Company ABC pays a dividend of $0.50, that’s a 5% return on your investment.
Market Note: Finding yield in today’s environment is not easy. Stocks as a whole yield around 1.75% and the 10-year treasury is at 2%. We are shooting to build portfolios that yield 3% by finding consistent and repeatable yield, mainly from dividends.
The evidence is pointing towards Yield playing a much bigger role in the overall outcome, as it had throughout much of the 20th century. Between the simple examples of how returns can be generated in this note, and the linked economic update – we thought it might be useful to share some client-friendly language of the forces at work.
On a side note, can we brag a bit for our partners on the Opus Small-Cap Value Plus strategy? We went in thinking the people were right, the process looked sound, and the philosophy complemented our approach. The track record looked great, but how would it do in ETF format? Well, small value as a whole has been a tough class, but the emphasis on real dividends helped it outshine 99% of its peers in its first 52 weeks(Source: Morningstar). Kudos to Len, Adam, David, and Brad on a great first year!
As always, we thank you for your trust and please don’t hesitate to reach out with questions.
The Impact Series is a model portfolio solution developed by Aptus Capital Advisors, LLC. Aptus Capital Advisors, LLC is a Registered Investment Advisor (RIA) registered with the Securities and Exchange Commission and is headquartered in Fairhope, Alabama. For more information about our firm, or to receive a copy of our disclosure Form ADV and Privacy Policy contact us. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any securities or to advise on the use or suitability of The Impact Series, or any of the underlying securities in isolation. Information specific to the underlying securities making up the portfolios can be found in the Funds’ prospectuses. Please carefully read the prospectus before making an investment decision. Diversification is not a guarantee of performance, and may not protect against loss of investment principal. Growth Composite Disclosure Statement: The Growth Composite contains fully discretionary investment accounts and is measured against the iShares Core Growth Allocation ETF for comparison purposes. The Growth Composite was created on December 30, 2016. Moderate Composite Disclosure Statement: The Moderate Composite contains fully discretionary investment accounts and
is measured against the iShares Core Moderate Allocation ETF for comparison purposes. The Moderate Composite was created on December 30, 2016. Conservative Composite Disclosure Statement: The Conservative Composite contains fully discretionary investment accounts and is measured against the iShares Core Conservative Allocation ETF for comparison purposes. The Moderate Composite was created on December 30, 2016. Disclosures Applicable to all composites: Aptus Capital Advisors is an independent, privately-owned investment firm, registered with the SEC. The firm maintains a complete list and description of composites, which is available upon request. This report is intended to be a one on one presentation. Results are based on fully discretionary accounts under management, including those no longer with the firm. Non fee-paying accounts are included in this composite. Past performance is not indicative of future results. Composite dispersion is measured gross of fees on a dollar-weighted standard deviation with total weighted return being asset- weighted. Returns are actual returns, not model-simulated returns. Aptus Capital Advisors is managed by humans who are subject to error and lapses in judgment.
The Impact Series Benchmarks are iShares Core Allocation ETFs. iShares Core Asset Allocation ETFs are designed as diversified core portfolios based on the specific risk consideration of the investor. Each iShares Core Allocation Fund offers exposure to US stock, international stock, and bond at fixed weights and holds an underlying portfolio of iShares Core Funds. Investors choose the portfolio that aligns with their specific risk consideration. iShares Core Allocation ETFs offer investments to meet a Conservative (iShares Core Conservative Allocation ETF), Moderate (iShares Core Moderate Allocation ETF), Growth (iShares Core Growth Allocation ETF), and Aggressive (iShares Core Aggressive Allocation ETF). Source: Blackrock Investing involves risk. Principal loss is possible. Investing in ETFs are subject to additional risks that do not apply to conventional mutual funds, including the risks that the market price of the shares may trade at a discount to its net asset value ("NAV"), an active secondary trading market may not develop or be maintained, or trading may be halted by the exchange in
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