Delaware Investments portfolio managers Bob Zenouzi and Damon Andres discuss long-term wealth accumulation amid a world of low and negative yields, with uncertain investment outlooks.
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In this webinar, the team will discuss:
<ul>
<li><p>Market forces currently shaping relative outlooks across asset classes; </p></li>
<li><p>Perspectives on the risks associated with reaching for yield;</p></li>
<li><p>The ways in which various factors may influence asset allocation decisions in broadly diversified portfolios, such as macroeconomics, credit outlook, and financial conditions. </p></li>
</ul>
Video Image:
Duration:
0000 - 00:58
Transcript:
S1 00:00 Good afternoon everyone. My name is Erica Kay and on behalf of the Delaware Investments, I'd like to welcome you to our Capital Markets Coaching Clinic this afternoon, where we will discuss the art of the blend. Whether it's keeping you ahead of the curve, when it comes to technology and social media trends, helping make your work day a little more efficient, or learning about the market from our team of experts, Delaware Investments strives to be your partner in growing your business and serving your clients. We will get started now. Our discussion this afternoon features Bob Zenouzi, our CIO here at Delaware Investments, of the real-estate securities and income solutions team, as well as Damon Andres, Sr. Portfolio Manager on the team. Between the two of them, Bob and Damon have. over 45 years of experience investing in income-oriented solutions in the closed-end fund, mutual fund, and institutional world. In addition to sharing their thoughts with you today, they'll also be soliciting your feedback. I'll be inviting you to join our conversation via several poll questions, so get ready to participate. I will turn it over to Damon to get us started. Damon?
S2 01:57 Great, thanks so much Erica and hello to everyone out there on the webinar. Thanks so much for your time and interest today in what we will be discussing today, what we call the art of the blend. And what we mean by that, in a general sense, is that there are secular changes and trends occurring that will require a change in how the investment industry thinks of asset allocation. Both investors and advisors can't simply build style boxes and then make over and underweight decisions on those style boxes anymore. Asset allocation and portfolio construction now needs to be more focused on a core solution approach as investors' needs or demands are changing coupled with an investment landscape that has evolved into a world of low yield and low growth. In the layout of today's webinar, I will first go over data and some slides on demographics, spending and growth that highlights the current investment predicament investors are facing today. And then next, Bob will discuss the implications of this secular shift, or what we call the predicament, in terms of market valuation, risks, and investor behavior. And finally, we will discuss what to do. And while there is no single answer or silver bullet given the investment backdrop, there is a change in investment approach that is a necessity to try to fill changing investors needs and demands in today's marketplace. And while this type of approach is something that we've been doing at Delaware Investments, really since the mid-90s in a couple of our products on closed-end, open-end funds with great success, it hasn't always been through that full cycle since the 90s. The most pertinent style as we have gone through great bull markets and technology booms, but it still, over that time, has put up great numbers. And then in today's marketplace, it's that similar type of approach that we think is going to be a necessity for both investors and advisors in constructing investment portfolios.
S2 04:36 So jumping into the first of what we call the predicament, we title it The Times are Changing, so to start off with demographics, which is a major factor today. What's going on in the US, in terms of demographics, is it something similar that preceded Japan's Lost Decade, which is now actually not a lost decade, but a lost two and half decades, and it's still an economy that is struggling to gain traction and to gain growth after they slipped into this lost decade in 1990. And while we're not out there trying to scare everyone, and we're not out there with any predictions or forecasts that the US will follow suit into a similar type of economic downdraft that Japan has experienced, the point is, that demographic shifts do have a material impact on economies, and more importantly, on investor preferences and needs. And all one really needs to do is, just type in Google 'lost decades and demographics' and there's plenty of research on how the demographic shift really impacted what's going on today in Japan. Bob often quotes in some of his presentations, what happened in Japan is - there are more individuals wearing Depends than there are wearing diapers as they have a massive bubble of an aging population. That's what you see on this first slide here. What's happening, as you can see on the chart on the left, in the mid part of last century, the average life expectancy of the US citizen was in the low to mid 60s and currently today it's reached into the mid 80s, which is over a 20 year increase in life expectancy. Relatively similar for male and female, in terms of expectancy now. What does that mean? It means that after retirement - we are generalizing our retirement age - investors will live another 20 plus years into retirement, which is significantly longer than US citizens have ever dealt with in the past.
S2 06:59 On the next slide, another way to look at this demographic impact is by the shift in the older generation, in terms of percent of the total population. This chart dictates the rapidly increasing portion of the US population that is 65 years and older. This older cohort, mostly represented by the Baby Boom generation, was once just over a tenth of the population, will soon represent over a fifth of the society in the US. This growing, aging portion of the population, coupled with a much longer life expectancy is going to have some material impact on investor preferences. Now we're going to jump into a couple of polling questions. If everyone can - on the computer - answer these questions, we'd like to see what their responses will be. First question is, what is the probability in terms of percentage, that a 70 year old person today will live to reach 80 years or older?
S1 08:11 I'll give everybody a second, a time to respond here. To see what you think, and what is that probability of a 70 year old today living until they reach age 80? We'll see what most of you thought, 70%.
S2 08:36 That's good. One, everyone is right and two, everyone is optimistic. So that is correct, it is 70%. The interesting part of this that I think is that, when you go back to middle last century, when my parents were growing up. That age 70 was past the average life expectancy already. That is the starting point of where we are today, where we see investors having to really change their savings and investment habits. The next question, another age cohort question. Which generation currently is the largest age cohort in America, Gen X, millennials, baby boomers, or what many people don't even know what's out there, but the silent generation?
S1 09:30 This is something I know advisors have been talking about what in their practices worked when they're getting to know your clients standpoint recently, but in getting to know your clients, it will also affect how you need to adapt for those clients. So just give everybody another second, which generation currently is the largest age cohort in America? And we'll see what the majority response with here. Little bit closer this time around.
S2 10:04 But we tricked them [laughter]. They're wrong. So wrong by one. Millennials, actually beginning with this year took over the baby boomers, in terms of the largest population. That being said, they are basically neck and neck in terms of absolute ties. The millennials, who are now ages around 19 to 35, are just over 75 million people. And the baby boomers, who are now 52 to 70, are just a hair under 75 million. So they're really neck and neck, but what's interesting is the millennial did surpass the baby boomers just earlier this year. I think what we find interesting about this statistic is when you think about these two cohorts and their ages that represent first and second place in terms of the proportion of the population. They are also what we think are the most significant target or potential sources for investment bias today. The millennials, again ages around 19-35, just starting to invest. A lot of them just getting to their first jobs and having some real income. From what we hear, they're looking at investments in a different way. They've seen a lot of volatility, corruption. The housing is a totally different impact on their portfolio today. Being able to approach millennials with more of a sound, visible investment approach we think is going to be critical. And then for the baby boomers, who are either just entering or about to enter retirement, have made their savings but now need to plan for their retirement with, as we've just been through, a life expectancy that's much longer than what advisors or society has dealt with in the past.
S2 12:09 Moving onto the next slide, which is another secular shift that we see, it's a change in the cost of healthcare. As you can see, Medicare and Medicaid spending really since 1990 grew at an 8% compound rate from around 12% to about 18%. And then healthcare spending at the percentage of GDP actually really took off and far outpaced that rate growing from around roughly 12% to almost 27% of GDP. This growth and health care spending along with the aging population again I think will have a significant impact on investors' preferences. Another way to look at this healthcare spending is from personal consumption or individual consumption point of view, which has also grown just as rapidly. And as you can see in the chart below, the health care line item that's highlighted is barely over 5% of personal consumption from the middle of last century. Health care is now approaching just shy of one-fifth of personal consumption. It's the second largest individual line item of personal spending just shy of housing and utilities combined. And we would expect that it actually will surpass that and become the largest line item of personal consumption in the near future. And while we don't have data on this, it's definitely logical or almost obvious that health care in terms of a percentage of personal consumption where the baby boomers, and even larger piece of spending than highlighted in this chart. So this massive increase in health care spending for the US, the personal consumption, and also especially for the baby boom generation, implies a meaningful shift in a more need- or necessity-based spending habit, and less discretionary spending for this age, this second-largest age cohort. And the result is for these investors they need to look for steady and recurring income from their investments. They are much less tolerant to volatility and seek downside protection. To further compound this predicament beyond demographics, beyond spending and need-based spending on health care, the US is in the midst of a potentially secular decline in growth rate. In fact, we can see the slowing growth is not just specific to the US, it's actually a global phenomenon. You can see from the chart, if history is any indication, the US is even due for a recessionary period sometime in the near future. When we look on this chart at the last four expansionary periods the actual growth rate during expansionary periods is meaningfully declining and the trend is clear and the term of those expansionary periods in the mid 80s was eight years, the mid 90s was about nine years, and in the early 2000s it was about five and a half years. For an expansionary period right now just after The Great Recession is really hidden a little over seven years. So definitely pushing the envelope in terms of longevity of cycles before you do enter into a recession. And one question we get again on this, is why not look at international or emerging markets for growth, and again I mention this is not just a US issue, this is a global phenomenon. You could look at other charts - it looks similar across the globe. And the other issue that we see with looking at international and emerging markets is even with their deceleration in growth, you also have increased risks because their economies are significantly more levered, their consumers are significantly more levered and their economies are linked towards more volatile commodity and energy markets. So from a risk/return perspective-- and history shows that they do not offer a meaningful boost to risk adjusted returns.
S2 16:42 Moving from GDP to an earnings based look at growth, we highlight this next chart. On the left, you can see that there's been weak and decelerating growth. In fact, the last four years have failed miserably to meet growth expectations on a global basis. Given current history, and current macro data, we would actually expect the same for 2017 estimates. As you can see, the chart on the left, in starting at 2013, original expectations were for 13% growth, and they ended up at 7. For 2014, original expectation's at 12, they ended up at 6. In 2015, original expectation's at 12, and they actually ended up at -2. In 2016, similar situation - 13 but ended up at 2. What's important to highlight here, is that each year that they failed to meet expectations, set up the following year should have an easier comp, and yet they still failed to meet expectations. Again, with this trend, and also the macro data that we're seeing currently, we would actually expect the same for 2017. On the right you can see, again we highlighted it, international - when you look across the globe - international does not necessarily provide any relief from this slow, or decelerating growth. This is just looking at what happened in 2016. It becomes even more pronounced if we could show the actual last four or five years of what happened to emerging market growth.
S2 18:28 Then finally, the last piece of the investment predicament, we call the income conundrum. For simplicity-- it's still relevant but we look at the yield at the ten-year US Treasury bond as a proxy for income generation. And there's a clear secular decline here since 1980. Even if we get a shift for any reason upward in this yield, perhaps the Fed raising rates in December, which is now the most likely scenario, it's hard to really understand or rationalize an increase in income that would really be meaningful for investors' portfolios. Even a doubling of yield off of such low basis doesn't have a very big impact. So the result of this drought in income, is that it's pushed investors to one, riskier or unconventional sources of income and/or two, a crowd into the traditional sources of income, but are forced to overpay and increase the risks.
S2 19:33 The next slide shows what's currently occurring in these traditional sources of income. And as you can see, across the different asset classes that investors traditionally use for income, The grey bars represent the historical ranges of yield, and the blue squares are the current actual yields generated by these asset classes. And the current yields are at, or very, very near, the all-time lows for virtually all of them. And those lows were just set in this recent cycle - they weren't from the last cycle or a few cycles ago. These are all being pushed to historical lows. So, given that backdrop, we see some major secular headwinds for investors, between the demographic shift, the change in spending needs-- or change in spending to needs-based spending from discretionary, slow global growth, and low historical sources of income. We ultimately feel this will change how investors and advisors need to structure their portfolios. And with that, I'll turn it over to Bob, to discuss the implication of what we see going on in the market today.
S3 20:51 Thanks Damon and good afternoon, everybody, thank you for joining us. After listening to David, and seeing these slides, a picture tells a thousand stories here, but some of these trends are no doubt irreversible. You have aging, which is leading to slowing growth, which has lead to low yields, which leads to lower returns, now you have increase in the cost of health care and basic necessities. So, if you're not thoroughly depressed at this point, I'm not sure what else we can do. But, for the most part, this is the facts, we are an aging society, not just here in the US but across the globe, Europe is over and as Damon mentioned, Japan is in dire straits on top of the fact that they have more debt than any other country as a percentage of GDP. I think that the cost situation is only going to get worse, given the fact that boomers are getting older and millennials are right on their tail. What could change, we think though is if there's a loss of confidence in central banks, or if we do go into a recession as earnings rates are coming down, credit spreads could widen out. Even though Treasury rates could stay low, high-yield bonds, investment-grade asset-backed securities, you could see higher credit spread. And so when I look at this picture of and this question about - are equities cheap or bonds expensive? - it all depends really on what happens to bond yields and investor expectation of the economy. Right now, you can see bond yields going back to the mid-'80s were in the 8, 9% range. And today, on a global basis, they are under 1%, so after taxes and inflation, you're earning nothing. And your bonds then you have $12 trillion of negative yields, and it's forcing investors into the equity markets. And there is a new acronym called TINA, There Is No Alternative, by going into equities, given how low bond yields are. And so the desire for yields is now being captured and satisfied in the equity market by investors, and so the issue isn't so much are equities cheap or bonds expensive, it's that it really comes down to the fact, will inflation rise or will there be a loss in confidence and/or recession that'll push bond yields higher? And if that happens, equities are not cheap. So it's a predicament that we're all facing as investors. I think we have to grapple with this reality, and investors need to understand that there is risk in equities if bond yields begin to rise.
S3 23:44 Following on the next slide, low rates and expensive defenses, as we call them. On the left chart, what you see is, first the global equity P/E, just P/E of global equities in the light blue, going back about 20 years, and you see currently at about 20 times. Not as high as they were in the tech bubble, but still not cheap, and mainly because bond yields were so low. But what you notice is after the GFC, and right before it really, there was this need for yield. And today, defensive P/Es, meaning those stocks that have higher yields or more stable cash flows, like consumer Staples, J&J, Proctor & Gamble, those P/Es now are at 23 times, and they've doubled off the lows from 2009. So that's just the clamoring for safety in yield by investors and what we call that is the bondification of equity. Investors who can't satisfy their need for yield in bonds have come into the equity market and bought REITs and utilities and MLPs in infrastructure and consumer staple names to get yield. And I think what's happened there is it's pushed those prices up in that has reflected in the second slide there to the right. When you look at the relative dividend yields of staples and health care, but really, the re-rating, meaning from higher yield and to lower yields relative to the market with telecoms and utilities. And bond yields stay where they are and we don't get a lot of confidence in central banks. And we then [we go into?] a recession and that regrade can continue, a lot lower than it was in '08. But you can see a pretty strong performance, so as long as rates stay low, the valuations can persist and we're seeing that continue into this year. Now, another way to look at valuations is by looking at the ends of stock P/Es versus P/Es of other parts of the market. So in this case the forward P/Es of high data stocks are now at 16 times earnings. Back at the bubble times, where those stocks were trading at 24, 26 times and you can see forward P/Es of low beta stocks, like utilities and REITs and consumer staples were trading 15, 16, and now that's reversed. And that's been reversed, really over the last three to four years. And it's about a seven or eight-point spread today. And I think there's many investors out there saying, "You know, I think it's time to buy banks," or "I think it's time to buy old technology," or "It's time to buy industrials or commodities," because they're so cheap. As we all know, valuations can persist at wide variations for long periods of time, and if we continue to have bond yields at these levels, there's no saying that forward P/Es of low beta stocks can go from 22 to 25 to 26 times, and forward P/Es of these high beta stocks, the gray that you see there, could just languish. And it's interesting, as we're investing every day, when we're seeing the markets come down, the equity markets are selling off, these low P/E stocks don't necessarily act defensively just because they have lower valuation. This clamor for yield, this clamor for safety - investors are continuing to buy even at high valuations. I guess the message here is careful about making a call just on pure valuation. There's other technical factors behind this that could push these valuations further along. Now, are we saying to go chase the highest yields?
S3 27:40 No, absolutely not, and on the next slide what you have-- and we're just using two examples of utilities in staples and looking at forward P/Es of S&P 500 utility sector versus the overall S&P. And you go back 20 years and you see that they're trading well above their historical average, 1.08 times versus 0.88. However, if you look of the past seven/eight years it's persisted at that high valuation, so again be careful about making just pure valuation calls. This is because of low rates hence pushing up the prices and pushing the yields lower, the sector. You can't have corrections. Just because you have a yield does not guarantee you downside support. We saw how much money was lost in high yield bonds and REITs and utilities back in the '08 downturn. Same with staples. They're selling at above their long term average, and you can see back in 2000 and 2008 they've lost money too. So, by chasing the highest yield, you have a problem, and the problem is that you're living longer - if you want to call that a problem - but if you chase the highest yield, you will have a problem later in life because you will run out of money. The highest yield is generally companies that have higher leverage, slower growth, and therefore they're paying out most of their income, hence the higher yield. So you can only meet the essentials of life, but you will not ensure a lifestyle or prepare for the unexpected. And that unexpected is most likely is some sort of health care scare. And with health care costs going higher, you need to grow capital, so if you just chase the highest absolute yield you will deplete capital. From the timing of your retirement, let's say 68, till hopefully you're living in 85 - and many are given the longer lifestyle. So, what we're saying is don't do the easy thing and chase the high yield. If a manager says I've got a fund with a 5% yield, well there's only one asset class right now in the world yielding higher than that and that's high yield bonds. So they're loaded up in high yield bonds, when you're chasing that high yield, what you've done is narrow the universe that you can invest in. Why would you want to narrow the universe? You want as wide the universe as possible to have the most opportunities. So, you submitting to that, to your worst instincts and just chasing the easy thing is far riskier today, because if credit spreads widen out, you will have a very risky portfolio and you will see the decline. It happened in 2013 in the taper tantrum, it happened in 2015. Yield, 20 years ago when Damon and I started managing multi asset income portfolios, yield was a desired trait. Today, it become a complete obsession. I just read today, we've had 36 ETF issues in the first 17 days of September and the largest ETF is an ETF buying the 10 highest yielding ETFs. So, it's gone beyond obsession to almost a craze for yield today. And so, we're asking investors and recommending is be patient, be smart, don't swing at every pitch. It's like what Warren Buffett says, "Let the game come to you and wait for that fat pitch and you'll get your opportunity." Look at MLPs today. Today is the time to look at MLPs, not two years ago, cause they've fallen 60% peak to trough. In 2011, there was an opportunity to buy cheap yield. In 2013, early this year when REITs sold off 12% and high yield was weak, those are the times to buy yield, not chasing it when everyone else is chasing it or creating ETFs on ETFs. So, if you buy yield cheap enough, you have embedded growth, you wait, earn your yield and then the stock will re-rate or the security will re-rate back to its intrinsic value, and that's how you can make money in yield stocks.
S3 31:53 To give you a sense of what's happened so far in 2016, we combed some data and we looked at large caps, small caps, and looked at other developed markets around the world. When we found that the top 20% of dividend yield versus its category as seriously outperformed and what you find is here in the US, large cap stocks for example, the top 20% of dividend yield of large cap stocks has outperformed all other larger cap stocks by 1,100 basis points, and that's just in eight months. In small cap it's not as much as 1,100, it's about 500, mainly because of the growth aspects of small cap but nevertheless still outperformance of the top 20% of dividend yields, and that's the common theme across the globe in the UK, in Japan, and other global markets. You're seeing 800 to 1,000 basis points or more of outperformance of the top 20% of dividend yields. This is just a sort. Investors are sorting from the highest yield to the lowest yield and they're buying the highest absolute yield, regardless of fundamentals. We found managing multi-class income funds that we invest on pure math, you lose, and right now it's some big momentum trade and the only place [it's working?] is continental Europe and that's because of the banks are having trouble and they have the highest yields and most likely will be cutting those yields going forward. It's a global phenomenon.
S3 33:31 And when we looked at large caps stocks here in the US, it's a similar picture. Consumer durable stocks, the top 20% of dividend yielding stocks are outperforming all their consumer durables by almost about 1,000 basis points capital equipment by almost 1,700 basis points. Across the board I think tech and-- pharma and biotech a little bit less mainly because, again, of the growth aspects. But no surprise at the far right you can see that energy and telecom are outperforming by 1,100 and 1,200 basis points. You just have this clamoring for yield and regardless of the market, regardless of the sector, regardless of fundamentals. And this reminds me of everyone chasing tech in 2000, everyone chasing the home buying in 2005 and 2006. And we all remember how that ended and they don't end well. So these are mania, and that's what we're in today is capturing the highest absolute yield is in that mania phase.
S3 34:40 I think that on the slide here where yield comes with risk, it's very educational. One would think that the higher the yield, the lower the volatility, and we sorted by these different assets classes, treasuries, munis, and all the way out to high yield bonds. And we sorted from the lowest yield to the absolute highest yield, equities and fixed income. And what we found, for example, was when you look at dividend equities here in the US or global equities about the same yield, 2.6. US is outperformed and this is from January of '09, so basically from the bottom, after the GFC then you find pretty good return, you know? US obviously has outperformed 17% annualized returns really strong 10%, but that comes with significant risk. You're taking about 100 basis points more yield and dividend equities over muni bonds but you get almost five times the risk or four and a half times the risk in standard deviation. 3.9% standard deviation versus 14.1. So you have to live with that volatility if you want just 100 basis points more yield. Let's go down the column and look at global REITs, at 3.7 or global infrastructure at 3.8. You see pretty decent returns. 14% annualized for REITs, 9 for global infrastructure. But look at the volatility. This is called chasing yield and the reason why the volatility is so high even though the cash flows are more stable than dividend equity and global equities is because we've compressed the valuation. When you compress valuation in terms of yields and you're closer to the treasuries and you have less buffer, a less margin of safety, you will then become more volatile. Remember, if you have 10 year treasury at 1.5% and it moves 25 basis points, it's a far greater impact on the market if you have a 5% treasury and that moves 25 basis points. That's just simple math. There's a great deal of volatility there in some of these bondified equity in global REITs and global infrastructure, and you're seeing that really prove itself into the volatility of 19 and 15%. Buyer beware of these higher yields. Lastly, high yield bonds still look attractive, decent return - pretty strong returns actually - over the last seven and a half years, with much less volatility and standard deviation. Higher yield may be a higher return, but certainly much higher volatility.
S3 37:32 Now, let's talk about the dangers of chasing yield, and I want to point out that we all remember 2008 and how every asset class went down. This is just from post the financial crisis, so this is after the financial crisis from January of '09 through June of 2016, and once again we took the same asset classes and sorted them from the lowest to the highest yield. We said during this seven year period, this recovery, what has been the drawdown? Of, let's say, dividend equities or global equities, and you can see it at 2.6 yield. You had a drawdown of 20% in global equities. That's a pretty significant drawdown, if you think that you have a safe yield here. Corporate bonds obviously 2.9 yield but only 5% draw down. Clearly, a safer bet there by going up yield and capturing only part of the draw down that you would in equity. Again, global REITs, global infrastructure given the valuations. You want higher yields? No problem. You can get higher yield, you will also have more drawdown. You'll get 27% drawdown in global REITs. This is post, again, post the GFC. Emerging markets, high yield bonds, again, not as bad, a little more attractive, obviously, higher yield but they're also dealing higher up in the capital structure.
S1 39:05 That'll be it. There's a couple of more poll questions coming up here. We've covered a lot the last couple of slides but I'm just curious to see out there, what was the peak to trough return performance in total return percentage for US REITs during the financial crisis? This will help set up some more coming conversation, as well. Give us your best guest at what the peak to trough performance was for the US REIT market was during the financial crisis. Let's see what the group comes back with here. I've got kind of a nice split here but the majority at that -45%.
S3 40:02 Well, unfortunately the majority was wrong. This is the danger of chasing yield. The peak to trough drawdown was 72%, from December of '06 until February of '09. Almost a two and a half year period but over two years. That's a significant drawdown. Think about it, 72% from a sector that has contractual leases in place and yet, you had a significant drawdown more than the market. Now, why is that? REITs are leveraged. At the time, they were eight times debt to EBITDA, and they have to pay out - because of REIT rules - 90% of their taxable income. And so investors still will have stable cash flows, the dividends are fine, and I have these leases in place, I'm okay. So what happens is when you can't access capital because you're paying out 90% of your taxable income, and the cost of that capital's going higher, investors will just assume that you can't refinance your debt, you can't finance your operations. And given the amount of debt that they had, eight times debt EBITDA, the significant drawdown. So buyer beware again, when the costs and the availability of the capital go the wrong way, i.e. the cost goes higher for that capital and the availability goes down.
S1 41:28 And the follow up to this as well, on the next poll here, what was the peak trough decline in operating income for US REITs during the financial crisis? So again, looking for that percentage [number of years?] on what was the peak to trough decline in operating income for US REITs during the financial crisis? We've got some options below and we'll see what the majority of responses here. We've got our closest poll with -35% looking majority here.
S3 42:15 Okay, well it would make sense to think you would believe that if the stocks fell 72%, the cash flows must have fallen somewhere close to 30 or 40%. The answer is -11%. Those that thought REITs have very stable cash flow, keep the occupancies, contractual leases in place, you're right. But what happened? Why did the cash flows fall 11% if the stocks fell 72% from that peak to trough? Because it had nothing to do with the fundamentals of real estate. So the approach you have to take in any of these sectors, long leases in place, they have to pay out. Most of their taxable income is understanding the capital market, specifically, the cost and the availability of debt and equity capital. So, fundamentally, real estate actually did okay. Commercial real estate did fine in the '07-'08 crash. It actually did better than the '01-'02 recession in terms of fundamentals, but REITs during that time period, because capital was still cheap and available, didn't have a downturn. In this case, they were over-levered, they had too much floating rate debt, and hence the fundamentals were okay. It was on the right-side of the balance sheet that they had troubles. So only 11% decline in fundamentals, but a 72% decline in price. It was a painful period REIT investors. Thank you for taking those poll questions.
S3 44:00 On the prior page, in the dangers of chasing yields, I neglected MLPs for a reason.I wanted to give MLPs their moment of glory here. About a year and a half, but I'd say, over the last two to three years, we would go on the road and we would hear from many FAs or investors that our fund had 2.6% dividend yield. These MLPs are yielding 4.5 to 5%. And we thought that MLPs would not withstand a decline in oil prices mainly because we didn't believe that the contracts, these take or pay contracts, that they advertised as safe and stable, would not be enforceable if the price of oil went down, just given our discussion with some of the energy analysts here. So we avoided MLPs for the better part of 2010, '11 and '12. And then come 2014, the yields were very compressed and we saw the price of oil then from September of '14 decline from about 90 down to the lows of $25 a barrel in early 2016. And so what would happen to those MLPs or what should happen? They should've been stable. Those pipelines should be flowing oil because they are take or pay contracts, and what happened was the EMP companies were somehow able to reduce the payment or just not pay, given the fact that the oil just wasn't flowing. They shut down the drillings and so there was no oil, so they were able to go to court or just refuse payment of oil. And so even it was flowing, they either had less payment or no payment coming through. And so what happened was with the MLPs that you saw were safe for the 4.4-4.5% dividend yield, they fell in price 61% from peak to trough in a 15-month period. So if you started off with a 4.3% yield, you lost 15 years of dividend yield in just 15 months. Okay. So what you have here really in reality was a cyclical industry pegged to a price of one commodity, oil. They levered it up and smacked a big yield on it to sell it and it was sold. And so you had to sell it at the bottom in December of last year/early January or you lost 50 to 60%. So buyer beware when a cyclical industry with a lot of leverage has a big yield. This was a wolf in sheep's clothing.
S3 46:38 So lastly in terms of the implications of all the slow growth and the aging population, is that companies had not been reinvesting into capex. And there are two things you can do with your cash flow at the end of the day. One, you can pay it out to investors in dividends or buy back stock, or you spend it on your own company, meaning reinvesting in capital expenditures, property planing equipment. And what we see now over the last five quarters and probably entering into the sixth quarter is declining growth of earnings per share and that's the light blue-- the dark blue line that you see in this slide. And so the implications of this is that even though we've seen slowing earnings growth, CEO's are people too and what they see are companies their peers raising dividends - and that's the light blue line, dividends per share - and their stock prices are going up. So CEOs continued to feed investors what they wanted, and that was higher dividends. Unfortunately over time, dividends can't grow if earnings are declining. And so today, yes, the S&P 500 payout ratio - dividends divided by earnings - is at its all-time high. It's at 38%. And so at some point, you're going to see that dividend-per-share roll over. And so when I see an ETF being issued today buying the next 10 highest yielding ETFs, I just wonder if they're taking this into account. And so I think that active management can really add value here because when the tide goes out, these ETFs are going down, and they're going down hard. And I think this is where active fundamental analysis of companies at the company level will allow us to differentiate between those companies that were just raising dividends because that's what the market wanted and those companies that have a real business model with high returns of capital and that can continue to raise dividends. So this is a real issue for investors and something that requires significant analysis.
S3 48:48 So as we enter the last couple minutes of our presentation-- what do you do? An aging population, you have low growth, low yields. Costs are going higher. It's a difficult environment, no doubt, for all investors. With that 70-year-old now who has a really good chance, a 70% chance of living to their mid 80s, they've got to be smart and diligent. As investors, as PMs we need to be smart and diligent and so do FAs. I think a combination of connecting a responsible level of income with appreciation is what makes sense. When you look at the entire universe of fixed income and hybrid equity and securities, there is plenty of opportunities here. I'll just mention for example, in preferreds we're finding 5% to 6% yielding preferreds and REITs, in the banking sector with two-year duration. Very insensitive. Convertible bond market you can get 3.5% to 4% yields with little equity sensitivity. This is a very inefficient, institutional market you can toggle between equity and bond sensitivity. Obviously, some REITs and MLPs are looking attractive, mostly the MLP side given the higher yields there. The fact that they are down 50% plus from peak. And option over-riding, I think it's a unique skill, but when you see stocks down and the volatility up, you can grab a lot of premiums. The real message here is invest up and down the capital structure, across geographies, buy cheap yield and seek steady growth going forward. The investment challenge then becomes to find income with growth in a risk-controlled way, and our approach is a responsible level of income and not the highest yield, because a responsible level of income will allow you to grow that capital so you don't deplete it in your later years. If you have a responsible level of income with growth that will provide you natural downside support. Not only downside against the equity markets but also against credit spread widening. So I'll turn back to Damon to finish off the last two slides.
S2 51:06 Yes, hello. Again, you're just finishing off what we laid out here and what we think is truly a change in environment for investors' needs I present this slide taking outside the box we call it, pun on the Ghostbusters movie, the Boxbusters. Really a move towards [solution?] based investing. The style boxes, everyone knows historically were designed to provide outright diversification. You add enough, you mix enough and you get better risk-adjusted returns. The problem though is the trends you see in the industry, some of it ETF-induced it, as Bob mentioned. Correlations have moved higher and traditional style boxes don't really give you that benefit anymore. And in addition to that, you don't really-- it's not focused on a solution. It's just trying to provide a good sharp metric or, you know, risk-adjusted return. And really, what we've laid out with demographics, change in spending habits, slower global growth, low income for a very long time here. Investors are demanding different things out of their portfolios. And we think the move is again, out of kind of a traditional style box, to focusing on the solution. And every client's going to be different. But it will be a blend of wealth accumulation, preservation of capital, certain level of income and downside protection. And again, there's no silver bullet here. And, but you know, there's active management we think really will provide the best type of return strength or solution-based investing. You know, the ETFs don't really have factors in mind, and they chase trends and fads. And what we're saying is don't chase those fads. Don't be forced into trying to provide an investment outcome that's unattainable. We've seen so many yield and income products on their initiation promising high yields in the 6 and 7% range. And we sit down trying to figure out how they can provide it. And the reality is they can't. There's smoke and mirrors out there, and they blow up and with the fads, we've highlighted what can happen to the downside when you-- and we pick on REITs and MLPs but look, there's time to own these, but there's time to avoid them. And you can't chase things into a crowded tray. So we think really having that mindful eye, trying to focus on solutions for our client, and not just diversification, is going to be the key.
S2 54:17 For that we kind of look at the next slide, which really is just a traditional efficient frontier. We throw all of those major asset classes out there, but that optimal portfolio can actually, with active management, fall outside of that efficient frontier. And that's because of just actively managing across, up and down, as Bob mentioned, up and down the capital structure and across geographies. And having a mindful eye on when risks or valuations or bubbles start to percolate and when you have opportunities to present yourself. And again, it seems as though we maybe picked on MLPs and REITs, but if you were mindful of valuations and, you could've owned some, but if you missed of a lot of it, there was great times to be buying REITs and MLPs. You kind of had to do it when the herd wasn't doing it and not chasing those trends.
S2 55:21 To summarize, on the final page we [inaudible] the whole presentation. There's a lot a lot of headwinds out there and it's a vastly changing landscape. Demographics are tricky and yield environment is tricky. And that's going to free the need for wealth preservation. Investors are living longer and they have more need-based spending. And then you have also the market which has become much more volatile in terms of certain segments getting to high valuations and create high risks. They can work for a little bit, but if you chase them too much or too far, the risks are very, very high.
S2 56:13 Then finally, just really the need for responsible income. Don't promise things that are unattainable. Income is low, and investors might think they should be trying to buy that income, but be smart and be responsible about the income that you have in your portfolio and if you're doing it right, the wealth accumulation, because of the mindful eye on valuations, you can take capital out of your portfolio and use that to subsidize any shortfall income. With that, I think we'll wrap up the presentation.
S3 56:57 Thank you.
S1 56:58 Yes, thank you to Bob and Damon for sharing a conversation with us this afternoon. I think what we've been left with here is a very honest conversation about the mindfulness to consider when working with your older clients and also your younger clients. You're really solving a solution for clients. And whatever that solution is along the spectrum of investment needs, that your clientbase may have, to not lose sight of that responsibility in your investing. I wanted to close with some more information so if you'd like any more information from Bob and Damon, please visit our website that you see on the screen. And for more regular commentary from this team and also our other investment team, please visit the insight section of our website and subscribe through the update for when new content is available. To learn more about The Evolving Advisor Practice Management program and to find your Delaware wholesaler, please visit delawareinvestments.com/evolving-advisor.
S1 58:31 Thank you again for your participation and have a fantastic afternoon.
The views expressed represent the Manager’s assessment of the market environment as of the date indicated and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. All charts shown throughout this presentation are for comparison purposes only. All charts / graphs throughout used with permission.
Investing involves risk, including the possible loss of principal.
All third-party trademarks cited are the property of their respective owners.
Diversification may not protect against market risk.
Gross domestic product (GDP) is the broadest quantitative measure of a nation's total economic activity. More specifically, GDP represents the monetary value of all goods and services produced within a nation's geographic borders over a specified period of time.
Earnings per share (EPS) is the portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company's profitability.
The BofA Merrill Lynch All U.S. Convertibles Index tracks the performance of domestic corporate convertible bonds and convertible preferred stock issues of all qualities and that have a market value of $50 million or more at issuance.
The Bloomberg Barclays U.S. Corporate High-Yield Index is composed of U.S. dollar–denominated, non-investment-grade corporate bonds for which the middle rating among Moody’s Investors Service, Inc., Fitch, Inc., and Standard & Poor’s is Ba1/BB+/BB+ or below.
The Bloomberg Barclays Municipal Bond Index measures the total return performance of the long-term, investment grade tax-exempt bond market.
The Bloomberg Barclays U.S. Corporate Investment Grade Index is composed of U.S. dollar–denominated, investment grade, SEC-registered corporate bonds issued by industrial, utility, and financial companies. All bonds in the index have at least one year to maturity.
The Bloomberg Barclays U.S. Treasury Index measures the performance of U.S. Treasury bonds and notes that have at least one year to maturity.
The Bloomberg Barclays U.S. Aggregate Index is a broad composite that tracks the investment grade domestic bond market.
The Bloomberg Barclays Global Aggregate Index provides a broad-based measure of the global investment grade fixed-rate debt markets.
The Citigroup World Government Bond Index measures the performance of fixed-rate, local-currency, investment grade sovereign debt from 23 countries.
The Dividend Aristocrats are S&P 500 constituents that have increased their dividend payouts for 20 consecutive years. The companies that make up the Dividend Aristocrats span ten different business sectors with both growth and value holdings.
The J.P. Morgan Emerging Markets Bond Index Global (EMBIG) tracks total returns for U.S. dollar–denominated debt instruments issued by emerging market sovereign and quasi-sovereign entities, including Brady bonds, loans, and Eurobonds.
The FTSE EPRA/NAREIT Developed Index tracks the performance of listed real estate companies and real estate investment trusts (REITs) worldwide, based in U.S. dollars.
The FTSE NAREIT Equity REITs Index measures the performance of all publicly traded equity real estate investment trusts (REITs) traded on U.S. exchanges, excluding timber and infrastructure REITs.
The MSCI World Index is a free float-adjusted market capitalization weighted index designed to measure equity market performance across developed markets worldwide. Index “gross” return approximates the maximum possible dividend reinvestment. Index “net” return approximates the minimum possible dividend reinvestment, after deduction of withholding tax at the highest possible rate.
The MSCI All Country World Index (ACWI) is a free float-adjusted market capitalization weighted index that is designed to measure equity market performance across developed and emerging markets worldwide.
The MSCI EAFE (Europe, Australasia, Far East) Index is a free float-adjusted market capitalization weighted index designed to measure equity market performance of developed markets, excluding the United States and Canada.
The S&P Global Infrastructure Index is composed of 75 of the largest publicly listed companies in the global infrastructure industry. The index has balanced weights across three distinct infrastructure clusters: energy, transportation, and utilities.
The S&P 500® Index measures the performance of 500 mostly large-cap stocks weighted by market value, and is often used to represent performance of the U.S. stock market.
The Russell 1000® Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values.
The Alerian MLP Index is the leading gauge of energy Master Limited Partnerships (MLPs). The float-adjusted, capitalization-weighted index, whose constituents represent approximately 85% of total float-adjusted market capitalization, is disseminated real-time on a price-return basis (AMZ) and on a total-return basis (AMZX).
Index performance returns do not reflect any management fees, transaction costs, or expenses. Indices are unmanaged and one cannot invest directly in a index.
The performance data quoted represents past performance; past performance does not guarantee future results.
Delaware Investments, a member of Macquarie Group, refers to Delaware Management Holdings, Inc. and its subsidiaries. Macquarie Group refers to Macquarie Group Limited and its subsidiaries and affiliates worldwide.
Neither Delaware Investments nor its affiliates noted in this document are authorized deposit-taking institutions for the purposes of the Banking Act 1959 (Commonwealth of Australia). The obligations of these entities do not represent deposits or other liabilities of Macquarie Bank Limited (MBL). MBL does not guarantee or otherwise provide assurance in respect of the obligations of these entities, unless noted otherwise.
The views expressed represent the Manager’s assessment of the named securities and market environment as of the date indicated and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Charts shown throughout presentation are for illustrative purposes only and are not meant to predict actual results. The information provided is not intended and should not be construed to be a presentation concerning any mutual fund.
For investment professional use only. Not for public distribution. Document must be used in its entirety.
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