Archive for September, 2012

More Volatility Does Not Create More Return, But Positive Capture Spread Does

Sunday, September 30th, 2012

We looked at more than 630 US domestic no-load mutual funds with at least $100 million of assets over 3-years, 5-years and 10-years as of 08/31/2012 to see how volatility relates to total return, and how the spread between upside and downside capture ratios relate to total return.

More volatility does not cause more return, but more spread between upside and downside capture ratios does.

The dozen equity ETFs with the highest capture ratio spreads and the dozen with the lowest capture ratio spreads are provided at the end of the article.

More Volatility Does Not Create More Return:

“More pain means more gain” is not borne out by these data. Linear regression does not show much correlation between volatility and return in the 3-year and 5-year historical time span, and only a little in the 10-year time span.

There is no apparent need to accept extra volatility if lower volatility options are available. There may be other arguments for volatility, but they don’t show in this particular data.

The “no pain, no gain” argument doesn’t seem to hold up well in light of this data.  Volatility may create trading opportunities for the nimble, but portfolios  that produce higher volatility do not produce correspondingly higher total returns.

The “r-squared” value on the regression trend line indicates the fraction of the variance from the regression line explained by the relationship between the X and Y axis data.  A zero value means no relationship, and a 1.00 value means a perfect relationship.


No trend, r-squared near zero.


No Trend, r-squared near zero.


Some trend, r-squared low at about 0.27.

More Capture Spread Creates More Return:

In contrast to volatility as an argument for higher returns which requires some faith or imagination,  capture ratio spreads appeal immediately on a logical basis.

Capture ratio spreads measure how much more of the upward moves of a market are captured by the portfolio than the downward moves.  If portfolio “A” goes up more in up markets and down less in down markets than portfolio “B”, then one would tend to assume that portfolio “A” is the superior choice.

Note that a good capture ratio spread does not mean that total return will be positive, just that total return should be better than a portfolio with a less good capture ratio.  That caveat is because if the number and depth of down market moves overwhelms the up market moves, the overall result for a long portfolio would likely be down.

What Are Capture Ratios:

Capture ratios measure a fund’s performance in up and down markets relative to the benchmark market index (in the case of US stocks typically the S&P 500).  The ratio in this article is calculated by determining each month the size and direction of the price change for the S&P 500; then determining the size and direction of the price change for the same period for the fund being evaluated; and then dividing the size and direction of the subject fund by the size and direction of the benchmark index.

Higher ratios are better for the upside ratio, and lower ratios are better for the downside ratio  The idea is to participate maximally in upside moves and minimally in downside moves.


Favorable trend (more capture spread –> more total return), r-squared 0.51.


Favorable trend, r-squared 0.89.


Favorable trend, r-squared 0.85.

 Ten Equity ETFs With The Highest Capture Spreads: 

Fund Name Ticker 3YR CS 5YR CS
PowerShares Dynamic Pharmaceuticals PJP 80.92 47.69
SPDR S&P Pharmaceuticals XPH 63.80 46.48
iShares Dow Jones US Pharmaceuticals IHE 65.34 41.25
SPDR S&P Retail XRT 65.80 40.33
iShares FTSE NAREIT Resid Plus Cp Idx REZ 71.61 25.64
iShares Nasdaq Biotechnology IBB 52.19 41.51
First Trust Health Care AlphaDEX FXH 50.47 35.09
PowerShares Dyn. Leisure & Entertain PEJ 55.07 26.06
First Trust Dow Jones Internet Index FDN 43.22 36.60
Vanguard REIT Index ETF VNQ 57.00 22.81
PowerShares Dynamic Retail PMR 48.97 29.31
Consumer Discret Select Sector SPDR XLY 52.26 25.36
Vanguard Consumer Staples ETF VDC 48.06 29.55

 Dozen Equity ETFs With The Lowest Capture Spreads:

Fund Name Ticker 3YR CS 5YR CS
SPDR S&P Metals & Mining XME (42.85) (5.52)
PowerShares Global Listed Private Eq PSP (12.87) (36.83)
Guggenheim S&P SC 600 Pure Value RZV (54.62) 2.82
PowerShares Cleantech PZD (41.60) (12.61)
Market Vectors Steel ETF SLX (57.01) (6.82)
Financial Select Sector SPDR XLF (26.91) (37.15)
SPDR S&P Bank ETF KBE (36.18) (41.44)
iShares S&P Global Financials IXG (47.60) (30.16)
iShares Dow Jones US Financial Services IYG (38.70) (40.46)
Market Vectors Uranium+Nuclear Enrgy NLR (78.35) (40.93)
PowerShares Global Clean Energy PBD (139.70) (70.76)
PowerShares WilderHill Clean Energy PBW (162.15) (93.43)

Disclosure:  QVM owns IBB in some portfolios.

Gold Versus CPI, Federal Debt and S&P 500 Indexed From 1971

Monday, September 24th, 2012

data source:  Saint Louis Federal Reserve

Compare Corporate Bonds In Long-Term Rising and Falling Rate Markets

Monday, September 17th, 2012

The page above is from a recent client letter, cover page reproduced below.

QVM Clients:

It may seem a bit out of place to be concerned about how corporate bonds will perform in a rising rate environment, just days after the Federal Reserve said it would keep short-term rates near zero until mid-2015 (almost 3 years from now).  However, interest rates must eventually rise.  Investors, and nations will not be willing to hold bonds at negative real rates of return forever.  Additionally, the bond market might begin to create its own forces at some point that the Fed cannot neutralize.

There was a period of about 40 years of rising rates peaking in 1981 (creating a headwind for bonds), and a period of about 30 years of falling rates from 1981 through today (creating a tailwind for bonds).

Most of what the majority of investors know about bonds comes from the last 30 years, and not the prior 40 years.  Bonds have not only been helpful to reduce portfolio volatility in the past 30 years, but they have been favorable total return generators.  How did they play in portfolios from 1941-1981 when they faced a headwind?

We will explore that in client letters over the coming year, to get you and us informed and prepared for the day the direction of interest rate changes reverses.

The attached one-page letter, provides some good basic chart and tabular information about the differences between the 1941-1981 period and the 1981-2011 period.  We will depart from and build from there in future letters.





Profits, Cash Flow, Dividends and Wages As Percent of GDP Since the 1940’s

Wednesday, September 5th, 2012

These data from the St. Louis Federal Reserve represent the combination of private and public companies in the United States.  The overall trend is that profits, cash flow and dividends are well above average levels, and wages are below average levels.

Corporate Profits as % GDP

  • Minimum: 3.01%
  • Maximum: 10.80%
  • Median: 5.85%
  • Average: 6.18%
  • Current: 10.56%

 Corporate Cash Flow as % GDP

  • Minimum: 4.72%
  • Maximum: 13.09%
  • Median: 8.76%
  • Average: 8.78%
  • Current: 11.69%

Dividends as % GDP

  • Minimum: 1.95%
  • Maximum: 5.86%
  • Median: 2.58%
  • Average: 2.98%
  • Current: 4.80%

Wages as % GDP

  • Minimum: 43.69%
  • Maximum: 53.41%
  • Median: 47.74%
  • Average: 48.31%
  • Current: 44.10%


Total Wages and Jobs, and Wages and Profits As Percentage of GDP

Wednesday, September 5th, 2012


Even though there are many unemployed and underemployed, the total amount of wages being paid into the economy is greater than in the pre-crash period.  That is a positive for the economy, even though there are many individuals and families left behind.



The total number of jobs is still nearly 5 million lower than before the last recession. Total jobs lost as a result of the recession were about 9 million, somewhat less than 1/2 have been regained. Part of that is due to substitution of capital for labor, and part is due to working employees harder.  While the economy is moving forward, the visible unemployment creates a sense of worry among the employed and among investors that makes the glass seem more half empty than half full.


Wages as a percentage of GDP has been declining since 1970, and is at an approximate low.  At the same time, corporate profits as a percentage of GDP rose significantly after 2000, took a steep dive in the last recession, but are now a larger part of GDP than before the recession.

The contrast is probably part of the social unrest over the “haves” and “have nots”, but for investors it should be noted that corporations are doing well.


In a prior article, we showed that US non-financial corporations have a better ratio of cash and short-term investments to total liabilities than they had before the 2008 stock market crash.  Similarly. we showed that households have a lower debt service burden to disposable income (and a lower total financial obligations to disposable income) than they did before the 2008 stock market crash.  Things are better, even though there is headline gloom over unemployment and a slowing global economy.

Corporate Profits, Cash Flow and Dividends

Wednesday, September 5th, 2012


The Federal Reserve provides data on combined private and public company profits, cash flow and dividends, shown in this chart.  Profits and cash flow are well above pre-2008 levels and dividends are nearly fully recovered.  Finances look good in the corporate world.

Looking only at dividends in investable ETFs, these charts from show the percentage change in dividends paid on IWB (for the Russell 1000 large-cap stocks) and IWM (for the Russell 2000 small-cap stocks) over 10 years, 5 years and 1 year.


5 Years

1 Year

The small-cap stocks have much lower current yields, but have increased their dividends (from low starting points) at a significantly faster rate than large-cap stocks.  Both large-cap and small-cap dividends rose over each period, but 1000 large-cap companies lagged inflation over the 5-year period (some selectivity could have eliminated that problem).


  • XLB: basic materials
  • XLE: Energy
  • XLF: financials

  • XLI: industrials
  • XLK: technology and telecommunications
  • XLP: consumer staples

  • XLU: utilities
  • XLV: healthcare
  • XLY: consumer cyclicals

Five of the nine sectors had dividend growth over 50% in the past 5 years:  energy, technology and telecomm, healthcare and staples.  The big drag were the financials, down 73%.  At one point before the crash, they accounted for a very significant portion of total dividends paid by the S&P 500


  • SPY: S&P 500 large-cap
  • MDY: S&P 400 mid-cap
  • IJR: S&P 600 small-cap

  • SDY: S&P 1500 Dividend Aristocrats
  • OEF: S&P 100
  • ISI: S&P 1500

Note that the S&P 1500 Dividend Aristocrats have experienced a reduction of 17% in dividends paid over the past 5 years. This is the result of two factors. First, banks which were historically members of the Aristocrats index, were virtually all eliminated in the 2008.  They were substantial dividend payers, and were replaced on average with stocks with lower yields.  Second, the nature of the Aristocrats index is not yield focused, but rather is focused on dividend payment consistency.  The index requires 25 years of back-to-back dividend payments without missing any, and increasing each year.  That rule does not necessarily lead to higher yields, and when former high yielding payers like banks dropped out, their replacements while consistent did not pay as much.


  • SDY: S&P 1500 Dividend Aristocrats (sponsor SPDR) trailing yield 3.14%
  • DVY: Dow Jones Select Dividend (sponsor iShares) trailing yield 3.41%
  • VYM: FTSE High Dividend Yield “Vanguard High Dividend” (sponsor Vanguard) trailing yield 2.79%
  • VIG: Mergent Dividend Achievers Select “Vanguard Dividend Appreciation” (sponsor Vanguard) trailing yield 2.05%

Disclaimer and Disclosure:

This and every post on this blog is subject to our general disclaimer.  As of the date of this post (September 4, 2012), we have positions in IWM.