JUNE 2009
How to Generate Income from ETFs
By William Parmenter, editor
Douglas Fabian talked on three related
investment themes, in a discourse titled “ETF
Strategies in a Difficult Market,” at the June 20 Los
Angeles AAII chapter meeting at Skirball Center.
Fabian is a familiar speaker to the Los
Angeles AAII chapter. He is president of Fabian
Wealth Strategies, a fee-only asset management
firm, investing exclusively in exchange-traded
funds (ETFs). He has been the radio talk show host
for over 10 years of the one-hour long, 10 a.m.
Saturday Wealth Strategies show on KRLA AM
870.
Fabian started his career in 1979 as a mutual
fund analyst for his dad, Dick Fabian, who also
used to speak to the Los Angeles AAII chapter.
Douglas’s father was so important to him as a father
and financial mentor that he treasures an 8 X 10
black and white photo of himself with his dad on
the top of his bookcase in his radio studio.
The three themes Fabian addressed in his
talk were: 1) the big picture, bull or bear market? 2)
rationales for putting more ETFs in your portfolio,
and 3) investing ideas in three sectors.
Shoots of green popping up in the economy,
accompanied by a 41 percent rise in the S & P 500
in only three months since the March 9 low
detonated a shrill chorus of cheerleading in the
financial industry.
In Fabian’s view the big up move in the
markets amounts to a bear market rally, with the
market teetering on the verge of another plunge into
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the abyss. The big down move could come soon.
Investors need to decide whether to increase or
decrease their exposure to equities.
The following four lines of evidence that
we are in a bear market could help investors
decide about their exposure to equities:
1. Debt destruction is still under way and
credit is still tight, especially for small businesses.
Banks have loans on their books that will go bad.
2. The rally was due to unprecedented
government spending and economic stimulation.
The questions are: will that spending continue,
and keep propping up the stock market?
3. Taxes are going up. Aren’t cops
swarming like wasps everywhere, stinging
everyone with tickets? Aren’t there rumblings
about city, state and federal taxes going up?
4. The economic indicators are bad.
Unemployment, already high, is going up.
Looking at the S&P 500 over two years shows it
starting at 1,500, dropping to 680 and rebounding
to 940, but it is below its 200-day moving
average, which is still moving down. Following
the 200-day-moving average is an easy and
accurate way to see which way the economy is
trending.
The second theme of Fabian’s talk was
rules for investing in ETFs. He suggested
investors put more ETFs in their portfolio, and
have a watch list of 20 to 30 ETFs.
Table of Contents
Douglas Fabian ETF Strategies in a Difficult Market p.1
Timothy Bock
Wealth Engineering
p.4
Orange County AAII Meeting Announcements………p.6
Fabian likes ETFs for their transparency.
Unlike mutual funds you know what you are
buying. ETFs’ expense ratios are substantially
cheaper than mutual funds, too.
Investors need to look at volume and buy
ETFs that trade at least 500,000 shares a day, as
that threshold denotes liquidity and institutional
involvement. Fabian pointed out that with ETFs it
is easy to put in an 8, 10 or 15 percent trailing
stop loss, and thereby control downside risk.
If you ever bought something and watched
it go straight down, you can better understand the
importance of stop losses. It helps to take your
churning emotions out of the investment process.
Question, if you had cut every loss at 20 percent,
would you be better off today?
Fabian referred to his four-page handout
that listed 150 ETFs that trade over 500,000
shares a day. Actually there are over 800 ETFs
but the other 650 have thin trading volume.
The handout grouped ETFs in various
categories,
such
as:
Domestic,
Bonds,
International, Finance, Health Care, Basic
Materials, Energy, Commodities, Real Estate,
Consumer/Cyclical, Technology, Industrials,
Utilities, Bear Market, Leveraged Indexes, and
Currency. In other words, the handout covered
the investment universe, giving the ETFs’ ticker
symbol, price and nine measurements of
performance.
Fabian commented that he was dealing
with a sophisticated investment group with the
AAII Los Angeles chapter, so he would not try to
explain various ETFs or offer caveats. AAII
investors were equipped to do their own analysis
and due diligence on prospective ETFs.
He did mention two ETFs as being
noteworthy, however. First was VTI, Vanguard’s
Total Stock Market ETF, which covers the whole
stock market. On June 18 it sold for $46.22, was
up 3.31 percent YTD, was 2.15 percent above its
200-day moving average and had 3.56 million
shares of daily volume.
Second was XLE, Energy Select Sector
SPDR, following 20 energy stocks. It sold on
June 18 for $49.96, was positive 4.58 percent
YTD, plus 1.51 percent above its 200-day
moving average and had volume of 25.1 million
shares, about twice as much as any of the other
10 energy ETFs listed.
The third theme of Fabian’s talk was
investing ideas and sectors. The three sectors he
highlighted
were:
Emerging
Markets,
Commodities and Income.
Fabian likes Emerging Markets because
the countries are sitting on a ton of cash, for
example China has $2 trillion in cash, mostly
U.S. Treasuries.
China recently surpassed
Germany to become the third largest economy
in the world. The emerging market countries
are poised to really grow.
Consider EWZ, iShares MSCI Brazil
Index, priced at $52.65 on June 18, with a 50.4
percent YTD growth, plus 25 percent above the
200-day moving average and volume of 21.6
million shares. Brazil has performed the best of
the group this year, and is a huge natural
natural resource play.
Los Angeles County Meeting Schedule
Westside Computer Group – Don Gimpel, 310/276-9875
dgimpel@prodigy.net Veterans of Foreign Wars Memorial Bldg.
Culver Blvd. & Overland Avenue, Culver City, Date and topic TBA
Pasadena Group – Meets at 7 p.m., meets at Lamanda Library,
140 S. Altadena Drive, Pasadena. (Meets third Tues. of the
month, except for August and December.) Topic TBA
Mutual Fund Group – Gunter Hagen 310/457-7404,
ghagen1@yahoo.com. Date and topic TBA at Fairview Library,
2101 Ocean Park Blvd., Santa Monica. The meeting is free to
the public
Stock Selection Group—Norm Langhout, 310/391-6430,
normlang@ca.rr.com. Fourth Wednesday of the month at 7 p.m.
Fairview Library, 2101 Ocean Park Blvd., Santa Monica. Topic
TBA
San Fernando Valley Group – Mid Valley Library Community
Room, 16244 Nordhoff St. North Hills, Date and topic, TBA
IBD Meet-Up/AAII CANSLIM Group –Fairview Library, 2101
Ocean Park Blvd., Santa Monica. Date and topic TBA
Los Angeles Chapter Skirball Center at 9 a.m, Sat. July 18.
Roger H. Shaar on Alternative Investing for the Individual
Investor: Much more Than Portfolio Diversification, and Kieran
Osborne, on Currencies: Trends and Implications in a Changing
World.
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The emerging market ETFs are doing
much better than the developed countries YTD
with their price increase ranging from plus 24.1
percent for EWY, South Korea to plus 50.4
percent for EWZ, Brazil
Fabian’s favorite emerging market ETF is
EEM, an emerging market index of about 12
countries including Russia, China, Brazil Hong
Kong and others. It has $21 billion in assets, and
its expense ratio is .72 versus 2.2 percent for a
mutual fund. Currently EEM is selling for
$31.59, is plus 26.51 percent YTD, is plus 17.95
over its 200-day moving average and its volume is
73 million shares daily.
Commodities were the second sector
highlighted by Fabian.
Commodities are
attractive because we are still in a deflationary
economy, with tight credit and on-going debt
destruction, especially in real estate.
Fabian likes DBC, Powershares DB
Commodity index, which invests in oil, coal,
silver, wheat, corn and soybeans, a diversified
commodities play (better than just placing a bet
on oil). DBC is up 10.4 percent YTD, with a
price of $23.40, plus 1.3 percent over its 200-day
moving average, and has a volume of 2.29 million
shares.
GLD, streetTRACKS Gold Shares is the
second largest ETF in the world, holding more
gold than Switzerland, the sixth largest gold
holder in the world. With a price of $91.61 GLS
is plus 5.8 percent YTD, 7.2 percent above its
200-day moving average and has trading volume
of 14.7 million shares.
Currently gold is a very crowded trade.
They are even selling gold in vending machines in
Germany. Gold could go from 938 to 1,000, a six
percent move, not a big change. There is too
much counter trading going on in gold. Fabian
expects gold to dip later this year, at which time
he will buy.
DBA, PowerShares DB Agriculture Fund
is a play on the notion that people in
underdeveloped countries are going to eat better.
That pushes up the prices for agricultural
products. Selling at $26.29 DBA is 2 percent
above its moving average, and could go up 20
percent this year.
DBA could be paired with MOO,
Market Vector AgriBusiness ETF, selling at
$34.32, up 23.23 percent his year and 13.34
percent above its 200-day moving average.
Moo has 40 stocks, including its number one
holding, Monsanto (which is working on disease
resistant food grains); another big holding is
John Deere. Wait and buy MOO in the low 30s.
In regard to strategy, Fabian said it is
dead money in your portfolio to buy a bad stock,
like GM or GE and hold it for a long time. It is
better to put in stop losses, and to trim out the
dead wood periodically.
Income was the third sector highlighted
by Fabian. In retirement, investors need to stop
thinking about growth and to start thinking
about an income stream. The downside of
growth is loss, and most people do a poor job of
managing loss and wealth destruction.
DVY, iShares Dow Jones Select
Dividend Income is YTD down 13.2 percent,
but it has a yield of 4.9 percent. PFF, HYG,
LQD, TLT and AGG all pay monthly income.
Of those, PFF iShares S&P U.S.
Preferred Stock is doing the best YTD at plus
8.1 percent. But this March PFF was down 40
percent; in June it was up 20 percent, and on
June 18 it was up 8.1 percent. Due to volatility
it is highly risky. Put it on your watch list for
weekly collection of data points. The U.S.
economy is still in very risky times, especially
the banking sector.
JYG, iShares iBoxx $ High Yield
Corporate does not look attractive despite being
plus 2.75 percent YTD, because it is not a good
time to be in junk bonds.
AGG, iShares Lehman Aggregate Bond,
is a place holder with a minus 3.2 percent YTD
return and a 3.67 percent yield. It is .7 percent
above its 200-day moving average.
The income ETFs look weak. Of six in
Fabian’s handout, four are down YTD. Only
PFF up 8.1 percent YTD, with a yield of 10.4
percent has encouraging numbers.
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In his conclusion, which Fabian called
Action Items, he asked investors to define their
objective: income, growth or a combination of
both.
Again, he suggested moving money out of
mutual funds, stating over $1 trillion is in
underperforming funds.
“They are just ripping you off,” he
remarked, using the strongest language of his
presentation. “There are about 10 percent good
mutual funds versus about 90 percent bad ones.”
He urged investors to do their research on
ETFs by checking them out in Yahoo finance, or
other reputable sources.
In the question and answer session, Fabian
reiterated he likes stop losses that are appropriate
to the type of investment. For emerging market
ETFs, he likes 15 percent, and for income ETFs,
he goes with 4 percent.
Fabian uses leveraged ETFs in his
Aggressive Portfolio at appropriate occasions,
noting that leveraged ETFs are more for traders
(short-term holders) rather than investors. He also
shorts ETFs for brief periods in a down market.
He commented that volume is the key
when trading ETNs.
In Fabian’s view, in the next three or four
years managers of retirement portfolios (for
example 401Ks) will be buying ETFs more.
As regard grading ETFs, Morningstar does
some grading. But remember ETFs are pure
index funds, so the index itself acts as a
benchmark.
Volume matters in buying ETFs, because
large volume shows institutional investors are
involved. Tiny volume indicates thin trading,
resulting in large gaps between bid and ask prices.
www.fabianwealth.com mentioned the
four portfolios, and their target returns net of fees,
managed by Fabian’s company: steady growth,10
percent; aggressive growth, 15 percent; steady
income, 7 percent; and managed municipal
income, 4 percent.
For a copy of Fabian’s June 20th Power
Point presentation request it via email at
askdoug@dougfabian.com.
Fabian gave a lucid, clear and well
organized presentation, befitting his status as a
professional speaker and radio show host. It was
remarkably free of self-promotion and sales
patter. He repeated questions, gave an animated
delivery and spoke with strong volume, so
everyone could hear him.
Wealth Engineering
By William Parmenter, editor
Timothy Bock gave a talk on how to
employ the science of investing for better results
at the June 20 Los Angeles chapter AAII
meeting at the Skirball Center.
Bock, president of Summit Portfolio
Management, has over 25 years of investing
experience. His firm has four offices, located in
Southern California and Las Vegas
Wealth engineering components are
seven, according to Bock.
The components are:
Invest using scientific evidence.
Take appropriate risks.
Measure risk and return.
Coordinate investing with financial
planning.
Limit and control costs (trading costs
and taxes).
Limit emotional influence (control greed
and fear).
Control security and fraud risk.
With
the
precipitous
economic
downdraft, investors have been deluged by bad
news concerning out-of-control hedge funds and
Bernard Madoff’s mother-of-all Ponzi schemes.
Fortune’s May 11 cover features the face
of a contrite and chastised Madoff, and a
tabloid-style screaming headline, “How Bernie
Did It.” The more than 20-page celebrity-gossip
clone article, replete with full-page color
pictures, reveals that Bernie cheated investors
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out of $65 billion dollars over decades.
At the end of June the court handed down
its decision, 150 years, the maximum possible, for
Bernie. Message ($65 billion too late) watch out
fraudsters. The government is going to toughen
up and tighten up on oversight.
It is also too late for many investors who
lost their money investing in hedge funds that
promised too much, charged too much, and were
too opaque. Once the rage, now hedge funds,
which have caused a lot of rage, are regarded as
dubious investment vehicles, in need of closer
monitoring and supervision.
Bock urged his auditors to watch out for
other frauds, such as certain life products and
annuities. Packaged financial products (note that
in the distribution phase all payouts are taxable).
Identity theft. And, commission-based financial
advisors, who use misleading sales tactics. (How
else do you expect them to make their sales
quotas?)
What to do? Caveat emptor. In investing
there is no guarantee and no warranty. You have
to do your own due diligence—even if you don’t
know how. The naked truth is that it is a jungle
out there. (Ask Tarzan.) Economic catastrophe
brings otherwise well concealed fraud, rottenness
and corruption to the surface.
When you hire someone to invest your
money, put the money in a third party account
with a firm like Charles Schwab, or Fidelity, so
you can monitor the transactions and keep control
of your assets.
Educate yourself on common scams by
going to www.quackloss.com. and do some
research for your own self protection..
Bock turned to the question of risk, saying
risk is not bad. Taking risks is what produces
returns. Investors need to understand risks,
control risks and measure risks. Market declines
are different than losses. Investors should avoid
uncompensated risks—those are risks without
compensating returns.
Regarding who produces better returns
active or passive managers, Bock comes down on
the side of the passive managers. In weighing in
on the side of passive management, Bock cited
the research of Eugene Fama, of the University
of Chicago, who developed the efficient-market
hypothesis in the 1960s.
The efficient-market hypothesis holds
that markets are the best summarizers of
information. The theory implies it is impossible
to tell which stocks are expensive or cheap
without expensive research or very unusual
skill. Thus it is better to buy indexes of stocks.
The arguments why passive management
is better include the ideas that: markets are
efficient. Concentrated portfolios carry more
risk and have less return. Superior returns are
due to lower costs and less taxation. Less than
one percent of active managers add value.
Analyzing track records does not help.
Forecasting is a futile exercise, because prices
already incorporate what we know about the
future.
Peter Lynch and Warren Buffett agree
that most investors should own index funds.
Only four percent of returns can be
attributed to stock picking. The other 96
percent of returns can be attributed to structure,
i.e. market (beta); size (market cap) and value or
growth stocks.
Market timing has a strong emotional
appeal. But many academic studies show that it
does not work. Most market timing newsletters
go out of business.
Index investors can improve returns by
tilting toward value stocks and small cap stocks.
That tilt improves a U.S. stock portfolio’s
returns by 3 percent, and in international stock
portfolio’s returns by 4 percent, Bock said.
John Bogle, formerly of Vanguard
Funds, disagreed in a Nov. 6. 2006 Wall Street
Journal article, contending that any return
advantages for small and value stocks are
temporary ones that an efficient market will
arbitrage away.
Periodic rebalancing of a portfolio is
desirable for several reasons. Rebalancing
maintains the desired risk level. It helps the
investor to buy low and sell high. It avoids
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timing uncertainty. And, it avoids emotional
distraction.
Bock likes to talk about the money
management firm Dimensional Fund Advisors,
(DFA), which is located on Ocean Avenue in
Santa Monica. Founded in 1981 the firm was
managing $73 billion in assets in 2005. Eugene
Fama was a board member in December, 2007.
DFA funds are mostly sold to institutional
investors, like pension funds and endowments,
which helps keep the staff costs down. Bock
passed out three free articles on DFA, which
brought out much information.
DFA funds are not available directly to
investors. They work through an advisor-only
network. They use passive management to keep
costs down and tilt to small caps and value stocks.
They have the number one stock funds rating by
professional advisors, said Bock.
Question, if all financial advice is
worthless and the only sensible strategy is to buy
an index fund that tracks the market, why would
anybody need DFA as a financial adviser? Why
would anyone pay DFA the 50 basis points it
takes off the top of its oldest fund?
DFA claims it can beat the market. The
reasons for DFA’s superior performance is varied.
In one case it found a better way to rebalance its
portfolio when the underlying index changed. In
another case, it came up with improvements in
capturing small-cap risk, according to an article in
the December, 2007 Conde Nast Portfolio.
Bock significantly omitted to tell whether
DFA funds were up or down year-to-date. If
down, he did not chose to disclose how far down.
Herein is the dilemma of investing in a
bear market. Mostly everything and everyone is
down. So why not just invest in the U.S. dollar
and wait it out?
Being less down than your benchmark
does not get you far, when being in cash, and
doing nothing, would be a superior strategy. The
blunt truth is that investors are interested in
absolute returns, not relative returns. Doing well
relatively may mean that you are going broke
slower than your benchmark. Absolute returns
tell whether you are actually making or losing
money.
Bock concluded with six steps to better
investing:
Manage risks, do not speculate.
Manage passively and get reduced costs,
lower taxes and better returns.
Focus
on
return,
taking
into
consideration market cap and relative value.
Control risks through diversification of
securities and countries.
Control emotional and psychological
influences.
Get expert guidance, if you are not an
expert.
Education Nuggets
By William Parmenter, editor
Dr. Don Gimpel’s entertaining and
informative five minutes of investor education
and announcements was not presented, due to
his absence from the June meeting.
Orange County AAII Announcements
Mark S. Wolfkiel will talk on Investing
in a Recession at 9 a.m. July 11 at the Balearic
Community Center, 1975 Balearic Drive, Costa
Mesa, contact phone number 714-754-5158.
The cost is $5.
Wolfkiel is a senior vice president of
Astor Capital Management.
Many economists and experts diagnose
the economy as being in a recession that could
last from a few more months to a few more
years. That leaves investors in a dilemma of
what to do with their investment money. Expert
opinion may not be of assistance, and in some
cases leaves prospective investors confused.
In Wolfkiel’s presentation, investors will
learn some basic rules for: dealing with the
current bear market, investing in turbulent
times, and diversifying to protect their assets.
For more information about the Orange
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County chapter of AAII and their meetings, go to
aaiichapter_orangecounty@yahoo.com.
freezing up of credit markets, or some other
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Book reviews are welcome. Mail disks
to: 319 Walnut Ave., Apt. 2, Long Beach, CA.
90802, or use email to send copy to the editor at
wparme1@lausd.net.
My home phone is (562) 437-2412.
Note to Pro Forma Contributors:
Please have your copy emailed to the
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article about the fragile financial system, the
Pro Forma
Pro Forma Editor
Pro Forma Editor, Emeritus
William Parmenter
Orvis Adams
SIG GROUP CHAIRMEN
IBD Meet-up/ AAII CANSLIM
Mutual Fund Group
Options Group
Pasadena Group
Palm Springs Group
San Fernando Valley Group
Westside Computer Group
Norman Langhout
Gunter Hagen
Robert Morgan
Ivan Wong
Patti Gammino
Evan Press
Don Gimpel
Pro Forma is offered free of charge exclusively via email and is also available for downloading from the
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The American Association of Individual Investors is an independent nonprofit corporation formed
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Pro Forma is published for advising members of the groups' activities and for sharing information. All material
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