Seeking Alpha

The Passive-Aggressive Investor For The Week Of September 16-20

by: Hale Stewart

Some investors may want to juice their potential results by adding "special situation" securities.

One of these is adding out-of-favor dividend aristocrats, taking their yield as part of the gain while also potentially gaining from capital appreciation.

The second is buying broad sector ETFs that take advantage of longer investment cycles tied to the economic cycle.

The Passive-Aggressive Investor is specifically for investors who take more of a passive approach to investing, using ETFs, Dividend Aristocrats and a more buy-and-hold strategy.

The first set of columns for this series are building on each other. In the introductory blog post, I explained the series' basic concepts while also introducing the initial securities I'd be using. In the second article, I introduced the ideas of standard deviation and correlation, while in the third article, I explained the importance of understanding the macroeconomic backdrop and the importance of understanding our individual risk tolerance. This article will introduce the idea of adding a bit of volatility to potentially juice returns.

But first, a bit of history. The use of ETFs in portfolio design and planning is, from an investing perspective, a relatively new phenomenon. The first ETF was formed in 1989; others followed in the 1990s. They gained momentum as an investment vehicle in the early 2000s and are now a common investment vehicle. They gained traction due to failure of active-management (see here). Investors have started to realize that buying indexes or structuring a portfolio of broadly-diversified ETFs to minimize risk was just as sound an investment strategy. This was the strategy pioneered by Jack Bogle of Vanguard.

So far, I've introduced two portfolios: a 50/50 combination of the SPY and IEF; and a portfolio containing 10% SDY, 45% PFF, and 45% VCIT. What about making one of these a "core" portfolio that comprises 75% of a portfolio's assets while allocating the remaining 25% to "special situations?"

Rather than look like this:

Portfolio 1 Portfolio 2
50% SPY 10% SDY
50% IEF 45% PFF
45% VCIT

The portfolios would look like this:

Portfolio 1 Portfolio 2
37.5% SPY 7.5% SDY
37.5% IEF 33.75% PFF
25% Cash 33.75% VCIT
25% Cash

The benefit of this second allocation is that the investor can now put the cash to work as situations develop.

That leads to the question of, "what exactly are these "special situations?"" The first involves dividend aristocrats - companies that have raised their dividend for 25 consecutive years. These are large, well-established companies that have made a decision to pay people to hold the company's shares. They are also well-managed, financially solid companies that are widely held. That combination means that their shares develop a natural bid in the market, especially when the stock's yield is high. Currently, there are seven aristocrats yielding 4% or higher:

Data from's custom portfolios.

All of those charts with the exception of AT&T (T) are in the bottom half of their respective 1-year trading ranges. The size of these companies and their high yields make these potentially attractive investments for investors who are willing to hold the stock for at least 6-9 months. Because of their high yields, these stocks would not need to rise much to make 10% in a year. For example, Helmerich & Payne (NYSE:HP) would only have to rise 3.47% (remember, the stock is already yielding 6.57%). Even if the stock stalls, the high yield means the issue probably has a natural floor underneath its shares while also providing the portfolio with additional cash in the form of dividend payments.

As I noted in the blog post introducing this series, I analyze Aristocrats as bonds instead of stocks. Because these are long-established companies, they're not going to grow at growth-stock rates, but instead at a pace more aligned with GDP growth. I look for solid balance sheets, manageable debt levels, and strong cash flow.

The second special situation is based on the idea of sector rotation and uses the following large sector ETFs. This idea was derived from Martin Pring's The All Season Investor, which shows that different sectors rise and fall at different times in the economic cycle. : These 10 ETFs cover the entire US economy, focusing on different sectors. Here are their 1-year charts: Several charts stand-out. Real estate (top row, second from left), consumer staples and utilities (middle row, last two on the right) are all in solid uptrends. This is a standard, late-economic-cycle development. Traders grow more defensive as the economic cycle ages, leading them to purchase more conservative stocks. Two sectors stand-out for their weakness: energy (top row, far left) has been negatively buffeted by weak oil prices while health care (bottom row, left) has been in the political cross-fire from both parties. The remaining charts are mostly positive from a technical perspective but are more speculative because they either carry more risk or are less likely to perform well towards the end of an economic cycle.

Let's take these concepts and construct another portfolio. To keep things simple, I'll use the SPY/IEF from the second column, but use the 75% asset allocation I mentioned above. We'll allocate the remaining 25% to the one of the conservative ETFs. But, which one? Let's use two criteria: 60-month beta (which tells us how risky an asset is relative to the broader market) and yield. As I noted above, the XLV (healthcare) has been under political pressure, so it's out. That leaves the XLU, XLP, and VNQ:

60-Day Beta Yield
XLU .21 2.89%
XLP .61 2.64%
VNQ .61 3.78%

Data from

Notice that the consumer staples ETF is yielding slightly more than 100 basis points below the real estate ETF for the same beta. So, we can drop that from consideration, leaving us XLU and VNQ. That leads to a key question: are you willing to take the additional volatility (the higher beta) for the VNQs for an additional 89 basis points in yield?

Let's game this out: Let's assume we're closer to the end of an expansion than the beginning. We already know that the Fed is moving towards a more dovish tone, which would help both ETFs. While there is more risk in the real estate ETF, it is well diversified, so we'll take the extra yield (and income).

So, here's the portfolio:

ETF Percentage
SPY 37.5%
IEF 37.5%
VNQ 25%

I'm not going to keep this as a model portfolio. Instead, please use this as an explanation for how you can add some potential upside to your ETF portfolios.

Stay tuned for the next Passive-Aggressive Investor.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.