Mid-Cap
Mid-cap stocks are an important part of any diversified portfolio. They offer the “best of both worlds”. That is, within mid-caps you will find both ‘off-the-beaten-path’ value stocks, as well as growth stocks.
What Is Mid-Cap?
Mid-cap (or mid-capitalization) is defined as companies with a market capitalization — or market value— of between $2 and $10 billion. As the name implies, a mid-cap company falls in the middle between large-cap (or big-cap) and small-cap companies.
These companies tend to be substantial firms with solid businesses, with an established foothold in their respective market. Mid-caps are often domestic or niche companies that are looking to expand.
And since mid-cap stocks may often offer both dividends and price appreciation, they can balance investment portfolios between income and growth. In effect, mid-caps offer a compromise between the growth, risk and volatility trade-offs of their larger and smaller counterparts.
There are two main benchmarks for mid-cap stocks:
The S&P MidCap 400 Index tracks the performance of 400 mid-sized U.S. companies with valuations between about $2 billion and $8 billion. As of September 2021, the median market cap of companies in this benchmark was nearly $5.5 billion.
The Russell Midcap Index tracks nearly twice the number of companies than the S&P index — more than 800 — and is a subset of the larger Russell 1000 Index. The companies in this index had a median market cap of $11.3 billion as of September 2021.
Why Invest in Mid-Cap Stocks?
Despite being often overlooked by investors, mid-cap stocks have delivered performance. Since 2012, the aforementioned S&P MidCap 400 Index has outperformed the Dow Jones Industrial Average.
And, according to Hennessy Funds, the longer mid-cap stocks are held, the more likely they are to outperform. In fact, 76% of the time, mid-caps outperformed small-cap and large-cap stocks over any 10-year rolling period in the past 20 years.
Hennessy (using Morningstar data) says that, not only have mid-cap stocks generated higher absolute returns over a longer time frame, but they have also provided these returns with less associated risk.
Over the 20-year period ended 12/31/21, investors in mid-caps have experienced higher returns and lower risk relative to investors in small-caps. In addition, while mid-caps had more risk than large-caps, investors have been rewarded with a higher return over the same period.
The outperformance of mid-caps stems from the fact that many of these companies exhibit solid growth, either as they expand overseas or into new products and services.
And historically, mid-cap companies offer one of the best ways to profit from an economic recovery. That is a result of their large exposure to the industrial sector.
The historical outperformance is clear to see.
After the early 2000s recession, mid-cap equities outperformed large caps for three consecutive years – 2003 through 2005. And similarly, mid-caps performed well after the global financial crisis, beating large caps four out of five years from 2009 through 2013.
How to Invest in Mid-Cap Stocks
It’s not wise for investors to randomly pick any mid-cap company. After all, mid-cap companies could be the large-caps of the future or of the past.
Your individual asset allocation will vary based on your risk tolerance and investment goals. However, mid-cap stocks do deserve a place in any portfolio.
That’s why the American Association of Individual Investors (AAII) in their model conservative, moderate and aggressive investment strategies have a 10% to 20% allocation to mid-cap stocks.
Investing in mid-cap stocks is easy. You can invest in a group of mid-cap stocks by buying mid-cap index funds, either mutual funds or exchange-traded funds (ETFs). There are about 40 such ETFs and 600 mutual funds.
By doing so, you can reduce the risk associated with owning any individual stock while positioning your portfolio to benefit from broader market gains.
You can find funds that track key mid-cap benchmarks, styles of investing like growth versus value and mid-caps in specific industries.
Your search can be made easier by using Magnifi, a search-based investing platform that can help match investments to your goals. Magnifi’s AI driven system finds investment suggestions for you based on just a few inputs.
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The information and data are as of the February 25, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Multifactor ETFs
As investors seek protection from stock market volatility and potential downturns, products have been developed to take up this challenge.
One of these types of products is the multifactor ETF, which first appeared in 2003.
What Are Multifactor ETFs?
Multifactor funds provide exposure to stocks with different characteristics—or factors—such as value and momentum, all in the same product. These ETFs take a broad index, like the S&P 500, and apply a rules-based quantitative process to select stocks based on the chosen factors.
These funds are part of the concept of “smart beta”, which involves building portfolios skewed to “factors” that have historically been correlated with outperformance. These include value, dividend generation, momentum, small size, quality, profitability and low volatility.
Much academic research has been done regarding these “factors”.
A landmark 1992 study, by University of Chicago Professor Eugene Fama and Dartmouth College Professor Kenneth French, argued that – based on history – focusing on smaller stocks and those with lower relative prices may improve a portfolio’s expected return. Subsequent research conducted by University of Rochester Professor Robert Novy-Marx identified profitability as another factor that enhances expected returns.
The beauty of multifactor ETFs is that they combine two or more of these elements. This approach is designed to increase diversification and provide a smoother ride for long-term investors since it sits between passive and active strategies.
The funds’ goal is to provide less risk than passive funds that track broad-based indexes, and at a lower cost than many active funds.
Why Invest in Multifactor ETFs?
Some investors dumped multifactor ETFs late in 2020. That’s because some of these funds underperformed the market average (S&P 500). This was almost solely due to the poor performance of value investing, which by one measure had its worst run for 200 years.
U.S. markets are more concentrated now than they have been in the past 40 years, with technology stocks, such as Amazon, Apple, Microsoft and Alphabet representing over 20% of the S&P 500.
So if an ETF is tracking the S&P 500, the portfolio will be highly concentrated in a few stocks, which will increase stock-specific risk that quite often should be diversified away, depending on your individual financial circumstances.
Multifactor ETFs seek to provide better risk diversification by identifying companies across a variety of areas, rather than focusing on a small number of heavily concentrated positions. By providing simultaneous exposure to multiple, uncorrelated factors, multifactor ETFs aim to enhance risk-adjusted returns over traditional passive ETFs and provide investors with a more consistent return profile over a full market cycle.
A key strength of these ETFs is their ability to manage the correlation between different factors in a way that a series of single-factor funds could never replicate.
The active returns of single factors have low correlation to each other, so it’s unlikely multiple factors will underperform at the same time. This means diversifying across multiple factors can smooth out your return without reducing performance potential.
Multifactor funds also have an advantage wherever performance fees are levied, in that they allow the netting of fees. An investor does not have to pay a performance fee for one factor that has shot the lights out, if another has tanked and dragged the overall performance back down.
How to Invest in Multifactor ETFs
Multifactor ETFs can be bought through any brokerage firm.
However, you should not invest in these funds blindly. How a multifactor ETF can enhance the existing investments in your portfolio has to be considered.
You will need to do some due diligence. Investors need to look well beyond just the fund’s name.
For instance, there are many different ways to measure the value factor, including price-to-book, price-to-earnings, and price-to-sales ratio. There are also numerous ways to measure profitability, another key factor.
The bottom line is that how a factor is measured can have a major impact on how the fund performs and interacts with the other factors bundled into the fund, as well as your own portfolio.
Importantly, keep in mind that multifactor funds can have a prominent place in portfolios, especially when different investment styles are fighting for dominance.
For help in finding the right multifactor ETF to fit your portfolio, please be sure to check out the Magnifi website under multifactor funds.
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The information and data are as of the February 15, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Preferred Securities
Preferred securities are investments that are popular with investors looking for a source of safe and steady income. It is a hybrid security, blending characteristics of both stocks and bonds.
What Are Preferred Securities?
Preferred securities are fixed-income investments with equity-like features. Many of them are issued by large banks and insurance companies.
Some of the key differences between common and preferred stocks include: preferred stockholders having a higher claim on distributions (dividends) than common stockholders; preferred stockholders usually have no or limited, voting rights in corporate governance; and, in the event of a liquidation, preferred stockholders’ claim on assets is greater than common stockholders but less than bondholders.
Here are some of the common characteristics of preferred securities:
Price and Yield: preferred stock shares are issued at a $25.00 price with a set yield. In order to get the annual dividend rate, multiply the yield times the share price.
Perpetual, but Callable: most preferreds are issued as perpetuals (they have no stated maturity date), but the issuer will have an option to “call”, or redeem the stock at a fixed value, before the maturity date – usually at 5 or 10 years after issuance.
Fixed and Floating Rates: preferreds with more debt-like traits can have fixed rate, floating rate, or fixed-to-floating rate dividends. Floating rate structures offer much lower interest rate risk than fixed rate bonds.
Cumulative or Non-Cumulative: deferred or missed payments on cumulative preferred securities accumulate as obligations of the issuer, and must be paid out to holders of preferred securities before common shareholders can receive any dividend payments. However, with non-cumulative preferred securities, missed payments do not accumulate as obligations of the issuer and shareholders are not entitled to receive missed payments.
High Quality Ratings: preferreds are often issued by investment grade entities, and even though they are typically ranked two or more notches below an issuer’s senior debt, many preferreds still garner investment-grade ratings.
Distributions are dividends, not coupon payments: preferreds pay dividends on a fixed schedule, rather than coupons like a bond. And in periods of severe financial stress, the issuer may skip a payment without triggering a default. Income earned from preferreds are usually taxed at a federal rate which is considerably less than ordinary income tax rates that are applied to other fixed income securities.
Junior Capital Structure Ranking: preferreds rank lower than senior debt, but higher than common stock in a company’s capital structure. That means, in the event of an issuer’s default, investors holding that company’s preferreds will get paid back after the bondholders and before the stockholders.
Why Invest in Preferred Securities?
While preferreds are stocks, they are vastly different from common stocks. So don’t get them confused. . .they’re a world apart when it comes to risks and rewards.
In brief, preferred stocks can make an attractive investment for investors seeking steady income, with a higher payout than they’d receive from common stock dividends or bonds. However, these investors may miss out on the upside potential of common stocks and the safety of bond payments.
In an environment of low interest rates and rising volatility, preferred securities are attractive because of their historically high relative yields and their ability to weather changing interest rate environments. They also may help diversify a fixed income portfolio, due to their historically low correlation to other bond and stock asset classes.
And since preferreds are predominantly investment grade securities, it helps investors manage their portfolio’s credit risk.
In addition, there is tax-advantaged income potential, since many preferred security structures pay qualified dividend income (QDI).
A few firms issue convertible preferred securities. They can typically be exchanged for a specified amount of a different security, often the common stock of the issuing company. Convertible preferred securities may combine the fixed income characteristic of bonds with the potential appreciation characteristics of stocks. There are often provisions attached to convertible preferred securities that place restrictions on when they can be converted. Since convertible preferred securities can be exchanged for shares of the issuer’s common stock, the value of these securities will be more volatile than your typical preferred security.
How to Participate in Fixed Income Investing/preferred Securities
Preferred securities, like other stocks and fixed income securities, can be purchased through your brokerage firm.
However, keep in mind that no two preferred securities are alike. So take the time to read the ‘fine print’ and determine whether a particular preferred issue aligns with your investment needs, risk tolerance, and goals.
Another aid for investors – either to find preferred securities, ETFs or funds, or even individual preferred stocks – is to check the Magnifi website under preferred stocks.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the February 9, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Real Assets
Real assets exist in the physical world, and their value derives from their physical qualities. This is in contrast to financial assets, like stocks, bonds, cash and cryptocurrencies.
However, one similarity between real and financial assets is that their valuation depends on their cash flow generation potential.
What Are Real Assets?
Real assets can be categorized into several categories: real estate; natural resources – oil & gas, metals and minerals, timber and farmland/agricultural commodities; infrastructure – energy pipelines, transportation (roads, airports, railroads), utilities, telecommunications infrastructure (cell phone towers, etc.); physical equipment (factories, machinery, buildings, etc.).
These real assets have their valuations tied to cash flow and how much investors are willing to pay for the future stream of earnings. However, one of the primary differences between many stocks and real assets is that real assets have intrinsic value in and of themselves.
Investing in a real asset typically has the following benefits:
- It earns good cash on cash yield
- Is contracted for a long duration
- Have a stream of cash flows that are tied to inflation
- Have lower volatility because they are privately owned
That is why real assets are so popular with institutional investors. Overall, real assets represent more than $10 trillion out of $27 trillion of global institutional assets under management in 2019.
Why Invest in Real Assets?
Due to their low correlation to other financial assets, real assets offer investors the opportunity for diversification. Diversifying one’s portfolio is key to limiting exposure in order to lower investment risk.
As Cesar Perez Ruiz, chief investment officer (CIO) at Pictet Wealth Management, said to the Financial Times: “Real assets are a good late-cycle investment, when increasing volatility can offer interesting entry points into areas that have low correlation with other asset classes.”
This asset class tends to be more stable than financial assets. Inflation, currency fluctuations, and other macroeconomic conditions affect real assets less than financial assets.
Real assets are particularly well-suited investments during inflationary times because of their tendency to outperform financial assets during such periods. The S&P 500 Real Assets Index, which launched at the end of 2005, has outperformed the S&P 500 in every high inflation year since its inception.
The asset management giant Blackrock looked at average annual returns in different regimes of growth and inflation over the past 20 years. It found that U.S. and global real estate, as well as global infrastructure, beat stocks and bonds when inflation is high. Outperformance was seen in both low and high periods of growth.
All that some real assets, such as commodities, need is a whiff of inflation to get rolling. For example, the Bloomberg Commodity Spot Index ended 2021 with a gain of 27%. That was the biggest yearly jump since 2009.
Also, real assets have appeal to investors searching for reliable income. Cash flow from real assets like land, infrastructure, and real estate projects provide sound and steady income streams to investors.
However, keep in mind that real assets are often less liquid (harder to sell quickly) than financial assets.
Another major plus for real assets versus say U.S. stocks is that the real assets market is often riddled with inefficiencies. The lack of knowledge about specific real assets (such as a copper mine or a cell phone tower) offers investors the potential for high profits.
How to Invest in Real Assets
The good news is that you do not need a lot of money to invest into real assets.
You could buy the actual real asset, such as silver coins. Or buy futures contracts on physical commodities. Or invest in real estate via fintech companies for just a few hundred dollars.
Investors can also gain exposure to these types of investments through individual stocks, ETFs and mutual funds. A simple search on Magnifi will help you find numerous ways to invest into real assets.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the February 9, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Outperformance
What Is Outperformance?
Outperformance is used to describe the returns of an investment producing better results when compared to another. The term is commonly used to compare an investment’s return to a benchmark index, such as the S&P 500.
For example, investors could say they “outperformed” the market, if their portfolios produced better returns than the S&P 500.
There are a number of reasons why stocks can outperform the market. These may include: a company’s revenues or earnings growing faster than expected versus its peers, superb management decisions, market preferences, network effects, its industry sector was undervalued and has now rebounded, or even sheer luck.
So how can you find stocks that will outperform the overall stock market?
Finding Outperformance
Investors are often able to achieve outperformance by determining where the economy/business is in its cycle, the strength of different sectors, and then picking the strongest stocks within those sectors to invest in.
An economic cycle, sometimes referred to as a business cycle, is the periodic growth and decline of a nation’s economy. Economic cycles can be broken down into four parts, each of which is associated with the outperformance of certain sectors:
Early recession:
The economy begins to slow and consumer expectations are falling. Growth is slowing as inflation climbs higher, and stock prices begin to look high compared to earnings. Interest rates are rising and the yield curve is flat or even inverted (meaning that long-term interest rates are equal to or lower than short-term rates).
Historically, the following sectors have profited during these times: consumer staples, such as food producers and grocery retailers, healthcare and utilities.
Recession:
Economic growth is down (GDP is contracting), and industrial production is at a low point. The unemployment rate is high and rising. Interest rates begin to fall, and the yield curve is normalizing (meaning that long-term rates are higher than short-term rates). Although consumer expectations are low, they are beginning to improve.
The best sectors in this phase include utilities, healthcare, and consumer staples early on and then cyclicals (such as energy and materials) near recession-end.
Early recovery:
The economy begins to improve, and consumer expectations continue to rise. Industrial production begins to grow. Interest rates are falling. Corporate earnings grow. People spend.
The sectors to consider investing in at this stage include: other cyclicals like transportation as well along with technology.
Late/full recovery:
Interest rates are on the rise and the yield curve has flattened. Industrial production is slowing and consumer expectations are beginning to fall. Sectors to consider include consumer staples and precious metals.
Part of the big picture analysis involved in deciding where we are in the business cycle includes interest rates and inflation.
How Interest Rates Play a Role in Outperformance
Interest rates rise and fall as the economy moves through periods of growth and stagnation and are important in crafting a portfolio.
When interest rates rise, some stock sectors – considered to be defensive – rise. These include the likes of healthcare, consumer staples and precious metals.
Also financial stocks may benefit as banks can earn more from the spread between what they pay to savers and what they can earn from highly-rated debt like Treasuries.
On the other hand, there are stock sectors that rise when interest rates decline. These include technology, utilities (and other high dividend payers) and commodities. And since lower interest rates tend to boost economic growth, small and midcap stocks also benefit.
How Inflation Plays a Role in Outperformance
Research from the investment firm Schroders found that equities outperformed inflation 90% of the time when inflation has been low (below 3% on average) and rising – that is where we have been for many years.
When inflation is on the rise, there are certain sectors that usually outperform the market. These include commodity-related sectors such as basic materials and energy, as well as some utility stocks.
Another industry to consider is real estate (equity REITs) – it is a real asset that produces steady income.
Investors can gain exposure to these types of investments through ETFs and mutual funds. A simple search on Magnifi indicates numerous ways for investors to access an array of funds with low fees.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the February 9, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Governance and Transparency
More and more investors – both institutional and retail – are applying environmental, social, and governance (ESG) criteria to their evaluation of the companies they invest in.
Governance, or this case corporate governance, is the system by which businesses are directed and controlled. It involves both the board of directors and management.
Corporate governance covers the areas of environmental awareness, ethical behavior, corporate strategy, and risk management.
What Is Governance and Transparency?
The core principles of corporate governance include accountability, fairness, responsibility, and transparency. Each of these four principles are essential parts of good governance.
Perhaps the most important of these principles is transparency. Shareholders (and even outsiders) should be informed about the company’s activities, what it plans to do in the future and any risks involved in its business strategies.
Transparency means openness, a willingness by the company to provide clear information to shareholders and other stakeholders.
Disclosure of material financial matters concerning the organization’s performance and activities should be timely and accurate. This will ensure that all interested parties have access to clear, factual information which accurately reflects the financial, social and environmental position of the organization.
Transparency ensures that stakeholders can have confidence in the decision-making and management processes of a company.
After the Enron scandal in 2001, transparency is no longer just an option, but a legal requirement that a company has to comply with.
Transparency is a necessity for the whole company. However, its presence is even more important at the top where strategies are planned and all the major decisions are made. Shareholders expect that the corporate board and upper management are open about their actions; otherwise, distrust will form and the stock price will likely suffer.
Why Is Governance and Transparency Important to Investors?
The reasons governance and transparency are important are self-evident.
Poor corporate governance can cast doubt on a company’s operations and its ultimate future profitability. In fact, S&P Global research on governance factors has shown that companies that rank well below average on good governance characteristics are highly prone to mismanagement and risk their ability to capitalize on business opportunities over time.
And there are studies that show a positive link between financial performance and strong corporate ESG policies and practices.
Aaron Yoon, an assistant professor of accounting information and management at Kellogg and George Serafeim at Harvard Business School, recently examined this question by analyzing data on more than 3,000 companies. They found that stock value did tend to rise after positive ESG news about a firm emerged, but only if the news was financially material—that is, related directly to the company’s sector.
The researchers also looked at what categories of ESG news elicited the biggest reaction from investors, given that ESG covers a huge range of company activities.
In looking at both material and nonmaterial news, they found that investors didn’t respond to every piece of ESG news. But they did react strongly to news about how products affected customers, such as changes in safety, affordability, or consumer privacy. So, if companies are looking for a positive market response, it might make sense for them to invest more resources in those areas. Improving labor practices and lowering products’ environmental footprints also were linked to bumps in stock prices.
That’s why understanding in particular the “G” in ESG is critical, as governance risks and opportunities will likely increase in the future as social, political, and cultural attitudes continue to evolve.
How to Invest in Transparent Companies With Good Corporate Governance
More and more investors are seeing the connection between ESG performance, value creation, and risk reduction. It makes sense that companies with strong ESG performance tend to be more efficient and less wasteful. They enjoy greater employee commitment and higher productivity. And they are more respected and better able to build brand equity. All of that reduces operational and reputational risks.
But of course, ESG investing covers a lot of ground, including governance and transparency.
Investing in such a broad theme can be challenging for investors, even professionals. Fortunately for individual investors, a search on Magnifi suggests that there are a number of ETFs and mutual funds that can help you access this rapidly growing style of investing.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the December 22, 2021 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Downside Protection
What Is Downside Protection?
No one wants to lose money on their investments, right?
After all, the whole purpose of investing is to build wealth in order to reach your financial goals – an early retirement, a college fund for your children, etc.
Achieving those goals is made a lot tougher with a substantial loss. For example, you would need a return of 100% in order to recoup a loss of 50%.
That’s why both individual and professional investors use various strategies to protect against losses.
All of these strategies can be called by the broad term ‘downside protection’ and may include the use of stop-loss orders, options contracts, or the buying of other assets that will hedge the risk of the underlying asset already owned.
Diversifying your portfolio is another, very broad-based way to provide downside protection on your total portfolio. As is lowering the percentage in your portfolio of volatile assets.
Why Is Downside Protection Important?
The pandemic-induced stock market selloff in March 2020 was just the latest example of why downside protection is important.
As with any insurance policy, a downside protection strategy is one of those things investors’ may not need… until they do. The whole point is to have the strategy in place before the unexpected happens, before the potentially catastrophic event occurs.
In other words, goal-oriented investors should place more emphasis on playing defense and minimizing drawdowns to their portfolio.
Let’s go back to the Great Recession. The S&P 500 fell 57.7% from its high in October 2007 before bottoming out in March 2009. The decline was the largest drop in the S&P index since World War II.
That type of decline would take a gain of about 125% just to get back to breakeven. That would be difficult if you are in or near retirement.
Examples of Downside Protection Strategies
Here are some examples of downside protection strategies:
Hedging is the most straightforward type of downside protection. Imagine you own 100 shares of XYZ company stock, which is trading for $33 per share. You can hedge your investment by purchasing one put option for 100 shares of the stock. Put options are contracts giving you the right to sell the stock at a guaranteed “strike price” for a limited period of time. Let’s say you bought a put option to protect your XYZ stock with a strike price of $30 per share. If the market price drops below $30, you can still sell your shares for $30 until the day the put option contract expires. If the price goes up, you let the option expire and all you lose is the premium you paid to buy the put option.
Another strategy for investing with downside protection is to write a covered call option. This means you write, or sell, a call option contract with a strike price that’s higher than the current market price. The purchaser of the call contract has the right to buy the shares from you at the strike price. If the price declines or does not go up to the strike price before the option expires, you keep the premium the purchaser paid. The premium provides some downside protection by offsetting part of any drop in the stock price. One negative feature of covered calls as downside protection is that you give up the possibility of making more money if the stock price goes above the strike price – you will lose the stock to the buyer of the call.
If you do not wish to use options, here are some other possibilities to consider:
- Traditional diversification – Treasury bonds and notes, real estate investment trusts (REITs) funds, precious metals.
- Riskier Hedges – managed futures, alternative assets
How Can You Manage Risk?
Each individual is different, with widely varying risk tolerance and views on what is risk. So it is a challenge to select the “right” approach to downside protection.
This challenge has been significantly more difficult in bullish market environments, as there is a temptation for investors to ignore downside risk in favor of capturing the seemingly endless upside for stocks. However, prudent investors are always prepared for the inevitable bear market.
There are several ETFs and mutual funds that aim to provide downside protection strategies. A simple search on Magnifi indicates numerous ways for investors to access these funds with low fees.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the December 22, 2021 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Quality Investments
What Is a Quality Investing?
Quality investing is an investment strategy based on a set of fundamental characteristics, such as a strong balance sheet, that is used to find the highest quality companies.
Warren Buffett’s mentor – Benjamin Graham – is considered to be the father of value investing. But he was also interested in quality investing.
Graham placed great emphasis on finding quality value stocks. His studies found that the biggest danger when buying value stocks was settling for low quality companies that were unable to compete.
Graham argued that finding quality stocks was the key to successful value investing. In other words, investors in general – but especially traditional value investors – leave money on the table when they ignore the quality dimension of value investing.
The characteristics of a quality company include: strong balance sheet (low debt levels), credible management, earnings stability, payment of dividends and operating efficiency. These companies have high profitability. High rates of return – particularly return on equity, cash flow generation and the profit margins of the business (which measure the ability of the company to generate profits from its assets) are found in quality companies.
There are also other two traits: the company has what Buffett described as an “economic moat,” giving it a competitive advantage over its rivals and a long enterprise life cycle, which means a company is investing in new technologies and products.
Why Is Quality Investing Important?
Quality investing is important simply from the fact that backtesting has shown that “boring” dividend-paying, stable companies have outperformed more risky investments for long periods of time.
Overall, quality stocks have outperformed both value and growth stocks since MSCI began tracking it in global markets in 2001.
An analysis done by the UK’s SN Financial Services comparing the MSCI World Quality index versus the MSCI World Value index was quite illuminating.
It found that from December 31, 1998 to December 1, 2020 quality outperformed value over the long term, +515.77% to +254.87%. Most of the outperformance came mainly from 2008 onwards (post-Financial Crisis).
This makes sense since a quality company is one that generates a lot of cash and reinvests it wisely so that it can defend and grow its competitive advantage.
What’s the Difference Between Quality Investing and Value Investing?
Many retail investors still confuse quality investing with value investing. But they shouldn’t.
Buying high quality assets without paying premium prices is just as much ‘value investing’ as is buying average quality assets at discount prices.
Quality companies have a high return on equity, low debt, and very stable earnings. And they are often among the most familiar names to investors.
These companies generate a return premium in excess of the market over time with lower risk. This return is accentuated when risk aversion is high or rising. Historically, many of these periods have often been associated with value strategies underperforming.
In addition, quality companies are able to sustain elevated profitability levels relative to the wider market for protracted periods. In contrast, investors actually tend to overpay for “growth”, getting sucked into glamour trades.
This leads directly to the outperformance of the “slow and steady” companies where strong fundamentals are not fully priced.
Quality investing also leads to a portfolio with lower volatility than the market.
Meanwhile, value stocks are simply perceived as being undervalued and investors buy a value stock for what they think to be less than its true worth.
However, value stocks are often cheap for very good reasons, such as poor management and a lack of innovation in a low-growth industry.
That’s why – as shown earlier – quality investing outperforms value investing over longer periods of time.
How to Participate in Quality Investing?
It is rather easy for you to be able to participate in quality investing.
Of course, you could buy individual stocks – the familiar names we all know. Many of them are members of the Dividend Aristocrats, which are S&P 500 companies that have paid and increased their dividend payments for at least 25 consecutive years.
However, an easier and more diversified approach is to invest in ETFs and mutual funds that focus on quality investing strategies. A simple search on Magnifi indicates numerous ways for investors to access these funds with low fees.
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with a Magnifi Account
Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the December 22, 2021 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Hedged Equity
What Is a Hedge?
In simple terms, a hedge is an investment that is made with the intention of reducing the risk of a large and adverse price movement in an asset.
Hedging is similar to taking out an insurance policy. And like insurance, there is a cost to hedging. While it reduces potential risk, it also reduces potential gains, since the hedge is usually taken in the opposite direction as the asset being protected.
In the investment world, the most common way to hedge is through derivatives. These are securities that move in correspondence to one or more underlying assets. Derivatives can include options, swaps, futures and forward contracts.
There are many kinds of options and futures contracts that investors are able to hedge against almost any investment, including stocks, fixed income, interest rates, currencies, commodities, and more.
The effectiveness of a derivative hedge is expressed in terms of delta or “hedge ratio.” Delta is the amount the price of a derivative moves per $1 movement in the price of the underlying asset.
The specific hedging strategy, as well as the pricing of hedging instruments, likely depends on the downside risk of the underlying security against which the investor would like to hedge. Generally, the greater the downside risk, the greater the cost of the hedge. Downside risk tends to increase with higher levels of volatility and over time.
For example, if you want to hedge your position in a highly-volatile tech stock, an option which expires after a longer time period and which is linked to this stock will be more expensive than say a short-term option on a consumer staple stock.
Note that funds designed for downside protection do not necessarily increase the likelihood of positive returns during market downturns.
Why Is Hedging Important?
Used wisely, hedging your portfolio can become part of your long-term investment strategy. Hedges can be applied and removed as needed, without disturbing your core strategy or long-term goals.
Most importantly, hedging can help provide short-term shelter from adverse market events. This provides you with an alternative to selling in a down market, being forced to take an investment loss and perhaps incurring redemption fees, transaction costs and tax consequences.
In essence, hedging is recognizing the dangers that come with every investment and choosing to be protected from any untoward event that can impact one’s finances.
As stated previously, hedging strategies have unique risks, costs and consequences of their own (management fees, taxable events, etc.). It is important that you fully understand the strategy you plan to use and read the prospectuses for any investments you intend to use as a hedge.
Examples of Hedging Strategies
There are several common hedging strategies investors use to help mitigate portfolio risk: short selling, buying put options, selling futures contracts (often on a stock index like the S&P 500), trading volatility, and using inverse ETFs.
Inverse ETFs rise in price when the market goes down. Retail investors often use these ETFs because they are less burdensome than the other hedging strategies. No margin, options or futures is needed to buy an inverse ETF.
Another common strategy involves the use of options. An option is an agreement that lets the investor buy or sell a stock at an agreed price (called the strike price) within a specific period of time.
Let’s say you own a stock. If you purchase a put option, and the stock falls in price, the put option will go up in price – offsetting at least some of the loss in the stock price.
How to Participate in Hedging Strategies
You’re already using hedges in your everyday life. The aforementioned insurance policies you buy are a hedge against future scenarios. While hedging will not prevent an incident from occurring, it can protect you if something bad happens.
So it makes sense to do the same in your financial life.
There are several ETFs and mutual funds that use hedging strategies that are designed to reduce risk. A simple search on Magnifi indicates numerous ways for investors to access these funds with low fees.
Unlock a World of Investing
with a Magnifi Account
Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the November 18, 2021 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Sustainability
What Is Sustainable Investing?
Sustainability – a company’s ability to create positive environmental and societal impact – is rapidly reshaping the corporate landscape. It is reshaping whole industries and generating new waves of growth.
The staggering scale of the disruption (and opportunities) that will play out over the next few decades are why many company executives right now are strategizing as to how to position their companies for the future in the face of ongoing megatrends, such as climate change.
More and more governments, as well as corporations, are pledging to back a United Nations campaign aiming for net-zero greenhouse gas emissions. This will affect how nearly every company operates.
Just the push to limit global temperature increases to under 2°C—the number one sustainability challenge of our time—will drive a massive transformation of the global economy. It will require investments totaling an estimated $100 trillion to $150 trillion by 2050.
Tomorrow’s best companies will be those that can operate outside of their comfort zone. Why? At its core, sustainability has a lot to do with resiliency.
Companies must build the capacity to adapt and innovate amid worldwide disruptions. In effect, sustainability requires “unlearning” how industrial society has operated for 150 years, and charting a new route to reach the same goal of delivering shareholder value.
Going forward, C-suite executives and boards must treat social responsibility and environmental stewardship not as separate functions largely disconnected from strategy, but rather as integral to corporate and business strategy.
Differences Between Sustainable Investing, Socially Responsible Investing, & ESG Investing
Sustainable Investing, Socially Responsible Investing (SRI), and ESG Investing are often used interchangeably. However, these investment approaches are each different.
Sustainability has become a catch-all term for a company’s efforts to “do better” or “do good.” This investment approach has three basic pillars: economic growth, environmental protection, and social progress. At times, this is referred to as “people, planet, and profits.” In a nutshell, sustainable investing directs capital to companies fighting climate risk and environmental destruction, while also promoting corporate responsibility.
In general, SRI investors encourage corporate practices that are morally grounded and promote environmental stewardship, consumer protection, human rights, and racial/gender diversity. Essentially, for socially responsible investors, morality trumps the bottom line.
ESG investing also focuses on three pillars. Environmental issues, which can include pollution, climate change, extreme weather, carbon management, and use of scarce resources. Social issues, which can include product safety, human rights, worker safety, customer data protection, and diversity and inclusion. Governance issues, which can include factors such as accounting standards compliance, anti-competitive behavior, and a strong ESG management process.
ESG data and metrics are used to gain insights into the success and value of a company’s performance and policies in order to mitigate risk and identify superior risk-adjusted returns. Essentially, the focus of ESG investing is on increasing the bottom line through investments in responsible companies that are being well managed.
Why Choose Sustainable Investing?
This type of investing has become Wall Street’s hottest growth area.
According to data supplied by The Forum for Sustainable and Responsible Investing, there are nearly $13 trillion invested into some form of socially responsible investing. And according to research conducted by Morgan Stanley in 2019, 85% of individual investors and 95% of millennial investors are interested in sustainable investing.
Sustainable investing makes a lot of sense, even if your only concern is the return on the money you are investing.
Like the tortoise in the fabled race with the hare, long-term investors are seeing growing evidence that this type of investing can beat traditional methods. For example, in the past few years, companies with higher ESG ratings had higher average return on invested capital, compared to companies with lower ratings, according to MSCI.
The reason for this outperformance is straightforward and obvious… ESG pushes companies to look beyond the next quarter or even the next three- to five-year business cycle in evaluating risk.
Even the results from the tough first half of 2020 were good. Morningstar said, “an impressive 72% of sustainable equity funds rank in the top halves of their Morningstar categories and all 26 ESG (environmental, social, and governance) index funds have outperformed their conventional index-fund counterparts.”
How to Participate in Sustainable Investing
With the large number of companies touting their sustainability credentials, you would need a ‘scorecard’ to keep track. A much easier route would be to purchase ETFs or mutual funds that invest in companies with specific sustainability goals. A simple search on Magnifi indicates numerous ways for investors to access sustainable funds with low fees.
Unlock a World of Investing
with a Magnifi Account
Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as of the November 8, 2021 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.