Archive for the ‘Investment Management’ Category

Sifting through the reels of available mutual funds to include in your portfolio is no easy task. Investors are faced with so many options that it is literally very interesting to try to figure out why one person chose one fund and another with the same tolerance for risk, available time and investment objectives chose a completely different fund. That could be why some people who disagree with our Top fixed income pick (a high yield fund) and our top small cap pick might have different ideas (although we can’t imagine why).

But one of the things nobody can really argue is the following: to pick a mutual fund, whether it is one we like or one we have never even mentioned on this site, one needs to study the MAPS (Management, Assets, Performance, Strategy) of the mutual fund in question. These are just the basics, folks. Spending ten minutes or so to say you understand them will reward you will less stress between the day you invest and the day your statements arrives in the mail.

M – Management: Arguably the least exciting part of your review process, getting to know the management team behind a mutual fund is important. Why? Because management dictates the fund’s style, how the assets will be invested. This is also important to know if you are going to base your investment decision heavily on some past performance record. The thing with management is that as it changes, so does the investment style and often even the fund’s strategy; what might have been a small cap domestic value fund one year can change to a small/mid cap blend fund with a management change. So, management is very important. Google the manager’s name, visit the fund company’s website to see what he or she has published there. Again, not very exciting, but it will reveal more than you think.

A – Assets: Possibly the most exciting part of your research will involve digging into the fund itself and finding out what underlying assets make it tick. Our High Yield Fund pick for 2010 for example has a very pretty asset list, with strong companies and a strong yield. In fact, those assets were probably one of the driving forces behind our taking a much closer look at the fund. But to date, that fund has underperformed its peer group. The reason this does not concern us, however, is that we believe in the strategy of the fund and its management team is strong enough to keep to it. But still, if we did not know what those assets were ahead of time, we never would have looked at what we believe is going to be one of the best-performing high yield funds this year.

P – Performance: We all know that past performance is never indicative of future performance. However, it does give us a scorecard for how the fund has performed. This is increasingly important now because the market turmoil of the past 2 years and some can help us gauge whether the performance has kept up or lagged the benchmark. While important from a trending perspective, however, past performance is never something that alone should dictate whether to purchase a mutual fund.

S – Strategy: A mutual fund’s strategy is a lot like a contract. If a fund manager states that the strategy is one thing but the fund goes ahead and gets involved with something completely off-side, then it makes sense to “fire” that manager and find another. For this reason, you should get to know the mutual fund’s strategy rather intimately because it will form the standard to which you hold the fund’s management team accountable for its performance. And if that fund manager should stray from the stated strategy, then it becomes necessary to re-evaluate your relationship with that fund and fund company.

MAPS. Not hard to remember and not all that time consuming to execute. By keeping this abbreviation in mind when evaluating possible investment avenues, you will gain a fair level of comfort and knowledge about the mutual funds your planner might be pushing and know whether they make sense for you.

Recently, the Mutual Fund Site presented a post about the easiest and smartest investment strategy: investing regularly on an automated contribution plan. This investment strategy is also (or better) known as Dollar Cost Averaging and makes perfect sense when used with mutual funds, whether more-volatile funds that invest in small cap stocks, index funds, or even bond funds.

Aside from buying more units when the markets are down (and less units when the market is up), Dollar Cost Averaging strips the issue of “market timing” out of your investment strategy. This can be fairly important because virtually nobody can “time” the market with absolute accuracy. That means only luck and no amount of research can help an investor buy at the absolute lowest.

Likewise, even the unluckiest investor will have difficulty buying at the absolute highest, but we often feel that way – that we bought at the highest and now our investments are doomed to fail.

This is where Dollar Cost Averaging makes great sense. Not only because it takes the “guess” work and “luck” out of the situation, but because historically it errs on the up-side. That means that if you use dollar cost averaging, your returns are more likely going to resemble the returns of someone who has the great luck and skill to buy at the absolutely lowest days.

This may seem strange because one would think that, statistically, you are more likely to buy the “average” or median between the best and worst possible days to invest. This would be true in a flat market, but historically markets have risen. Therefore, in a 10-year rolling average, even the “worst” possible day will be the best day at some point.

In fact, a Canadian Financial institution actually ran these numbers based on their market, the S&P TSX index. In their illustration, if you were to invest at the absolute worst days over the period of 1989 through to 2009, your returns would still be positive at 5.42% annually. The absolute best days: 7.36%.

And by employing a Dollar Cost Averaging strategy and invested each month on the first business day of the month, your return would have been 6.38%, less than 1% lower than if you had invested at the absolute best time possible for the year but nearly 2% better than if you had invested on the absolute worst days.

Interesting that a simple, more-affordable strategy could yield such positive results. But again, when you look at the historically rising market, it makes sense. In a declining market, the rates above would probably be reversed, but ultimately, investing through an automated investment program (dollar cost averaging) allows you the benefits of not having to worry about the impossibility of market timing, especially when it comes those riskier mutual funds, like those investing in small cap stocks. The investment strategy, however, can be used with other types of investments as well, even those in declining market-value environment such as bond funds.

Give it some thought….

One of the reasons we like the Ivy Small Cap Value fund so much that we named it as one of our top mutual fund picks for 2010 is that it invests heavily in the right kind of financial services firms. The kind that have great value, even if they are consider small cap stocks or mid-cap stocks. We feel that as an investment strategy, these types of securities will allow the Ivy fund to not only outperform in pure growth areas but with its generous dividend it will also generate some decent income.

One of our reasons for liking the Ivy fund is that its underlying securities stand to benefit handsomely from a housing recovery, something we have already started to see according to a recent post over at Reuters about Homebuilder Confidence.

So why Ivy Small Cap Value and not something like the Fidelity Real Estate Income fund? After all, some of these real estate funds produce fairly substantial gains and income — Fidelity’s sure is one of them with a nice 4.8% yield and high returns compared to its peers, along with its “low” risk rating. But comparing Fidelity’s fund to Ivy’s is not a proper comparison. You cannot compare the two.

You cannot compare a real estate income fund to a small cap value fund.

For starters, funds like Fidelity’s are part of the income class. They invest in income-producing securities with roughly 50% of their total holdings in bonds. Of the 20% they hold in  stock, guess what 91% consists of? (Hint, we talk about about them a lot and suggest the difference between “good” and “bad” financial services firms to hold. Somewhat surprisingly, they seem to be holding the “bad” ones).

In comparison, the Ivy fund is equity driven. They have a purpose, with roughly 40% of their portfolio invested in the type of securities that will benefit from the same recovery from which a pure real estate fund (equity based) should.

So while the Fidelity Real Estate Income fund exists to produce income, Ivy Small Cap Value exists to generate long-term gains with income being a nice bonus. For people who are bullish on real estate, Ivy still makes better sense as an equity play because it stands to profit from the recovery. For the Fidelity fund to remain attractive, rates would have to continue dropping, which is still possible given how fixed mortgage rates continue to drop).

Ivy, however, does not need a housing recovery to remain a top-performing small cap stock fund. Why? Because the majority of its securities are already profitable. Remember, there is a difference between good and bad financial stocks; Ivy knows the difference because they hold the good ones. And those firms will only see their revenues increase when housing makes its come-back.This of course is one of the benefits to holding small cap stocks in a portfolio in the first place.

Would we recommend the Fidelity fund as an income play? Not now (besides, we prefer the Janus High Yield Fund as our preferred income fund for the year. Does that mean the Fidelity Real Estate Income fund is a bad one? Definitely not; it just does not make much sense as an investment strategy right now. And we feel our statement is fully backed up by the yield curve.

As an investment strategy, putting $12,000 into a mutual fund today versus spreading that $12,000 over the course of twelve months (or $1,000 per month) is statistically not such a smart move… well, unless of course you invest $12,000 per month or at some kind of regular interval. This has nothing to do with the mutual fund in question. Instead, investing regularly has its share of perks, in fact enough of them that investors would be silly not to take advantage of them from Day 1.

To illustrate just how powerful regular investments can be versus single, lump-sum investments, consider that even if a security value drops, you can still come out with a gain if you make your investment purchases on a regular basis.

To add credibility to our little illustration, we will look at S&P 500 values for 2009. Our first investor will invest $12,000 on the first business day of January while our second will invest $1,000 every month on the first business day of that month. By December 2nd, they will have both invested at total of $12,000.

As we can see from the chart below, the investor who invests every penny at once will be ahead by 19% on December while the investor who puts $1,000 aside every month is only marginally ahead of that investor at 20.57%. The difference of $200.10 hardly seems worth it in the end… or does it? Putting yourself in the shoes of the two investors might tell us a different story as we work our way from month to month.

Take look at the Investor #1 who goes “all-in” on January 2, 2009. How would this investor feel one month later on the first business day of February when that $12,000 investment is down 11.41%, a loss of nearly three thousand dollars. Would Investor #1 be getting sick to her stomach on the first business day of March when that investment is down 24.79% or a heart-stopping $2,974.63?

In comparison, after that first business day purchase in March 2009, Investor #2 would have put $3,000 away and lost just 13.3% or $398.86. In absolute terms, Investor #2 would probably feel a lot better than Investor #1 at this point. And any sinking feeling of loss would be gone for the rest of the year for Investor #2 by the time the first business day in April rolls around and he see his investments roughly at a break-even point (a 0.26% gain actually) while Investor #1 is still not eating or sleeping because they are still down nearly 13% or $1,554.67.

In fact, while Investor #2 watches his investment gain throughout the rest of the year (except in July, when they slip from being “up” 12.27% in June down to being “up” only 8.53% in July), Investor #1 has to wait two extra months before they break even again… and that victory is really short-lived because in July they will have seen their investment swing back into the red again. Talk about an emotional roller-coaster ride for Investor #1 — while Investor #2 recorded just 2 “down” periods for the year Investor #1 was in the red for 5 of the 12 periods, a little more than 40% of the time!

And what if either Investor had lost part or all of their regular income and needed to draw on their investment after 3 months? At that point, only Investor #2 showed a gain of any type meaning Investor #1 would have been cashing in at the absolute worst time possible.

Of course, in the end, Investor #2 actually ends up being $200.10 ahead of Investor #1, thanks entirely to their regular contributions allowing them to purchase more units. After understanding the probable emotional turbulence that Investor #1 experiences, the extra $200.10 seems like only a single piece of what is really much-larger bonuses — these being the reduced stress levels, the added units and the lower dollar-value losses when things turn South.

This is not magic. You can run the figures yourself using S&P 500 closing prices found at Yahoo! Finance. But remember: investing regularly in mutual funds really can make a big difference.

Illustration A (S&P 500 values; Invest One-Time vs. Invest Monthly)

Illustration A

Over the last month or so, the Mutual Fund Site has had a lot to say about the financial services industry, whether we were bragging about our top small cap fund pick for 2010 (for those who have not read the post, the fund in question is the Ivy Small Cap Value fund), talking about the importance of dividend funds in building a profitable portfolio, or tooting our own horn about how we did a great job applauding Dryden’s approach with financials.

To tie these areas together, let’s consider that our 34% of our small cap fund pick for 2010 consists of regional financial services companies, many of which contribute heavily to the fund’s average dividend yield of 2.8%; many dividend funds will rely heavily on financial services companies whose stocks have become devalued to the point that the dividend yield alone makes them attractive assets to own; and Dryden’s Financial Services fund owns a substantial amount of high-dividend paying Canadian bank stocks.

The point above may not be obvious.

What we have here is something of a reverse-engineering problem. Consider that Canadian banks have been touted as the most solid in the world and they pay healthy dividends. Consider that dividend paying stocks are instrumental in ensuring healthy returns, whether inside or outside of a mutual fund investment. And consider, lastly, that Canadian banks are heavily involved in the retail banking segment of their  country, just like the regional banks held in the Ivy Small Cap Value fund are. In fact, those financial services firms in the Ivy fund are doing exactly what Canadian banks are doing – lending responsibly to Joe Public so he can go and buy himself a home, car, boat, whatever and get the economy turned around.

The point above might make a little more sense when you consider that regional banks are an important party in the economic recovery efforts that are being promoted by US officials like Barack Obama, Timothy Geithner, and a host of others who have taken a hard-nose approach with the “big” banks who are often blamed for bringing an end of the last economic boom and practically killing the global economy. In fact, a lot of these officials are trying to convince these big banks into behaving the way these smaller banks are behaving.

So what might that mean for the regional banks?

Well, it could be acquisition for one thing. Canadian banks, who conduct business in a similar manner as these regional banks, have been acquiring some of these regional banks for some time (and now with the US dollar as low as it has been, the Canadian Banks’ purchase power has increased) such as TD Bank purchasing Commerce Bancorp, an award-winning regional bank based out of Cherry Hill, NJ, in 2007.

More likely, however, is that these smaller banks, which pay bigger dividends (based on dividend yield) than their big bank counterparts like Citi and Wells Fargo, will have the support and encouragement of government. They are already operating the way the government would like to see them operate; they already understand responsible lending practices, they are already profitable and fiscally strong (one in particular has increased its equity value by more than 50% over the past two years alone!). The government should love these players.

And, most importantly, when the economy turns around and people start waiting in line for mortgage approvals, credit card approvals and other types of credit or credit-related services, these regional banks will see their income increase exponentially. Why? Well, they are already profitable and the economy is just slowly finding its feet.

It’s a perfect situation for mutual funds like the Ivy Small Cap Value fund (we went so far as to call buying this small cap fund a no-brainer). And for the strong-willed investor with the right risk tolerance, time horizon and investment objectives, it becomes and easy lesson in investment strategy, one that requires very little advanced research. It’s almost the best-kept secret in the mutual fund space (except we exposed it, and we are always proud to help out). And if you are not sure how to get your hands on these stocks, just head on over to Ivy and let them do the number crunching and trading for you.

Just yesterday (February 14, 2010) the Mutual Fund Site announced its top small cap pick for 2010 — the Ivy Small Cap Value fund. In that long-winded post, we outlined various reasons why this small cap fund is a no brainer, why all of the ducks are lined up and its sights for gains are clear for this year. With the mildly improving interest in housing thanks to the gradually improving employment figures, a lot of regional banks like those held by the Ivy Small Cap Value fund stand to profit. What emphasizes this fact is that a lot of regional banks are better positioned when financial service reform will start to take shape.

Okay, this entry is not intended to regurgitate what we wrote in our release or in the post. With that in mind, we will examine one area that makes this small cap mutual fund one of the most intelligent mutual funds available to the investors with the right risk tolerance, time horizon and investment objectives. Why? Because its dividend yield!

We have spoken at length about dividend funds and the importance of dividends in helping boost earnings withing a mutual fund. In fact, we have gone so far as to suggest that dividends can make the difference between what people perceive as a smart investor and an unlucky one. Where the Ivy Small Cap Value fund makes such a great investment is in its dividend yield of 2.8%.

Remember, value funds’ primary area of focus for returns lies in the abilities of the mutual fund manager to pick up underpriced assets. If the fund manager wanted dividends to prop up returns, he or she would be managing a dividend fund. With Ivy, the point is clearly in the “value” its assets offer. This can be supported by the relative low average P/E for the fund of just 15.7. This tells us that the underlying securities are clearly undervalued.

So where do these dividends come from, exactly?

We mentioned yesterday that three of its Top 5 holdings are Wintrust, IBERIABANK and East West Bancorp. Their dividend yields are 0.6%, 2.5% and 0.3% respectively (as of Friday’s closing price). Now, IBERIABANK’s dividend is clearly the highest, but still falls short of the fund’s average dividend yield. And with just 77 securities in its portfolio, obviously some of the other financials are paying much higher dividend yields. Look at First Niagara Financial Group as an example; they pay 4.1%.

And all of these financial services companies are strong. They have solid and/or growing equity positions, they are profitable and, well, they pay decent dividends.

Let’s look at some of the bigger financial services options out there.

• Citigroup. Its dividend yield is 0%.
• Wells Fargo. Its dividend yield is 0.7%
• Goldman Sachs. Its dividend yiled is 0.9%

The point here is that so many value investors will throw money at the big guns. Those are the large financial services firms listed here, two of which are terrific “buys” according to the well respected analysts surveyed by Thompson/First Call as well as other prolific stock analysts. But what about First Niagara, IBERIABANK and a handful of other in Ivy’s small cap fund?

These are what people call as investment “Secrets.” They are those dividends that people chase (within reason of course; no sense in buying a bankrupt stock even if it pays a 10% dividend!). The dividends that people wish they knew about.

Is there risk in a small cap fund? Yes. Is there risk in the Ivy Small Cap Value fund? Yes (although Morningstar lists its risk as low compared to its peer group). But when you have a small cap fund that pays 2.8% in average dividends, the fact remains that dividends are not only an important part of smart investment management, but are an essential contributor to a mutual fund’s returns.

When most people think about small cap mutual funds, the music from the Twilight Zone starts to play in the back of their mind. They know that small cap funds are an important investment management strategy, something that needs to find a place (even a small place in percentage terms) in their asset allocation model, but this part of portfolio building is arguably one of the toughest (next of course to specialty funds). I am also one of those apprehensive investors when it comes to Small Cap Funds. So let’s examine why they are so scary. Ultimately, what makes small cap funds a scary, dark corner is their underlying assets, which are small cap stocks.

…what makes small cap funds such a scary, dark corner is their underlying assets…

And those stocks, thanks to the credit crisis that began in 2007, have become under-capitalized (it has been tough enough for big, AA-rated corporations to secured funding), profit-margin pressured (the big guys need to survive, the small guys need to make money), quarterly, trailing losses (price cutting to compete for smaller opportunities means losses), and we could spend a whole page rhyming off what makes so many small cap so darn scary. But perhaps the next paragraph will really hammer home the reality about this niche category.

One more thing worth noting is that so many small caps are now officially “bankrupt,” meaning they owe more than they own thanks to the list noted above, plus the sharp decline in demand for their products over the past two yeas. This not only makes small caps a really scary place to invest, but it leaves the investor waiting at the edge of their seat for each quarterly announcement. Will this bankrupt company finally start making money or will this be the quarter that gets their bank line yanked, stripping them from any source of capital and forcing them to shutter up? Those fears are very real and they are a lot more common in small caps than any other segment.

So where does that leave investors? How can one pick a small cap mutual fund that will not get hammered by failures?

The first place to start is the underlying assets. While this is important when investigating all mutual funds, it is particularly important when sifting through potential small cap investments. Why? Because if those underlying assets are at risk (such as some housing stocks, some small-cap biotech, some small-cap alternate energy, resources, etc., etc., etc., etc., you get the point) then the fund’s risk profile will skyrocket as well.

You need to know what those underlying assets are!

This then begs the question: what sectors are more apt to prosper in times of economic recovery? We already looked at small cap mutual funds that invest in housing and discussed how this sector can be profitable but also involves some risk. And we already looked at a Dryden Fund that invested in financial services, a segment, we believe, that stands to benefit from financial services reform.

Now if we take a step back and explore what needs to happen for housing to recover the way some of these housing-heavy mutual funds need them to, what needs to happen? Of course, lenders need to start spending money. Some government officials (namely the President) have expressed a demanding sense of urgency in getting big banks to lend more (while simultaneously increasing reserves and adopting safer lending practices, which is the finest example of a paradox to be uttered). But before those big banks start screwing up again, what really needs to happen?

Regional banks and other financial institutions needs to start lending again. And not big-time lending; we are talking about safe, retail lending, the kind that really depends on capacity to repay and borrower creditworthiness. We firmly believe that regional banks can get this right, they can control their lending practices and they can have a solid impact on economic recovery, the kind that will help those home builders and individuals alike. And solid impacts are important; without them, we have superficial growth aka stimulus that dries up once the funding is spent.

One fund that has all of the right underlying assets is the Ivy Small Cap Value fund. The bulk of their holdings (a staggering +34%) is in financial services assets. Companies like East West Bancorp, IBERIABANK Corporation and Wintrust Financial are included in their Top 10 holdings (note: all three of these financial services companies also pay dividends with the fund’s dividend yield at 2.8%, another bonus: see also Why Dividend Funds Can Take You From Zero to Hero….). While this is a strong weighting in an area that the Mutual Fund Site believes will be instrumental in economic recovery, consider that there are only 77 holdings in the fund. This allows for tighter management, which we believe is necessary when you have such a heavy weighting in one given sector.

Ivy Small Cap Value is considered a LOW RISK small cap mutual fund with ABOVE AVERAGE returns, the perfect recipe for long-term capital appreciation. This speaks to the skill of the fund’s management team, led by Timothy Miller since 2008.

Ivy Small Cap Value is a no brainer

But the numbers here are what impresses us the most. Average Price-to-Earnings is an attractive 15.7. Price-to-Sales is 0.4 while price-to-sales-growth is 7.5. And we already discussed that pretty little dividend yield of 2.8%. This becomes a no brainer. Plain and simple. Low risk, properly priced assets, and tremendous future growth potential all highlight just how well this small cap mutual fund can perform.

The risks with this fund lie in its heavy financial services weighting. While is offset to a large extent by its Industrial Materials and Consumer Services weightings, we believe that if financials disappoint, then Consumer Services probably will not be far behind. Notwithstanding this, Ivy Small Cap Value has outshone the category and benchmark while minimizing risk and, more importantly, picking up assets at great prices

Even with its relatively high Expense Ratio of 1.42%, the Mutual Fund Site has chosen the Ivy Small Cap Value fund as its top Small Cap Mutual Fund pick of 2010. An easy decision, actually, once all of the other small cap mutual funds were cut from the short-list.

While mutual funds by themselves offer tremendous diversification potential within sectors, industries, market capitalization and so on, unless you invest in balanced funds, proper asset allocation is usually only achieved by holding different types of asset classes. Understandably, giving up the potential for aggressive gains in growth funds (which are usually suggested through historical return data) in favor of more stable returns in bond funds is not an easy thing  for most investors to do. However, while those historic gains might seem attractive at first sight, proper asset allocation is paramount if one wishes to achieve long-term growth and income.

All investors need to do is look back to 2009 to see just how powerful proper asset allocation can be. For example, the S&P 500 returned roughly 20% throughout all of 2009 (over 60% since its impossible-to-predict low in March 2009). Investing in a 30-year Treasury by comparison would have returned roughly 65% a staggering amount of return for that same period.

While 2009 was undoubtedly one of those “off” years, the data from 2008 tells a similar story about the importance of proper asset allocation through asset class diversification. Arguably a devastating year for equities, 2008 was also a painful (a much more painful in fact) period for long-term Treasury bonds. For that year, equities gave up a touch more than 35% while 30-year Treasury gave up marginally more. While both were evidently “losers” in terms of total return, equities actually outperformed the 30-year Treasuries.

And one year earlier, 2007, also teaches a valuable lesson. While equities ended the year up nearly 5%, 30-year Treasuries were down nearly that same amount.

By incorporating an asset allocation model that touches all asset classes (we are simply looking at the S&P 500 and 30-year Treasuries here), investors will not only sacrifice some of the “wild” gains by being 100% invested in equities, but they will mute those losses in one classes by offsetting them with investments in another.

To illustrate this, consider that same period from 2007 through to 2009. While the year-by-year playbook shows favorably for equities, in fact the 2009 gains in 30-year Treasuries would help produce positive (or less negative) returns for an investor who purchased an S&P 500 Index Fund as well as a long-term bond fund. With a long-term bond fund that imitates the returns on 30-year Treasuries returning nearly nothing over that same period, the other fund, which follows the S&P 500, would still be down roughly 20%. In other words, an asset allocation model that splits the assets 50/50 between an index fund and a long-term bond fund would have only lost a little more than 10% (instead of the full 20%).

Mutual Funds are an interesting beast when you get into dividend funds. Some investors feel that dividend funds are where to invest any and all amounts of money and this argument actually has some merit. After all, dividend-paying securities usually generate enough cash to make dividend payments and they are typically the largest stocks by market capitalization (though not always). But talk is cheap when it comes to investment management, so we came prepared to back up our argument for why dividend funds can take you from zero to hero in one year.

Some of the sweetest statistics around involve securities. Where mutual funds become a lot more attractive is in their management levels — you do not have to find the best dividend-paying securities because the fund manager will do all of that work for you.

The S&P 500 is a great starting point. Of thee 500 securities included in the S&P 500, 73.6% of them (or 368 of 500) pay dividends. That means that an Index fund alone will pay dividends within the fund.While this is not impressive on its own, consider that dividend funds will choose the best companies and, most likely, the best companies of those that pay highest-paying dividends.

The average dividend yield on the S&P 500 as of February 8, 2009 was 1.89%. Understandably, this is not a rate that would knock most people off their feet. The US Treasury Bond term that comes closest to such a yield is the 3-year Treasury. Go to 5 years and your Treasury Bond yield exceeds the average dividend yield on the S&P 500. Why does this matter? Well, nobody has ever been considered a hero by investing in 5-year Treasury Bonds and turning an “easy” hands-off rate of return that would make many people jealous (that being said, people who do pull off great returns investing this way are actually called genius or lucky, or probably both).

That average yield of 1.89% takes into account all S&P 500 securities, including the 132 that do no pay any dividends at all. The average dividend for those 368 securities that do pay dividends is actually 2.43%, better than the 5-year Treasury Bond rate of 2.31%. Now, 2.43% is a little better (much better than banks and investment houses will pay on a 1-year term deposit), but definitely not enough to make someone an investment “hero.”

So, how can one improve their dividend yield to something that would not only put even the 30-year Treasury Bond investor to shame, but would make all of your friends at the golf club blush with envy? Take a peek at the top-25 highest dividend companies where the average yield is actually 6.89%. Now we’re talking; that alone represents a more than one third of the 19% that the S&P 500 returned in all of 2009 (Jan-Dec).

Now, however, comes the question of “quality.” What do these top-25 dividend-paying securities have to offer? Are they on the brink of reducing their dividends? What do analysts think?

Well, Frontier Communications which has the most aggressive dividend yield is rated as a Hold on average by the 10 analysts surveyed by Thompson/First Call. On a year-over-year basis, Frontier is seeing growth in their quarterly earnings, although this is definitely nowhere near substantial enough to base an investment decision. What mutual funds hold Frontier outside of an Index fund? Reaves, DNP, and MFS are the largest holders.

Some of the other companies in this Top 25 include Verizon, Leggett & Platt, Eli Lilly and Integrys Energy. Obviously, these are all companies that most people have heard of, but whether they are worthy of hard-earned investment dollars is a decision often best-left to the mutual fund managers who have the resources to study every little detail of these securities.

So, in answering how dividend funds can take an average investor from zero to hero, consider that as of February 2010, these Top 25 securities in the S&P 500 are paying an average yield of 6.89%. That does not take into account any growth, which many of these shares have already given back. Next step is to short-list the dividend funds that actually perform and exceed standard performance levels.

One of the most e-mailed op-ed columns in the NY Times was published on February 1, 2010… a few days after the Mutual Fund Site released its write-up on the Dryden Financial Services Fund, a mutual fund that has a strong reputation for its investment management prowess and stunned investors with staggering returns in 2009.

Why is this important and why should you care?

Let’s take a look at the column in question. In it, Nobe Prize winner, Paul Krugman describes how the Canadian banking system, which was coincidentally modeled after the first American secretary of Treasury, Alexander Hamilton, is remarkably the soundest system in the world (versus the US system at 40th). More specifically, Krugman points out that the banking reform currently pushing its way through the system will substantially Canadian-ize the domestic banking system.

In addition to the obvious statements by Paul Volcker (who advocated in early 2009 that his vision for the banking system “looks more like the Canadian system…”) and those by President Obama (let’s not get started), it seems that the US banking system may some day soon resemble Canadian system.

This is key, and also brings us to the importance of the publication dates for these two pieces. Less than a week prior to Krugman’s op-ed column, the Mutual Fund Site gave “top marks” to the Dryden Financial Services fund. And guess what makes up their core holdings. That’s right, Canadian banking stocks.

More than 11% of their meager $162 million under management is invested in Canadian banks. In fact, three of their top 25 holdings are Canadian banks, all of which have among the lowest P/E ratios in the fund’s top 25. What makes this interesting is that the Dryden Financial Services mutual fund has outperformed, by a long-shot, the S&P 500 as well as its peers in the last year, proving that their investment management strategy and, most importantly, their attention to detail has really paid off. Some of this might have to do with the Canadian banks’ ability to maintain dividends and, in many cases, increase those dividends. If bought at the right time, some of those yields would have exceeded 8%. Still, even with an 8% dividend yield, another 60% in return had to come from somewhere…

Does Krugman’s popular piece provide support for investing in a mutual fund like Dryden’s? Not necessarily, although it certainly provides some credibility to why we, at the Mutual Fund Site, gave Top Marks to the Dryden mutual fund. More importantly, given the amount of attention the New York Times piece has attracted, it seems that, if governments start modeling their financial services firms after the Canadian system, and it seems they will, Dryden could see some good, long-term growth provided their investment management team and strategy remains intact.

One of the most-common questions that investors ask themselves before deciding on where to invest is whether they should put their money in an ETF or in mutual funds. While both behave similarly and share many of the same characteristics as far as pooled investments go, they actually differ quite a bit. Ultimately, an ETF makes sense for investors who are able to dedicate some time to the management of their funds and a mutual fund investment makes sense for someone who wants as little involvement with their investments as possible.

Of course, the above statement should not be taken as gospel. In fact, mutual funds require some involvement as well, requiring something more like executive-level involvement whereas managing one’s ETF portfolio is more like a being a foreman, you will get your hands dirty pitching in but you don’t build the product from the ground up.

Mutual funds require executive-like, top-down management whereas ETFs require frequent, hands-on/foreman-style management on the part of the investor. Pick which works best for you.

Being a Foreman – ETF Investing

While managing an ETF portfolio will involve some hands-on involvement on the investor’s part, there are many benefits to investing in ETFs. Among these benefits include low management fees and extreme management styles. Whereas most mutual funds will hold straightforward, long investments (i.e. a buy and hold strategy with some derivative use), ETF’s can become increasingly complex, taking on short positions not only on stocks but currencies, commodities and so on.

For the most part, a foreman is in the trenches, putting in sweat and labor, getting the job done. Managing an ETF portfolio is very much like that. Know how to trade, know what to buy and what to sell, and know how to execute.

In fact, you can literally find an ETF to meet virtually any investment need you might have, including hedging your investments against currency volatility, hedging against potential downswings in a market where you are mostly holding for the long-term. In other words, ETF investments are a lot more exotic than mutual fund investments… in fact, they are often a lot more exotic than straightforward stock securities!

This does not necessarily make an ETF more dangerous or even risky than a straightforward mutual fund investment, but it certainly involves a lot more participation on the part of the investor. Itinvolves understanding the underlying securities and how they operate. A “bad” investment choice with an ETF will result in buying high and selling low (a common mistake we all make, even the professionals at times), incurring enough in brokerage fees to make the “discounted” management fees associated with ETFs make mutual fund management fees look like a giveaway.

Investors who do not pay attention to the way their ETF portfolio is behaving learn the hard way that they have gotten in over their head. This results in losses.

Of course, not all ETF portfolios need to have “the exotics” included in the plan. A buy-and-hold investor who might otherwise be a mutual fund investor can find an actively managed ETF that behaves like a tactical balanced fund (in fact, it is probably easier to find such an ETF than it is to find a mutual fund that behaves this way).

Executive Style Management – Mutual Funds

Contrary to the involvement needed to properly manage a profitable ETF portfolio, mutual funds require very little involvement on the investor’s part. Initially, of course, the investor needs to outline his investment plan and put together an investment management strategy, but beyond this the investor can review his or her mutual fund statements whenever they come in, make changes if needed, and move on with life, all within the span of half an hour.

An Executive studies the numbers and starts making calls when things don’t look right. For the mutual fund investor that can be a call to his or her financial planner. It can also mean firing people (like the planner) or filling a position with someone else (like switching from one fund company to another).

The downfall is that mutual funds come with higher management fees. As well, they are not traded on an exchange which makes them, for the most part, a lot less liquid than ETF investments. As well, due to the high level of regulations surrounding mutual funds, they are unable to properly hedge again risks, both real and perceived the way that an ETF can (and even if the actual ETF does not hedge against such risks, there is surely another ETF out there that, if purchase properly, will mitigate those risks).

So for investors who want to know where to invest — in an ETF or mutual fund? — the answer can be found in another question: What type of manager are you?

Questions about where to invest money invariably come down to finding the right asset allocation model for the investor. The process of asset allocation normally becomes a tad simpler when the investor is looking at mutual funds as a way to not only secure solid returns (good and bad) but proper investment management.

Defining the right asset allocation model is not a two-minute process. As the cornerstone of your investment management strategy, it should never be taken lightly given the variations from one model to another.

Ultimately, any portfolio that incorporates equities into its program will fall under three different types of asset allocation models; conservative, moderate and aggressive, with conservative being the least risky and aggressive being the most aggressive.

Taking a closer look at each model, we will see the following:

Conservative Asset Allocation
25% Cash, 60% Income and 20% Equities.

With the exception of cash, the bulk of the investor’s attention (or the adviser’s) will be spent analyzing the quality of bond funds or other types of income-producing investments to incoporation in the model. With equities at just 20%, breaking the total portfolio into specialized growth funds would be futile. In most cases, the 20% Equities would be properly diversified by number of shares and type of shares and possibly even geography.

The Income component however will need to draw on several specific funds in order to be properly invested. This can include a small amount (say up to 10%) in high yield investments with the balance being spread around different bond funds (government bonds, muni bonds, etc., etc..). The point is that the income-heavy Conservative portfolio really puts a lot of attention on the Income aspect.

Moderate Asset Allocation
10% Cash, 30% Income, 60% Equities.

The greatest area of focus in a Moderate portfolio is shared by the Equities and Income areas. Some specialization will occur in the Equities portfolio (perhaps 10% to 20% in highly specialized funds, such as Real Estate, Energy, Healthcare and so forth) while the balance can easily be spread among domestic growth funds, value funds or a blend of both (up to 20%) with the balance being further diversified by geography.

Of course, the bond funds held in such a portfolio will also demand investor attention. A smaller amount of specialization is needed here (say 5%), but investors would be wise to consider high yield investments for this small percentage with the remaining 25% being gobbled up with high quality bond funds including a good spread between government and corporate bond funds.

Aggressive Asset Allocation
5% Cash, 15% Income, 80% Equities.

The Aggressive portfolio becomes an Equities-focussed portfolio. The investor will typically incorporate highly concentrated equity funds for up to 50% of the total portfolio in areas like Real Estate, Healthcare, Energy, Resources, Small-Cap, Venture and so forth. This represents a tremendous risk to the overall performance of the portfolio in terms of overall strategy. As such, the strategic asset allocation may shift on a micro level (shifting from 50% in specialty funds during boom periods to a more defensive 20%, and vice versa).

The Cash and Income components of such a portfolio then become secondary and normally represent the liquidity portion of the portfolio. Many investors are simply looking for safe parking spots for such money in order to take advantage of opportunities in equities and to earn income on funds they know they will not want to reinvest for some time.

These three asset allocation models evidently take a look at three types of investors insofar as equities holdings are concerned. Of course, these portfolios can become even more conservative once equities are removed. These models show the difference between the most conservative portfolio and the most aggressive and illustrate just how important the asset allocation process really is, even when (or especially when) dealing with mutual fund investments.

If one were to look at high return investments, there could be a couple of places one might look. Growth funds might be an obvious starting point, but is quite likely too generic a field to find something with true, high returns. In most cases, one will have to resort to specialized fields. Over the past three years, such a specialized field might have been gold and other resources. Just prior to the recession – agriculture. And prior to that – real estate. But Fidelity’s Select Medical Equipment and Systems has not only been one of the most steady mutual funds over the past 10 years but also one of the best high return investments.

As the name suggests, the Fidelity Select Medical Equipment and System mutual fund is a mutual fund focused on the medical equipment and systems arena. As far as growth funds go, however, this niche mutual fund has been a top performer among other growth funds, having tripled investors’ investments over the past 10 years. Compare this to the S&P 500 which has yet to return your original investment (as of January 28, 2010).

So that begs the question: what makes high this particular mutual fund so special

Well, with $1.3 Billion under management, the fund is quite large. However, it has not allowed its size to get to its head and holds a fairly tight portfolio of just under 60 securities, all of which are somehow related to the healthcare industry. In terms of investment style, the fund does not follow the others with just one or two choice deviations. In other words, it does not list list GE shares as a top holding. In fact, this top performing mutual fund is considered a mid-growth fund according to its investment style; its holdings are mid-cap and are considered growth investments (versus value investments). From a percentage-of-holdings viewpoint, though, the largest exposure is to large-cap securities; with a fairly substantial exposure to small-cap securities (roughly 10% of its total holdings) the overall investment style gets bumped downward into the mid-cap range.

The impact of this mutual fund’s investment style is that risk is marginally above average (yet is not considered high risk). This has no double allowed it to achieve above average returns over the past 3, 5, and 10 years. With the protection offered by large-cap holdings combined with the growth potential of small- and mid-cap securities, this fund has steadily outperformed the Index with the exception of one year… 2006.

The fund’s largest holding (at 14% of the portfolio, this is a big gamble) is Covidien PLC, a company that touches commercial, institutional and retail markets. Over the past year, it has added 33% to its stock price, itself a nice a return. Less than a week ago, Piper Jaffray upgraded its view on this stock to Outperform; the mean rating is a mildly strong buy… and that can explain why Fidelity has gotten in deep with this security.

Do these stats really qualify the Fidelity Medical Equipment and Systems fund as a one of the best high return investments on the market?

Well, that really depends. For investors looking to get an edge without having to take a scary amount of risk, then of course it does. With a fairly low Beta (0.76) and returns that outpace the market’s, this is one of those growth funds that makes achieving great investment returns look easy and stress-free.

But for investors who want continual mid- to high-double digit returns regardless of risk, then maybe this is not one of those high return investments. Can we suggest real estate funds? Commodity pools? A Gold bear-ETF? Even then, what are the risks and are they worth the potential returns?

See you can say just about anything that gives a 50% return is a great investment, but when you factor in risk and consistency, is it really?

That is where this fund differs and why we think it is one of the best high return investments for those with courage. High returns, marginally above average risk and a history that speaks for itself. If you’ve got $2,500 available to add diversification and a bit of specialization to your growth funds portfolio, consider the Fidelity Select Medical Equipment and Systems fund.

Balanced mutual funds offer a great way for investors to get away from the responsibility of investment management. After all, this is the very reason why so many people will choose balanced mutual funds — they are hands off, an “easy” and thoughtless way to invest. Indeed, a lot of financial planners will recommend that balanced funds are where to invest your money. And in theory, this makes great sense. Balanced mutual funds are either actively managed in terms of assets or in terms of asset allocation. Either way, a lot of faith is placed in the fund manager.

Here, let’s take a look at the risks to both. With a balanced mutual fund where the fund manager decides what to buy, what to sell and when, you have to believe that the manager really knows what he or she is doing. Why? Because if they are wrong, you lose. And the manager will either keep his or her job, not get a bonus, or have to find another job. Will the fund manager lose as much as you will? Probably not. Because fund managers make a lot of money, they can easily recover whereas all the money you have “gambled” on that manager’s bad bets will be difficult to rebuilt.

Now, how about balanced mutual funds where the assets are not so much a problem as the asset allocation model. That means that if you choose a balanced fund that stick to a particular asset allocation, you are trusting that this asset allocation will not only perform over the course of your time horizon but will allow sufficient growth in the equity class and enough security in the income class. Like stock-picking, determining a proper asset allocation model takes a bit of skill, particularly where destination (e.g. 2015, 2020, 2035, etc.) portfolios are concerned.

So, does a balanced mutual fund make sense for you? Probably. But which works best? One with an active trading strategy? One with a specific asset allocation model? One with a destination or fixed time horizon? You will have to choose which investment management style works best for you, your risk tolerance and your investment objective. But understand there are risks involved with each.

As far as growth mutual funds are concerned, Dryden offers one of the top performing mutual funds out there in its financial services specialty fund; the Dryden Finances Services Fund. With nearly $13 billion under management, the expectations for this fund are quite high. And with a new manager handling the investments since January 2009 (Mark T. Lynch, who has been with the fund in different capacities since the fund’s inception in 2001) there is no reason to believe Dryden will not continue to deliver.

In reviewing this fund’s top holdings, it seems evident that Dryden’s investment management focus is on only the largest-cap banks, both domestically and, more interestingly, overseas. Well, we should make a quick clarification… overseas should really read “foreign” since nearly 12% of its top holdings are in fact Canadian banks. Those 3 banks stand quite high in Dryden’s Top Holdings – numbers 3, 8 and 9.

While Canadian banking is a lot less lucrative than domestic financial institutions, there has been a lot of attention on Canadian banks as they have been leaders in global risk management and in banking system reform. As well, Canadian banks (at least those held by Dryden) have been fortunate to enjoy continued profitability, allowing them to maintain their dividends, something that many others have been unable to uphold.

The rest of the portfolio is actually a lessing in investment management. With just 40 holdings, this fund is tightly managed as far as growth mutual funds go. Dryden has carefully chosen their holdings so as to provide a broad geographical exposure so as to not over-expose their fund to any single banking environment. Its top 3 holdings are represented almost equally by Chinese, US and Canadian banking systems.

The benefits to the Chinese system is that government is heavily involved and with the inflow of money into China, its banks will rank among the largest in the world, providing ample opportunity for investors. On the Canadian front, their banking system is among the most stable in the world. Also highly regulated, their system will stand to benefit from the country’s heavy dependence on resources. While Canadian financial services may no benefit directly from the growing demand for the country’s resources, it will benefit from the flow-off through its large retail presence.

And of course, the damaged domestic banking system has a lot to look forward to. With closer government scrutiny, the domestic system is believed to become one of the safest and largest in the world, but with greater government interest there are also risks to this model. This explains why Dryden has heavily invested in banks that stand to really benefit from different markets, including some of the riskier markets like the domestic and some EU systems.

Areas of concern with the fund would the current manager’s short tenure. While Mark T Lynch clearly has the experience needed to fill the shoes of previous managers of this fund, how he will realistically ensure future performance remains unknown.

As well, the fund has shifted its asset allocation over the past three years, with it taking a Large-Cap blended approach in 2007, then shifting to a Mid-cap blended approach in 2008 and ending 2009 as a Large-cap value fund. While of this can be attributed to recovering stock prices, one must still question whether this has been a management strategy and what other types of investment management changes remain on the horizon.

However, one thing remains clear: the Dryden Financial Services Fund is arguably one of the strongest performing and managed mutual funds in the industry. Their investment management skill speakds for itself and where growth mutual funds are concerned, this is one fund that stands to benefit at least during the first part of this period of economic recovery.