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.
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I think Greenspan is getting senile, today he said that you can stop asset bubbles by increasing capital requirements. That just increases the cost of credit. The next time you have a real estate bubble, you’ll have the same problem, assuming that banks are still in the business of loaning against real estate. If you want to stop this problem, then eliminate the federal subsidies for real estate development and investment, then require people in that industry to put their own money at risk instead of someone elses. If Greenspan really wants to change the banking system, though, then simply ban 95% and 90% LTV loans. Require a bigger equity cushion. BTW, the “too big to fail” argument is a fallacious one. During the Great Depression, Canada had no bank failures. The reason was that their banks were very large. The banks closed branches, etc., but none of them failed. By contrast, the US was dominated by thousands of very small banks, and we had more than 10,000 of them fail. So there is nothing inherently unsafe about a banking system dominated by large banks. The real problem with large banks is that during good times, they don’t provide enough competition for each other.
Canada’s banking system is certainly unique. During good times, they appear uncompetitive globally but during tough times, they look heroic. Although “bank failures” per se is extremely uncommon in Canada, it was not that long ago that they saw massive financial service firm failures (look back at the 1980’s for example, which coincided with the S&L failures in the US). Also, we cannot forget that those big banks wanted to get bigger in the 90’s so that they could better compete globally against the same firms that have recently had trouble — RBS, Citi, Goldman and so on. In fact, one Canadian bank in particular was hoping to merge with a US partner. Since the Canadian government at the time refused to allow this to happen, those Canadian banks look heroic today… and the country enjoys a solid financial system, albeit an extremely conservative one.