Thursday, March 21, 2013

Bridgeway Funds semi-annual report

I don't often blog about investing, but I was reading the latest semi-annual report from the Bridgeway Funds, and a few things caught my attention - this graph, for example:

(click to embiggen)

The top line graphs the price per book value (one of many valuation metrics) of the U.S. stock market, going back to 1972. The bottom line is the price/book of just high yield dividend-paying stocks.

The point of this was to demonstrate that high yield stocks have generally been valued less than the market as a whole, but how that has changed recently:
On the basis of one measure of valuation, “price to book value”, they are the most expensive, relative to other stocks, we have seen at any time in our data history going back to 1972. On this measure, the price of these stocks has already been bid up on a relative basis. For the first time in at least four decades, high yield large cap stocks are actually more expensive than the broader market. Buyer beware.

That's interesting enough, for some of us, so I'll elaborate (and if you're not interested in this kind of thing, you might as well stop reading now).

Stocks which pay a high yield in dividends might be, for example, government-regulated utilities which make a reliable profit (since they can raise rates to cover costs), but will never make an excessive profit (because regulators won't let them gouge their customers too much).

Others might just be large companies in mature industries. They make a good profit, but there's usually not much growth potential, so the company is not valued as highly as other companies.

These days, most companies don't pay out much in dividends, because they want to use that money to grow. You see, a bigger company benefits the people who run it (and the people who make these decisions), and wealthy investors don't need the cash and don't want to pay taxes on a distribution.

Now, if you're a retiree on a fixed income, you probably want a steady stream of cash. But unless you own enough stock that you don't actually need the money yourself, you're not going to have much influence in any of this. Technically-speaking, you might 'own' part of a company, but you don't control it.

So most retired investors tend to own a lot of bonds. Besides, they're normally safer than stock (safer and less volatile). But after the worst economic collapse since the Great Depression, bonds yield hardly anything at all, and cash is even worse. So retirees have been searching for higher yield (and taking on more risk in doing so, though some of them may not realize that).

This is just basic supply and demand. More people are searching for yield, so they've bid up the price on these high yield dividend-paying stocks. Now, they're very expensive, compared to other stocks, by historical standards.

Please note: this doesn't necessarily mean they're too expensive. It doesn't necessarily mean that you shouldn't buy them. It doesn't even mean they won't hold up better if the market crashes. It's just, well,... buyer beware. It's seldom a good investment if you pay too much for it. (How much is too much? I have no idea.)

But take a look at that graph again, this time at the general market (the top line). Look at the late 1990's. Look at that peak in 2000 and at what happened afterwards. Trying to pick the short-term moves of the stock market is a fool's game,... but why wouldn't everyone have been worried about valuations like that?

For the most part, though, it was just the reverse. That was a time of irrational exuberance. The stock market was screaming upward and it would never drop again! Supposedly. (And suppose you saw how expensive it was and got out in 1997 or 1998. The market continued to scream upward after that, for another couple of years, anyway. And everyone but you would be making money.)

That graph even understates it, because some parts of the market were still dirt cheap back then. At work, they switched our 401-k plan at the very peak of the market, dumping the boring old funds they'd had previously and loading up on the go-go growth funds which had been climbing ever higher.

I remember going to a meeting of plan participants and asking for just one small-cap value fund in our investment plan, just one. But the 'experts' who were providing this plan to us (not our HR department, but the investment professionals they'd hired) explained that "no one" wanted to invest in small-cap value funds anymore.

Within a few months, the collapse came. Note that this wasn't like 2008, where everything dropped. No, this collapse was focused on those particular go-go growth stocks, and especially on tiny internet stocks with massive valuations and no revenue. Those small-cap value stocks I'd wanted did extremely well then.

But just for an idea of how things went with the more speculative investments, here are the results of the NASDAQ Telecommunications Index: Up 103% in 1999, Down 54% in 2000, Down 49% in 2001, Down 54% in 2002. I knew a guy who'd bought at the peak, when our company 401-k was switched into this kind of stuff, and finally got out at the bottom, three years later, just as the market was ready to turn around again.

Last I heard from him, he was wondering about finally getting back into the market again. This was not long before the 2008 crash. After all, everyone else had been making money for four or five years by then...

Anyway, there are many things I like about the Bridgeway Funds (including their rule that the CEO can't be paid more than 7 times as much as their lowest-paid full-time worker - compared to the more typical corporation where the CEO might get 300 or 400 times as much as the average worker), but this post is too long, already.

I do, however, want to point out how much fun it is to look back at the annual returns of their funds, since this report also indicates whether they did better or worse than their primary benchmark (which varies, depending on the fund). Take the Ultra-Small Company Fund, which was the first fund I bought from them, many years ago.

This fund invests in very, very small companies, and it's... unbelievably volatile (it dropped 46% in 2008, which was actually a little better than its category). The first years I owned it, it just blew the lights out. I didn't have much money in it back then, but it was certainly an incredible fund. Then came that crash I've been talking about at the end of the 1990s.

In 2000, the S&P 500 dropped 10% and the NASDAQ, which contained more of those high-flying growth stocks, dropped 39%. The Bridgeway Ultra-Small Company Fund gained almost 5%, beating its benchmark. (Remember how I said that not everything had dropped?)

2001 was a little different, though. Thanks largely to the 9/11 attacks, the overall market was down again, and this time, the Ultra-Small Company Fund did worse than its benchmark index. However, it still went up 34%. Yes, if I remember correctly, the average small-cap value fund was up almost 40% that year. And this is when those growth stocks were still crashing.

In 2002, the Ultra-Small Company Fund again beat its benchmark, with a gain of 4%. But the overall market did very badly that year. For most indexes, it was the worst of three very bad years. So what would you do then? You win the prize if you said, "Buy!" because 2003 was a very good year indeed!

True, my fund failed to outperform its benchmark, but with a gain of almost 89% that year, it's hard to complain much about that!

Note that this fund hasn't done as well recently (although it had a good year last year). But you can't buy it, anyway, since it's closed to new investors. Indeed, even current investors can't add to their holdings, since Bridgeway wants to keep this fund very small. (At the bottom of the market, in early 2009, I was able to put a bit more money into it, but that opportunity didn't last long.)

In fact, that's why I'm mentioning it here. You see, I don't want to give investment advice, even by implication. I'm not qualified to give investment advice, so please don't think that any of this is a suggestion of what you should be doing. I just think this stuff is interesting, so I wanted to talk about it. That's all.

Well, there's lots more I could say, but I think we've all had enough, haven't we? :)

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