Thirteen high-risk, high-reward picks that will add a little sizzle to clients' portfolios.
As companies evolve through their life cycles, there are usually two growth phases that allow investors to make money. The first is the startup phase, where a company's products and services start to gain acceptance and growth accelerates as demand intensifies. Over time, as the company tries to meet this growing demand, its resources are stretched and the company requires more investment to capture its next leg of growth. During this time of reinvestment, most investors typically think that the company is a fallen star, and they punish the stock price. This creates an opportunity for savvy investors--who aren't afraid of a bumpy road--to make money by capturing the company's second phase of growth. This story is typically known as a fallen growth story, and while it can be very fruitful, it can also be a graveyard without the right investing temperament to ride out the wave.
Overview by Justin Fuller
Mutual Fund: FBR Focus
ETF: SPDR S&P Homebuilders
Stock: Coldwater Creek
Value investing essentially boils down to getting more in value than what you are paying for in price. Deep-value investing can be classified as buying those securities that could potentially be near bankruptcy and worth nothing, but if they make it through and avoid insolvency, they could be worth multiples of the current stock price. To be sure, this type of investing is not for the faint of heart and is only appropriate for investors who are comfortable with risk and willing to do a lot of work on their investments. What's more, it's sometimes better to buy a basket of these types of securities than only one, as this strategy allows investors to spread their risky bets over a wider range of potential outcomes.
Overview by Justin Fuller
Mutual Fund: Schneider Small Cap Value
Separate Account: Pzena Large Cap Value
Income matters. This old saw is no less true for being so often repeated. When global markets were steadily ascending, it was easy to focus exclusively on capital appreciation. But a dollop of economic and market uncertainty has more investors discovering the reassurance that a steady stream of income brings. It's simple: It takes cash to consistently pay dividends, and you can't fake cash. High-yielding securities not only provide steady income, they also attest to an entity's financial health. Below are several securities we are confident will maintain their solid income streams.
Overview by Michael Breen
Mutual Fund: T. Rowe Price Tax-Free High-Yield
Stock: Allied Capital
One of the largest feathers in Allied Capital's hat is that it has maintained or increased its regular dividend for more than 40 years. The total return Allied has generated for shareholders has averaged 12.4% annually from 1996 to 2007, compared with only 8.1% for the S&P 500 during this time. The stock is yielding almost 14%. While this yield is attractive, it also points to some risks to investing in the company. Because Allied pays out the majority of its earnings, it depends on the capital markets to finance growth. Moreover, to finance dividend growth, the new equity must be issued at a premium to book value. Historically, gaining access to capital has not been a problem, but recently, Allied's stock price has swooned, reducing the premium to book value at which the firm is able to issue new equity. If these tight capital-markets conditions persist, Allied could be worth much less, but should the firm return to some form of historical normalcy, the total return on an investment in Allied could easily exceed its already-lofty dividend yield.
Once upon a time, not too long ago, the practice of merely investing in foreign stocks might have been considered risky. Now, investors fret about having too small a foreign stake. Oh, how the times have changed. Yet, while investors' comfort with investing abroad and sophistication in building portfolios has clearly grown, it's not as if there's any shortage of high-quality, if slightly aggressive, foreign-investing options to consider. We've teed up a few below, ranging from a Chinese chipmaker and a globe-trotting international small-cap manager to an equally intrepid team that turns foreign benchmark-hugging on its head.
Overview by Jeffrey Ptak
Mutual Fund: Oakmark International Small Cap
Separate Account: Thornburg International ADR
This isn't your standard foreign large-blend offering. For sure, this separate account owns plenty of well-known mega-cap names. But manager Wendy Trevisani and her team apply several tweaks that set their strategy apart. Trevisani earned her stripes working as part of Bill Fries' team at Thornburg International Value, a top mutual fund. This separate account shares much with that fund. For one, the portfolio is fairly concentrated. At just 45 holdings, it holds about one fifth the names that its typical peer does. And the fund's country and stock allocations share little with the benchmark index. For example, the portfolio's 15% stake in telecom stocks is nearly three times the MSCI EAFE Index's. Going its own way has paid off, and we expect similar long-term success here. The separate account certainly isn't a wild child, but it's quirky enough to add some diversification to a portfolio.
It's not necessary to reinvent the wheel when diversifying your portfolio. Sure, a number of specialty products have launched in recent years that do a fine job at diversification. But some of these are more sophisticated than many investors need, and most are pricey. And remember, a low correlation between the securities in your portfolio isn't a victory in and of itself. If a security goes its own way solely because it has steadily lost money or lagged while the major indexes and the rest of the portfolio have compounded nicely over time, that doesn't help anyone make money. Here are a few straightforward securities from traditional categories that can add spice to your portfolio while still generating solid long-term returns.
Overview by Michael Breen
Mutual Fund: Julius Baer Global High Income
An experienced manager and flexible mandate give this fund an edge. Although domestic junk bonds correlate with the U.S. economy, this fund can spread its bets around. Veteran manager Greg Hopper buys low-rated corporate debt from the United States and abroad. He mixes in local-currency and dollar-denominated sovereign debt and the occasional emerging-markets issue or busted convertible. The result is a nicely balanced portfolio that has performed well while providing diversification. The portfolio has no correlation with the broad bond market as represented by the Lehman Brothers Aggregate Index. Lower costs would be nice, but the fund's 1% expense ratio is below its category's average.
ETF: iPath Dow Jones-AIG Commodity
We have misgivings about the price of this exchange-traded note, which we think ought to levy a lower expense ratio in order to compensate investors for the credit risk they court. (An ETN is a debt instrument issued by a bank, Barclays Bank in this case.) But there's no other U.S.-listed ETF that tracks the Dow Jones-AIG Commodity Index, the benchmark that we think does the best job of balancing risk and reward by affording investors exposure to a wide variety of commodities, from lean hogs to crude oil. What's more, unlike some other commodities baskets, the energy subsector doesn't dominate the Dow Jones-AIG index, which caps subsector weightings at 34% of assets. Of course, commodities have been on a tear in recent years, making a correction--spurred by curtailed demand or other factors--a possibility well worth considering. Further, even a diversified commodities vehicle like this can be volatile at times; the ETN's standard deviation has been roughly 1.5 times that of the S&P 500. But commodities are useful diversifiers, making this ETN a worthwhile candidate for investors willing to court the bumps along the way.
Mutual Funds, Separate Accounts: Michael Breen
ETFs: Jeffrey Ptak, CPA, CFA
Stocks: Justin Fuller, CFA