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Faber: Payout ETFs Not All About Dividends

Cinthia Murphy


Mebane Faber, co-founder and chief investment officer of Cambria Investment Management, just rolled out Cambria’s first solo ETF—the Cambria Shareholder Yield ETF (SYLD). The launch came hand in hand with the publication of a short book titled “Shareholder Yield, A Better Approach to Dividend Investing”—and together the two debuts point to a subject near and dear to Faber.

In a recent visit with IndexUniverse.com’s Cinthia Murphy, Faber made the case that most investors take a myopic view to dividend investing. He stressed that investors need to understand companies can do a few things with extra cash, such as pay dividends; buy back stock; or reinvest in the business.

Overall, Faber said a “holistic” approach to dividend-driven investing is imperative, and he argued that his new ETF and three other yield-focused funds that will follow will all hew to that requirement. All the firm’s funds are actively managed, including the nearly $60 million Cambria Global Tactical ETF (GTAA), that was brought out in fall 2010 through a partnership with AdvisorShares.


IU.com:Dividend-focused investing is a hot theme, but you make the argument that we’re too focused on a company’s operations than on its capital allocation. Why is that important?

Mebane Faber: This is an often-overlooked area. Dividends are great, and the evidence has been that dividend-paying stocks—and higher-dividend-yielding stocks—have outperformed the broad market both in the U.S. and around the world for as long as anyone has been calculating returns. But dividends are only one of five things a company can do with its cash when it’s making money:It can pay dividends; it can buy back stocks; it can pay down debt; it can acquire other companies; and it can reinvest in the business. The last two are growth initiatives, where you’re acquiring or reinvesting internally, and the other three are ways of returning cash to shareholders.

Our argument is that it doesn’t make sense from an investor standpoint to just focus on one of those areas because it doesn’t give you the whole picture. Particularly in the U.S., we’ve seen a large shift starting in early 1980s from companies mostly paying dividends to now buying back more stock. It was a structural shift after the government passed a rule that gave companies safe harbor from buying back their stock. Buybacks and dividends are basically the same thing mathematically speaking, but buybacks have a little better tax treatment than dividends, so we’ve seen this huge shift to companies now paying out more in buybacks than paying out dividends. To ignore that alternative route to cash distribution is a big mistake.



IU.com:Is that the main reason companies seem to be paying out less cash in dividends these days?

Faber: When you adjust the yield for the amount of buyback stocks, it often changes the picture. You need to look at dividend and net buybacks—you need to look at it holistically. A lot of companies pay out $20 in dividends, but a lot of companies just like them will pay out $20 in dividends and retire $20 worth of stock. It doesn’t make too much sense for us to focus on only part of the universe.

Dividends are a simple story, and people are comfortable with that. It’s a little bit more difficult to track what companies are doing with buybacks—they tend to be more volatile, too. But research shows it doesn’t matter how a company pays out its cash, but the total amount they are paying is a better indicator of stock performance going forward.

IU.com:Is it true that reinvested dividends represent over half of an investor’s annualized returns on a stock over time; they’re that important?

Faber: Over time, yes. If you take out dividends and just have price returns, dividends end up accounting for a lot of the returns. But that’s because historically dividend yield has been around 4 percent, and they are around 2 percent now. It’s a hypothetical argument because if companies didn’t pay out any dividends, the stock returns would be all from price. But the message we are trying to convey is that dividend yield is a very strong component of returns over time.

IU.com:Are there other factors that go into this equation?

Faber: The other lever of this discussion, the choice to do buybacks should depend on where the stock is trading relative to the intrinsic value of the company. If you are management or a shareholder, you should only want to do a buyback when the stock is trading for less than intrinsic value, so that you are getting, say, a $1 for 80 cents or something like that—it’s a very direct transfer of wealth from seller to buyer. You are picking an additional value arbitrage where you’re buying your own stock for cheaper than it’s worth.

The flip side is also true. If a company is buying stock when it’s expensive, you’re destroying shareholder wealth. So, what you really want is companies that have a methodology or a systematic process for buying back stocks rather than just buying back regardless of what their prices are.


IU.com:A lot of people are now saying U.S. stocks are overvalued. What happens, then, to this concept?

Faber: There’s a chart in the book that shows what the total return of stocks are when they’re expensive and what they are when inexpensive, and it goes a step further and divides those into the components of the return—price increases and dividends—and what you find is that when the stocks are expensive, essentially all of the returns come from yield because you’re not getting a price appreciation.

We argue that it’s even more important right now when stocks are expensive to target these companies that pay out a large percentage of their cash through dividends and buybacks. It’s a perfect time to be focusing on those companies.

IU.com:What’s the biggest mistake investors make when they jump into dividend-focused investing?

Faber: Dividends are great, but one of the problems with them is that if you look at high-dividend-paying companies, they often have high yields because of one of two things:They’re either paying out a huge part of their earnings as dividends or they are often fairly leveraged. In both cases, that’s a recipe for the company to then cut the dividends going forward, and you can find in academic literature that a lot of these high-yielding companies often don’t realize those dividends because they have to cut them and it’s unsustainable.

And if you look at the returns of the highest dividend-yielding stocks, they’re often not that much better than the next 20 percent of dividend stocks because of that higher risk. In 2008-2009, these stocks got hit especially hard as value stocks for those reasons.

The other problem is that a lot of money has rushed into these dividend stocks as people look for yield. So now you have this compression where they used to trade at a discount to the overall market, but now that’s gone. If you compare the valuation of a shareholder-yield portfolio to the broad S'P 500 and broad high-dividend portfolio, it’s a much cheaper portfolio, so you have more of a low-valuation portfolio that you don’t have in the dividend space.

If you focus only on dividends right now, you’ll end up with a portfolio that’s S'P-like with nothing more going on other than paying out more in dividends with higher debt. In my opinion, that doesn’t sound great.


IU.com:Is this ETF you just rolled out, the Cambria Shareholder Yield ETF, the answer to that problem? Can you explain what shareholder yield is all about?

Faber: We think it’s the answer. There are three components that go into shareholder yield:dividends; net buybacks; and paying down debt—the last one is not as clean-cut as the other two because that’s not directly distributing cash, but it’s another way of shifting ownership to the equity holder from the bond holder. We look at those three, and we begin by sorting companies by yield, combining both dividends and net buybacks. We don’t care how you pay those out as long as you have a high-enough number, and we reduce the universe to the top 20 percent of those payers, and then we apply additional screens based on valuation, quality, momentum and a final sort on full-shareholder yield to come up with the final portfolio.

We think it’s a much more holistic look at all of the factors together. There are other ETFs in the market that focus on one or the other—dividends or buybacks—but we argue that they’re making a mistake by looking at only one side of the coin.

IU.com:Does a strategy like this work in any market environment, or it is particularly suited for the current environment?

Faber: Essentially, you’re buying quality companies that are inexpensive that have the ability to distribute high amounts of cash, and typically those qualities correlate very highly with quality U.S. companies that are shareholder-friendly. You are also avoiding companies that are not shareholder-friendly, like those that are issuing a ton of stock and diluting their shareholders, and that’s important because you’re not only taking what’s good but you’re also avoiding what’s bad.

If you just invest in a broad S'P fund, or broad market-cap fund, you’re getting those capital destroyers in your portfolio. About 20 percent of companies have this negative yield where they’re diluting their shareholders. There are also a lot of companies out there that pay high dividends but are issuing so many shares that they swamp the dividends, diluting shareholders. People who focus only on dividends would never see that, and I think that’s a really important story and something that people miss out on.

IU.com:What’s your main objective with this ETF and the book? This is your first fund launched under your own banner, but there are already more in registration.

Faber: This is our first solo effort, but we have three more filed. Our goal over the next few years is to launch five to 10 actively managed funds that are quantitatively based, that are aimed at disrupting the high-fee mutual fund and hedge fund space. This particular fund takes aim at the dividend space, but we are looking to disrupt mutual funds and hedge funds—where they are charging 2 percent in fees for 20 percent performance—by charging much more reasonable fees.

IU.com:Why active management? Why not create an index?

Faber: I’m a quant, so everything we do could easily be indexed. I could write down the rules in no time. But one of the dirty secrets of indexing that no one talks about is that a lot of indexes get front-run by hedge funds and other traders, and that’s a very real cost to the index and the fund. You disclose your rules, and the next thing you know, there are traders out there front-running your index.

We’re not looking at being black box; we want to give you an idea of what we’re doing, but we also don’t want to say “here are our exact rules,” because that’s a very real drag on performance that a lot of these funds suffer from that publish their indexes.

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