<p>As I move closer to retirement and realize that I am the world’s worst stock picker (well, except for Bill Miller during the financial crisis) I am becoming increasingly interested in high yield, low volatility strategies. In the good old, pre-Helicopter Ben days the strategy was easy: simply invest in laddered CDs, or something similar. But under current conditions, that strategy is not going to yield much. So I’m interested in alternatives.</p>
<p>The most promising strategy that I seen so far involves buying a high yield etf like HYG and hedging it with a leveraged inverse etf like TZA. However, because of the characteristics of leveraged etfs, that strategy requires frequent rebalancing (at least weekly and ideally daily), which is a pain in the butt and incurs substantial transaction costs.</p>
<p>I’d be interested in comments people might have on that strategy and also any other high yield low volatility ideas.</p>
<p>I would be interested in this also. I don’t know of any means of doing what you are asking - most hedging strategies that I know of incur either substantial cost and or substantial losses. I think you would have to do a number of things that would be very time consuming unless you have a financial planner implement them - combination of annuities, dividend stocks,laddered bonds, diversification etc - the things from investing 101. I’ve been selling OTM puts and generating good income particularly in this high volatility time.</p>
<p>If you’re no good at stock picking, I’d look at the two companies that have a good history of providing decent returns: Fidelity and Vanguard. Then I’d look for a balanced fund that has some investment in stocks and some in bonds. Fidelity handles DH’s 401K and we have it in a “2020” fund–meaning we plan to retire in 2020. It has done quite well.</p>
<p>The financial advice columnist for the LA Times says she can always tell when she is dealing with newbies when they ask her where they can get a 10% return with zero or near-zero risk. There is no such thing.</p>
<p>My main dividend stocks are AEP (American Electric Power) and PVX (Provident Energy Company). AEP is fairly stable. PVX is all over the place trading from the high-7s to the low 9s recently but I’ve been in it for many, many years. In 2008 (I think that’s the year) market plunge, it went down to about $2 which meant that it had a 30% dividend yield. Talk about free money! It didn’t stay down there for very long.</p>
<p>I also have held Intel for a while - it has about a 3.5% dividend yield. It was above four recently but they’ve had a lot of share price appreciation recently. 4% is considered a good dividend - I don’t think that I’d call it high-yield.</p>
<p>My mother bought GE when it was in the $40s and has held on for about a decade. She doesn’t care about the stock price; she just cares about the dividend. You get to a certain point where you just care about the income and can ignore the stock price. Most people that I know of that aren’t in retirement can’t do that because their net worth is current and now and it is painful when that’s what you are focusing on. If you focus on the income side and have a company with a good history on generating dividends, then it does make it possible to hang on when the stock market is in roller-coaster mode.</p>
<p>You do have to watch out for extreme cases where a company goes bankrupt or has a significant event that affects their dividend payout. Some of the Wall St bankers that were considered Blue Chips have suffered through that.</p>
<p>.Either there is something I am not understanding (always a strong possibility) or I am not explaining the theory very well. So I’ll try to explain the theory in greater detail so dstark and others can point out the flaw. I’ll use BGZ in place of TZA because the numbers are cleaner. (The reason that I originally referenced TZA is that it is more volatile, and in this context the volatility of the hedge is actually your friend.</p>
<p>Daily changes in HYG are correlated to changes in SPY; let’s assume that the mean daily change in HYG is one half the mean daily change in SPY. In addition, we know the mean daily change in BGZ is negative three times the daily change in SPY. So if you begin with a portfolio of $600 of HYG and $100 of BGZ and maintain that ratio over time, you will have a portfolio that, over time, will maintain a constant value and in addition will get the dividends from your $600 of HYG. You will have some daily fluctuations, but they should balance out over time.</p>
<p>The trick is to keep the relative values of HYG and BGZ constant. (There is also the problem that the beta of HYG in SPY terms is not constant, but I think the fluctuations should not be that great). You can solve the relative value problem by rebalancing daily, avoiding the compounding problem that bedevils leveraged etfs generally. </p>
<p>You still have the problem of the transaction costs associated with rebalancing. You can reduce those costs by rebalancing less often, but then your HYG/BGZ ratio will get out of whack. (Even thinking about the math required to figure out this effect makes my head hurt, but note that the issue is quite different from the standard “how does BGZ perform relative to SPY” question).</p>
<p>On the window trading issue, the question is how far out of whack you are going to get because you are not getting a real time price. Since you would only be trading a small portion of the position each day, I suspect not very much and that in any event the impact of the divergences should even out over time.</p>
<p>“IMO, slow and steady wins the race.”</p>
<p>I’m actually a great believer in this investment philosophy. The problems is that in the current interest rate environment, slow and steady has become stopped and steady.</p>
<p>I know a bunch of guys that trade TNA and TZA daily. I tried out TZA once, made a lot of money in a short period of time but I had to watch the thing for the whole time of the trade. Not something that I can do on a regular basis. It certainly is a blast but I’ll leave that sort of things to the guys that are really, really good at it and that have the resources to watch the tape.</p>
<p>By the way stock picking doesn’t work particularly well right now because of high correlation arguably due to etfs, high frequency trading etc. - perhaps in the future as in the past, it will work.</p>
<p>“On the window trading issue, the question is how far out of whack you are going to get because you are not getting a real time price. Since you would only be trading a small portion of the position each day, I suspect not very much and that in any event the impact of the divergences should even out over time.”</p>
<p>No they don’t. There is a downward bias to the leveraged etfs…You need to rebalance at the close…or you are going to get killed…</p>
<p>I do know of a methodology of significantly beating the market at least over the last 10 years - unfortunately I’ve tried to improve on it and have not had success.</p>