This is an interesting one from Doug Fabian that I got a few days ago, teasing an income boosting strategy that uses dividends in a special way. He’d like you to sign up for a subscription to High Monthly Income to find out how to get this great dividend cash flow.
In his words, “I couldn’t believe my eyes when I recently discovered a totally legal loophole in the new U.S. tax law that you can exploit to collect 50% more dividends than you already are!”
The Gumshoe doesn’t much care whether you subscribe to High Monthly Income or not, but I do think it’s better to remove the immediate temptation of this hidden teaser and make the decision with a clear head. So let’s figure out what investments he’s talking about, and then if you want to go subscribe to his newsletter, you go right ahead.
And we’ll let slide for the moment the fact that he calls this “Dividend Doubling Dynamos” while only claiming that they allow you to gather 50% more dividends.
Still, 50% ain’t bad. So how does this work?
He says you can get 10-14% annual dividend yields, along with “double digit” capital gains, which certainly adds up nicely. Feel those palms getting itchy yet?
He talks about the fact that the magic of this system began with the tax cuts of 2003, which is when everyone really started to love dividends again — remember, analysts used to make fun of dividend payers during the internet boom, as if sending the money back to shareholders meant that companies didn’t have anything cool and exciting to do with their cash (those that actually had any cash, at least). So the bursting of the internet bubble made everyone (myself included) much more interested in dividends, sort of rediscovering what Jeremy Siegel also emphasized with his recent book, The Future for Investors, that dividends are what matters more than anything else over the long run. Mark Skousen has been a convert to this way of thinking, too, with his new high income newsletter, and there are dozens of other high income services that try to trade on our new(ish) thirst for dividends.
So the 2003 tax cut set rules for holding periods but, if you follow those rules, taxes qualified dividends at a much lower 15% rate (“qualified” dividends are most common stock dividends, save REIT-like structures, partnerships, and some foreign issues that don’t trade on a US exchange).
So, as you can probably imagine, the 61 day part refers to the required holding period — if you don’t hold a stock for at least 61 days including the ex dividend date, the dividend doesn’t qualify for the lower tax rate. Please don’t take my word as your tax advice, but that’s the basic rule.
But the teaser here is not for a dividend stock in particular, but for a group of money managers, who Fabian calls the “3D” Managers (that’s for Dividend Doubling Dynamos”) — this management team apparently decided that they had to take advantage of the new tax law and come up with a way to profit from dividends and enhance their returns with a new trading strategy.
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That new trading strategy is a variation on “dividend capture,” which has been a well known trading strategy for decades, but one that was changed significantly by widespread recognition of the techniques and, of course, by the new rules in the 2003 law that were in part designed (depending on who you talk to) to reduce the widespread short term trading of the dividend capture strategy.
The various strategies that fall under the classic “dividend capture” name have been hallmarks of the finance literature for a long time, and have made some academic careers, but there’s not necessarily just one strategy. The basic strategy relied on trading immediately around the dividend (ie, buy on the day before ex dividend, sell on the ex dividend day) — that way, you get the dividend and, because stocks — at least, in theory — generally went down by a little bit less than the dividend amount due to the impact of the tax law at the time, you got a corresponding capital loss that was a little bit smaller than your dividend gain — and you could use the capital loss to offset your dividend for tax reasons. This is all the time I’ll spend on this, because that original “classic” dividend capture strategy doesn’t really work anymore — and I think I probably haven’t explained it very well, anyway, let alone covered all the myriad variations that have been tested over the years.
So anyway, this teaser is for a fund company, and for three specific funds, that have come up with a new dividend capture strategy that apparently is working very well.
So what clues do we get about these specific investments?
He calls them a “non stop dividend machine,” and he describes their basic strategy thusly:
“After pocketing the dividend and nailing down the 15% tax rate — they quickly sell the stock and plow the fund money back into other securities poised to announce their own dividend payouts and ex-dividend dates … And on and on it goes. Over and over again, they pile up dividends … Over the past seven years the “3D” funds have been averaging 12% in dividend returns.”
So, essentially a constant dividend chain and a search for the next great dividend — and the 61 day period is the reason you get 50% more dividends (in number of dividends, not necessarily in cash amount). Most dividend stocks pay quarterly, but if you are switching every 61 days to a different stock that’s about to go ex dividend, you theoretically have time in a year to harvest six dividends with the same capital.
And yes, 6 is 50% more than 4.
The managers also apparently look for special dividends, which are the one-time payouts that companies often make if they have unusually high cash flow for some reason. (There’s also quite a bit of academic research around these, by the way, and most folks seem to agree that — ON AVERAGE — stocks that pay special dividends also give above average capital gains in the 6-12 months following the dividend. I don’t know how reliable this “average” is, or whether it will hold true in the future — it certainly doesn’t always work. FYI, This is the strategy that Stansberry and Associates is following, or some like variation, with their Dividend Grabber service — it doesn’t look like it’s working with their heavily teased recommendation of Palm so far, and that particular service is also the one that I’ve gotten the largest number of complaints about from irritated subscribers. Don’t know if that means anything, but thought I’d pass it along.)
But back to business — what are these funds?
The specific details are not enough to make me 100% certain, but I’m 99% sure that these have to be …
The various dividend capture funds from Alpine.
This consists of …
Alpine Global Dynamic Dividend Fund (a closed-end fund, the ticker is AGD)
Alpine Total Dynamic Dividend Fund (another closed-end one, the ticker is AOD)
Alpine Dynamic Dividend (a regular open end mutual fund, AVDVX)
This is the only management shop that I know of that has three dividend capture funds employing more or less the same strategy. The two closed end funds do pay their dividends monthly, I’m not sure how it works with the regular mutual fund.
As you might imagine, given the current mania for international stocks, the Global CEF is quite popular — at least, as measured by the premium you have to pay for the shares, currently the premium is about 4%. I hate paying premiums for closed end funds, since on average the trade at a discount for good reasons, but I suppose that some that have reliably excellent strategies might be worth it (this is sort of like paying a 4% load for a mutual fund bought through a broker — though you do get to hope, at least, that if they keep trading at a premium someone will buy it back from you at at least the same 4% boost over the net asset value.) It has almost always traded at a premium over the past year. The expense ratio is not outrageous for a global fund at 1.24%, though of course lower would be nicer.
AOD, the broader total dividend fund that focuses on US stocks, actually has a higher current distribution yield (a bit over 11%, versus about 9% for AGD), the expense ratio is essentially identical and the premium more reasonable — it trades at about a 1.25% premium right now, though it has recently traded at a discount as well and, a few months ago, traded at a much larger premium … AOD’s premium/discount moves around a lot more than AGD’s.
And the regular mutual fund, according to Morningstar, ranks 4 stars — but they’re a little cautious that the performance (it has significantly outperformed its peers and the S&P 500 since the 2003 inception) might not be sustainable as the fund grows. I don’t know if that’s a reasonable fear or not, though it’s one that Morningstar often mentions for funds that have a lot of small and mid-cap stocks, and it might be more significant for high turnover funds like these, too (capturing those dividends and keeping to this strategy means a lot of trading).
Generally, also note that the “real” expense ratio is going to be significantly higher — you’re indirectly paying for the huge transaction volume that these trading strategies require, though it’s reflected in lower returns, not in higher costs. Since this is a fairly unique strategy that requires active trading and high turnover, it’s probably not fair to compare them to more standard high turnover funds, however.
In my opinion, what you’re really paying for aside from the management of the dividend capture trading process, is the manager’s ability to choose the right companies — remember, there are thousands of dividend paying stocks out there, and unless you’re creating some kind of index that trades around all of their dividends (which wouldn’t work, since that index itself would resolve any inefficiencies over time), you’re relying on someone choosing the stocks that will work best with this strategy. This is generally called “manager risk,” and it’s basically the same risk of any managed fund — you’re relying on someone to be smart and make good decisions.
So are these worth your time? Well, only you can answer that, of course, but personally I’d be much more inclined to go with one of these than to try to set up my own dividend capture trading system in my own account. That’s not to say that it’s a strategy I’m convinced is appropriate for me, but it is certainly one that gets a lot of interest — and I will at least applaud Doug for recommending that folks outsource it to professionals. Alpine, if I’m right in the assessment that these are the managers he’s recommending, is certainly the leader in this small niche field to the best of my knowledge, and they don’t seem to be charging outrageous fees or making unattainable promises … so that’s good.
Do keep in mind that part of this strategy (all of these funds use the specific “dividend capture” strategy with only about a third of their portfolio — the rest are special situations dividend investments, or “core” good dividend payers) relies heavily on the fact that dividend income is favored over short term capital gains in the current tax code, which might well not be the case in a few years.
But that said, funds like this make a lot more sense to me for individual investors than do the various advisory services that purport to sell you a dividend capture strategy for you to implement — it’s frankly a pain in the arse to trade around dividends, watch those 61 day windows for IRS regulation holding periods, and be extremely disciplined to buy and sell according to the plan. It can be extremely tempting to allow yourself to diverge from the mechanical part of the system by, say, holding onto a stock that you see performing extraordinarily well, or selling a stock that’s falling by far more than the dividend payment, but doing so before your 61 day deadline.
It strikes me that you’ve got to almost be a machine to trade this system yourself, not to mention have enough money to diversify this plan across at least a dozen or so stocks to cut your risk, so it strikes me as a time-intensive losing proposition for most small individual investors. But these funds have clearly got a system that works farily well – our old friend Carla Pasternak actually submitted something to Seeking Alpha a few months ago about one of the Alpine funds (she runs a competing high yield investing service that we’ve looked into before, I think her last teaser that we reviewed was for the Korea Fund, another closed end fund). She also wrote another explanatory article about the basic dividend capture techniques that’s fairly informative.
I do like the dividends — some of my favorite investments at the moment are unusually high dividend payers, but I haven’t tried to do the dividend capture and I probably won’t. That said, these imbalances can certainly remain in the system for a loooong time and I’m certain plenty of folks are working the dividend capture strategy effectively … on balance, I’d say Doug has a fair idea here of outsourcing it to a good fund manager — and at least, thanks to your friendly neighborhood Stock Gumshoe, you’ve got an idea of where to start your research.
Just as an aside about Fabian: Mark Hulbert has written quite a bit about Doug Fabian over the years, partly because he started in the business at the feet of his father, Richard Fabian, who was a strong believer in mechanical market timing using the 39 week moving average. (I have no idea why 39 weeks, but I’m sure there was a reason.) Doug has gotten a bit of grief over the years for straying away from his dad’s strictly mechanical system, but his main newsletter still has a great long term average return. The newsletter teased here, the high income one, hasn’t been around nearly as long and I don’t know what the long term performance has been.
So note that I’m taking this comment out of context, since Hulbert was writing about the Douglas Fabian’s Successful Investing newsletter, not about the one being teased here. But I like the quote, so thought I’d share it with you:
“I would argue that if someone as smart as Douglas Fabian, who has as much training as he does in the art and science of market timing, has this much difficulty doing better than a mechanical system, then the odds are probably very poor for us too if we were ever to try.”
In all of the investment ads I see I don’t often hear folks extolling the virtues of any kind of mechanical investing system for long term investors, but that seems like what Hulbert is doing in this quote (the article is here, if you’re curious, it’s from last Spring). Food for thought.
I hope the rest of your day is filled with profit and joy — mechanical or otherwise.