Emerging Bonds from Emerging Markets

06/18/2013 8:00 am EST

Focus: STRATEGIES

David Fabian

Managing Partner, FMD Capital Management

Having become a fan of emerging-market bonds and domestic dividend-paying stocks, David Fabian of Fabian Capital Management unfolds some of his team's top picks to take advantage of those markets.

Nancy Zambell: My guest today is David Fabian, and he is managing partner at Fabian Capital Management. Welcome, David, to The Daily Guru.

David Fabian: Thanks so much for having me, Nancy.

Nancy Zambell: You are quite welcome! Tell us a little about your company.

David Fabian: At Fabian Capital Management, we are a fee-only investment advisor specializing in actively managed ETF and mutual-fund portfolios. We are really huge advocates of exchange traded funds because they are so diversified, very low cost, liquid, and easy to trade.

One of the benefits of working with our firm is because we are an active manager, we believe in growing and protecting your portfolio in any market environment. And we do that through risk-management practices and stock losses. We strive to provide very low volatility and total returns for our clients by being balanced and proactive with our asset allocation for both growth and income portfolios.

Nancy Zambell: For the average investor, David, are ETFs are a better way to go than individual stocks? Especially for someone who is a newbie?

David Fabian: Absolutely. One of the benefits of working with an ETF as opposed to an individual stock is that you don't have to pick the right company within the right industry within the right sector.

With individual stocks, you have to do a lot of due diligence and research about specific companies. You have to follow very closely what their earnings are, and how their stock is performing.

Certainly, within individual stocks, a lot of times you can pick very big winners. You can have individual stocks that move 30%, 40%, 50%, sometimes even 100%, if you pick the right one.

But with an ETF, you are so much more diversified. It is so much easier to target a specific sector or a specific theme in your portfolio, and you just don't have the type of business risk that you do with an individual stock.

For more novice investors or casual investors—or casual investors for their retirement accounts—we just feel that ETFs are such an excellent tool for their portfolios.

Nancy Zambell: Do you use ETFs on both the long and the short side?

David Fabian: We do, typically. We are more geared toward the long side for our clients. A lot of times instead of actually going short, we will go to cash or use fixed income as a proxy. We will sometimes hedge some of our long positions with a very small short position.

We try to stay away from leverage, though. Leverage has gotten a lot of headlines in the media, as far as being very dangerous for your portfolio, and a lot of people have migrated away from that for a number of years. We are a little bit more conservative, but we will use some small short positions if we feel that the timing is right.

Nancy Zambell: How do you feel about income investments right now? Are you thinking that "Sell in May and go away" was a good thing, and now maybe we are going to have the summer doldrums where income might be a little bit better than equities?

David Fabian: I do feel that for bonds, the recent Federal Reserve comments of tapering asset prices were a little bit premature. We saw the ten-year Treasury yield go from a low of 1.6% at the beginning of May all the way to a high of 2.2% in a matter of two or three weeks—which is a huge move in a very short period of time.

I think that this has worked off some of the overbought momentum in bonds. So right now, I am actually starting to look to increase my bond exposure, because I believe that there has been a lot more value come into the market.

We did take action and reduce our exposure in early May, when we started to see some cracks in the bond market, but there are a lot of areas that are presenting very good value right now.

One of the areas that I am targeting is emerging-market corporate bonds. They got severely beat up over the last several weeks, but the yields are so much more attractive than domestic fixed income. That's why I am going to be looking to be a buyer of securities in this sector.

One of the areas, though, that I am staying away from for fixed income is TIPS, because the added inflationary component of TIPS just doesn't justify owning them for your portfolio over a normal Treasury bond. And TIPS have just been severely beaten up over the last several weeks.

Of course, with any equities or fixed income, we always do recommend that you have a stop-loss or a sell discipline on them. That way, you don't get caught up in a situation when we start to see a big shift in interest rates.

I don't think that the interest rate situation is going to be as dire as a lot of people have predicted. I still think that summer is going to be very good for fixed income.

There is probably going to be more volatility on the stock market and the equity income side than bonds. So that is where people are going to have to be a little bit more cognizant of their exposure. But volatility is an opportunity as well.

Right now, stocks are anywhere from 3% to 5% off of their highs, depending on what you own, what sectors you are in. But if we do see stocks fall anywhere from that 5% to 10% range, I think that that is going to create an excellent opportunity. And I am looking to be a buyer of equity income at some very nice discounts here.

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Nancy Zambell: Are you thinking about stocks with dividends?

David Fabian: Absolutely. One that I really like for our clients—that I am going to either look to add to or start a new position over time in—is the iShares Dow Jones Select Dividend Index (DVY).

Many people own this fund. It is sort of midcap-focused, but it has about 100 stocks that have some of the highest yields available.

Right now, DVY is yielding about 3.6%. It is an excellent opportunity just to get very broad-based exposure, using a very inexpensive exchange traded fund for your portfolio.

Another ETF that we really like for the equity income space is the First Trust NASDAQ Technology Dividend Index (TDIV). It is a technology dividend value play. It has really outperformed traditional technology sectors like Technology Select Sector SPDR (XLK).

It pays a quarterly dividend yield. And a lot of the companies in this ETF—like Apple (AAPL) and IBM (IBM)—are adding value for their shareholders by distributing their profits in the form of dividends and share buybacks, which is why a lot of the stocks within this index have done quite well.

Nancy Zambell: I have to laugh when you talk about technology with value and income, because I remember clearly the days when there was no income attached to technology stocks. We have really changed!

David Fabian: It has always traditionally been known as such a growth sector, and the companies typically don't reinvest a lot of profits to give back to their shareholders. They are using them for growth, development, and research.

But in recent years, we have seen a shift in their corporate governance and their gameplan to return value to shareholders. And it has really worked out well for a lot of those companies.

This is a very unique index from First Trust that has captured some of these companies, and we really like it. When you look at the performance metrics versus other technology indexes, it has done quite well.

Nancy Zambell: You mentioned stock buybacks. Are you a fan of buybacks? Some advisors say that we prefer to have dividends—even special dividends—rather than buybacks. What is your view?

David Fabian: We typically target stocks and sectors that are more dividend-oriented. What we are looking for is total return at the end of the day, so we like to see both price performance and strong dividend streams in the ETFs and stocks that we are targeting for our clients.

Nancy Zambell: Earlier, you mentioned emerging markets in terms of income. Are you doing anything with emerging-market equities?

David Fabian: Right now, for our growth clients, we have actually been scaling back our position in emerging markets over the last several months—just because they have underperformed so much this year.

Emerging markets have really not followed what is going on in the domestic markets. If you look at China, India, or Brazil, many of those countries are down this year while the S&P 500 is up 15% or 16% so far this year. Emerging markets have really lagged.

We do like them as a long-term theme for our portfolio, but we don't have a great deal of exposure right now. If we do start to see a sell-off in the summer, they could be very attractive values that we will start to buy into and add to positions over time. But right now, they are just not adding a lot of value to the portfolio.

Nancy Zambell: Last question, while we are on the international theme. What is going on with Japan these days? Are you in the WisdomTree Japan Hedged Equity (DXJ), or have you gotten out of that?

David Fabian: Well, Japan has been a very interesting story. [We've seen] huge moves in Japanese stocks.

It has all been driven by what is going on in the Japanese yen. Today, the CurrencyShares Japanese Yen Trust (FXY) saw an increase of about 2%, which really affected what is going on in Japanese stocks.

DXJ basically owns both Japanese stocks and hedges against the Japanese currency. What that fund really wants to see is a falling yen and rising Japanese stock prices. What we have actually seen just recently is that the reverse has been going on. So that position has fallen about 20% in the last two weeks.

It has been a huge gatherer of new assets so far this year, but I am very cautious on it right now, just because of all of the volatility that has come back into that space. I think that it is an excellent play from a long-term perspective, but it is going to only do well if we both see a falling yen and a rising Japanese stock market. So you have to be very careful about where you buy it.

And it just has really become a very overheated sector, with all of the quantitative easing and loose monetary policies that the Bank of Japan has been implementing to stimulate asset prices. It just really became overbought and overloved by a lot of investors—both in Japan and here in the US.

Now we are starting to see money coming out of that space. We are starting to see more volatility come back in, which can be an opportunity. You may want to be a buyer into this dip, but I would start very small and make sure that you are averaged into the position over time with a stop-loss, so that you don't get beaten up too badly if this recent downturn continues.

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