UTILITY DIVIDEND TRADING PLAN
V5.2, April 2011
Background- The Story
1. Fund Investment Return Objective
2. Fund Benchmark
3. Fund Investment Approach
4. Who Should Invest
5. Summary Results
6. Risks
7. Reporting
Appendix 1: Stock Candidates
Appendix 2: Trading Details
Appendix 3: Pilot Fund Performance
Appendix 4: Fund Performance as of 4/1/11
Background..The Story
In early 2008 the market seemed overvalued. Looking to make a portfolio more defensive, while still generating some income, a decision was made to overweight the utilities sector in the overall portfolio.
Having decided to overweight this sector, various vehicles to invest in this sector were examined including:
- A passively managed industry etf, specifically XLU
- An actively managed sector fund, specifically fidelity select utilities
- “Buy and hold” of a few “blue chip” individual utility stocks
- “Swing trade” between several sector stocks capturing as many dividends as possible.
On July 1 of 2008, capital was put into a few approaches and tracking of performance of for the first and last approach was initiated.
Who knew,that the overall market was on the brink of possibly the most volatile, confusing time of a generation. Over the next four quarters, the S&P plunged to 666 and the rebounded over 1000. Moving to more defensive market position using any of the above approaches would seemed to have provide some amount of safety. The results for the period of time from 7/1/08 to 7/1/09 were
- XLU return - -29%
- Swing trading for Divided Capture - +9.8%
The difference in results from two defensive maneuvers using the same equities was stunning. Could the results be an anomaly? Sure, it takes a long time and lots of data to “prove” an approach is really better. However, an approach which did such an incredible job of protecting capital during catastrophic market times was worthy of further investigation. Hence on 7/1/09,the Utility Dividend Capture (UDC) Fund was officially launched.
1. Fund Investment Return Objective
This conservative fund's objective is preserve capital while generating a modest, but consistent return.
- Absolute performance return objectives are 6 -10% per year. More specifically the fund's goal is to break even (i.e. preserve capital) in quarters when the US stock market is down while making 2% per quarter when the US stock market is up.
- The fund strives to be less volatile than the overall stock market.
2. Fund Benchmark
The fund will benchmark itself against
- A S&P 500 index fund (DSPIX)
- The Spyder Utility Select ETF (XLU)
Similar to the absolute performance objective above it is anticipated the fund will outperform this index in down markets and under perform this benchmark in up markets, but yield a consistent, positive, fairly uncorrelated result. Hence, the fund should be considered as a hedge against the volatility of the equity markets and an alternative investment vehicle
3. Fund Investment Approach
The fund will pursue this objective by owning utility stocks such as those shown in appendix 1 whose dividend yield is greater than 3%. The fund will own the stock for a relatively short period of time (usually a few days to a few weeks) with the objective of capturing, on average, approximately a 1+% quarterly dividend. The fund will striving to break even on the capital gains portion of each transaction, but overall a capital loss is anticipated to be generated. Obviously this loss needs to me less than the dividend capture amount for the fund to be successful.
An investor desiring more detailed information on this approach is highly encouraged to read trading details in appendix 2.
The general approach behind this fund is called a dividend capture technique. There is some research available on the internet about this general approach and its potential use. In general, this approach is not viewed as having a great chance of success because “efficient market theory” states that the stock’s price should adjust downward by the amount of the dividend on the date the stock “goes x”. In the real markets (as opposed to theory) the stocks’ price does adjust down by the amount of the dividend on the the x date. However, the fund's belief is that this adjustment will get overwhelmed by the general volatility of the market. This belief has been validated by results to-date. As shown by the performance section of this document with nearly 3 of 4 trades being profitable (74% win rate).
There are unique aspects of the fund’s approach that transcend most of the general writing about dividend capture.
First, the approach focuses only on stocks in the utility industry. These stocks have several key characteristics.
- They are highly correlated. With a high correlation it matters a lot less which of these stocks the fund owns. They will perform similarly, and switching between them is hence less risky.
- They are very conservative investments in regulated industries with tangible assets which seems to make the risk of huge downside losses lower but also lowers the the opportunity for huge capital gains.
- The conservative nature of these stocks means that large, HFT, hedge funds will not be playing in this space.
Second this is somewhat a unique time in the market.
- Volatility is at historically high levels which means “market noise” is more likely to overshadow the impact of the dividend on the stock price Specifically, historic volatility for xlu and utility stocks is in the mid teens. Hence for a 1 week holding period it would be fairly likely (i.e. a 1 std) event that a stock may move plus/minus 2%. That 4% range can overwhelm the 1% change in stock price when the stock goes x-dividend. In recent time, actual volatility for stocks in the xlu have increased to be over 20% range. With that increased volatility it is fairly likely (i.e. 1 std) that the stock will move plus/minus 3%, This 6% range is now 50% larger than in previous times and the impact of the x-dividend change in stock price is even less significant.
- Dividend yields are high especially in relationship to treasury rates.
Buying and rolling through utility stocks over the course of a quarter should capture over 20% in dividends annually. Given general volatility of the market there seems there is a good probability that normal market fluctuations will overwhelm the dividends negative impact on the stock price and allow the manger a chance to exit the position if not for a capital gain profit, at least for a loss less than the dividend received..
4. Who Should Invest
Investors should consider this fund if they
- are in search of steady, absolute returns and the preservation of capital
- desire exposure to US utility stocks.
- looking for less volatile, somewhat uncorrelated returns to the US equities market.
5. Fund Performance Summary
While past performance is no guarantee of future results, Appendix 3 contains more details on past fund results.
- The pilot version of the fund (in operation from 07/01/2008 to 06/30/09) easily achieved the objective of the fund. Specifically, The Fund retunred 9.5 % while the XLU returned -28.4% over this period, and the S&P 500 was down 26.4% That is n over performance of the benchmark by 37.9%. Much more importantly these results were consistent with the absolute return goal of the fund to preserve capital in a down market.
- For the first fiscal year of operation, (July 1 2009 – July 1 2010) the fund returned 11.5%. easily achieving its absolute return goal of 8-10%. During this period of time the benchmark XLU returned 8.7% and the S&P500 was up 11.2%.
- For the first the quarters of the second year of operation (July 1 2010 – Ap r 1 2011) the fund returned 11.9%.
Appendix 3 & 4 contains much more detailed information about fund returns
5. Risks
Obviously the fund is subject to all the usual financial services caveats including but not limited to
- there are absolutely no implied or stated guarantees in this document,
- past performance is no indication of future results,
- this investment is not insured by the FDIC, SIPA, or any other agency,
- investing involves risk (duh), an investor should understand the risks associated in investing in the stock market and the specific manager
- etc, etc, etc
6. Reporting
Monthly - upon request after the end of each month the manger will provide a short summary of the performance of the fund, transactions from the past month, current holdings, etc.
Quarterly - after the end of each quarter the manager will update the prospectus with actual results.
APPENDIX 1
Stock Candidates
| COMPANY | Type | Market | Symbol | |
| Xcel Energy Inc. | multi | Minni | XEL | |
| Nicor Inc. | gas | GAS | ||
| PG&E Corp. | multi | No Cal | PCG | |
| Nstar | elec | Mass | NST | |
| OGE ENERGY | elec | OK | OGE | |
| Progress Energy Inc. | elec | Carolina | PGN | |
| ONEOK | Gas | rocky | oke | |
| NiSource Inc. | multi | NI | ||
| Alliant Energy | multi | Wisc | LNT | |
| Pinnacle West Capital Corp. | elec | Phoenix | PNW | |
| Southern Co. | elec | Atlanta | SO | |
| FirstEnergy Corp. | elec | Ohio | FE | |
| American Electric Power Co. Inc. | elec | ohio, rural | AEP | |
| Consolidated Edison Inc. | multi | NY | ED | |
| CenterPoint Energy Inc. | multi | Houston | CNP | |
| Dayton Power and Light | Ohio | DPL | ||
| Teco Energy Inc. | multi | Tampa, Fla | TE | |
| AGL RESOURSE | Gas | Atlanta | AGL | |
| Allete Energy | Minni | ALE | ||
| Duke Energy Corp. | elec | DUK | ||
| Excelon Black Hills Corp | multi | mtn nw, so dakota | BKH | |
| Atmos energy | Gas | dallas | ATO | |
| Integrys Energy Group Inc. | multi | midwest, chi | TEG | |
| Great Plains Energy | elec | Kansas City | GXP | |
| Dominion Resources Inc. | multi | Virginia | D | |
| Northeast Utilitiy | multi | Mass/Conn | NU | |
| Nevada Energy | elec, gas | Nevada | NVE | |
| Constellation Energy | multi | CEG | ||
| Westar | elec | Kansas | WR | |
| Pepco Holdings Inc. | elec | Maryland, NJ | POM | |
| SCANA | multi | South Car | SCG | |
| Ameren Corp. | multi | Mo | AEE | |
| DTE Energy Co. | multi | Detroit | DTE | |
| Northwest Energy | SD, Mont | NEW | ||
APPENDIX 2
Trading Guidelines
Within the guidelines of the fund investment approach defined in section 3, the manager has total discretion and flexibility over trading decisions. However, it is anticipated, in normal market conditions, the manager will use the following guidelines to guide his trading activities.
Stock Purchases
- The fund will normally buy a stock from the list of candidate stocks after the company has announced their quarterly dividend but before the x-dividend date. However, if there is capital available in the fund the manager may purchase a stock before the announced dividend as long as the dividend pay out ratio is reasonable (less than 75%.)
Stock Sales
- In most cases, the fund will sell the stock after the x-dividend date (when the dividend is captured) when the stock exceeds its purchase price by 1% or in the judgment of the manager the capital is better served being redeployed into a different utility stock shown in the appendix to capture its divided.
- In order to manage risk and take advantage of quick market upside moves, the fund will also consider selling a stock
- when it decreases by more that 10% during the holding period based on some s tock specific news
- prior to the x-dividend date if the stock moves substantially upward (i.e. ore that 4.0%) from the purchase price to take capital gains profits
Turnover Rate/Holdings/Diversification
The cycle will be repeated many (approx 20) times a quarter based on the dividend payout schedules for the stocks. That means most of the time an investor's capital will be in from 1-3 of these stocks , with no more than 50% of the fund invested in any one stock. During periods when the manger is transitioning between holdings an investor's investment may be divided between cash, and utility stocks. In certain transition periods the fund may be 100% in cash.
The manager will strive not to purchase multiple stocks on the same day, or sell multiple stocks on the same day, but rather spread the shifting of capital over multiple days. This provides some level of risk reduction.
While covered calls and the sale of puts were used to enter/exit a few positions during the pilot program, there are is no plans to use any options strategy in this version of the fund.
APPENDIX 3
Pilot Performance
From July 1, 2008 through the June 30, 2009 the manager used his own capital and the trading guidelines in appendix 2 to conduct a pilot of this fund. Obviously, a one year period is a relatively short-period of time upon which to determine a long-term scorecard for the fund. Also, this particular period of time was perhaps the most volatile period of time an investor may ever endure so it may not be representative. Conversely, the fact that this approach yielded a positive absolute return in a period of huge market lose is a positive indication for the potential for the fund.
Time Period XLU Return Fund Return Over/Under Perform
Q3 2008 - 17.6% + 7.6% +25.2%
Q4 2008 - 11.6% + 5.6% +17.2%
Q1 2009 - 11.0% - 10.8% + 0.2%
Q2 2009 +10.4% + 8.1% - 2.3%
TOTAL -28.4% + 9.5% +37.9%
During the pilot period the fund held 35 positions (bought and sold).
- Dividends of 23.7% of the total original invested capital were generated
- From a capital gains perspective the fund lost 14.2%.
- 21 of the 35 positions were closed with modest small gains
- 5 of the 35 positions were closed at near the price paid. Essentially no gain/loss
- 9 of the 35 positions were closed at a loss.
Obviously a few of these losses were quite significant. The manger has examined these periods and tried to adjust guidelines to minimize these situations in this version of the fund, but the risk of these types of individual transaction loses can not be entirely eliminated.
The capital gains losses above included over 3% in cumulative transaction fees. The current version of the fund has switched providers for trading and should see these fees be reduced to less than 1%. If this provider was used last year overall performance would have been over 2% better.
A spreadsheet file containing details of each transaction is available upon request.
APPENDIX 4
Fund Performance & Comments
RESULTS
The fund launched on July 1, 2009. Quarterly performance for its first fiscal year is shown below. The funds return of over 11.5% exceeded the overall absolute annual return objective and the quarterly objective of preserving capital in down markets while making modest returns in up markets. Further the fund beat the XLU benchmark by 2.8% and the S&P500 benchmark by 1.2%
Time --------Returns -------- Comp to XLU Comp to DSPIX
Period Fund XLU DSPIX Perf. Corr. Perf. Corr.
Q3 2009 +4.9% + 6.3% +11.4% - 1.4% .88 - 6.5%
Q4 2009 +3.9% + 7.0% + 6.0% - 3.1% .72 - 2.1%
Q1 2010 +2.2% - 4.4% + 5.4% +6.6% .79 - 3.2%
Q2 2010 +0.1% - 3.7% -11.4% +3.7% .87 +11.4%
TOTAL YR. +11.5% +8.7% +10.3% +2.8% .76 +1.2% .90
TOTAL YR. +11.5% +8.7% +10.3% +2.8% .76 +1.2% .90
The fund had its best performance quarterly return since inception of 6.6% in the first quarter of the fiscal year. However, as expected, the fund did not keep pace with its benchmarks during periods of high performance.
Time -----------Returns -------- Comp to XLU Comp to DSPIX
Period Fund XLU DSPIX Perf. Corr. Perf. Corr.
Q3 2010 + 6.6% + 12.2% + 11.2% - 5.6% .87 - 4.6%
Q4 2010 + 2.4% + 1.1% +14.8% +1.3% .69 - 12.4%
Q1 2011 + 2.6% + 3.4% + 5.9% - 0.8% .69 - 3.3%
Q1 2011 + 2.6% + 3.4% + 5.9% - 0.8% .69 - 3.3%
YTD +11.9% +17.3% +35.2%
COMPONENTS OF REUTRNS
The fund plan to captures over 20% per year of dividend payments, and incur capital gain losses of a lesser amount. The quarterly results shown below illustrate these results.
Time Period Dividends Cap. Gain Total Fund Return
Q3 2009 + 7.73% - 2.86% + 4.87%
Q4 2009 + 8.22% - 4.29% + 3.93%
Q1 2010 + 8.10% - 5.93% + 2.17%
Q2 2010 + 7.98% - 7.89% +0.09%
TOTAL + 34.5% -22.6% +11.45%
Q3 2010 + 5.53% +1.08% + 6.61%
Q4 2010 + 5.61% - 3.25% + 2.36%
Q1 2011 +5.95% - 3.34% +2.61%
YTD +17.09% - 5.51% +11.98%
Q4 2010 + 5.61% - 3.25% + 2.36%
Q1 2011 +5.95% - 3.34% +2.61%
YTD +17.09% - 5.51% +11.98%
VOLATILITY
An objective of the fund is to have low volatility. The funds standard deviation calculation on daily changes in net asset value is shown below, and illustrates . Assuming the math is correct.
Time Period XLU SD Fund SD Vol Compare
Q3 2009 1.11% 0.44% 60% less volatile
Q4 2009 0.92% 0.70% 24% less volatile
Q1 2010 0.88% 0.68% 23% less volatile
Q2 2010 1.26% 1.07% 15% less volatile
Q3 2010 0.94% 0.62% 35% less volatile
Q4 2010 0.56% 0.34% 39% less volatile
Q1 2010 0.68% 0.44% 35% less volatile
Q1 2010 0.68% 0.44% 35% less volatile
WIN RATE
The approach has shown a consist win rate over time. Nearly 3 of 4 winning trades.
Nbr of
Time Period Trades Win Loss %
Q3 2009 18 14 4 77.8%
Q4 2009 17 12 5 70.6%
Q1 2010 19 13 6 68.4%
Q2 2010 22 16 6 72.7%
Q3 2010 15 12 3 80.0%
Q4 2010 19 14 5 73.7%
Q1 2011 17 13 4 76.5%
Q4 2010 19 14 5 73.7%
Q1 2011 17 13 4 76.5%
TOTAL 127 94 33 74.0%
A spreadsheet file containing details of each transaction is available upon request
