Why I Bought This Stock Buybacks ETF

Written by Steve Hercenberg   
Tuesday, 01 July 2014 11:09

A Core/Satellite Portfolio (see previous article, “The Best of Both Worlds”) is an alternative investment strategy for investors in today’s volatile market.  To build an effective core/satellite portfolio, start with biggest part of the portfolio, the Core. Then, add Satellites to enhance performance and fill gaps left by the Core holding.  This blog will focus on selecting a Core investment using this strategy.

PowerShares Buyback Achievers Portfolio (NYSE – PKW - $44.85) offers the best of both worlds—a proven track record of higher rewards than the S&P 500 during bull markets and lower drawdowns during market corrections.  PKW invests at least 90% of its total assets in common stocks that comprise the NASDAQ US Buyback Achievers Index. This index has only those U.S. corporations that repurchased at least 5% of their outstanding shares (buyback less issuance) over the previous twelve months and meet a minimum liquidity requirement of trading at least $500,000 per day on average. The Fund and the Index are reconstituted annually in January and rebalanced quarterly in January, April, July and October. PKW offers the following benefits to the Core-equity portion of a Core-Satellite portfolio:

  • Transparency.  While PKW has no fixed number of stocks, it reconstitutes its holdings annually and rebalances its weights quarterly. Index weights are based on relative market capitalization and are capped at 5%.
  • Proven track record.  See Graphs 1 and 2 below comparing PKW’s closing price performance since inception with alternative strategies. The graph compares PKW with the price performance of the S&P 500 Index (^GSPC), an equal-weighted version of the S&P 500 (VADAX), a low volatility alternative as First Trust Morningstar Dividend Leaders Index ETF (FDL), and the Vanguard Total Stock Market (VTI).
  • Passively managed.  Because PKW is passively managed, investors can enjoy lower turnover, lower costs, and lower taxes.
  • Market-cap weighted.  Cap-weighting assigns the greatest weights to the largest companies. Since market capitalization is highly correlated with liquidity, cap-weighting ensures that the portfolio is mostly invested in highly liquid stocks, thus reducing expected portfolio transaction costs.
  • Less Volatility. Because of the buyback program, PKW’s portfolio comprises extremely profitable, highly cash-generative companies, with managements focused on shareholder value. In addition, 80% of the fund's assets are in firms that Morningstar considers to have an economic moat. In other words, firms that have wide moats (e.g., well-known brand name, pricing power, new leading innovative products or manufacturing processes with patent protection, or a large portion of market demand), have more competitive advantages than their competitors.  These moats in turn act as barriers against other companies wanting to enter into the industry.  Investors’ perceptions of reduced business risk from these moats could translate into less volatility in stock prices.

In addition, if some of the companies were to buy back their shares when management deems them a bargain, it could provide a floor when share prices have been falling. As a result, volatility could be condensed further.  So, the future long-term benefit of buybacks implies that fewer shares outstanding will translate into less downside risk since both earnings per share and book value per share increase compared with previous years.

PowerShares Buyback Achievers Portfolio (PKW) offers the best of both worlds—a proven track record of higher rewards than the S&P 500 during bull markets and lower drawdowns during market corrections.  Because PKW is passively managed, investors can enjoy lower turnover, lower costs, and lower taxes.  Because of the buyback program, PKW’s portfolio comprises extremely profitable, highly cash-generative companies, with managements focused on shareholder value. In addition, 80% of the fund's assets are in firms that Morningstar considers to have competitive advantages.  Although it has lagged the S&P 500 so far this year, we project that PKW will outperform the index reaching $50 to $52 by the end of the year.

Disclosure: The author and his clients are long shares of PowerShares Buyback Achievers Portfolio exchange traded fund.

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