Durable Dividends

Diversification: The Closest Thing You’ll Find To A Free Lunch On Wall Street

Nick Ward

56 postsAugust 9, 2021

Last week some pretty interesting news broke that impacted many income oriented investors.

Newtek Business Services (NEWT), a popular business development company, which was a star over the last 18 months or so as a top performer amongst its peer group, unexpectedly announced that it had agreed to acquire National Bank of New York City in a move which would transition the BDC into a bank holding company.

Not only was this move surprising, but it was also upsetting, because of the likelihood that the transition will result in a significant dividend cut in the coming years.

After rising roughly 100% on a year-to-date basis prior to this announcement, Newtek shares were down roughly 25% last week.

In short, this single announcement destroyed a lot of short-term capital, but more importantly, it’s likely to lead towards a 30-50% dividend cut in 2022 (because, assuming the deal goes through, NEWT will no longer be a BDC, and therefore, it does not have an obligation to pay out 90% of its income to shareholders).

Investors who relied on the company for passive income likely saw their retirement plans changed dramatically last week. Yet, while no one could have known about this BDC’s bank holding company aspirations, anyone who owned NEWT shares could have taken steps to reduce their risk.

Thankfully, NEWT is not a company that I own personally. Nor is it a stock that I selected for The Intelligent Dividend Investor portfolio because of concerns about its future dividend growth prospects (even before this deal was announced, I had concerns about the BDC’s ability to produce reliably increasing passive income). However, I do know that this is a company that many high yield investors had latched onto because of its strong performance lately and I wanted to write this piece about risk management because I know that there are important lessons to be learned from this sell-off.

The fact is, none of us are perfect. I’m certainly not. Actually, I almost sat down and wrote this very same piece several months ago when one of my largest high yield holdings, AT&T (T) announced that it was merging its content business (Warner Media) with Discovery (DISCA) in a tie up that is also likely to result in a significant double digit dividend cut once it closes in mid-2022. T shares have struggled since that announcement was made, which is especially upsetting because prior to news of that merger, I really thought that AT&T’s operations were turning a corner after years of empire building M&A activity.

With examples like this in mind, I want to focus on the easiest method that I’m aware of that investors can take to help to protect themselves from unpredictable losses and dividend cuts: diversification

You’ll hear naysayers critique diversification with statements like, “Your 20th best idea is nowhere near as good as your highest conviction pick, so why not invest heavily in your very best ideas?”

And they’re right about that. However, I think it’s also important to note that no one knows what the future will hold, and anyone who says that they can accurately predict the future is either naively optimistic, overly arrogant, or worse, a lair.

All you have to do is look at Newtek’s performance running up to the bank transition announcement, or AT&T’s fundamentals (the company was taking market share in the mobile space, reducing its debt load, reaffirming full-year free cash flow guidance, and maintaining a relatively low, 65% dividend FCF payout ratio) to realize that you there was no way to predict such negative announcements (in terms of dividend income) on the horizon.

In short, there are events that occur in the stock market that no one, without insider knowledge, could possibly prepare for. That’s part of the reality of equities. They are risk assets, after all.

However, getting back to the focus on this piece, investors can hedge against these unforeseen pitfalls by ensuring that their asset allocations are properly weighted and that they are not exposing themselves, or their passive income streams, to outsized single stock risk.

There’s no such thing as a free lunch on Wall Street. Those who don’t believe in the benefits of diversification will argue that the opportunity cost associated with spreading wealth around, instead of heavily investing in your very best ideas, is too high of a cost to pay. But, in my view, as a dividend growth investor, I’m more than willing to build a diversified portfolio of blue chip holdings because I think it’s more than possible to maintain the quality of one’s overall portfolio while diversifying industry and sector exposure.

Simply put, diversification is as close to a free lunch as it gets and therefore, I think investors who don’t properly manage their equity weightings are doing themselves a disservice.

Acceptable equity weights will vary from individual from individual, depending on variables such as their risk tolerance, their conviction levels, their investing timelines (how much time would they theoretically have to recovery from an overweight bet gone wrong), their savings rates, and their margin of safety with regard to the difference between their passive income stream and their expected lifestyle spending needs in retirement.

Once again, I’ll say that there is no one way to skin the cat as far as diversification goes, meaning that I don’t have a perfect formula to avoid risk. However, ignoring the practice completely is a dangerous game to play.

The sell-offs and likely future dividend cut announcements by Newtek and AT&T are keen reminders of this.

So often, I talk about how well I sleep, as a dividend growth investor, knowing that I’m making money every night while I slumber. However, I will also say that my asset allocation plays a large role here as well.

Because of my disciplined stance when it comes to single stock risk, I know that no single unforeseen event like these can derail my retirement plans. In short, I’ve prepared for the unknown ahead of time because when it comes to reaching my long-term financial goals, I’m doing my best to leave no stone unturned. We never know where the next big threat will come from, but they’re always looming.

That’s unavoidable. But, proper portfolio management practices can help everyone reach their financial goals with relatively little stress or energy.

If you’re interested in learning more about how to manage a dividend growth portfolio, check out The Intelligent DIvidend Investor.

This service involved an actively managed portfolio which has had a perfect dividend growth record since being launched on March 1st, 2020. I manage this portfolio and I’m incredibly proud to have made it through the pandemic period, not only without a dividend cut, but with every single one of our holdings maintaining their annual dividend growth streaks.

But, the service is more about stock picks. In every monthly newsletter I discuss various portfolio management strategies that dividend growth investors should be aware of, helping subscribers to learn and grow as they move along their journeys towards financial freedom.

Disclosure: Nicholas Ward is long T.

Nick Ward

56 posts

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Nicholas Ward is a research analyst who currently writes for Seeking Alpha, The Dividend Kings, iREIT, and Forbes Real Estate Investor. Before that, he was Founder and Editor-in-Chief of The Dividend Growth Club, as well as the Income Minded Millennial. Nicholas has also contributed to Sure Dividend, Investing Daily, and The Street, where he covered stocks in Jim Cramer's Action Alerts PLUS Portfolio.

Nicholas holds a bachelor of arts from The University of Virginia, where he studied English and studio art. Prior to transitioning into the financial industry, he managed a vineyard in the foothills of the Blue Ridge Mountains.

REIT Mutual Fund	Symbol
Alpine Realty Income and Growth Fund	AIGYX, AIAGX
American Century Real Estate Fund	REAIX, REACX, AREEX, AREWX, ARYCX, AREDX
Real Estate Securities Fund	MRESX
AR Capital Real Estate Income Fund	ARIAX, ARICX, ARIPX
AssetMark Real Estate Securities Fund	AFREX
Aston/Harrison Street Real Estate Fund	AARIX, ARFCX
Baron Real Estate Fund	BREIX, BREFX
BlackRock Real Estate Securities	BIREX, BAREX, BCREX
Brookfield U.S. Listed Real Estate Fund	BRUAX, BRUCX, BRUIX, BRUYX
CGM Realty Fund	CGMRX
West Loop Realty Fund	REIIX, REIAX, REICX
Cohen & Steers Institutional Realty Shares	CSRIX
Cohen & Steers Realty Income Fund	CSEIX, CSDIX, CSBIX, CSCIX
Cohen & Steers Realty Shares	CSRSX
Columbia Real Estate Equity Fund	CREAX, CREIX, CRRVX, CRERX, CREEX, CRRFX, CREWX, CRECX, CREBX
Compass EMP REC Enhanced Volatility Weighted Fund	CWRAX, CWRIX, CWRTX, CWRCX
Davis Real Estate Fund	RPFRX, DREYX, DRECX, DREBX
Delaware Real Estate Investment Trust Portfolio II	DPRTX, DPRBX
Delaware Real Estate Investment Trust Portfolio	DPREX, DPRSX, DPRRX, DPRCX
DFA Real Estate Securities Portfolio	DFREX
Dunham Real Estate Stock Fund	DAREX, DNREX, DCREX
DWS RREEF Real Estate Securities Fund	RRRRX, RRREX, RRRAX, RRRSX, RRRBX, RRRCX
DWS RREEF Real Estate Securities Income Fund	REFAX, REFCX, REFIX, REFSX
Eaton Vance Real Estate Fund	EAREX, EIREX
EII Realty Securities Fund	EIIRX
Fidelity Advisor Real Estate Fund	FHEIX, FHEAX, FHETX, FHECX, FHEBX
Fidelity Advisor Real Estate Income Fund	FRIRX, FRIQX, FRINX, FRIOX
Fidelity Real Estate Income Fund	FRIFX
Fidelity Real Estate Investment Portfolio	FRESX
Fidelity Spartan Real Estate Index Fund	FSRNX, FRXIX, FSRVX
Fidelity Series Real Estate Equity Fund	FREDX, FREFX
Fidelity Series Real Estate Income Fund	FSREX, FSRWX
Forward Real Estate Long/Short Fund	KSRYX, FRLSX, FFSRX, KSRAX, KSRCX, KSRBX
Forward Real Estate Fund	FPREX, FFREX, KREAX, KRECX
Forward Select Income Fund	KIFYX, FSIMX, FFSLX, KIFAX, KIFBX, KIFCX
Franklin Real Estate Securities Fund	FREEX, FRLAX, FRRSX, FSERX
GMO Real Estate Fund	GMORX
Goldman Sachs Real Estate Securities Fund	GREIX, GRETX, GREAX, GRESX, GRERX, GREBX, GRECX
Great-West Real Estate Fund	MXREX
Heitman REIT Fund	OARTX, OBRTX
ING Real Estate Fund	CRARX, IREWX, IDROX, CLARX, CRWRX, CRCRX, CRBCX
INVESCO Real Estate Fund	REINX, IARFX, IARIX, IARYX, IARAX, IARRX, IARCX, AARBX
Ivy Real Estate Securities Fund	IRSAX, IREIX, IRSYX, IRSRX, IREEX, IRSCX, IRSBX
John Hancock Real Estate Securities Fund	JIREX
Johnson Realty Fund	JRLTX
J.P.Morgan Realty Income Fund	URTLX, JRIRX, URTAX, URTBX, URTCX
J.P. Morgan Security Capital U.S. Core Real Estate Securities Fund	CEEAX, CEERX, CEEFX, CEESX, CEECX
J.P. Morgan U.S. Real Estate Fund	SUSIX
Lazard U.S. Realty Equity Portfolio	LREIX, LREOX
Lazard U.S. Realty Income Portfolio	LRIIX, LRIOX
Manning & Napier Real Estate Series	MNRIX, MNREX
Morgan Stanley Institutional U.S. Real Estate Portfolio	MSUSX, MUSDX, MSULX, MURSX
Natixis AEW Real Estate Fund	NRFAX, NRFYX, NRFBX, NRFCX, NRFNX
Neuberger Berman Real Estate Fund	NBRIX, NBRFX, NREAX, NRERX, NRECX, NRREX
Nuveen Real Estate Securities Fund	FREAX, FARCX, FRSSX, FREBX, FRLCX, FREGX
Oppenheimer Real Estate Fund	OREAX, OREIX, OREYX, ORENX, OREBX, ORECX
PHOCAS Real Estate Fund	PHREX
PIMCO RealEstateRealReturn Strategy Fund	PRRSX, PETPX, PETAX, PETDX, PETCX, PETBX
Pioneer Real Estate Shares	PWREX, PYREX, PCREX, PBREX
Principal Real Estate Securities Fund	PIREX, PIRPX, PREPX, PRETX, PREJX, PRRAX, PRERX, PRENX, PRAEX, PRCEX, PRLEX
ProFunds Real Estate UltraSector ProFund	REPIX
Prudential Select Real Estate Fund	SREAX
Prudential U.S. Real Estate Fund	PJEAX, PJEZX, PJECX, PJEBX
REMS Real Estate Income 50/50 Portfolio	RREIX
REMS Real Estate Value-Opportunity Fund	HLRRX, HLPPX
Rydex Real Estate Fund	RYREX, RYHRX, RYCRX
SA Real Estate Securities Fund	SAREX
SEI Institutional Mgd Real Estate Fund	SETAX, SEIRX
Spirit of America Real Estate Income & Growth Fund	SOAAX
SSgA Clarion Real Estate Fund	SSREX
Stratton Real Estate Fund	STMDX
T.Rowe Price Real Estate Fund	TRREX, PAREX
TIAA-CREF Real Estate Securities Fund	TIREX, TRRPX, TRRSX, TCREX
Vanguard REIT Index Fund	VGSNX, VGRSX, VGSLX, VGSIX
Virtus Real Estate Securities Fund	PHRAX, PHRIX, PHRCX, PHRBX

REIT ETF	Symbol
Flex Shares	ASET
Wisdom Tree Global Ex-US	DRW
S&P 500 Equal Weight	EWRE
iShares FTSE Industrial/Office	FNIO
MSCI Real Estate Index	FREL
S&P REIT Index	FRI
First Trust S&P REIT	FRI
iShares Real Estate 50	FTY
Flexshares Global	GQRE
iShares Cohen & Streers	ICF
iShares International Developed RE	IFGL
iShares US RE	IYR
Premium Yield Equity REIT	KBWY
ETRACS Monthly Pay 2x Leverage	MORL
Market Vector Mortgage	MORT
iShares Global REIT	REET
iShares FTSE Mortgage	REM
iShares Residential	REZ
IQ US Real Estate Small Cap	ROOF
iShares FTSE NAREIT Retail	RTL
DOW Jones Global RE	RWO
SPDR Dow Jones	RWR
Schwab US REIT	SCHH
Super Dividend REIT	SRET
ProShares Ultra RE	URE
Vanguard REIT	VNQ
Vanguard Global ex-US	VNQI
iShares International Developed	WPS
Wilshire US REIT	WREI
Pacer Benchmark Data & Infrastructure RE	SRVR
Pacer Benchmark Industrial RE	INDS
Pacer Benchmark Retail RE	RTL
Hoya Capital Housing	HOMZ
NetLease Corporate RE	NETL

REIT Name	Ticker	Annual Increases/yr
Federal Realty	FRT	51
Universal Health Realty	UHT	33
National Retail Properties	NNN	29
Realty Income	O	27
Tanger Outlets	SKT	26
Urstadt Biddle	UBA	25
Essex Property Trust	ESS	25
W.P.Carey	WPC	22
National Health Investors	NHI	17
Equity Lifestyle	ELS	15
Digital Realty	DLR	15

Diversification: The Closest Thing You’ll Find To A Free Lunch On Wall Street

Nick Ward

56 postsAugust 9, 2021

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Diversification: The Closest Thing You’ll Find To A Free Lunch On Wall Street

56 postsAugust 9, 2021

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