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Timely Articles

Sharing the Wealth: The Case for Equities
Jim Parker
Vice President, Dimensional Fund Advisors
May 24, 2012

Quiz Question: What do these companies have in common—Whitbread of the United Kingdom, Molson Coors of North America, Qantas of Australia, Honda of Japan, and Adidas of Germany?

Yes, they all deliver consumer products and services. Whitbread is in hospitality, Molson Coors is in brewing, Qantas is in airline transportation, Honda is in automotive products, and Adidas is in sportswear.

But that's not all these companies have in common. Have you guessed yet?

Yes, they are all well established and have internationally recognized brand names.
  • Whitbread has been around since 1750, when Samuel Whitbread started the first mass production brewery in the UK. The company now employs more than 40,000 people worldwide and serves more than 19,000 customers per month.
  • Brewing conglomerate Molson Coors has a history going back to 1774 in England, 1786 in Canada, and 1873 in the US. It now employs 15,000 people, services 30 countries, and boasts more than 65 individual brands.
  • International airline Qantas was founded in outback Australia in 1920 as "Queensland and Northern Territorial Aerial Services," operating fragile biplanes. It now employs 35,000 and is one of the most recognized airlines in the world.
  • Honda's roots go back to 1937 when a young mechanic named Soichiro Honda started a business making piston rings. Honda is now the seventh-largest automaker in the world with 180,000 employees and nearly 500 subsidiaries.
  • Adidas, renowned for sports apparel, has a history dating back to the mid-1930s when it was a single, small factory run by a humble shoemaker Adi Dassler. The company now employs 47,000 people and sells its products around the world.

Have you guessed yet? Yes, these are all consumer products companies. They all have long histories and humble beginnings. They all operate internationally. They all employ thousands of staff. And their products are globally recognized.

But that's still not all. Give up yet?

The answer is that these companies all operate in the capital markets. They have grown from humble beginnings, partly because they have issued equity and tapped the savings of millions of investors, who in turn have shared in their successes.|

It is worth keeping this in mind when you hear grim stories about the future of equity investment and the global economy.

It is true that we have been through and continue to feel the effects of a global financial crisis. This crisis caused strains in the banking system of many developed economies and continues to cause knock-on effects today, particularly in Europe.

But think about this. For all its troubles, the world economy is still growing. The International Monetary Fund estimates global economic growth this year of about 3.5%, accelerating to 4% in 2013. For emerging and developing economies, the growth assumptions are about twice that.

Economic growth means an increase in the world's output of goods and services. This increased productive effort is derived from a number of inputs—namely labor, materials, energy, intellectual capital, and financial capital.

So at Honda, for instance, researchers might be working on new technology for a zero-carbon emission electric vehicle. To do this, it will hire skilled labor, bring together the raw materials, apply its intellectual capital, and raise funds by issuing shares.

As an investor, your role is to supply the final element—the financial capital. In doing so, you take a risk. But you also get to share in the profits of this endeavor. So, unless you think the people of the world are going to stop buying cars, stop taking holidays, stop eating at restaurants, and stop playing sports, it seems foolish to assume that companies' demand for capital will not continue.

That capital is not free. It costs companies to tap the savings of others. And that cost is your expected return as an investor. That return is not there every day, every week, every month, or even every year. But over time, there is a return on capital for those who are patient and who diversify away risks they don't need to take.

If there were no return, there would be no capitalism. This is not a perfect system by any means. There are questions by some about its efficiency and by others about its equity. But it's the system we have and that most of us work under.

So to no longer participate in the equity market is to deny yourself a share of the wealth that these companies create—companies that provide livelihoods to millions and products to millions more.

Sharing the wealth means owning shares. Quiz over.
Should Investors Buy High-Dividend Stocks?
First Quarter 2012

With bond yields still hovering around historic lows, some investors may be tempted to consider dividend-paying stocks as a way of generating income from their portfolios, presumably with the benefit of not having to sell from their principal. But before embarking on this strategy, it is important to understand several considerations:

SIMPLE MATH: When firms make dividend payments, it is relatively common for the stock price to decrease on the ex-dividend date by an amount roughly equal to the dividend paid. For example, an investor holding 10 shares of a stock priced at $100 per share has a total account value of $1,000. If the stock pays a dividend of $5 per share, the stock price would generally drop to $95 on the ex-dividend date, so the investor’s overall account value does not change due to dividend payments. If the investor takes the dividend in cash, he would have $950 in the stock and $50 in cash. Taking the dividend payment in cash for spending purposes actually reduces the principal value of the account. Fundamentally, it is no different from selling the stock without waiting for the dividend payment. The same principle applies to distributions in mutual funds.

TOTAL RETURN: The total return of holding a stock is the sum of its dividend payments and price appreciation, and that sum is what should really matter to investors, not just the dividend. Until this quarter, Apple chose to reinvest its profits rather than pay dividends, and over the past decade it has been one of the best-performing stocks in the US market. Should investors have stayed away from Apple just because it wasn’t paying dividends? Many small cap stocks reinvest their earnings and don’t pay dividends, yet as an asset class have higher expected returns than large cap stocks.

TAXES: Until a few years ago, many investors purposefully avoided dividend-paying stocks because of the high tax rates, which were lowered in 2003 to 15% for most qualified dividends. Unless Congress takes action, the top tax rate for the highest earners is set to jump to 43.4% next year, as reported in the Wall Street Journal. That is a maximum income tax rate of 39.6%—since dividends will once again be taxed as regular income—plus a 3.8% tax on investment income as part of the healthcare overhaul passed in 2009.

Dividend-paying stocks certainly have a place is a holistic portfolio, but such a strategy should not supersede other fundamental tenets of investing, such as diversification and focusing on the sources of risk and expected return. Generating lifetime income from an investment portfolio is too complex of an issue to be solved by simply chasing stocks with high dividend yields.

By Apollo D. Lupescu, PhD, vice president. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell securities. Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.
Living with Volatility
Jim Parker, Outside the Flags
Vice President, Dimensional Fund Advisors
August 9, 2011

The current renewed volatility in financial markets is reviving unwelcome feelings among many investors—feelings of anxiety, fear, and a sense of powerlessness. These are completely natural responses. Acting on those emotions, though, can end up doing us more harm than good.

At base, the increase in market volatility is an expression of uncertainty. The sovereign debt strains in the US and Europe, together with renewed worries over financial institutions and fears of another recession, are leading market participants to apply a higher discount to risky assets.

So, developed world equities, oil and industrial commodities, emerging markets, and commodity-related currencies like the Australian dollar are weakening as risk aversion drives investors to the perceived safe havens of government bonds, gold, and Swiss francs.

It is all reminiscent of the events of 2008, when the collapse of Lehman Brothers and the sub-prime mortgage crisis triggered a global market correction. This time, however, the focus of concern has turned from private-sector to public-sector balance sheets.

As to what happens next, no one knows for sure. That is the nature of risk. But there are a few points individual investors can keep in mind to make living with this volatility more bearable.
  • Remember that markets are unpredictable and do not always react the way the experts predict they will. The recent downgrade by Standard & Poor's of the US government's credit rating, following protracted and painful negotiations on extending its debt ceiling, actually led to a strengthening in Treasury bonds.
  • Quitting the equity market at a time like this is like running away from a sale. While prices have been discounted to reflect higher risk, that's another way of saying expected returns are higher. And while the media headlines proclaim that "investors are dumping stocks," remember someone is buying them. Those people are often the long-term investors.
  • Market recoveries can come just as quickly and just as violently as the prior correction. For instance, in March 2009—when market sentiment was last this bad—the S&P 500 turned and put in seven consecutive months of gains totaling almost 80 percent. This is not to predict that a similarly vertically shaped recovery is in the cards this time, but it is a reminder of the dangers for long-term investors of turning paper losses into real ones and paying for the risk without waiting around for the recovery.
  • Never forget the power of diversification. While equity markets have had a rocky time in 2011, fixed income markets have flourished—making the overall losses to balanced fund investors a little more bearable. Diversification spreads risk and can lessen the bumps in the road.
  • Markets and economies are different things. The world economy is forever changing, and new forces are replacing old ones. As the IMF noted recently, while advanced economies seek to repair public and financial balance sheets, emerging market economies are thriving.1 A globally diversified portfolio takes account of these shifts.
  • Nothing lasts forever. Just as smart investors temper their enthusiasm in booms, they keep a reserve of optimism during busts. And just as loading up on risk when prices are high can leave you exposed to a correction, dumping risk altogether when prices are low means you can miss the turn when it comes. As always in life, moderation is a good policy.
The market volatility is worrisome, no doubt. The feelings being generated are completely understandable. But through discipline, diversification, and understanding how markets work, the ride can be made bearable. At some point, value will re-emerge, risk appetites will re-awaken, and for those who acknowledged their emotions without acting on them, relief will replace anxiety.

1. World Economic Outlook, IMF, April 2011.
Dimensional Fund Advisors LP ("Dimensional") is an investment adviser registered with the Securities and Exchange Commission.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. This article is provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.
Is It Different This Time?
Second Quarter 2011

For the twelve-month period ending June 30, 2011, equity investors around the world enjoyed the equivalent of blue skies and bright sunshine while the economic news was partly cloudy at best. Among forty-five developed and emerging-country stock markets tracked by MSCI, all but five had double-digit total returns (in US dollar terms), and twenty-five had returns of 30% or more.

If someone had told us a year ago that global markets would stage such a broad-based rally, we would have been inclined to think that trends in employment, housing, and financial distress were about to take a pronounced turn for the better. It seems hard to argue they have done anything of the sort. Somehow, despite gloomy financial page news that keeps repeating itself, equity prices marched substantially higher.

The moral of the story? Investors should be skeptical of their ability to predict future events and even more skeptical of their ability to predict how other investors will react to them.

Last Year's Headlines
  • "Europe Crisis Deepens as Chaos Grips Greece" Moffett and Granitsas. Wall Street Journal, May 6, 2010
  • "Fearful Investors Are Pulling Out" Adam Shell. USA Today, May 20, 2010
  • “Housing Prices Remain Weak" Sara Murray. Wall Street Journal, May 26, 2010
  • "Fear Returns—How to Avoid a Double-Dip Recession" Cover story. Economist, May 29, 2010
  • "Spill Tops Valdez Disaster—Deep Trouble" Weisman, Chazan, Power. Wall Street Journal, May 28, 2010
  • "Discouraging Job Growth Batters Stocks" Don Lee. Los Angeles Times, June 5, 2010
  • "Economic Outlook Darkens" Cheng and Lahart. Wall Street Journal, June 2, 2010
  • "Bond Fund Managers See Signs of a Bubble" Sam Mamudi. Wall Street Journal, June 8, 2010
This Year's Headlines
  • "Greek Woes Fuel Fresh Fears" Walker and Benjamin. Wall Street Journal, May 10, 2011
  • "“Fear Wins: Stocks Resume Long Slide" Adam Shell. USA Today, June 16, 2011
  • “Home Market Takes a Tumble" Timiraos and Wotapka. Wall Street Journal, May 9, 2011
  • "The World Economy—Sticky Patch or Meltdown?" Cover story. Economist, June 18, 2011
  • "Japanese Nuclear Crisis Is Ranked at the Level of Chernobyl" Mitsuru Obe.Wall Street Journal, April 12, 2011
  • "Jobs Data Stoke US Recovery Fears" Harding, Bond and Mackenzie. Financial Times, June 4, 2011
  • "Stocks Plunge Amid Fears That Global Economy is Slowing" Christina Hauser. New York Times, June 11, 2011
  • "Why Are Investors Still Lining Up for Bonds?" Jeff Sommer. New York Times, May 29, 2011

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