Blog - The Margin Investor

14% Div Yield Portfolio - Same risk as S&P 500

11/26/2012

Dividend Yield focused strategies have become increasingly popular among investors seeking to enhance the cashflow and income generated by their portfolio. Much of the interest in this strategy is driven by a lack of sufficient investment opportunities in bond markets. Simply put, bond yields are far too low to warrant meaningful attention from income driven investors.

It's not all bad news though - the current climate is also punctuated by healthy dividend payouts on a wide range of equity securities.

In this post we'll explore a portfolio that has the same level of risk as the S&P 500, but with dividend yield of 14%. This strategy is made possible by the low level of margin loan rates currently available to investors. For example, a 200k account at Interactive Brokers has a loan rate of roughly 1.4%.

"Simply put, bond yields are far too low to warrant meaningful attention from income driven investors."

Long/Short Portfolio
Typically, a portfolio with such large dividend yield comes with substantial risk. In order to mitigate this risk we'll use both long and short positions. This allows us to hedge out a significant portfion of this risk.

We utilize the following assumptions for constructing our portfolio:

Leverage: No more than 5:1 leverage will be allowed. Note that this level of leverage can only be achieved with a Portfolio Margin account. If you don't have a PM account, see our list of Portfolio Margin brokers to find a suitable broker.
Min/Max Individual Stock Weighting: no more than 3.5% of the portfolio can be invested in any single stock (anything greater would result in far too much asset-specific risk).
Portfolio Construction Method: Mean variance optimization is used to ensure the portfolio minimizes risk while maximizing dividend yield. The risk model used in this optimization attributes risk to style and sector factors. This is similar to models available from commercial vendors such as Barra, Northfield and Axioma.

Below you will find an analysis of the long/short portfolio, as well as the composition of the portfolio itself. Figure 1 shows that the portfolio has roughly the same risk as the S&P 500. You can also see how the portfolio compares to other portfolios of interest.

Figure 1. Our Long/Short portfolio has roughly the same level of risk as the S&P 500, which is also about half the risk of a crude oil position.

Figure 2 shows that there are 168 positions in the portfolio: 92 long and 76 short. The total risk is shown and is also decomposed across the long and short sides. The risk displayed here is quoted as the annualized standard deviation of returns. Note that this risk in the "Longs" and "Shorts" columns is additive. That is, the risk on the long side plus the risk on the short side equals the Risk in the "Total" column. If you look at the "Shorts" column, you will notice that many of the numbers are negative. This tells out the short positions are acting as a hedge to the long positions and therefore reduce risk.

Risk is also attributed to "Common Factor" risk and "Asset Specific" risk. Common Factors drive returns across multiple assets and thus are the source of correlation between securities (think sector/industry risk and the so called "style" factor risk such as value/growth and size). In contrast, asset specific risk emanates from a the operations of an individual company and is diversifiable within limits (i.e. asset specific risk decreases as we add positions to the portfolio). As we can see, Common Factor risk dominates the portfolio at 14.63%, while Asset Specific Risk is 7.74%. To get to the Portfolio Total Risk, we add the square of the Common Factor Risk to the square of the Asset Specific Risk and then take the square root of this number.

Figure 2. Our Long/Short portfolio utilizes leverage of 4.9 and has an annualized standard deviation of 16.55%. The short side acts as a hedge and thus lowers portfolio risk.

Figure 3 shows the exposure and risk attributable to the common factors. Focus your attention on the last column which represents the amount of risk contributed by exposure to the given factor. As we can see, most of the risk is driven by exposure to three of the common factors: Utilities Sector factor, Services Sector factor, and the Growth/Value factor. The table also shows that some of the factors act as a hedge and thus end up reducing risk. For example, exposure to the Health Care factor reduces risk by 1.442%

Figure 3. Exposure of our Long/Short portfolio to the various common factors that drive portfolio risk.

Below is a table containing the portfolio's positions assuming a portfolio net equity value of $1,000,000. The share quantity can be scaled up or down to accommodate the actual amount available to be invested. For example, if you only have $100,000 to invest then scale down the positions by a factor of 10.

Most of the columns in the table are self explanatory, however, the "Component Total Risk" deserves further commentary. The Component Total Risk represents the risk emanating from that specific position considering the portfolio context. A positive value means the position adds to risk. A negative value means the position decreases (i.e. hedges out) risk. The sum of these values is equal to the "Portfolio Total Risk" show in Figure 2.

Portfolio Composition - Long/Short with 14.3% Dividend Yield

Ticker	Trade Type	Trade Quantity (# of Shares)	Weight	Component Total Risk	UnWeighted Div Yield	Weighted Div Yield
&CASH		-171677	-17.17%	0.00%	0.00%	0.00%
ABT	BUY	543	3.50%	0.25%	3.17%	0.11%
ADBE	SELL	1048	-3.50%	-0.10%	0.00%	0.00%
ADSK	SELL	1101	-3.50%	-0.03%	0.00%	0.00%
AEE	BUY	1226	3.50%	0.36%	5.57%	0.20%
AEP	BUY	853	3.50%	0.38%	4.59%	0.16%
AIG	SELL	237	-0.78%	-0.05%	0.00%	0.00%
AIV	BUY	217	0.54%	0.04%	3.10%	0.02%
AKAM	SELL	524	-1.88%	-0.05%	0.00%	0.00%
ALXN	SELL	370	-3.50%	-0.13%	0.00%	0.00%
AMD	SELL	6219	-1.21%	0.05%	0.00%	0.00%
AMZN	SELL	47	-1.13%	-0.07%	0.00%	0.00%
AN	SELL	832	-3.50%	-0.25%	0.00%	0.00%
APOL	SELL	73	-0.14%	-0.01%	0.00%	0.00%
AVP	BUY	2454	3.50%	0.21%	5.37%	0.19%
BBBY	SELL	582	-3.50%	-0.11%	0.00%	0.00%
BBY	BUY	2991	3.50%	0.35%	5.62%	0.20%
BIG	SELL	775	-2.21%	-0.12%	0.00%	0.00%
BIIB	SELL	234	-3.51%	-0.20%	0.00%	0.00%
BMY	BUY	1073	3.50%	0.30%	4.20%	0.15%
BRK-B	SELL	395	-3.50%	-0.28%	0.00%	0.00%
BSX	SELL	6261	-3.50%	-0.17%	0.00%	0.00%
BWA	SELL	76	-0.50%	-0.02%	0.00%	0.00%
C	SELL	971	-3.50%	-0.26%	0.11%	0.00%
CA	BUY	1584	3.50%	0.07%	4.57%	0.16%
CAM	SELL	643	-3.50%	-0.18%	0.00%	0.00%
CBG	SELL	1959	-3.50%	-0.20%	0.00%	0.00%
CCI	SELL	518	-3.50%	-0.25%	0.00%	0.00%
CELG	SELL	164	-1.29%	-0.07%	0.00%	0.00%
CERN	SELL	121	-0.95%	-0.02%	0.00%	0.00%
CFN	SELL	1248	-3.50%	-0.19%	0.00%	0.00%
CINF	BUY	868	3.50%	0.29%	4.05%	0.14%
CLF	BUY	1121	3.50%	0.36%	6.96%	0.24%
CME	BUY	641	3.50%	0.23%	4.08%	0.14%
CMG	SELL	98	-2.69%	-0.06%	0.00%	0.00%
CMS	BUY	1488	3.50%	0.35%	4.08%	0.14%
CNP	BUY	1817	3.50%	0.36%	4.21%	0.15%
COP	BUY	618	3.50%	0.29%	4.66%	0.16%
CRM	SELL	61	-0.97%	0.01%	0.00%	0.00%
CTL	BUY	909	3.50%	0.27%	7.67%	0.27%
CTSH	SELL	395	-2.63%	-0.07%	0.00%	0.00%
CTXS	SELL	259	-1.60%	-0.01%	0.00%	0.00%
CVC	BUY	2504	3.50%	0.44%	4.27%	0.15%
CVX	BUY	332	3.50%	0.30%	3.37%	0.12%
D	BUY	698	3.50%	0.35%	4.14%	0.14%
DD	BUY	812	3.50%	0.24%	4.01%	0.14%
DF	SELL	285	-0.48%	-0.02%	0.00%	0.00%
DLTR	SELL	833	-3.50%	-0.14%	0.00%	0.00%
DNR	SELL	2224	-3.50%	-0.19%	0.00%	0.00%
DO	BUY	520	3.50%	0.26%	5.25%	0.18%
DOW	BUY	1191	3.50%	0.28%	3.96%	0.14%
DPS	BUY	781	3.50%	0.21%	3.04%	0.11%
DRI	BUY	654	3.50%	0.25%	3.54%	0.12%
DTE	BUY	594	3.50%	0.36%	4.04%	0.14%
DUK	BUY	579	3.50%	0.36%	5.01%	0.18%
DVA	SELL	281	-3.13%	-0.23%	0.00%	0.00%
ED	BUY	647	3.50%	0.35%	4.46%	0.16%
EL	SELL	587	-3.50%	-0.14%	0.00%	0.00%
EMC	SELL	1411	-3.50%	-0.02%	0.00%	0.00%
ETFC	SELL	4300	-3.50%	-0.18%	0.00%	0.00%
ETR	BUY	564	3.50%	0.38%	5.33%	0.19%
EXC	BUY	1225	3.50%	0.36%	7.28%	0.25%
FE	BUY	852	3.50%	0.34%	5.34%	0.19%
FFIV	SELL	323	-2.98%	0.03%	0.00%	0.00%
FISV	SELL	464	-3.50%	-0.13%	0.00%	0.00%
FMC	SELL	639	-3.50%	-0.22%	0.64%	-0.02%
FRX	SELL	1050	-3.50%	-0.21%	0.00%	0.00%
FSLR	SELL	289	-0.71%	-0.04%	0.00%	0.00%
FTI	SELL	838	-3.50%	-0.21%	0.00%	0.00%
FTR	BUY	7795	3.50%	0.43%	8.91%	0.31%
GAS	BUY	932	3.50%	0.36%	4.88%	0.17%
GCI	BUY	1963	3.50%	0.36%	3.87%	0.14%
GILD	SELL	270	-2.06%	-0.12%	0.00%	0.00%
GIS	BUY	2	0.01%	0.00%	3.14%	0.00%
GNW	SELL	5641	-3.19%	-0.20%	0.00%	0.00%
GOOG	SELL	4	-0.27%	-0.01%	0.00%	0.00%
GT	SELL	2188	-2.59%	-0.18%	0.00%	0.00%
HAS	BUY	561	2.15%	0.12%	3.66%	0.08%
HCBK	BUY	4289	3.50%	0.38%	3.99%	0.14%
HCN	BUY	581	3.50%	0.31%	4.94%	0.17%
HCP	BUY	766	3.50%	0.31%	4.41%	0.15%
HNZ	BUY	599	3.50%	0.22%	3.45%	0.12%
HPQ	BUY	2814	3.50%	0.13%	4.22%	0.15%
HRB	BUY	1920	3.50%	0.33%	4.45%	0.16%
HSP	SELL	815	-2.40%	-0.13%	0.00%	0.00%
INTC	BUY	1775	3.50%	0.13%	4.49%	0.16%
ISRG	SELL	12	-0.65%	-0.04%	0.00%	0.00%
JDSU	SELL	2025	-2.36%	0.00%	0.00%	0.00%
JNJ	BUY	503	3.50%	0.28%	3.48%	0.12%
K	BUY	633	3.50%	0.21%	3.14%	0.11%
KIM	BUY	1826	3.50%	0.27%	4.00%	0.14%
KLAC	BUY	775	3.50%	0.15%	3.40%	0.12%
KMX	SELL	32	-0.11%	-0.01%	0.00%	0.00%
LEG	BUY	1276	3.50%	0.31%	4.19%	0.15%
LH	SELL	105	-0.88%	-0.06%	0.00%	0.00%
LIFE	SELL	699	-3.50%	-0.21%	0.00%	0.00%
LLTC	BUY	362	1.18%	0.04%	3.13%	0.04%
LLY	BUY	733	3.50%	0.31%	4.13%	0.14%
LMT	BUY	381	3.50%	0.26%	4.42%	0.15%
LO	BUY	284	3.50%	0.19%	4.90%	0.17%
LRCX	SELL	990	-3.50%	-0.09%	0.00%	0.00%
LSI	SELL	5216	-3.50%	0.03%	0.00%	0.00%
LUV	SELL	2103	-1.97%	-0.16%	0.33%	-0.01%
MCD	BUY	402	3.50%	0.28%	3.26%	0.11%
MCHP	BUY	1167	3.50%	0.15%	4.77%	0.17%
MNST	SELL	402	-1.85%	-0.02%	0.00%	0.00%
MO	BUY	1045	3.50%	0.20%	5.08%	0.18%
MU	SELL	6162	-3.50%	-0.07%	0.00%	0.00%
MUR	BUY	599	3.50%	0.35%	6.39%	0.22%
MYL	SELL	705	-1.91%	-0.12%	0.00%	0.00%
NBR	SELL	2496	-3.50%	-0.22%	0.00%	0.00%
NOC	BUY	535	3.50%	0.30%	3.31%	0.12%
NU	BUY	928	3.50%	0.35%	3.31%	0.12%
NUE	BUY	851	3.50%	0.30%	3.59%	0.13%
NYX	BUY	1530	3.50%	0.30%	5.28%	0.18%
OI	SELL	1769	-3.50%	-0.22%	0.00%	0.00%
PAYX	BUY	1079	3.50%	0.28%	4.01%	0.14%
PBCT	BUY	2941	3.50%	0.32%	5.46%	0.19%
PBI	BUY	3133	3.50%	0.24%	13.43%	0.47%
PCAR	BUY	126	0.54%	0.04%	3.48%	0.02%
PCG	BUY	871	3.50%	0.35%	4.54%	0.16%
PCL	BUY	833	3.50%	0.30%	4.02%	0.14%
PCLN	SELL	21	-1.35%	-0.05%	0.00%	0.00%
PCP	SELL	195	-3.50%	-0.27%	0.07%	0.00%
PEG	BUY	1197	3.50%	0.36%	4.79%	0.17%
PEP	BUY	89	0.62%	0.04%	3.04%	0.02%
PFE	BUY	1427	3.50%	0.28%	3.61%	0.13%
PHM	SELL	2055	-3.50%	-0.22%	0.00%	0.00%
PLD	BUY	383	1.31%	0.09%	3.30%	0.04%
PM	BUY	387	3.50%	0.19%	3.56%	0.12%
PNW	BUY	710	3.50%	0.35%	4.28%	0.15%
POM	BUY	1832	3.50%	0.37%	5.66%	0.20%
PPL	BUY	1246	3.50%	0.35%	5.07%	0.18%
PXD	SELL	324	-3.50%	-0.18%	0.08%	0.00%
RAI	BUY	812	3.50%	0.22%	5.40%	0.19%
RDC	SELL	451	-1.49%	-0.09%	0.00%	0.00%
RHT	SELL	267	-1.33%	0.00%	0.00%	0.00%
RRD	BUY	3673	3.50%	0.38%	10.91%	0.38%
SCG	BUY	776	3.50%	0.35%	4.35%	0.15%
SE	BUY	1246	3.50%	0.35%	4.11%	0.14%
SNDK	SELL	174	-0.70%	-0.04%	0.00%	0.00%
SO	BUY	833	3.50%	0.35%	4.60%	0.16%
SPLS	BUY	2888	3.44%	0.24%	3.64%	0.13%
SRCL	SELL	380	-3.50%	-0.25%	0.00%	0.00%
STX	BUY	1218	3.33%	0.12%	4.26%	0.14%
STZ	SELL	30	-0.10%	-0.01%	0.00%	0.00%
SWY	BUY	2064	3.50%	0.28%	3.89%	0.14%
SYY	BUY	1129	3.50%	0.29%	3.54%	0.12%
T	BUY	1019	3.50%	0.28%	5.20%	0.18%
TE	BUY	2159	3.50%	0.37%	5.40%	0.19%
TEG	BUY	665	3.50%	0.36%	5.17%	0.18%
TER	SELL	2197	-3.50%	-0.05%	0.00%	0.00%
TSO	SELL	299	-1.25%	-0.07%	0.29%	0.00%
TYC	SELL	1265	-3.50%	-0.21%	0.00%	0.00%
URBN	SELL	444	-1.68%	-0.09%	0.00%	0.00%
VAR	SELL	79	-0.55%	-0.04%	0.00%	0.00%
VMC	SELL	432	-2.13%	-0.15%	0.08%	0.00%
VNO	BUY	1375	3.50%	0.26%	3.69%	0.13%
VTR	BUY	538	3.50%	0.30%	3.79%	0.13%
VZ	BUY	800	3.50%	0.32%	4.67%	0.16%
WAT	SELL	418	-3.50%	-0.06%	0.00%	0.00%
WIN	BUY	4207	3.50%	0.32%	12.02%	0.42%
WM	BUY	1082	3.50%	0.27%	4.38%	0.15%
WMB	BUY	1047	3.50%	0.26%	3.89%	0.14%
WPI	SELL	407	-3.50%	-0.22%	0.00%	0.00%
WPX	SELL	2116	-3.50%	-0.24%	0.00%	0.00%
WYNN	SELL	82	-0.90%	-0.06%	0.00%	0.00%
XEL	BUY	1345	3.50%	0.36%	4.06%	0.14%
XLNX	BUY	1024	3.50%	0.12%	2.52%	0.09%


TOTAL:			100.00%	16.61%		14.32%

9 Comments

TR_trader

11/27/2012 01:23:30 am

Very interesting analysis. Did you put any limits on the universe of stocks to choose from?

Jason Apolee link

11/27/2012 01:27:09 am

Yes, I limited the selection universe to only stocks in the S&P 500. So, there are no ETFs or foreign stocks for example. In theory it is easy to expand the selection universe but then you have to deal with liquidity concerns.

Dan25

11/27/2012 02:34:02 am

You say it has the same risk as the S&P 500. Does that mean this longshrt portfolio is correlated to it as well? I know of hedge funds that use market neutral strategies like this.

Jason Apolee link

11/27/2012 02:48:25 am

No, that's not what I mean. It has the same level of risk, but not the same type of risk. Basically, the portfolio should be relatively uncorrelated to the overall market. In fact, I calculate a negative Beta (~-0.25) to the L/S portfolio. Therefore, we can expect a slight negative correlation.

The L/S portfolio is very much similar to a "market neutral" portfolio except that I didn't explicitly set a constraint to set Beta to 0 when running the optimizer. In theory though, this could be done.

J Bodwell

11/28/2012 05:35:52 am

Do you have a long only version of this portfolio?

Jason Apolee link

11/28/2012 05:50:43 am

I could create a long only version without too much effort. However, you would end up with some risk issues since the shorts are there to hedge the longs. We would need to decrease leverage significantly, which in turn would decrease dividend yield.

Dennis

11/14/2013 02:32:09 am

Please forgive the newbie questions:

How did you determine the number of equities that were needed on the long/short sides?

How would one create his own hedged portfolio and adjust risk? I'd love if I could reduce risk and still maintain a double-digit yield.

Jason Apolee link

11/23/2013 12:58:10 pm

It was totally driven by the software I utilized to generate the trade list. The software runs an optimization that balances the longs with the shorts and finds the optimal mix including the number of longs and shorts required to minimize risk given a yield target.

It's pretty hard to do this without software as there are just too many factors and variables to consider. This was a very attractive portfolio back when I created it and the performance has been great. It's getting much more difficult to find really good yield opportunities these days without taking on more risk.

Dennis

11/27/2013 02:58:56 am

Thanks for the response Jason. What software did you use to do the optimization and generate the trade list?

14% Div Yield Portfolio - Same risk as S&P 500

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