Stock buybacks are soaring, reaching new highs each year since the 2008 credit crisis, but that doesn’t mean investors who own buyback ETFs are raking in outsized returns. Quite the contrary, in fact.
The PowerShares Buyback Achievers Portfolio (PKW | B-95), for instance, is a $3 billion fund that invests in U.S. companies that repurchased at least 5 percent of their outstanding shares in the previous 12 months. The idea here is that a company knows the best valuation of its stock, so it knows best when it’s a good time to buy up some of its own stock. Buybacks are meant to boost share prices, and therefore returns, by cutting shares outstanding.
A different strategy in the space, the AdvisorShares TrimTabs Float Shrink ETF (TTFS | C-83), sets out to outperform the Russell 3000 by generating both higher returns and lower volatility using buybacks. The actively managed fund selects stocks based on three trends over the past 120 days: decreasing outstanding shares; increasing free cash flow; and shrinking leverage.
So far this year, TTFS has done better than PKW, but neither has really stood out against a simple allocation to the SPDR S&P 500 (SPY | A-100), as the chart below shows:
Chart courtesy of StockCharts.com
Buybacks aren’t doing much to translate into returns because share prices are already too high in many cases, some say. More than six years after the market bottomed, air at the top of this stock rally is getting rarefied. Instead, companies buying their own stocks are often underperforming the broader market.
“We are big fans of equity income investing and because of this, share buybacks—often the antithesis to dividend payments—are not exactly something we are keen on,” Andrew Lapthorne, of Societe Generale, said in a recent research note.
“Some may believe that a pick-up in share buybacks is indicative of an undervalued stock market. Nothing could be further from the truth—rather, it is the other way around,” Lapthorne added. “Companies execute buybacks when they are flush with cash, when cash flows are strong and as a consequence when share prices are elevated.”
CEOs Have Bad Timing
The reason for that is that buybacks typically follow the business cycle in the stock market. In other words, buybacks tend to pick up pace as the market breaks new ground. Goldman Sachs recently estimated that in 2015, companies will spend 30 percent of their cash on buybacks—back in 2009, they spent 13 percent, according to Real Money.
“CEOs historically have been poor at timing buybacks,” Meb Faber, head of Cambria, told ETF.com. “A lot of companies don’t know what to do when they have cash and the market is going higher. When things are going poorly or we are in a bear market, they batten down the hatches, which is probably the opposite of how they should do it.
“Buybacks and M&A tend to pick up closer to market tops,” Faber said. “We’ve seen this story before; there’re always higher new highs. But it’s probably closer to the end than to the beginning.”
If buybacks tend to pick up pace in market tops, most buyback indexes tend to indiscriminately buy companies that are buying back stock, without screening for valuation or any other metrics that would weed out those who are buying $1 for $1, Faber says. These companies paying top dollar for their stocks in top markets will eventually struggle.
Long Arm Of The Fed
In theory, if a company gets it right, and buys its stock at a good value, it will deliver positive results to shareholders. That purchase is often done to return cash to shareholders instead of investing in things like research and development, or even acquisitions.
But it could be the phenomenon in buybacks is merely a result of Fed policy, which has inflated equity prices and kept rates extremely low. It may be that companies are buying back stocks in an effort to maximize “short-term shareholder value at the expense of investing in the future,” Rick Rieder, CIO of fundamental fixed income for BlackRock, said in a blog.
“In my opinion, today’s [share buyback] boom is just one economic distortion created by the Federal Reserve’s excessively accommodative monetary policy,” Rieder said. “The boom is, in essence, a response to today’s extraordinarily low interest rates, which have translated into abundant liquidity for corporations seeking to borrow cheaply in the capital markets.”
The extraordinary pace of buybacks—some $133 billion took place in April alone, according to BlackRock—could, over time, prevent companies from investing in their core businesses and threaten their credit quality, Rieder says. That diminishing credit quality is already beginning to surface. That’s not good for companies, and it’s not good for investors either.
“The global economy is witnessing a massive redistribution of wealth and income with borrowers, equity shareholders and short-term investors benefiting; and savers, bondholders and longer-term investors being placed at risk,” Rieder added.
In the here and now, does any of this matter to ETF investors who own funds like PKW and TTFS? Probably not much.
“From the point of the investor, none of it matters as long as the trend is up,” Faber said. “That’s what matters most.”
But the market is expensive, possibly near a top, and finding value is key. Beyond value, looking outside of the U.S. might also be a good idea because valuations here are high, making the opportunity set smaller here relative to other markets, Faber says.
Go cheap and go global is his message.