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Wednesday, July 26, 2017

The Costliest Mistake A Young Investor Can Make....

...Is not owning enough stock

The Website Nerd Wallet did a comprehensive study of the cost to millenials of not investing in stocks


Avoiding the Stock Market May Cost Millennials $3.3 Million 

You can read the details of the study on the linked article . But this chart from the article comparing 100% stocks to a savings acccount or simply keeping the cash unde the mattress (or in a non interest paying accoun t such as many checking accounts.


Of course the advadvantage younger investors have is their long time frame leaving them the power of compounding as ividends and gains and in riding out any short term declines in the market.

The advantages for those younger investors is even greater if the take advantage of the tax advantaged accounts by making full use of the tax advantaged vehicles of Roth or Traditional IRA and employer sponsored 401k. With the availability of no commission ETFs at several major brokerage firms a young investor could set up monthly deposits of a broad based ETF such as a total stock market index fund to meet the $2000 maximum IRA contribution. If the young investor has access to an employer sponsored 401k opting for the maximum contribution not only builds more tax deferred savings it works on autopilot..it is money the young person never sees in his bank account. Should the employer be one of the relatively few that offers a match to the 401k contribution passing up on that i simply passing up on free money. Although for many recent years companies have been eliminating the match on 401k contributions, the WSJ reports that there are some signs that the trend has reversed.

This chart from the WSJ shows the growth of wealth when an employee taskes advantage of the employer match,






Of course the same rules that apply to all investment portfolios apply here: a diversified portfolio of low cost ETFs or mutual funds. Given that the portfolios should be all stocks one or two ETFS a total US and/or a total world index ETF should suffice,

Monday, July 24, 2017

Hope Springs Eternal to "Beat the Market at Endowments...this Time Some Suffer Massive Losses on "Alternative Investments"

As someone who has taught a class in investment management for not for profits it is an area I watch closely. I had thought that the tide had turned among not for profits(as it has for individual investors) towards indexing. Apparently there are many who--in search of market beating returns-- still venture into alternative investments.In most cases the investors had lower returns particularly taking into account the high fees charged on these investments.
But I have never seen the case of an alternative investment going to zero value as in this case.From the WSJ
From $2 Billion to Zero: A Private-Equity Fund Goes Bust in the Oil Patch

 
The Evolution of Investing by Not For Profits




For years probably dating from the 1990s up through the 2008 financial crisis the “gold standard  for not for profit investing was the “  Yale model” defined by the FT :

Definition of Yale model

An investment model developed by David Swensen, the chief investment officer at Yale, that relies on modern portfolio theory and invests heavily in alternative or non-liquid investments.
The Yale model calls for a high allocation to equities, diversifying the portfolio, avoiding market timing and investing in private markets that can increase earnings potential. Also known as the endowment modell. [1]

Yale's 2006 annual report can be found here 
It actually shows a relatively low allocation to stocks vs the average of endowments: 14.9% to foreign equities vs.the endowment average of 21.4% and 4% to domestic stocs vs. the endowment average of 19.6%

This  strategy outlined in Swensen’s book Pioneering Portfolio Management outlines this strategy but his book for individual investors Unconventional Success advocates a simple policy using index funds--a strategy adopted by many not profits as well .

The Yale endowment had several advantages vs. others  in implementing this strategy It got into many of the alternative asset funds particularly venture capital early  before the area became overinvested. The prestige of having the endowment  as an investor let them invest with lower fees than other investors. And the fund established structures so that their funds were separated from the overall investment portfolio preventing any liquidity issues. It also had a large highly skilled staff.

Not surprisingly many many other endowments hastened to copy the Yale Model and hold large allocations to alternative investments often without the qualified personnel to properly screen the prospective investtments.
The results were far from impressive. As investment advisor and author Rick Ferri wrote in Forbes the returns were worse that a simple index portfolio




The Added Risk In the Yale Mode
Probably second to the Yale Endowment in its reputation of sophistication and quality of in house staff would be the Harvard Endowment. Yet the endowment had a nightmare year in 2008, not only with a 20%+ loss but also a liquidity crisis as they found that not only were many of their securiiteis marketable some of the  - under the terms of the structure- could  demand more cash for investments from investors.
After replacing leadership for the endowment and putting Janet Medillo in charge the endowment continues with a very high allocationf to alternative investments But according to Medillo it now places a greater emphasis on liquidity.
The Move to Indexing
After all these difficulties with alternative investments poor performance, high fees and low liquidity some of the largest institution investors in the world announced that they were giving up on these instruments and moving to indexing. The country’s largest pension fund Calpers was probably  the first to make the change in a big way. And many others followed giving the impression of a lage scale move out of the “Yale Model

Several major state pension funds have shifted to indexing but the biggest move was by Calpers the California state pension fund.


From Bloomberg

How big a deal is this? Well, we're talking about nearly 1.7 million public employees and an investment portfolio of $258 billion as of June 30. On that date, 35% of the portfolio was in passive investments and 65% was actively managed.
On Sept. 16, the Calpers board adopted a lengthy set of "investment beliefs," from which I will quote here briefly, specifically from No. 7 of a total of 10 beliefs:
"Calpers will take risk only where we have a strong belief we will be rewarded for it
“Sub-beliefs:
·         An expectation of a return premium is required to take risk; Calpers aims to maximize return for the risk taken
·         Markets aren’t perfectly efficient, but inefficiencies are difficult to exploit after costs
·         Calpers will use index tracking strategies where we lack conviction or demonstrable evidence that we can add value through active management
·         Calpers should measure its investment performance relative to a reference portfolio of public, passively managed assets to ensure that active risk is being compensated at the Total Fund level over the long-term”
But the bottom line is simple enough. Expect the percentage of Calpers assets held in indexed, passive investments to rise, and rise dramatically. Consequently, actively managed assets will decline.
It will probably take such a massive pension system months to make a move, but once it does the eventual goal is likely a flip to 65% passive and 35% active — maybe more, maybe less. It's a hard row to hoe after decades of paying active managers, but Calpers has clearly taken on a new direction.
1. The sixth-largest pension fund in the world, second in the U.S. behind the federal employees plan, just endorsed passive investments — index funds — over paying active managers to attempt to "beat the market."
2. Cost is the reason why. High active management fees greatly diminish the likelihood of beating the benchmarks.

Seems some people clearly didn’t get the message from the Calpers decision.  Greed and the prospect of “beating the market” through an exotic alternative investment strategy led to investment losses that are probably unprecedented for major investors. Even investors with Madoff didn’t wind up with zero.
More from the WSJ article linked above:
Though private-equity investments regularly flop, industry consultants and fund investors say this situation could mark the first time that a fund larger than $1 billion has lost essentially all of its value…..

EnerVest’s collapse shows how debt taken on during the drilling boom continues to haunt energy investors three years after a glut of fuel sent prices spiraling down.
I would think that many of those invested in the fund didn’t understand the amount of leverage in the fund. Some form of leverage is involved in virtually every major investment disaster. No unleveraged investment goes to zero.
The strategy is described as follows:(my bold)

EnerVest Ltd., a Houston private-equity firm that focuses on energy investments, manages the fund. The firm raised and started investing money in 2013, when oil was trading at more than double the current price of about $45 a barrel. But the fund added $1.3 billion of borrowed money to boost its buying power. That later caused it trouble when oil prices tumbled...

The strategy isn’t as risky as staking wildcatters or borrowing heavily to buy entire oil companies, but profits are usually lower. To juice returns, however, funds managed by EnerVest and rivals that shared the strategy borrowed money as if they themselves were oil companies, encumbering all of the funds’ assets with the same debt.
Doing that eliminates a key protection for private-equity investors, which generally finance each investment independently so that soured deals don’t put good ones at risk. The use of fund-level debt effectively cross-collateralizes assets, meaning that good investments can be pulled down by bad ones.
Institutional investors were drawn to these so-called resource funds because they typically pay out steady streams of cash as soon as they make their first investments, unlike other private-equity investments that can take years to bear fruit, said Christian Busken, who advises endowments and other big energy investors as director of real assets for Fund Evaluation Group LLC.

A number of prominent institutional investors are at risk of having their investments wiped out, including Caisse de dépôt et placement du Québec, Canada’s second-largest pension, which invested more than $100 million. Florida’s largest pension fund manager and the Western Conference of Teamsters Pension Plan, a manager of retirement savings for union members in nearly 30 states, each invested $100 million, according to public records.
The fund was popular among charitable organizations as well. The J. Paul Getty Trust, John D. and Catherine T. MacArthur and Fletcher Jones foundations each invested millions in the fund, according to their tax filings.
Michigan State University and a foundation that supports Arizona State University also have disclosed investments in the fund.
The WSJ noted another loser
 Orange County Employees Retirement System, already has marked its investment down to zero, according to a pension document.
If there is a single pension fund in the country that should have implemented a policy of investing only in simple unleveraged investments it is Orange County. The highly leveraged strategies of treasurer Robert Citron led to a default on bonds and a 1994

The bottom line is the one that Calpers concluded: alternative investments are not worth the additional risk....and that is' conventional " hedge funds and private equity funds which were the alternatives Calpers had invested in. How much more could the case be made against alternative investments when they involve complex leveraged strategies. But it seems there is always someone who lets his greed and overoptimism lead to venturing into exotic investments In this case the results were as bad as possible...the investment going to zero.


















  



   


Tuesday, July 11, 2017

So much for that "but what about Warren Buffett response to a presentaion on why indexing is the best strategy

WSJ today

Warren Buffett’s Berkshire Moves Away From Stock Picking

Bid to buy Oncor is latest sign of the company’s growing reliance on running businesses




...... Buffett rose to fame as a stock picker and continues to invest tens of billions in equities and other securities for Berkshire’s portfolio.,,,
But today, those investments are “de-emphasized,” as Berkshire earns significantly more income from its operating businesses, Mr. Buffett said in his February letter to shareholders. Berkshire has undergone a “gradual shift from a company obtaining most of its gains from investment activities to one that grows in value by owning businesses,” he wrote.

And anyone watching Berkshire past the headlines would have noted this is nothing new:

The conglomerate’s shift toward regulated businesses began in 1999, when Berkshire announced an agreement to buy its first utility business, and accelerated with the 2009 agreement to acquire railroad Burlington Northern Santa Fe

Friday, March 10, 2017

Warning Signs?

WSJ: (both articles on March 10)

Corporate Insiders Haven’t Been This Uninterested in Buying Stocks Since Ronald Reagan Was President

There were 279 insider buyers in January, the lowest in records going back to 198




Individuals Tiptoe Further Into Long-Running Stock Rally

Choice for some individual investors: miss out, or risk getting in at the top

Monday, March 6, 2017

What is in Those Value and Momentum ETFs?

My previous post noted the shift from value to momentum since the turn of the year. Below are top holdings and sector weightings for those ETFs.


MTUM Momentum

Top Holdings

Company
Symbol
% Assets
Facebook Inc A
5.44%
Amazon.com Inc
5.20%
Procter & Gamble Co
5.18%
Johnson & Johnson
4.71%
Microsoft Corp
4.43%
UnitedHealth Group Inc
3.62%
NVIDIA Corp
2.64%
Qualcomm Inc
2.59%
Alphabet Inc A
2.59%
Alphabet Inc C
2.51%



Sector Weightings (%)

SectorMTUM

Basic Materials

0.02

Consumer Cyclical

0.07

Financial Services

0.04

Realestate

0.03

Consumer Defensive

0.1

Healthcare

0.13

Utilities

0.07

Communication Services

0.04

Energy

0.02

Industrials

0.1

Technology

0.39



VBR Small Value

Top 10 Holdings (4.64% of Total Assets)

Company
Symbol
% Assets
Targa Resources Corp
0.56%
Huntington Ingalls Industries Inc
0.51%
CDW Corp
0.47%
Atmos Energy Corp
0.45%
Broadridge Financial Solutions Inc
0.45%
UGI Corp
0.45%
The Valspar Corp
0.45%
Steel Dynamics Inc
0.44%
Westar Energy Inc
0.44%
East West Bancorp Inc
0.42%



Sector Weightings (%)

SectorVBR

Basic Materials

0.07

Consumer Cyclical

0.11

Financial Services

0.2

Realestate

0.1

Consumer Defensive

0.04

Healthcare

0.06

Utilities

0.06

Communication Services

0.01

Energy

0.06

Industrials

0.18

Technology

0.1











VTV Large Value



Top 10 Holdings (27.62% of Total Assets)


Company
Symbol
% Assets
Microsoft Corp
4.41%
Exxon Mobil Corp
3.21%
Berkshire Hathaway Inc B
2.92%
Johnson & Johnson
2.84%
JPMorgan Chase & Co
2.80%
General Electric Co
2.43%
AT&T Inc
T
2.39%
Wells Fargo & Co
2.35%
Procter & Gamble Co
2.16%
Bank of America Corporation
2.11%





Sector Weightings (%)

SectorVTV

Basic Materials

0.03

Consumer Cyclical

0.05

Financial Services

0.24

Realestate

0.01

Consumer Defensive

0.09

Healthcare

0.13

Utilities

0.06

Communication Services

0.05

Energy

0.1

Industrials

0.12

Technology

0.12

Saturday, March 4, 2017

Phase 2 of the “Trump Rally” …. Getting Riskier?






There is no doubt that the markets have had a strong rally since election day. But the market movements since the turn of the year may indicate that the markets may have moved into a riskier phase where the forces of momentum, fear and greed have taken hold.



I always find amusing the explanations for short term expecially one day market movements. Often there are internal factors to the markets that are responsible for the large moves more than a news event; even though pundits point only to the news event. I am reminded of the episode described in a recent book on hedge funds in which the hedge fund needed to buy stocks simply to unwind a complex position that involved short positions in those stocks. As the stocks rose in response to their buying (which had absolutely nothing to do with the specific fundamentals of the companies) they laughed as they looked up at their television screens and watched as pundits gave “fundamental analysis” of the companies to explain the rise,

In my view, something similar happened during the one day move up of 1.7%   in the S+P 500 the day after Trump’s speech to Congress. Somehow a “more Presidential” tone a more businesslike blue tie substituted for the red ones he usually preferred and a list of proposals short on specifics and sure to face a tough time in Congress with at best implementation over a period of months if not a year “explained the move”.



A more nuanced approach would take account of internal issues within the market and behavioral factors.

 For example, the “implied volatility “(VIX) has gone up as the market has risen. The VIX is generally referred to as the “fear index”. But more correctly it reflects the price of options and while it is certainly a fear index when the price of downside protection options(puts) goes up, an increase in demand for options that increase in market value when markets rise (call options) can also cause an increase in the VIX. One popular strategy among investors has been the “covered call” in which the investor owns the stock and sells a call option at a strike price above the current market price with the investor collecting the option premium. Such a strategy is very attractive if the stock remains stable or rises modestly…the investor collects the extra money from the call premium and the call premium gives a bit of a cushion against falls in the stock’s value. But when the market rallies sharply and the stock price moves above the strike price the short call rises in price and the investor is unable to profit from the large rally in the stock price. As investors rush to buy back the short (sold) call options demand goes up as does implied volatility (VIX). And the call buying creates a cascading effect creating further demand for the underlying stock or index.



Other factors unrelated to the “more Presidential tone” in a single speech are related to investor behavior No doubt a one day market move leads to short covering by those leveraged traders that had positioned themselves to a market decline. And one cannot underestimate the behavior of investors “professional” and individual who anxious not to miss out on the party who “throw in the towel” and buy stocks…even at record highs.

During Wednesday’s rally, the Dow Jones Industrial Average shot up more than 300 points, carrying blue chips over 21000 for the first time in history. The Dow closed at 21005.71 on Friday.
On Wednesday, $8.2 billion in new shares were created in State Street Corp.’s SPDR S&P 500 ETF, the market’s oldest and largest fund. Daily fund flows can be volatile, particularly in this $250 billion ETF, which State Street said is the most-traded security in the world.


Big institutional investors use the ETF to put cash to work in a variety of ways while they select individual stocks.
That wasn’t necessarily the case Wednesday, said Matt Bartolini, head of SPDR Americas research for State Street. He examines daily flows in a larger context, looking at trading in options, futures and other ETFs to determine if a one-day flow is part of a larger trade. While there was some options activity Wednesday, it wasn’t enough to explain the big inflow, which was the ninth-largest in the fund’s history.
“One-day flows around market events, like [President Donald] Trump’s address to Congress, can be indicators of market sentiment,” Mr. Bartolini said.
Still, such enthusiasm on the part of retail investors, after years of apathy, could be a reinforcing sign that the yearslong rally is getting tired. Wall Street lore has it that individual investors are often late to step in or out of the market.






One way to see the difference in the market behavior in the period from election to year end and that of 2017 is to look at “factor/smart beta” ETFs. These ETFs some newer and some that have been around for quite a while overweight stocks with specific characteristics.

Evidence is quite strong that two factors: value and momentum have long term outperformance over traditional cap weighted indices. And the two factors can be complementary as each factor shows strong performance under different periods and market conditions.

 I think the best explanation is behavioral: value stocks outperform because investors tend to get over pessimistic on stocks pushing their prices down below levels that could be justified by their fundamentals. As the great value investor Benjamin Graham wrote “in the short term the market is a beauty contest in the long run it is a weighing machine”. Value ETFs include Vanguards large cap Value ETF (ticker VTV) and small cap value ETF (ticker VBR)



Momentum strategies form a way to take advantage of the “beauty contest” aspect of markets by holding stocks that have strong upside price momentum and selling them when the momentum slows even before the stock declines in value or selling when the price movement reverses. The largest momentum factor: ETF has ticker MTUM
So, it is interesting to see the two phases of the post-election market rally by comparing the overall US stock market (ticker VTI) with the large cap value ETF VTV the small cap value ETF VBR and the momentum ETF VBR.
Here is what the price movements looked like from the day after the election through end 2016 (the line graph shows performance, the bar graph both performance and volatility. The colors are same in both charts). Value performance massively exceeded momentum which increased in value only .5% far below the overall market and the value indices which also outperformed the overall market (Vanguard total stock market ticker VTI)








The market since the beginning of 2017 shows a totally different story: a massive outperformance for momentum stocks…in other words a major reason for the stocks that are outperforming is that they are already going up….in other words a major reason for the market going up since the turn of the year is the “beauty contest”.





during the day from its IPO price. The bulls are counting on Snap performing post IPO like Facebook


 while bear race concern ti will look like twitter post IPO.



:



There are plenty of cautionary signs.

The IPO is unusual in that investors aren't granted voting rights for the shares on offer. Instead, Spiegel and Murphy own the bulk of shares with such power.

Snap isn't making money, even though it's a huge hit with mobile users, averaging nearly 160 million visitors daily and nearly 10 billion video views daily. The company lost $514.6 million on sales of $404 million in 2016, and user growth has slowed. Investors can't tell if it's another Facebook, on the way to giant user growth, sales and profits, or the next Twitter, whose tepid user growth has disenchanted advertisers and kept it in the red.

Among the optimists, Doug Clinton, an analyst with Minneapolis-based Loup Ventures, thinks Snap could grow revenues 100% to $800 million in 2017 and says Snap is smart to position itself as a camera company.

I have no idea how SNAP stock will perform in the future nor do I place much faith in short term market forecasts. Mine or anyone else’s. But I am sure that long term investors benefit from the following:

Not market timing

Sticking to a long-term allocation



Rebalancing their portfolios which leads to selling parts of their portfolio that have increased in value and buying those that have underperformed.



But time after time shows that investors professional and otherwise tend to chase markets and buy high and sell low…. phase two of the “Trump rally” may be one of those examples.

A recent research paper for Financial advisors from Vanguardbased on their research on fund flows through January 2017(and those trends doubtless continued) reached similar conclusions:





Investor risk: Pedal to the metal ... or not so fast?

Key highlights
Our risk speedometers show that recent months echo a common trend: As stock prices rise, so does investor willingness to take on risk.
·         The strong inflows to riskier assets can further increase investors' risk profiles, exposing their portfolios to even greater downside risk. This is particularly concerning, given the current market conditions and our guarded outlook.
·         This may be a good time to review your clients' portfolios to make sure they're not overly vulnerable in the event of a market correction. Rebalancing can help reduce downside risk.


·   


We've long tracked industry cash flows to develop insights into what investors, collectively, are doing with a substantial portion of investable assets.1 Our risk speedometers—our unique lens on investor behavior that we introduced last month and have updated with January data below—and related cash-flow research also highlight trends that may not be apparent in raw cash-flow data. The result is a nuanced picture of how investors are responding to market developments. These nuances sometimes reveal that the reality of investor behavior is more complex than conventional wisdom suggests.

Global equity markets continued their upward trajectory in January, with the FTSE Global All Cap Index returning 2.7% for the month and 6.2% for the three months ended January 31. To no one's surprise, industry cash flows favored riskier asset classes, including U.S., international, and sector equities. In January, these funds and ETFs, netted more than $31 billion, bringing their three-month net cash flow to nearly $100 billion. This is the largest three-month net investment since December 2014 and the ninth-largest in history.