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Thursday, June 7, 2007

This Adviser Gets Lots of Publicity....But Is His Advice Any Good ?

Florida financial planner Harold Evensky is a favorite of the media sure enough. But as I noted in an earlier blog some of his investment decisions leave me perplexed.

He was at it again in the WSJ’s monthly fund supplement.:

Mixing It Up
A Portfolio's Big Core

A financial planner recommends broad-market funds as a solid foundation, with the riskiest action in 'satellites'

June 4, 2007

Put the bulk of your money in broad-market-index funds, and use a small portion to try riskier investments.

That's the investing mantra of Evensky & Katz Wealth Management, a Coral Gables, Fla., fee-only financial-planning firm that works with wealthy individuals.

Sounds basic enough…but the devil is in the details and it seems at every opportunity other tan picking broad index funds, Evensky makes some questionable picksTHE JOURNAL REPORT


…To build the moderate-risk portfolio, Mr. Evensky says he uses a "core-and-satellite" approach. About 48% of the assets are invested in core stock funds, which represent the broad market and whose allocation isn't likely to change for three to five years. "The purpose of the core is to cost- and tax-efficiently buy the market," says Mr. Evensky.

Again, it sounds good but as we will see it simply doesn’t match what he actually does in some of his “core “ choices.

About 12% of the portfolio is invested in satellite holdings -- funds that provide exposure to niche segments of the market. These are essentially short-term bets that Mr. Evensky believes will deliver a high return over a 12-month period or less. These funds may have higher expense ratios, and they may be tax-inefficient, volatile or generally higher in risk than the funds used for core holdings.

Folks like John Bogle reckon that the above factors knock 2 -3 % off the funds after tax return and Mr. Evensky acknowledges it will generate higher volatility. More risk and a 2 -3% handicap from day one…go figure

The idea is that, net of expenses and taxes, the satellite funds "will do two percentage points better than the broad market," says Mr. Evensky. He calls these funds "the alpha generator," meaning an investment that will generate excess return.

This is an breathtaking assumption. In order to get to the 2 -3% after tax excess return over the broad market, the underlying assets (using Bogle’s assumption) of these funds will have to generate in pre tax , pre fee returns. I wouldn’t think the odds will be in one’s favor.

The model portfolio is tweaked for clients' other holdings, tax brackets and other factors.

Here is how the firm's current model portfolio for moderate risk breaks down:

CORE HOLDINGS: Most of the core stock funds track market indexes or are managed largely through computer programs that identify certain types of stocks, not by stock pickers looking for great ideas. For many years, Mr. Evensky used a mix of actively managed funds and index funds for core holdings, but in 2002 he concluded that, over the next 10 years, the U.S. market wouldn't deliver as strong a return as it had in the prior 10 years. So, to get decent returns, it was even more important to pay attention to the cost of funds his clients' owned, steering him more toward the low-cost index world.

In many broad areas of the U.S. stock market, Mr. Evensky says that, net of expenses and taxes, "we don't think there are managers that are going to do better than the index."

True enough, but there is no reason to think that this isn’t the case in ALL markets US and foreign

Nearly a fourth of the portfolio is currently invested in iShares Russell 3000 Index ETF, an exchange-traded fund that tracks the Russell 3000 index, which measures the performance of the 3,000 largest U.S. publicly traded companies based on total market capitalization.

About 8% is allocated to DFA US Small Cap Value Portfolio, a small-stock fund run by Dimensional Fund Advisors Inc. DFA runs a variation of an index fund, based on computerized screening of stocks that aims to identify groups of shares with certain risk and return metrics. Another 4% is in iShares S&P Midcap 400 Index, a stock index of midsize companies.

For foreign investing, Mr. Evensky allocates about 13% to Julius Baer International Equity, a fund that largely buys companies in developed countries. It is run by a stock picker. "We think that the manager can add value," he says

He may think so but there is little data to match his claim. His choice is particularly surprising since he is evidently one of the limited number of advisers that has access to DFA international funds that can exploit the historical outperformance of small and value stocks around the world.

The numbers don’t surprise me when I compared DFA’s international index funds with the Julius Baer active fund. It is most likely that all of the index funds would generate a lower tax bill than the Juliud Baer fund. This is most certainly true of the DFA Tax Managed Fund which outperformed the Julius Baer fund on a pretax basis for 1, 3 and 5 years. No doubt the after tax comparison would reflect even more poorly on the Julius Baer fund So even though Mr. Evensky thinks it’s important to put his clients into low cost funds, he puts them into the Julius Baer fund with a 1.19% fee and gets nothing from it vs the DFA index funds with far lower fees.

Data is as of May 31



1 Year

3 Years

5 Years

DFA Tax-Managed International Value Portfolio





DFA International Small Cap Value Portfolio





DFA International Small Company Portfolio





DFA International Value Portfolio





Active Fund Chosen By Evensky

Julius Baer International Fund





But wait, things get even stranger as Evensky explains the “satellite portion of his portfolio>

SATELLITE HOLDINGS: These holdings are assessed every month and changed frequently. "That's where the best action is," Mr. Evensky says.

Currently, the team is betting on iShares Russell 1000 Growth Index ETF, an index of growth companies, which are those whose earnings are expanding rapidly. Mr. Evensky believes growth companies are going to regain favor with investors, though he has less confidence in them now, he says, as their performance lately has been relatively flat and their stock-market comeback not as quick as his firm had expected. In March, Evensky & Katz cut the allocation to this fund to 2.5% from 4.5%. On this one you’re just betting on your manager’s market bets as he flits in and out of a sector. Based on the quote, you make your own judgement.

Since September 2005, Mr. Evensky has been buying a fund that invests in short-term bonds of emerging markets, Pimco Developing Local Markets. He says this is a play on currencies and a source for yield, with the potential to gain from the improvement in the quality of many of these emerging-market bonds.

Here’s the description from the Pimco website

“The Developing Local Markets strategy involves investment in currencies of, or in fixed income instruments denominated in the currencies of, developing markets”

In other words, the fund invests in foreign debt, denominated in foreign currencies (taking sovereign and currency risk) to pick up a bit of yield. The fund holds 11% of its assets in polish debt 10% in Mexican.

The fund has an expense ration of 1.25% so just to stay even with a low fee bond index fund, the underlying assets need to outperform by a full 1% (quite a bit in bonds where the long term return is 5 -6%). The fund has no long term track record; the website lists a one year return of 12% and a year to date of 4.9%.

Big numbers, but given the risk compared to a US short term bond fund not much of an alternative for the fixed income portion of a portfolio. In fact the risk is probably closer to an emerging markets stock fund . Much like the stock fund the performance of this fund is dependent on the performance of the emerging markets economies and their currencies

Here’s Another one that struck me as odd

A recent satellite addition is Old Mutual Analytic Defensive Equity, which uses mathematical models to buy stocks world-wide, while using derivatives like options to hedge its market risk. "It doesn't fit any neat category," says Mr. Evensky, but he is convinced "it will generate that 2% alpha for us."

The fund has been around for a little bit more than a year and it’s one year return is 17.89. I have no idea where Mr, Evensky got this 2% number from unless the fund manager gave him numbers based on hypothetical performance of their system

Here’s another strange one

Not all of the firm's satellite bets pan out. For nearly two years, the model portfolio included a fund that bet against 30-year U.S. Treasury bonds, expecting that the fund would gain as long-term interest rates in the U.S. rise; when interest rates rise, existing bonds, which are paying lower interest rates, fall in value. But long-term rates haven't risen as fast or as much as the team had expected, so last month it decided to sell out of the fund. "If there is substantive change, we will revisit it," Mr. Evensky says.

The team is still deciding where to put that money, he says

This one is a very risky trade for a conservative portfolio, He likely used the rydex mutual fund designed to provide the inverse of the return of the long term treasury bond,

here are the ugly numbers:

Annual Average Total Returns

Month End
(as of 05/31/2007)

Qtr End
(as of 03/31/2007)

1 Yr



3 Yr



5 Yr



10 Yr



SI (Inception date 03/03/1995)



Fees and Expenses

Total Expense Ratio


Risk Measurement as of 06/06/2007

3-yr Beta Compared to Fund Benchmark


In other words the fund is 36% more volatile than the long treas bond.

In the past, Mr. Evensky has experimented with several other kinds of funds within the satellites, including a commodity-oriented fund and one that invests in real-estate investment trusts.

Interesting ,Evensky lists as satellite choices 2 sectors which most academics and industry researchers regard as asset classes that should be a permanent part of all portfolios. This is certainly the case for reits (and now that index funds and etfs are available, international reits). An asset class that long term data shows offers strong returns with limited risk relative to equities and bonds as well as diversification. A very strong case can be made for a permanent allocation to reits of 7-10% .

Here are some number on reits compared to the overall US stock mkt (Russell 3000):

Monthly: 01/1979 - 04/2007


1 Month

3 Months

6 Months

1 Year

3 Years

5 Years

10 Years

Russell 3000 Index









Dow Jones Wilshire REIT Index









There’s a bit of a strange choice on the bond side as well:

BONDS: "In general we are in fixed income to preserve capital, we are in stocks to make money," he says……

8% is assigned to PIMCO Foreign Bond Fund [U.S. Dollar-Hedged].

If the goal is to preserve capital why wander into a fund like the one above

From the website of Pimco here’s the strategy:

  • Invests primarily in high-quality, non-U.S. intermediate-term bonds. As over half of the world's fixed-income securities are issued outside of the U.S., the Fund adds diversification to any bond portfolio.
  • Tempers risk by investing primarily in investment-grade bonds and hedging at least 80% of its foreign currency exposure to protect against unfavorable currency fluctuations

So the fund can retain 20% of its assets exposed to currency fluctuations, it is also more exposed to interest rate fluctuations in numerous countries, the interest rate risk for each county must be monitored and managed. All in the portion of the portfolio designed to preserve capital rather than make money. And all (we guess), to pick up a little extra yield. The result was that in most periods, all that extra risk produced less than 1% of excess return vs an extremely low risk index of short term treasury bnds and investment grade corporate bonds.


1 Year

3 Years

5 Years

10 Years

US Corporate and Government Index 1-3 Years






Pimco Foreign Bond Fund






I must say I am jealous of Mr. Evensky’s ability to get himself in both the nyt and wsj within a single month. I am also in a state of perplexity over his portfolio allocation

Tuesday, June 5, 2007

This doesn’t need much comment:...

From the WSJ June 4, 2007

Regulatory Spotlight
Brokers' Liability for Advice
June 4, 2007; Page R2

Call it the $276 billion question: That is the estimated amount of money in about 1 million fee-based brokerage, or "wrap," accounts. The fate of this money is up in the air after the U.S. Securities and Exchange Commission last month threw in the towel on a controversial rule.

The SEC said it wouldn't fight a March federal-court decision that abolished the rule, which shielded brokers from some liability for advice they gave to holders of fee-based accounts…….

The rule was controversial because it exempted stockbrokers who oversee fee-based accounts from a fiduciary duty when providing "incidental" advice tied to buying and selling securities.

A fiduciary duty requires acting in a client's best interest. The Financial Planning Association protested in court that stockbrokers were collecting the same fees as investment advisers for similar advisory work -- without having to meet the stiff fiduciary legal standard.

In the wake of the SEC retreat, some firms told financial advisers to stop offering fee-based brokerage accounts immediately,

Draw your own conclusions why that may be ....and hold onto your wallet.