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Thursday, December 31, 2009

Business/Finance Books of The Year

2009 was a big year for business books although I cannot claim to have read all or even most of them, I have give most of the more notable ones at least a quick review. The two that will be read long after most of the others are :

How Markets Fail by John Cassidy's book is almost 2 books in one. The most valuable first sections is a comprehensive intellectual review of the schools of economics that explain that the market doesn't always 'get it right". Most notable is his part in the revival of interest in Hyman Minsky who wrote decades ago about patterns of credit bubbles. The second section is a good analysis of the current financial crisis. At a minimum, grab a latte in your bookstore and read the introduction.

The Myth of the Rational Market by Justin Fox. This book is a great complement to Cassidy. Fox does much the same thing as Cassidy but concentrates on the field of  finance rather than macro and micro economics. Fox traces the growth of quantitative finance, the belief in efficient and rational markets and the real world and intellectual challenges that  have arisen to challenge it . A particularly attractive part of the book is that Fox was able to interview so many of the participants in these debates.

Both these books succeed in explaining complex concepts in a way that is accesible to the general reader and yet they are useful to the specialized reader. And in the spirit of their (and my) skepticism of the "physics envy" in academic finance and economics the authors manage to explain everything without a single equation !

Both these books are on the syllabus of my investment management course.

Happy New Year

Tuesday, December 29, 2009

How Could This Chart Not Influence Your Future Asset Allocation ?

 From the FT (above)

Developed vs Developing Country Economies as % Of World GDP

Since 1999  emerging and developing countries = 36%  of world gdp 2009 48%

Advanced economies went from 64% to 52%

Is there any possible reason to think that this trend will rverse itself ?

MSCI World index of Developed Markets in dollar terms over the period -19.5$
MSCI Emerging Market Index  +94%
BRIC Markets (Brazil, Russia, India, China)  +173.5%

from the NYT
As long-term investments go, emerging markets seem to have a lot going for them. On average, developing countries have less sovereign, corporate and household debt than developed countries. Their economies are also growing faster than industrialized ones. Merrill Lynch predicts that emerging market economies will grow 6.3 percent next year, while the global economy expands by 4.4 percent.

Emerging markets are eclipsing their developed peers in other ways as well. Imports to the BRIC nations are likely to surpass imports to the United States for the first time ever in 2009, according to Morgan Stanley.

For the moment, the developing world is the engine of global growth. Emerging markets accounted for virtually all of the year’s growth in global output, because developed economies shrank or were flat. Even if developed countries recover completely in 2010, emerging economies will account for 70 to 75 percent of the growth in global output “for the foreseeable future,” said Mr. Conway of Schroders.

Developing nations are also assuming a bigger role in the world economy. Morgan Stanley predicts that developing countries, including those in the Middle East, will account for 36 percent of total global gross domestic product in 2010, up from 21 percent in 1999.


Wednesday, December 23, 2009

Gold: A Portfolio Diversifier ?

A portfolio addition that adds to diversification and thus reduces a risk in a portfolio i.e. it should have low or negative correlation with othe holdings,.. Listening to those gold ads one certainly gets the impression that is the relationship between gold and stocks and would be the results of  adding gold to a portfolio.

Remember if 2 holdings move in tandem even if one outperforms the other they can still be highly correlatted. For instance emerging markets have strongly out performed the US market but in the same direction hence
 their correlation for one year is ,88(88%), I didn't have access to the data for gold but just eyeballing the charts for een vs sp 500 ( top chart) it is surely very similar to the gold sp500 one year (middle) and 2 year (charts) i,e, high correlation.

gold's (GLD)return ytd is  22.7%
S+P 500 (SPY) 25.97%
 emerging markets index (VWO) 71.23%
DBB (base metals ) +82.79%
mention that to Glenn et al when you call in

Sunday, December 20, 2009

Some Good Investing Lessons

From the LA Times

Tom Petruno of the LA Times published a column with his 5 "investment lessons of 2009" They are nothing remarkable, but 3 of them are worth reprinting here. The fact that they need to be pointed out shows how often investors fall into the traps pointed out by researchers in behavioral finance.

But I would make these 2 observations about the ones I reprinted here:

1. Probably the most important role a professional investment advisor can provide is to "save investors from themselves" by preventing them form learning these lessons with their own money. The saving in "tuition" alone is often worth the fee. Although of course the advisor should do more.

2. On the other hand if you have a professional investment advisor and he has not avoided the pitfalls listed you advisor.

From tHe article here are the 3 of the article's 5 investing lessons that will stand the test of time

* Keep the faith in the world's emerging markets. For much of this decade, Americans have been advised to invest overseas because that's where economic growth was likely to be fastest in the long run -- particularly in developing economies such as China, India and Brazil.

The story line still holds up. If anything, it's more appealing now than a year ago. No surprise, then, that many emerging markets, after falling more sharply in 2008 than the U.S. market, also have come back much faster this year.

The average emerging-markets stock mutual fund is up 68% in 2009 after losing 55% last year.

Obviously, emerging markets are more volatile than developed markets, and that isn't going to change soon. But the world is a much different place from even a decade ago. It isn't just that emerging economies are growing faster; they also have accumulated vast wealth that gives them economic critical mass.

We are the debtor now; they are the creditors. Why would you not want a long-term stake in the creditors?

* You can still trust basic portfolio diversification. In other words, making sure your portfolio has a broad mix of investments remains the best strategy for achieving growth without undue risk to your nest egg.

In the fall of 2008 nearly every type of asset was collapsing, largely because hedge funds and other big investors had to sell whatever they could to raise cash as credit dried up and lenders called in loans....

Simply put, broad-based diversification raises the likelihood that you'll always have some assets doing well, at least partly offsetting those that aren't. And if some chunk of your portfolio is holding up in tough times, you will be less inclined to sell your losers at the wrong point -- i.e., at or near the bottom.

Diversification is such a simple concept, and so easy to accomplish. It's amazing to me how many investors think there must be some trick to it.....

* Don't invest solely by looking in the rearview mirror. After a year like 2008, it may be hard to take your mind off how much you've lost. That's understandable, but it also can obscure the opportunities in front of you.

Classic rearview-mirror investing leads to buying what has recently performed best. That's the opposite of what people know they should do, which is to buy low.

I think the greater problem now with the rearview mirror is that many people can't stop thinking about how much they're down. Stop counting your losses, and focus more on what your portfolio needs to meet your long-term goals. You'll feel better.

Friday, December 18, 2009

We Know We Should Index But We Can't Seem to Resist....

,,,the urge to look to gurus to tell us how to invest. And given the time of year we will be inundated with the "best moves to make for 2010". Interestingly Israel has been a center for research in behavioral finance led by nobel prize winner Daniel Kahneman.

But that doesn't prevent the "seeking alpha syndrome" from being alive and well there. Human nature seems the same around the world From Slate

The Myth of the "Typical" Investor

Who is Mrs. Cohen from Hadera, and should Israelis care where she puts her money?
By Daniel Gross
Posted Tuesday, Dec. 15, 2009, at 1:44 PM ET

EL AVIV, Israel—Amram Aharoni has a serious résumé, but he has the mien of a comedian. On Sunday at the Globes' Israel Business Conference, Aharoni, who teaches investment theory and finance at the Herzliya Interdisciplinary Center, ran through his many qualifications—degrees from Tel Aviv University, a doctorate in finance from New York University, many years of experience in the financial sector—before throwing up his hands. "I'm supposed to be a specialist in the capital markets, but I want to confess that many times I know nothing. How can I not foresee the future and any junior analyst can tell me what's going to happen?" In laying out the modern case against active asset management, Aharoni name-checked the efficient markets hypothesis, Nassim Nicholas Taleb's The Black Swan, and ran through a bunch of gems from the behavioralist playbook (like those surveys that show most people think they're above-average drivers). Aharoni assembled a series of analysts' quotes making foolish and wrong short-term market projections, and displayed a chart showing that out of a few dozen Israeli investment funds, only three beat their benchmark indices over eight years.

And then … he turned over the session to a panel of six Israeli economists and asset managers who offered opinions on what would happen next in the markets and where people should put their money.

The conference's schedule was full of boldface names, including Prime Minister Benjamin Netanyahu, technology entrepreneurs, and Israeli business leaders. But the name on everybody's lips in this session was someone I had never heard of: a Mrs. Cohen from Hadera—G'veret Cohen m'Hadera, in Hebrew. How would she react to the news? Where is she putting her money now? Given the knowledge that it's tough to beat the market, should she just invest in index funds? Is she buying bonds, or gold, or avoiding the dollar? And what should she be doing

She's a housewife, manager of her home's finances; she's skeptical, careful, conservative yet susceptible to advice and prone to fads, but ultimately influential to the direction and performance of the domestic capital markets.

Despite the Hype... Many Investors Seem to Be Getting the Right Message....

....and voting with the dollars in a landslide money is going into low cost etfs and coming out of illiquid expensive hedge funds of funds (the hedge fund vehicle targeted at individual investors. See the two articles below

But the dollar$ still in the hedge fund area relative to etfs is still shockingly high imo. At $440 billion worldwide it is a big number. Even if the number of $752 bln in US assets invested in etfs doesn't include the indexed assets invested in US mutual funds and indexed investments outside the US, it is still too low imo relative to the hedge funds of funds numbers.

The most common fee structure for the hedge funds of funds is 2% annual fee + 20% of profits. A well diversified portfolio if etfs could be constructed with an annual fee of .25% with no performance fee at all. That means the hedge fund of fund investors with their $440 billion in assets will be paying an absolute minimum of $7.7 bln in additional fees

my bolds, my comments in bold italics

Assets at Funds of Hedge Funds Drop by Nearly Half Since Peak .

The fund-of-hedge-funds industry has seen its assets continue to drop sharply this year, amid investor withdrawals as its performance has fallen farther behind actual hedge funds.

In terms of asset flows, 2009 has been the worst year on record for funds of hedge funds, with net redemptions amounting to $164 billion world-wide in the first 11 months of the year, leaving total assets at $440 billion, according to data provider Eurekahedge. Value of assets under management peaked at $823 billion in May 2008, meaning assets have now dropped by nearly half.

not only are hedge funds a poor investment, hedge fund of funds the vehicle targeted at "mass affluent" investors perform even more poorly than the overall universe of hedge funds (and often charge additional fees)

Funds of hedge funds have underperformed the hedge-fund industry by more than eight percentage points so far this year, significantly worse than in previous years. The Eurekahedge fund of funds index was up 9.17% for the year to the end of November, while the overall Eurekahedge hedge fund index was up 18.24%; similarly, the HFRI fund-of-funds index published by data provider Hedge Fund Research was up 10.69%, while its overall hedge-fund index was up 18.72%.

In previous years, funds of hedge funds generally underperformed hedge funds by at most a couple of percentage points, according to Hedge Fund Research's figures, with the difference largely attributable to fees.

The fund-of-hedge-funds industry comprises 3,110 funds, according to Eurekahedge. This is 15% down from the total at the end of 2007. The fact that the number of funds has fallen by only 15%, while assets under management have fallen by 50%, indicates that most managers have continued to run their funds but with reduced assets.

The money flows have been in the other direction with regard to etfs:

from index universe

November ETF Assets Hit Record Levels

Investors poured $17.5 billion in new cash into exchange-traded funds and exchange-traded notes in November, according to new data released from the National Stock Exchange, pushing total assets under management in the U.S. to a new record of $752 billion.

Year-to-date, investors have poured $89.7 billion in new cash into various exchange-traded products; down from $132 billion for the first 11 months of 2008, but a strong showing nonetheless.

Most of the inflows were into ETFs, which gathered $17.1 billion, and now have $743 billion in assets under management. ETNs gained $354 million in new flows; combined with market returns, that brought their total AUM to $8.2 billion

Wednesday, December 16, 2009

Bad Investing Advice From the WSJ (again) This Time on Foreign Bonds

Another bad source for investment advice

WSJ December 8, 2009 my bolds
advice for the individual investor:

Why Foreign Bonds Make Sense For Income-Oriented Investors . by Jennifer Levitz

actual news from the foreign bond market
DECEMBER 9, 2009

Countries' Debt Woes Pose Risk to Upturn

WSJ today page one

Debt Fears Rattle Europe

The euro tumbled as debt woes spread around the euro zone from Greece, where pledges of austerity and fiscal rigor failed to stem growing fears that the Continent's economic recovery could be derailed.

The euro fell as low as $1.4505 on Tuesday, its lowest level since early October. New worries about Austrian banking also roiled markets, with rumors of trouble at an Austrian lender with shaky investments in Eastern Europe following Monday's surprise nationalization of another Austrian bank at the behest of the European Central Bank.

Greece is just "the tip of the iceberg," said Norbert Barthle, budget spokesman for the ruling Christian Democratic Union of German chancellor Angela Merkel. The exploding budget deficits of weaker economies have forced Germany and other financially stronger countries to think about how to shore up other members of the euro zone against a potential financial-market rout.

Portugal, Ireland, Italy, Greece and Spain, a group traders have disparagingly dubbed "PIIGS," all have huge budget deficits and very low growth prospects, which means their debt is on course to rise further, fast.

The countries' wages and costs have steadily risen, but as euro-zone members they can't respond by devaluing their currency, a problem that strains the bonds tying together the currency bloc. Their soaring deficits are testing the credibility of the euro zone's so-called stability pact, in which governments promise not to spend wildly.

WSJ Updates US Again On International Bonds....

another bad source for investment advice
WSJ December 8, 2009 my bolds

Why Foreign Bonds Make Sense For Income-Oriented Investors . by Jennifer LEVITZ
DECEMBER 9, 2009

Countries' Debt Woes Pose Risk to Upturn

WSJ today
Debt Fears Rattle Europe

The euro tumbled as debt woes spread around the euro zone from Greece, where pledges of austerity and fiscal rigor failed to stem growing fears that the Continent's economic recovery could be derailed.
The euro fell as low as $1.4505 on Tuesday, its lowest level since early October. New worries about Austrian banking also roiled markets, with rumors of trouble at an Austrian lender with shaky investments in Eastern Europe following Monday's surprise nationalization of another Austrian bank at the behest of the European Central Bank.
Greece is just "the tip of the iceberg," said Norbert Barthle, budget spokesman for the ruling Christian Democratic Union of German chancellor Angela Merkel. The exploding budget deficits of weaker economies have forced Germany and other financially stronger countries to think about how to shore up other members of the euro zone against a potential financial-market rout.
Portugal, Ireland, Italy, Greece and Spain, a group traders have disparagingly dubbed "PIIGS," all have huge budget deficits and very low growth prospects, which means their debt is on course to rise further, fast.
The countries' wages and costs have steadily risen, but as euro-zone members they can't respond by devaluing their currency, a problem that strains the bonds tying together the currency bloc. Their soaring deficits are testing the credibility of the euro zone's so-called stability pact, in which governments promise not to spend wildly.

Some Better News For An Endowment Using the "Yale Model" for Investing

After all the bad news regarding endowments using the "yale model" with a heavy weighting towards "alternative asset classes" such as venture capital, the year end news is much more positive: Nevertheles imo the issue of limited liquidity and potential liquidity crises due to venture capital investments, has not gone away. I'll leave it to readers to decide whether Stanford dodged a bullet in terms of liqudity needs or if this proves the efficacy of the strategy,

my bolds my comments in blue

from Bloomberg

Stanford Cancels Private Equity Stake Sale as Endowment Gains
By Gillian Wee

Dec. 15 (Bloomberg) -- Stanford University, the fourth wealthiest school in the U.S., canceled its plans to sell portions of its $6 billion in buyout funds, distressed securities and energy funds, as its endowment gained in the last six months.

“We didn’t have to have the liquidity,” John Powers, chief executive officer of Stanford Management Co., said today in a telephone interview. “As we felt better about the liquidity situation, we’ve been more price-sensitive and felt less the need to sell.”

Stanford, near Palo Alto, California, decided not to sell its stakes as its endowment made money over the last six months, Powers said. The school was seeking to sell as much as $1 billion, or 8 percent of its $12.6 billion fund to capitalize on rising private-equity values tied to the 60 percent increase in stock prices since March. The university’s investments lost 26 percent in the 12 months ended June 30.

It seems from the above that the reason that Stamford didnt need to sell its venture capital stakes was because it's liquid uinvestments increased in value (along with the overall equity market) enough to meet their liquidity needs. It also seems from this (below) that the buyers wanted to cherry pick from Stanford's holding interested in buying the assets that Stanford was probably least interested in selling. Also note that one category the potential buyers were interested was growth equity, a highly liquid asset class

Stanford’s bidders, a mix of secondary funds and sovereign wealth funds, were most interested in its buyout funds, followed by growth equity and natural resources, Powers said. The school’s decision to cancel the auction was first reported today by the Wall Street Journal.

Stanford’s buyout funds comprised a quarter of the portfolio’s value, including future commitments, according to a transaction summary obtained by Bloomberg. Private-equity funds that invest in oil and gas account for 17 percent and firms that buy distressed securities constitute 14 percent.

The school’s illiquid investments offer “immediate access to a mature and diversified portfolio of funds ready to be harvested, as well as exposure to 2008 and 2009 vintage funds with significant capital to deploy in a very attractive investment environment,” according to the document, which was prepared by Cogent Partners, the Dallas-based firm handling the sale. The stakes also carry $4.92 billion in future commitments to the managers.

Tuesday, December 15, 2009

Two More Examples Of Why You Shouldn't Own Actively Managed Mutual Funds

I have written numerous times of the many pitfalls of owning actively managed mutual funds, two recent articles highlighted two major problems with actively managed funds.My comments in blue
my bolds

Style Purity:
  The investor who purchases an actively managed mutual fund does not really know what he owns. The category or "strategy" of the mutual fund may or may not accurately reflect what the fund actually holds. Take for example this recent  WSJ article on equity mutual funds holding gold in their portfolios:

Funds Take a Shine to Gold

Some Managers Fear Inflationary Effect of Stimulus; Others See Fuel for Returns


Mutual funds that seldom indulged in commodities now have a lot riding on gold.

Diversified stock funds have been purchasing actual gold bullion, and also piling into gold exchange-traded funds and stock of gold-mining companies. They've been doing it partly as insurance against a worrisome monetary situation and possible inflation, and partly to goose their returns. 

In the past, some funds dabbled with gold-mining stocks occasionally, but seldom owned bullion, says Bridget Hughes, an analyst with fund tracker Morningstar Inc. The funds are joining a crowd of big-time players, such as hedge-fund operator John Paulson, who have rushed into gold. "They're taking small positions, as protection," Ms. Hughes says of the mutual funds. "This is not a short-term move for them."

Among funds, the most active buyers have been in the large-capitalization growth category, says Financial Research Corp. Since June, these funds boosted exposure to metals and to mining equity, most of that in gold, to an average 3% of their portfolios, from 0.9%. .....

"I didn't own gold before, but when I heard Washington talking about a new economic stimulus, I changed my mind," says Steven Leuthold, head of Leuthold Core Investment fund, which began buying bullion three months ago. Gold now makes up 2% of the $1.4 billion in the wide-ranging fund, whose positions include airline, bank and tech stocks. "This is insurance in case the house burns down."

These fund managers all express varying degrees of unease about what they see as willy-nilly government expansion of the monetary base world-wide to combat the recession. "We're creating money by fiat, and gold is historically the best protection against that," says First Eagle's Mr. Deshpande.

"I don't go home glad that I'm holding gold, and in fact, I hate it," says Stephen Leeb, whose Leeb Focus expanded gold assets from 5.3% last summer to 11.6%. "But the world is in trouble, and that depresses me."

Unlike many diversified managers, Michael Avery, co-manager of the $19 billion Ivy Asset Strategy, isn't new to gold. He pumped up the fund's bullion stake from 10% of assets two years ago to 17% in late 2008, amid the worst of the financial crisis. This year, he sold some to reap profits and is standing pat at 14%........

Why is this a bad thing ? Because one purchases a stock fund as part of the stock allocation of one's portfolio. If that fund is holding commodities such as gold it throws off the asset allocation. Presumably the investor that wanted a commodity/gold allocation would have already done so through an investment vehicle clearly designated as holding gold. Call me old fashioned but I think diversified equity funds should hold equities. Using exchange traded funds and preserving style purity one would hold equity exchange traded funds and a gold exchange traded instrument for the gold allocation.  And label me a skeptic but it makes me a little uneasy to see a fund manager that never before held gold to jump in for the first time three months ago smart move or late to the party ? Of course since these are actively traded funds that only report their portfolios on a quarterly basis, investors will only know that the fund has increased, decreased or even eliminated its gold position after the fact. Which makes it impossible for an investor to carefully monitor and control his asset allocation.

Manager Risk

Many investors purchase actively managed mutual funds in order to get access to a "genius manager" that will generate extraordinary returns. It is well documented that it is difficult if not impossible to identify such managers in advance and that there is little persistence in performance. But the recent upheaval and fund manager TCW illustrates another risk: there is no guarantee that the "star manager" will remain at the helm of the fund you invest in. You may think you are investing with a manager but in fact you are investing with the fund, the manager is ultimately a free agent.

The episode at TCW is not common but neither is it unique and it is certainly part of the inherent risk in owning an actively managed fund. From the WSJ. My comments in blue, my bolds

Trial by Fire for Managers Now Running Fund at TCW


A week ago, Tad Rivelle was managing some $30 billion, mostly in high-quality, broadly diversified bond portfolios. Now, he is also running $65 billion worth of complex mortgage securities and other bonds left behind by an ousted star bond manager.

Mr. Rivelle is one of the founders of Metropolitan West Asset Management LLC, which agreed Friday to be acquired by TCW Group Inc. The same day the deal was reached, TCW booted its investment chief, Jeffrey Gundlach, who had piled up outsize returns in recent years by buying beaten-down mortgage securities. Much of Mr. Gundlach's team followed him out the door. The result was that Mr. Rivelle and his 30-person investment team had to manage TCW bond portfolios, starting immediately.

Such abrupt transition of investment responsibility is rare in the history of asset-management deals. The MetWest team needed to swiftly convince investors that it could fill the shoes of Mr. Gundlach, nominated recently as bond-fund manager of the decade by investment-research firm Morningstar Inc.

Arriving at TCW just hours after the announcement, Mr. Rivelle knew the integration had to begin at break-neck speed.

"Anything can happen in a situation like this," says Eric Jacobson, director of fixed-income research at Morningstar. "There's plenty of room to screw things up."

Friday night, MetWest mortgage specialists Mitch Flack and Bryan Whalen started diving into the portfolios managed by Mr. Gundlach. Though MetWest runs $18 billion worth of mortgage portfolios, it is known more as a generalist bond manager, whereas Mr. Gundlach was intensely focused on the niche. The MetWest team worked through the weekend to familiarize themselves with all the holdings. "Bryan and Mitch are the two most bleary-eyed individuals," Mr. Rivelle says.

At 5.a.m. Monday, Mr. Rivelle arrived at the TCW offices. Redemptions started rolling in. Investors yanked more than $1 billion that day from the roughly $12 billion TCW Total Return Bond Fund. On Tuesday, managers had to sell about $450 million worth of nonagency mortgage-backed securities to meet redemptions. Depending on market conditions from day to day, such securities can be extremely tough to trade. Mr. Rivelle says the bonds traded well, selling at or near where they had been valued on TCW's books. Managers also reduced cash and agency mortgages held in the fund to keep the asset allocation similar to the way Mr. Gundlach had left it....

Mr. Rivelle rejects the notion any bond manager has a secret formula that can't be replicated. Bond selection "doesn't rely upon some supercomputer or massive brain," he says. Which leads me to the conclusion one is better off indexing,

MetWest's and TCW's flagship mutual funds have some similarities but also some big differences. Managers of both portfolios saw great value in nonagency mortgage-backed securities last year and now devote roughly one-third of assets to these holdings. But Metropolitan West Total Return Bond Fund is a broad mix of corporate debt, mortgages, government securities and other holdings, while the TCW Total Return Bond Fund is almost entirely in mortgages. And the TCW fund had more than 30% of fixed-income holdings in bonds rated "single-B" or lower as of Sept. 30, according to Morningstar, while the MetWest fund had only higher-quality bonds.

Mr. Rivelle says he may tweak the mix of holdings Mr. Gundlach left behind. "There are ways to upgrade the portfolio, and we're studying those," Mr. Rivelle says. "There are securities that we think are weaker levels of 'Alt-A,' " he says, referring to a category of riskier mortgages.

The managers would be wise to shift to more easily traded holdings, since they may be hit with more sizable redemptions, says Morningstar's Mr. Jacobson. If Mr. Gundlach resurfaces at a new firm, they should expect "another wave of selling" as some clients follow the ousted manager, he says.

"We're not simply being reactive," Mr. Rivelle says. "We want to ensure there's an ample measure of liquidity" to meet redemptions.

By December 11 TCW reported redemptions of 30% of the funds assets.

What are the consequences of all this unanticipated events at TCW Total Return Bond Fund for Investors:

  1. One's assets are no longer managed by a "top manager" with expertise in lower quality complex mortgage securities the current manager has limited expertise in this area.
  2. It is unclear whether the fund's new manager will pursue the same strategy as the previous manager thus making it difficult to monitor one's fixed income allocation.
  3. The fund has had to liquidate large parts of its portfolio due to redemptions it is unclear how that has changed the risk and prospective return characteristics of the portfolio. It is also highly possible that these sales can generate taxable gains for investors.
  4. Since there is a high likelihood of further redemptions, the fund must hold larger than customary levels of cash and liquid securities. Such securities generally have lower yields than the instruments held in the long term holdings of the fund.
Needless to say none of these problems would have occurred with exchange traded bond funds.

Food for thought:

the one year return for the TCW total return fund is 21.84%. The LQD high grade corporate bond etf has a return of 17.74%, the high yield bond fund HYG 50.69%.

So a mix if 85% high grade corporate bond and 15% high yield would have generated higher return at lower cost, full transparency and none of the headaches associated with "manager risk"

Friday, December 11, 2009

Don't Get Your Investment Advice from Maria of CNBC Either...

I tend to leave it on with the sound off if at all, but I did catch this one.

NASDAQ stocks with the biggest potential for big gains:

"We went through the nasdaq and found the stocks trading at the biggest discount to analysts forecasts" (and those have the most potential for increasing to that target is I guess the rationale for highlighting them).

More logically the segment should have been labelled:

"Nasdaq stocks where analysts have been least accurate in predicting future stock price."

but of course that would have highlighted how bad stock analysts (frequent guests on cnbc) are at predicting stock prices.

Wednesday, December 9, 2009

Oops They Did It Again...Don't Get Your Investment Advice From the WSJ

WSJ Yesterday:

DECEMBER 8, 2009. my bolds

WSJ December 8, 2009 my bolds

Why Foreign Bonds Make Sense For Income-Oriented Investors .ArticleCommentsmore in Personal Finance ».
by Jennifer LEVITZ

It's never been easy for investment advisers to convince people that foreign-bond funds are a good bet. Typical investors have home-country bias, or a preference for Treasurys, municipal bonds and U.S.-company debt. Foreign bonds "often get a short glance," says Tom Roseen, a research manager at Lipper Inc. "People are more willing to…explore foreign-equity funds."

Yields are markedly better even in many relatively safe countries with stable governments and economies. For instance, Australia's two-year government bond yields 4.4% versus 0.8% for a U.S. Treasury of the same maturity.

These days, the debt of some foreign governments may look safer than the bonds issued by cash-strapped U.S. cities and states....

... money is streaming into foreign bonds, both government and corporate, largely through U.S.-based global bond funds, which have attracted net inflows this year of $76.8 billion through October in the strongest showing since his firm began tracking the bonds in 2003.

Concerns about Dubai's fiscal strength, after a state-run company sought to delay debt payments, show that the risk of bad debt is still out there,... says Arijit Dutta, a Morningstar Inc. analyst. But he expects the Dubai disruption to be a "fairly local problem" and says it's still the case that many emerging markets have improved over the past 15 years as investments. "Many of the bigger markets…Brazil, Mexico, and Russia, are way more fiscally responsible than in the past and have improved capacity to service their debt," he says.

Overall, investors "now have a sizable alternative to the domestic U.S. bond market," says Mr. Dutta. He recommends that investors keep between 10% and 40% of their fixed-income portfolio in foreign bonds.

Mr. Carlson runs Fidelity New Markets Income, an emerging-markets bond fund that recently has been adding to its investmenThe fund was up 44% through November and ranked fourth in its emerging-markets bond fund category in trailing three-year returns, and second over the past five years.

Mr. Carlson says he finds many emerging countries ts in debt issues by the governments of Venezuela, Argentina and Russia. to be "less levered" than the U.S. and growing faster.

"It's a play on global growth and sound fiscal policies," Mr. Carlson says

href="href="">WSJ Today

DECEMBER 9, 2009

Countries' Debt Woes Pose Risk to Upturn

Worries over finances of some of the world's governments rippled through financial markets Tuesday, as a series of negative credit-rating actions served as a reminder of the fragility of the global recovery....

Fitch Ratings cut Greece's credit rating a notch to the lowest level in the 16-nation euro zone, raising concerns that Athens could be sparking the biggest fiscal crunch the European monetary union has faced in its 10 years. Moody's Investors Service sliced ratings even more on Dubai government-controlled companies, renewing worries about the Arab emirate. Moody's also said the U.K.'s rating would be at risk if it didn't lower its budget deficit....

...Investors reacted to Tuesday's debt worries by retreating from riskier assets, punishing currencies like the euro and the British pound. Bonds of riskier countries dropped. debt.

Russia's finance minister added to the chorus of concerns Tuesday. He said Russia is "still a weak link" in the global economy and would be vulnerable in case of a reversal of the tide of money now flowing in, partly because of higher oil prices.

.In coming months, Russia is seeking to borrow in foreign currency for the first time since it defaulted on sovereign debt in 1998, triggering a financial convulsion.

The euro is the centerpiece of Europe's drive toward closer political union, but skeptics have long warned that a monetary union isn't sustainable without more powerful pan-European political institutions.

Greece's struggles threaten the first real fractures in the European currency union since its inception in 1999. The union has a single currency and monetary policy, but each of its 16 members has its own fiscal policy.

The European Commission projects Greece's 2009 budget deficit at almost 13% of gross domestic product, versus an EU average of just under 7%. Greek government debt, currently about 112% of GDP, probably will balloon to 130% before stabilizing, Fitch said.

Fitch cut Greece's rating a notch to BBB+, still within investment grade, citing its lack of decisive action to rein in the deficit. High debt and a sluggish economy are shared by Portugal, Ireland and Spain, creating a risk of contagion if investors flee Greek assets.

"This raises question marks over the long-term viability of the euro's current membership," said Simon Tilford, chief economist at the Center for European Reform, a London think tank. "On current trends," he added, "we'll end up with economic stagnation and mounting political tensions in the euro zone, and, at worst, fiscal crises and a loss of political support for continued membership."

Investors sold the euro in the wake of Greece's downgrade. Late Tuesday in New York, one euro bought $1.4704, down from $1.4813 a day earlier, continuing a slide that started Friday when the U.S. reported upbeat jobs data. Stock markets in the U.S. and Europe declined, with Greek shares down more than 6%. Seeking safety, investors drove up the prices of U.S. and German government bonds. In a sign investors want to park cash in secure places through year-end, the U.S. Treasury sold four-week bills with a zero-percent yield.

The premium investors demand for holding 10-year Greek government bonds compared with the safer German government bonds hit its highest point since April. The premium, or spread, rose to as much as nearly 2.3 percentage points Tuesday, making it more expensive for Greece to refinance its debt.

Yet the fact that financial markets "are punishing the bad and rewarding the good is a positive development," said David Woo, head of global currency strategy at Barclays Capital in London. He said that what Greece is facing now -- a very public reprimand and higher borrowing costs -- is "a form of policy discipline for the Greek government to do the right thing."

Greek Finance Minister George Papaconstantinou pledged steps to restore fiscal credibility, doing "whatever is needed to meet our medium-term goals." But Greece's newly elected socialist government so far has failed to persuade EU officials or investors it will take the painful measures, especially spending cuts, that analysts say are needed to avoid a debt crisis. But Ireland is expected Wednesday to announce cuts in spending, including on public services.

Greece's problems underscore longstanding concerns the European monetary union lacks the tools to make sure members' debts don't spiral out of control. The reece's financial problems even worse.

Investors are also focused on the highest-rated borrowers. The U.S. and U.K. are among those with a triple-A rating, but Moody's cautioned Tuesday that without action to curb deficits, both could drift toward a possible downgrade.

Tuesday, December 8, 2009

All That Glitters,,,,,

Gold vs The Base Metals Index (black line) One Year Chart

and an interesting piece from on who is touting gold in the mass media:

,,,,And it’s become an increasingly profitable synergy for everyone involved - the retailers, the networks and an array of hosts including O’Reilly and Beck, as well as radio talkers Mark Levin, Michael Savage, Laura Ingraham, Dennis Miller, Fred Thompson and G. Gordon Liddy.

I have no idea when the gold rally will end, but I have little doubt it will be ugly when it does. And doubly so for those who purchased gold coins in search for a buyer. At least the holders of the etf will find a liquid market low transaction costs.

Sunday, December 6, 2009

Emerging Market Bonds Don't Make Sense to Me...Unlike Emerging Market Stocks

click on any chart to enlarge

The recent new stories about Dubai's debt (as well as that of Greece and a list of others) got me to revisit my thoughts on emerging markets bonds. I haven't changed my mind...they don't make sense to me as part of a portfolio.

The rationales for holding emerging market bonds are that it is a diversifier for portfolios, that it offers a way to participate in the growth of emerging markets and that it offers a yield pickup compared to US treasuries. I'm not convinced.

The lowest cost and most readily available vehicles for investing in emerging market debt are the ishares etf (ticker emb) and the powershares etf (PCY). Both invest only in dollar denominated debt.

In my view investors looking to participate in the growth of the emerging markets are far better off doing so through equities. And those looking for a yield pickup would be better advised to look at high yield corporate debt.

My Rationales:


First off, these vehicles since they invest only in dollar denominated debt, do not offer currency diversification a major reason to add international investments to a portfolio. Secondly although the correlation statistics vs US bonds is relatively low for the entire (short) period that they have been in existence it is important to remember the limitations of simply using such statistics. As is well known, the only thing that goes up in a down market is correlation. And it is in the down markets particularly the extreme down moves that one most wants diversifiers in a portfolio. As can be seen in the charts above comparing emerging market stocks (blue), the sp 500 (brown) and PCY (black), the powershares emerging markets debt etf offered little shelter during the most severe drops of last fall. Yes 2008 ended with PCY outperforming the emerging market stocks vs -48.9% vs -18.8% but it was not necessarily a diversifier, it simply had less volatility. The comparison charts are for two years(top chart) and ytd (second chart).

This year's performance shows that emerging market debt is far inferior to equities as a means to participate in the growth of emerging market economies. The eem is up 68.8% this year vs (a still very impressive) 36.18% for PCY. But I would argue that the eem is far better to gain exposure to emerging market growth. And the logic is simple: the fastest growing emerging market economies have little if any debt. And the emerging market debt etfs have holdings based on a weighting of soivereign debt outstanding

This brings me to the most important distinction between emerging market bonds and emerging markets stocks. The stongest performing emerging markets run current account and budget deficits and therefore (with the major exception of Brazil) have little sovereign debt. For that reason the country allocation of the emerging market bond etf offers far less exposure to the fastest growing emerging market economies. Compare this list of top country holdings in the emerging markets stocks etf (eem)

Brazil 14.83%
South Korea 12.43%
China 11.16%
Taiwan 10.41%
South Africa 8.08%
Hong Kong 6.84%
Russia 6.28%
India 5.96%
Mexico 4.64%
Israel 3.31%

Now compare the top holdings of the ishares emerging markets bond etf

Brazil 10.88%

Russian Federation 10.22%

Mexico 8.94%

Turkey 8.38%

Philippines 7.00%

Indonesia 5.43%

Colombia 4.70%

South Africa 4.68%

Venezuela, RB 4.49%

Peru 4.30%

Other/Undefined 31.00%

and the top holdings of the powershares bond etf

Name PercentageOfFund

Then consider which list gives most exposure to the fastest growth in the emerging markets world. Consider another point: the potential for capital gains in emerging markets bonds is limited: the total return comes from any fall in interest rates and the current yield. Considering that the yield spread over treasuries this year has declined from 1200 to 400 basis points (12% to 4%) over treasuries it would seem the potential for more capital appreciation in emerging market bonds is limited. By contrast the potential for gains in emerging markets stocks is not capped in the same way. While this year's returns are not a predictor of the future the relationship between the emerging markets stocks and bond etf returns this year is instructive. In a boom year for flows into emerging markets the ishares emerging markets bonds etf (EMB) is +26.84% the powershares emerging bond etf (PCY)+36.18% and the ishares stock etf is +68.84%.

The WSJ in a recent article on emerging mkt bonds displayed a chart showing the growth of $100 in emerging market bonds since 1994. It indeed looks impressive. I then ran a chart for emerging markets stocks based on growth of $1 over the same period (just multiply by 100 to get the exact comparison) the bond chart is the insert the larger chart is for stocks. Over the period $100 invested in emerging markets bonds would have grown to $500, that same $100 invested in emerging market stocks would have grown to $2400.

Another point: while there are actively managed emerging market bond funds that invest in local currency denominated bonds (with the higher fees and other negatives of actively managed funds), the emerging market bond etfs invest only in dollar denominated bonds. Therefore unlike emerging market stock etfs the bond etfs do not give currency diversification.

Finally the yield pickup: as noted the yield spreads of emerging market bonds vs US treasuries have narrowed tremendously this year. As noted, this means that both the potential for further capital appreciation is limited and the yields have dropped considerably for the PCY the current yield is 6.29% for the emb it is 5.11. Given the credit risk associated with emerging market bonds it would seem to me those looking for yield pickup might be better served looking at US high yield corporates the ishares HYG is still yielding 8.95%. The comparable treasury etf yield is 2.76%. Of course the yield spreads on the US high yield bonds have narrowed tremendously yielding a total return this year of 36.99%. Potential for future capital gains are probably limited and there is certainly credit risk here as well but at least the yield differential is more attractive.

So while I am a big advocate of international diversification in portfolios with a significant allocation to emerging markets, in my view the case for stocks far outweighs the case for bonds.

Thursday, December 3, 2009

In Case You Still Thought You (or your broker,advisor, morningstar or magazine) Can Successfully Pick Actively Managed Funds That Outperform the Mkt

WSJ today

Top Mutual Funds: Just Luck or Skill?
Study Questions 'Active' Managers

It's impossible to tell whether actively managed funds that beat the market do so out of luck or skill, according to a new study by the professors who've championed index investing.

The claim means that investors can't know for sure how good their active manager is, say the professors, Eugene Fama and Kenneth French.

"People don't understand the effects of chance [on returns]," said Mr. Fama.... (Find a copy of the report at the Social Science Research Network.)

The fact that some funds in the professors' study beat the simulations does suggest that by picking the right funds investors can consistently outperform the market. But there's just one problem, according to the professors: The "good funds are indistinguishable from the lucky bad funds that land in the top percentiles."

That leaves picking the right fund a matter of guesswork. So even if investors stick with the top performers, they're running a risk because the manager's good results could be based on luck.

The presence of both good funds and lucky bad funds means it's likely that investors focused on top performers will end up with returns close to the market.

In an interview, Mr. Fama cautioned that this doesn't mean all index funds are viable options—there are index funds that charge high fees, for example. Investors should stick to low-cost and efficiently managed index funds, he said, naming Vanguard Group's offerings as among the best

kudos to Prof Fama for mentioning Vanguard and not Dimensional Fund Advisors the firm he is affiliated with (or maybe the reporter left that mention out of the article.

the full Fama - French paper is here

Monday, November 30, 2009

In Case You Are Under The Illusion That the Mutual Fund Industry Cares About Your Financial Well Being....

the WSJ gives us this convoluted tale of load mutual funds (my italics and bolds)

B Shares Sent to Detention


Mutual-fund firms are giving B shares an F—and kicking them out of school.
More fund companies are dropping B shares, a class of mutual-fund shares that hit investors with a back-end sales charge, known as a "load," once investors sell. The more-numerous A shares levy a load at the time of purchase.

The bear market and its aftermath, the woes of asset-backed securities and regulatory problems have put pressure on the B shares' fees earned by fund houses and the brokers who peddle the B portfolios. "So they are eliminating B shares from their sales platforms," says Eric Jacobson, director of fixed-income research at fund tracker Morningstar Inc. "When things were growing regularly, the whole scheme was fine. Now it is not."....

. The fund industry says B shares are shrinking due to lower customer demand. In fact, the number of B shares offered and the class's sales volume have gone down because the fund companies and brokers no longer want to peddle the Bs. ....

There never was genuine consumer demand for "B" shares. They were simply a marketing gimmick:

A shares, with their up-front loads, were the norm years ago, until the advent of no-load funds from the likes of the Vanguard Group and T. Rowe Price sent load houses scrambling for a product to competee. In the late 1980s, they came up with B shares, which sales reps touted as a cheaper way to own funds than A shares.

If you think many investors understood this(below) or brokers clearly explained them (yes the info was eventually buried in the prospectus) I can assure you that you are sorely mistaken. I worked a few months (i wouldn't sell this stuff which made me very unpopular) at a firm they peddled only load funds I can assure you that few of the salespeople could calculate the costs of investing over time in the different share classes. But they definitely knew what the payout (commission) was.

The differences among share classes are complex (now there's an understatement) Typically, with A shares, investors are charged a 5.75% up-front load, whose proceeds are split between the broker and the fund company. On top of that, the investors might pay 1.20% of assets in yearly fees to the fund house.
B shares have a lower load, often around 4%, but impose a higher yearly fee, usually on the order of 1.9%. Investors in B shares have to pay the load if they sell the fund. That 4% load, however, shrinks to zero over time, usually six or seven years. Then the B shares morph into A shares, and investors pay the As' lower yearly fees. (For the most part, fund families that are dropping their B shares will let keep existing B holders in place, since they will eventually be phased out.)
A third class, C shares, has a smaller load that often goes away sooner, perhaps in a year, but they don't convert to A shares and investors must keep paying fees as high as those of B shares in perpetuity.

And here is where the marketing sleight of hand comes in: when the good guys with no loads and low management fees came into the game some informed investors complained to their brokers about paying hefty front end loads (commissions) to buy mutual funds. So the marketing whizzes came up with the B shares: no front end load but higher annual management fees (so the investor doesn't see it clearly) and a gradually declining back end fee upon selling the fund (effectively locking the client into the fund company (a stable stream of asset management fees for the fund company) or hitting him with more fees if he wants to sell withing a period lasting 5 yrs and sometimes longer. A classic use of behavioral finance: bury the explicit costs and convince the investor it is very close to a no load mutual fund.

And here comes the real reason for the decline in "B" shares. It's all about broker payout and little if anything about consumer preferences. If the conditions described here would have never materialized the brokers would still be flogging those b shares,

Brokers, however, don't want to wait around in hopes of collecting a back-end load from B shares some day. When B shares are sold, fund houses take no cut and pay brokers the entire 4% load as an incentive. In lieu of a slice of the 4% load, the companies charge the higher yearly fees. Until a year ago, the fund firms could finance that 4% outlay to the brokers by securitizing the Bs' 1.9% yearly fee income.
Trouble is, asset-backed securities were decimated in the bear market and haven't recovered yet. With securitizing scarce, that means the fund houses, out of their own pockets, must underwrite the brokers' 4%.
Worse, both brokers and fund houses collect less these days from Bs' loads and fees because fund values, while improved since last March's market low, are nowhere near the levels earlier in the decade. A 4% load and a 1.9% yearly fee bring in less today, when B shares' assets total $113 billion, than they did in 2007, when B assets were $234 billion.
B shares first ran into trouble, and inspired industry unease, when regulators began looking into whether brokers were pushing the Bs even though another type of investment was more suitable.

(what a shocking surprise)

In 2005, to mollify the regulators, many fund firms put ceilings of $50,000 or less per customer on the amount of B shares that could be sold.
The fund houses that are backing out of B shares are mostly tight-lipped about why they are getting out.
"Demand for the share class has declined dramatically," thus fund houses no longer are enamored of them, says Chris Doyle, a spokesman for American Century Investments.

the above quote may be true but only it is demand from the commissioned brokers, not investors that Mr. Doyle is speaking about.

Tuesday, November 24, 2009

Do I Really Have to Comment On This ?

The WSJ may be good for some things but market forecasts....not so much

After 3 days of looking at this nonsense my head is spinning

WSJ November 23,2009 pg. A1:

Investors Dial Back Risk as Year-End Nears

Signs of wariness are appearing in financial markets as investors worry that the end of the year could bring challenging trading conditions.
Last week saw a steep drop off in stock-market trading volume and a surge in demand for short-term government debt, indications that investors and financial institutions are growing cautious and retreating from riskier bets.
That defensive behavior is relatively common toward the end of the year. But this year it's happening earlier than usual. An uncommon confluence of events is driving the shift. The biggest catalyst is a reluctance among investors to take on new aggressive bets and avoid a late-year blow-up in their portfolios. Many are sitting on big gains after a 58% surge in the Dow Jones Industrial Average since early March and record returns from some corporate bonds.
"People who have booked some significant gains…are looking to take risk levels down," says Brian Fagen, co-head of Americas liquid market sales at Barclays Capital.

WSJ November 24,2009 page C1

What Gloom? Blue Chips Rise 132.79, Gold Joins In

WSJ Novemeber 25 pg c1

Turkey' Day? Stocks Don't Believe It


People don't typically give Thanksgiving presents, but the stock market does.

For decades going back at least to the end of World War II, stocks have shown above-average strength over the Thanksgiving period.

The Wednesday before the Thursday Thanksgiving holiday and the Friday afterward normally show higher gains than typical Wednesdays and Fridays, according to data from Ned Davis Research.

In fact, the entire week before Thanksgiving usually is a strong one for stocks, says Paul Hickey of Bespoke Investment Group in Harrison, N.Y.

Alas, the good cheer doesn't last. The week after Thanksgiving typically shows a decline....

Sunday, November 22, 2009

The Case For A Globally Diversified Portfolio: A Look At The Last Ten Years

Some interesting charts and tables in the nyt over the weekend (see above) sent me to the computer to put together some numbers for 10 year data. The top chart (click to enlarge) shows the 10 yr growth of a $1 investment domestically and internationally. In descending order ten year performance : emerging markets 11.49%, total world ex us 3.94%, developed international 2.46% and S+P 500 - .95%.

While many after last year's turmoil have argued that "diversification doesn't work" my response would by: yes and no. Diversifying across types of equities is not likely to insulate a portfolio from market declines. Among the non US categories listed above all the correlations to the US mkt were all virtually the same= around .8. So it is certainly unlikely that one's foreign stocks will "zig" while the domestic stocks "zag". In fact as we have seen in several market crises "the only thing that goes up in a down market is correlation". The correlation between all types of risk assets goes up in a sharp market decline. The only asset that diversifies away from market risk are riskless assets such as tbills.

But this does not argue against global diversification within one's equity allocation. As can be seen from the data here much of the growth in the world can come from outside the US and while it is true that stocks are highly correlated around the world it does not argue for missing out on global growth. In fact whether on a global gdp basis or a global market capitalization perspective one could argue that investors' portfolios should have a significant allocation to non US stocks.

In my view that international allocation should contain at least an equal weighting of developed and emerging market stocks based on the relative outlook for growth around the world. Of course this is not for the faint of heart, emerging markets in the past and likely in the future have more volatility than US stocks. Besides the relative growth story. One can argue that in increasing one's weighting in emerging markets one also has the strength of future money flows as a tailwind:

Institutional investors around the world are strategically increasing their international and emerging weightings. US institutions are significantly underweighted (one report shows them less than 12% weighted in non us stocks).

Despite the large "hot money" flows into emerging markets of late, US retail investors retain a heavy "home country bias" something that will be changing among more stable 401k and other retail investors.

Probably even more importantly as the middle class grows in these markets locals will begin to have investable savings which they will invest in their home markets. Add in an infrastructure of pension funds, insurance companies and mutual funds all of which are at their infancy and one can imagine quite a bit of room for more money to flow into the equity markets of the emerging markets.

Wednesday, November 18, 2009

Another Terrible New Product From The Mutual Fund Industry

And another example how the mutual fund industry is dedicated to producing "products" in reaction to past market actions which appeal to investors tendency to extrapolate future events from what has happened in the immediate past.

What is particularly sad (or aggravating) is that the marketers clearly have read up on behavioral finance and clearly (in the marketers jargon) "frame" the marketing pitch of these products to hit the hot buttons of the worst foibles of individual investors.

I posted already about how the Putnam group appeals to investor nervousness by offering a fund that purpors to guarantee stable returns in both up and down markets.

Here's another one guaranteed to appeal to the nervous investor. A mutual fund that not only will be able to succeed in stock picking, it will also be successful in market timing.

As I have pointed out numerous times about actively managed funds that concentrate stock picking. Such funds dont reduce risk they just add what I call "manager risk" to an investment portfolio in addition to market risk as opposed to a portfolio of index instruments where there is only asset class. With funds described below there is the additional "manager risk" of the portfolio manager's skill in market timing.

While the fund companies may sell these funds as an increased opportunity for the fund to beat the market (add alpha) statistics for actively managed funds have shown us adding manager risk (in this case stock picking and market timing) makes it more not less likely the fund will underperform the relevant index.

from the WSJ my bolds and comments in italics

More Mutual Funds 'Time' Market

In an effort to lure back investors still wary of stocks, more mutual-fund managers are playing a risky game: timing the market.
Many of these funds promote their ability to avoid big losses by trading in and out of the stock market at just the right time.(what else would their marketing material say ? that they sometimes get in and out of the market at the right time and sometimes fail to do so ?)Some are labeled "tactical allocation" or "dynamic" funds. But even funds that don't openly tout such strategies are moving in and out of big cash stakes, betting that they can outsmart the volatile market. Quaker Small-Cap Growth Tactical Allocation Fund, launched late last year, now has about half its assets in cash, down from as much as 95% last year. The new John Hancock Technical Opportunities Fund had about 12% cash at the end of October and is managed using a strategy that devoted roughly 90% to cash early this year.

Hmmm....seems like the market timing of these funds was less that perfect for these funds.

Almost as important as difficulty of successfully timing the market when using the funds is the lack of transparency. This lack of transparency makes it particularly difficulty to constuct a portfolio. To give a simple example: if one's portfolion target is 65% equities, how can one be sure that the allocation is on target if one of these funds is held. When a fund can got from all to zero cash it is impossible (particularly when there is no requirement to even give that information on a real time basis.)

So no suprise that like many of the "exotic" products sold to investors by the mutual fund industry the results are disappointing:

These and several new funds from firms like Legg Mason Inc. and Morgan Stanley's Van Kampen Investments have leeway to make swings between cash and other investments. But funds attempting to time the market often deliver erratic performance, charge high fees and rack up big trading costs.

But of course from the point of view of the mutual fund industry disappointing results for investors don't make them a loser as long as they can be sold:

These funds are something of a bright spot for the fund industry, which has seen billions flow into bond funds but little cash go to more-profitable stock funds

Of course I cant deny that some of these funds can do well over short periods of time but experience tells us there will be little persistence among the outperformers.:

Some of these funds have beaten the market in recent years. Ivy Asset Strategy, for example, gained an annual 14.9% in the five years ending Nov. 10, compared with less than 1% for the Standard & Poor's 500-stock index. But they can also give investors whiplash. The Encompass Fund fell 62% last year, landing at the bottom of its world-stock category. This year it's leading its world-stock category with a nearly 110% gain

And here is the marketing strategy peddle products that can be marketed as "would have should have" holdings during the recent market turmois. Of course a simple long only index strategy would have produced returns of 25.6% in the US S+P 500 in 30.3% in developed international and 74.7% in emerging markets.

Fund companies say investors spooked by the recent market turmoil are demanding more-flexible products. Many investors have been frustrated "with investment products that were not able to react to the environment that we just went through," says Joel Sauber, head of U.S. products at Legg Mason. The firm's new Legg Mason Permal Tactical Allocation Fund can stash up to 40% in cash.

In fact as behavioral finance teaches us those "spooked investors" would have run to the market timing fund and the precise time they should have been in a low cost globally diversified indexed portfolio,

I certainly agree with the more critical views here"

A study from New York University's Stern School of Business suggests market-timing can work for some mutual-fund managers. The best stock-pickers during economic expansions also show some market-timing ability in recessions, the study found.

I am more in agreement here
But academic research raises doubts that the typical fund manager can successfully time the market over the long haul. Anders Ekholm, adjunct professor at Hanken School of Economics in Helsinki, (says).
There are a couple of reasons why the deck is stacked against market-timers, Mr. Ekholm says. Market-timing requires more trading, and transaction costs hurt performance. What's more, while a manager may relatively easily dig up some unique information that gives him an edge in selecting an individual stock, it's difficult to get such superior information about the overall market.

In a real triumph of marketing over good sense the fund companies apparently are not even touting the funds as a "side bet" for a small portion of a portfolio. Then again why would they ? the more money in the fund the more money for them.

Though some fund companies are promoting their new tactical-allocation funds as core holdings, analysts are skeptical. If the manager makes a wrong call, like plowing into cash before a market rally, "that could really hurt the investor," says Karin Anderson, mutual-fund analyst at Morningstar.

Funds dodging in and out of the market also tend to be quite costly. The A shares of Quaker Small-Cap Growth Tactical Allocation Fund charge annual expenses of 2.59%.

Once a new and creative product for the fund companies is a poor investment choice,

About That Putnam Absolute Return Fund....

the one that targets a return of 1% above inflation and has an annual fee of 1.25%

Why would anyone rationally invest in that rather than buying a ten year TIP with a guaranteed inflation protected return (currently 1.84%) and no fees at all.

As I have said about many financial products...they are sold not bought (or more correctly only bought after they are sold).
And many actively traded mutual funds especially those with "new strategies in light of changing investment conditions" are simply profitable products capitalizing on investory foibles well documented in behavioral finance.

Tuesday, November 17, 2009

Is Gold Really A Hedge Against Inflation

the folks over at present some strong evidence that it has failed to be an inflation hedge over long periods

See that in the graph the nominal price of Gold is flat but the inflation adjusted price is not. If Gold perfectly hedged inflation the inflation adjusted price of gold would overlap the nominal price.

In fact over most of the last 20 years oil has been a better inflation hedge than gold.

Shiny Metals or Dull Metals ?

When it comes to gold put me in the camp that I found from James Wolcott on the Vanity Fair blog. I am 100% in agreement:

I agree with legendary value investor John Neff (former manager of Vanguard's Windsor Fund) who said, "Gold isn't an investment, it's an enthusiasm." And when I see how many people are being sucked into gold investments from all those cheesy radio and TV ads (with their overt or sometimes explicit survivalist overtones), I see another bubble being blown that at some sad point will go blooe

I have never had much enthusiasm for gold for a number of reasons:

It doesn't pay interest or dividends.
It has no industrial uses.
It is a momentum play subject to bubbles and busts.
And as noted above any investment touted by G.Gordon Liddy in ads on the Glenn Beck Show gives me pause.

Popular lore touts gold as an inflation hedge. In fact the record for gold as an inflation hedge is at best uneven. The chart in the next post shows gold's real vs nominal price. A separate post illustrates this with an interesting graph.

So other than momentum what factors might be driving the metal higher (or adding to the momentum other than the masses blindly buying and momentum players jumping on ?

Unwinding of hedges by gold producers: gold producers often sell their production forward to lock in prices. As gold rises these hedge transactions become losers and the gold producers are unable to benefit form higher prices. As the producers throw in the towel on their hedges they need to buy gold. But this is a finite driver of demand, once the hedges are unwound the transactions are finished. On the other hand if the gold price starts to sag the producers will sell again.

Central Bank purchases of gold. In my view this will be a very finite source of demand. As I noted gold pays no dividends or interest. So consider the central bank of china or any other country. $10 billion (a tiny amount of reserves) put into gold as opposed to US treasury bonds means foregoing $350 million of risk free interest. That is no small sum particularly when multiplied by 10 or 100.

Interestingly, and to me not surprisingly, while all the breathless voices in the media have been fixated on gold, it is the "boring" industrial metals that have had a much bigger price appreciation. The chart compares the gold etf (gld) and the base metals etf DBB composed of equal weighting of aluminum, copper and zinc.(see lower graph)

I am not in the business of price predictions but in my mind there are several factors connected to economics and not "enthusiasm" that can continue to underpin long term price increases in these metals.

Most fundamentally these are a play on growth in the developing world you cant do much infrastructure expansion without those metals. The demand will only increase further when the developed country economies show some growth

Secondly these metals as well can perform well as inflation hedges.

Additionally there is a move into commodities as a permanent allocation in many institutional portfolios. In contrast to the flows into gold this is not "hot money". Much of this money is indexed and gold holds a small weight in most of them The Dow Jones commodity index (etn DJP ) for example gold has a 7.5% weight silver another 2.5% industrial metals have a 24% weight

a recent ft article reported

At a Credit Suisse conference in September, 51 per cent of managers surveyed said they would increase their level of commodity investment to overweight over the next year, compared with 30 per cent now.
Barclays says ETF inflows have been bolstered by a renewed interest in broad-based commodity indices, which can enhance portfolio diversification and reduce volatility.
"The evidence is that investors continue to value commodity exposure for portfolio diversification and as an inflation hedge," says Barclays: "We expect this trend to continue, with commodities continuing to capture a growing share of the global investment portfolio."
Kamal Naqvi, a director in commodities at Credit Suisse, says commodities are now widely recognised as a key influence over returns from other asset classes. "The outlook for crude oil prices is now an accepted driver of future economic growth and inflation expectations," he says.

All that glitters is not necessarily gold. Other interesting ways to participate in this area is through the stocks of the materials producers: XLB is the SPDR of US materials companies, MXI is the global materials ishares etf. The latter is compared to gold in the lower chart.

Wednesday, November 11, 2009

Emerging Markets: Bubble or On the Way to a Return to Trendline ?

Perhaps the bubble type activity was on the downside as emerging markets plunged in sympathy with the US and developed markets . The markets were not decoupled but looking at economic performance in the past year the growth stories seem to be decoupled.

Overdone on the upside or just reverting to the long term trend ?

The second graph shows inflows into emerging markets mutual funds and remember that is only a fraction of the inflows into emerging markets

Tuesday, November 10, 2009

Not A Good Explanation for The Emerging Market Rally And I Am Not At All Sure It's A "Bubble"

Jason Zweig in the WSJ presents the argument that money flowing mindlessly into the emerging markets etfs is responsible for a bubble in those markets. As I will show not only is that argument not persuasive, the entire argument that these markets are in a bubble should be regarded with skepticism.

My bolds and italics

Are ETFs Causing an Emerging-Markets Bubble?

U.S. investors have pumped roughly $26 billion into emerging-markets funds so far this year. Of that, $15 billion came in through exchange-traded funds -- portfolios that hold every stock in a market benchmark with utterly no regard to price.

Several hedge-fund managers and other active stockpickers have told me that this "mindless money" is distorting valuations and pumping up a potentially monstrous bubble.

First off note that 42% of the money flowing from US investors into emerging markets went into active funds, add in cross border flows into emerging markets from the rest of the world and local investors in those markets and I would be shocked if US etf inflows represented more than 50% of new inflows into developing markets. Global cross border inflows into emerging market funds were $80 billion, add in hedge funds, pension funds, cross border flows within the emerging markets and local investments into home markets and that etf inflow starts to look very small.

Courtesy of Investment News here (next paragraph) is a list of institutions that have added to their emerging markets holdings as of late I would assume only a small percentage went into the emerging markets etfs, and I think it is safe to say that the new investment by these institutions (and there are many many others) dwarfs the $15 billion into etfs. Even if the market runup is due to "mindless buying" it seems more likely it is not buying of the emerging market etf.

Some funds that have added exposure to emerging markets in the past year include the 2.5 trillion Norwegian-kroner ($448 billion) Government Pension Fund-Global; the 64.25 billion Australian-dollar ($59.3 billion) Future Fund; the Ilmarinen Mutual Pension Insurance Co. of Finland, a 21.6-billion-euro ($32.2 billion) multiemployer pension fund; the $23 billion Arizona State Retirement System; the 7-billion-pound ($11.6 billion) West Midlands Pension Fund; and the Vermont Pension Investment Committee, which oversees the state's funds, including the $1.5 billion State Teachers Retirement System and the $1.3 billion State Employees' Retirement System.
The $201.1 billion California Public Employees' Retirement System is in the middle of a broader review of its global-equity portfolio, which accounted for 51.7% of total assets as of July 31.

more from zweig:

"At first blush, it is hard to imagine that they are wrong. As money pours into the ETFs, they must mechanically match their holdings to those in the emerging-market indexes. That forced buying drives up stock prices, attracting still more new money into the ETFs, spiraling stock prices even higher."

Actually market performance in emerging markets calls the above in question. If it were really market cap weighted index buying that was "mindlessly" driving up the value of stocks in the index, then those stocks with large weignts in the index would have grown in value far more than those stocks with very low weights in the index.

But that is not at all the case. and we have a point of comparison. Dimemensional Funds (DFA) has an indexed fund which holds small cap emerging market stocks (DEMSX), precisely those that have a low weight in a market cap weighted etf like EEM. That fund is up 90.1% ytd vs 65.13% for eem. If there is "mindless buying of emerging market stocks" maybe its the small caps.
(bar chart)

In fact Zweig is more skeptical of the bubble argument although the does warn of the narrowness of some of the indices.:
But that is nothing new. Some emerging-market ETFs invest in indexes that are so concentrated that they mightn't fully reflect the real economy. The Brazilian market "has been top-heavy for years," says Dina Ting, who manages the iShares MSCI Brazil ETF. "There's two big companies, and then the stocks just fall off a cliff in terms of size." Indeed, at the end of 2007, according to data from MSCI, Petrobras and Vale together constituted 50.3% of the index -- a much greater share than today. And the two companies traded at much higher multiples of their earnings and assets in 2007 than they do now.
(which should either argue that the concentration risk has diminished or that it didnt particularly impact returns in the past,

Furthermore, even if emerging-market ETFs have contributed marginally to the boom with their forced buying, some may soon become forced sellers.
Thanks to obscure provisions of the U.S. Internal Revenue Code and the Investment Company Act of 1940, which governs how mutual funds are organized, ETFs can't allow their assets to become over-concentrated in a handful of holdings. In general, they can't keep more than 25% of their money in a single stock, and at least half of their assets must be in securities that each account for no more than 5% of total holdings.
Now that emerging markets have risen so far so fast, these tax requirements may compel some large ETFs to begin selling their biggest holdings.

So what does all this mean for investors? ETFs probably haven't caused a bubble, and they might even help a bit to prevent one from forming. But many will remain superconcentrated bets on very risky markets. If you invest in an ETF with most of its assets in a few stocks and think you have made a diversified bet, the real bubble is the one between your own ears.

But if emerging markets etfs contribute marginally to the boom, why would one expect their forced selling to have more than marginal impact when they sell

In fact the argument against a bubble in emerging markets can be made on several counts:

valuation: as investment news notes:

Vinicius Silva, an analyst at Morgan Stanley, calculates that emerging markets are trading at 12.9 times their expected earnings over the next year. Since 1993, that average has been 12.8 times earninngs. Emerging markets as a whole are neither a bubble or a bargain.

In fact if one assumes emerging market gdp and thus earnings is accelerating it would seem to me a premium over the average p/e since 1993 is justified.

emerging markets as a % of world market cap. As the bar chart shows this % has been growing steadily (24% in this measure). Relative to market cap US investors are significantly underweighted in emerging markets and the slower they are to put new money in the further underweighted they will become. Using a % of world GDP as a measure the underweighting is even more significant, And I would suspect individual investors as a whole are in the same position. Top left chart (click to enlarge the bar of emerging as % of world market cap)

Investment News reports :

some consultants and money managers think that pension funds still have a long way to go and need to in-crease those allocations closer to 35% of total assets — or roughly the weighting of emerging markets in the global economy — from the current allocation of about 5% or less for the average fund.
“Where pension funds are [invested in emerging markets], relative to where they should be, is a massive underweight position,” said Jerome Booth, head of research and a member of the investment committee at Ashmore Investment Management Ltd. “This reality has been true for a while, but the credit crunch has made it much more obvious.”

So it is not surprising to see the chart (posted separately) of net flows into emerging markets. A bubble or a long overdue global allocation based on changes in the world economy.

Finally a look at this long term chart of eem may indicate that rather than a bubble on the upside this year, the markets experienced panic selling in a downside bubble last year and now are returning to a long term trendline of growth. (see nov 11 entry)

In sum I would hesitate to label the emerging markets rally this year a bubble despite the eye popping returns. Valuation, economic growth and money flows seem to justify a strong market. But emerging markets are always volatile and not for the fainthearted.