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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.

Thursday, November 5, 2009

Putnam Investments Has Quite A Deal For You....

I have been looking into the newest product/gimmick from Putnam Investments, their absolute return funds, These funds are designed to produce a targeted return over inflation as represented by the till rate. The target returns are 1% 3% 5% and 7%.

I'll have more to say about this fund in a later post but the unattractiveness of the 100 fund is apparent based on the fees alone. This fund which has a target return of 1% above tbills is 71% cash equivalents and carries a management fee of 1.25%.

Let's count the cash equivalent portion as virtually the same as a money market fund.
With 71% of the portfolio in cash and multiplying the management fee of 1.25% by 71% that means you are paying a management fee of .89% (.71x 1.25%) which is obviously outrageously high and figure the other 29% of the assets which are all bonds is the equivalent of a bond fund that part of the portfolio carries and effective management fee of .53%(.29x 1.85) not terrible but not very attractive compared to the vanguard short term bond etf fee of .11%.

so an investor could create a portfolio that would perform in pretty much the same manner with 2 holdings

a low cost money fund (vanguard's is .14%(
a short term bond etf (etfs as low as .11%)

so the portfolion would have a blended management fee of .12% ! (.71x.14% +.29x.11%)

Oh, and just to "sweeten" the deal for investors, this fund carries sales charges. The A shares with the 1.25% operating expenses have an intial sales charge (front end load) of 3.25%. That means of every $100 invested $3.25 goes out in a sales charge. Which actually means that in the first year of any investment the it is impossible under current market conditions to provide a net return to investors of 1% above inflation as represented by tbills.

Here's the math

90 day tbill rate .07%
1% return above tbill 1.07%

so the value after one year on an investment in the fund after deducting sales charges is 97.43 or a loss of 2.57%. If you do the math you can see that the tbill rate has to rise to 2.25% to even breakeven with this fund.

It seems the putnam 100 is one to just say no to. Putnam funds are only available through financial advisors. Needless to say I have great problems with any advisor that would recommend this fund.

more later

Tuesday, November 3, 2009

Morningstar Tells Us (Again) That Their Ratings Have No Predictive Power But Some People Never Seem to Listen

The WSJ carries an interesting but strange article about an adviser who "bucked the trend" by investing in a mutual fund rated with only one star from Morningstar. The interesting thing to me is that this "investment professional" would take the morningstar rating as a serious input into the portfolio allocation. It is also disappointing that the WSJ would think it newsworthy that the morninstar ratings are useless in predicting future performance. The head of morningstar's mutual fund research makes this clear in the article and a careful reader of material from morningstar for years (as well as academic research) would have know this for at least a decade.

This still doesn't stop many of my colleagues from using morningstar software called principia and screening for funds with high "star ratings' when constructing portfolios. In my portfolios I only use index funds or etfs and I never check their ratings although I may compare those index investment vehicles in the same asset class with regards to fees and index methodology.

My bolds and italics

A Financial Adviser Bucks Star Power
Morningstar Is Just a Guide, He Says

When David Kudla, chief investment strategist at Mainstay Capital Management, added a mutual fund that had been given a Morningstar rating of just one star to clients' portfolios last December, some called to question his decision.

"Some were appalled by it," Mr. Kudla said of his adding White Oak Select Growth (trading symbol WOGSX), which then carried Morningstar's lowest rating, to some of the financial-advisory firm's accounts.
He chose the fund because Mainstay expected technology, in which the White Oak fund is heavily weighted, to be among the sectors performing well in 2009, said Mr. Kudla, also the company's chief executive.

I'm not sure that if the above was one's outlook the more appropriate decision would be to add weighting of technology through an allocation to one of the technology etfs with style purity and lower fees.

Mr. Kudla says the fund's performance and rating underscore an important point: Morningstar ratings can be especially misleading at market inflection points.
"A rating based on the performance of an aggressive-growth equity fund, which includes the worst bear market since the Great Depression, was not a good indicator of how that fund was about to perform in 2009," he said. Mr. Kudla takes Morningstar ratings into consideration, but only as one factor among many

and here is the quote from morningstar treated as if it is a new revelation or admission when in fact it has been stated numerous times over the year (although I would be the first to admit morningstar does give mixed messages.

Russel Kinnel, director of mutual-fund research at Morningstar, said the ratings are meant as a quick summary of past risk-adjusted performance and don't have "any great predictive power." Morningstar has found, however, that five-star funds generally perform better than one-star funds, and that the ratings are more predictive when there is a "smoother patch" in stock-market volatility, he said.
The ratings can be a good way to quickly check a portfolio, Mr. Kinnel said. "If a fund is one star, you'd want to know why it's doing so poorly; there could be a good reason," he said. In contrast, Morningstar's analyst "picks and pans" indicate which funds the investment-research firm's analysts believe investors should and shouldn't buy, he said

I'm not sure about the picks and pans either both because I haven't seen any data with their track record and because Morningstar gioves a mixed message on picks and pans since some of the picks are active funds but morningstar consistently speaks positively about the advantages of index instruments over actively managed mutual funds

Monday, November 2, 2009

Inverse Etfs....As I Was Saying

The WSJ's James Stewart may be a bit confused about them (see oct 29 blog entry), but the FT is quite clear on how imperfect a hedge vehicle they are: my bolds and italics

Upside-down’ investors may not see risks
By Sophia Grene

Index tracking or passive investment is now well established as a sensible form of investing. But what if you believe the index in question is likely to fall? Or you think it will rise and you want to exploit your belief to the utmost?

For investors with those beliefs, there are inverse and leveraged indices. Although these sound straightforward – just take an index and turn it upside down! – it does not work quite as simply as that.

An inverse index is constructed by calculating the return of an index, including price movements and dividends, then reversing it. They are most often used as the underlying index for an exchange traded fund, and many investors see them as an alternative to shorting an index. This is particularly useful for those whose investment mandates do not allow them to short directly, just as a leveraged index ETF, which offers multiples of an index’s returns, directly or inverse, gets around restrictions on leverage.......

However, regulators are now looking closely at how they function and whether they are being properly represented to investors.

Almost all of the inverse products rebalance daily, which is no problem if the market is moving smoothly in one direction. More volatility makes it more complicated, as daily rebalancing means the inverse index returns can veer far away from the return one might expect with a naïve calculation of the return of the long-only index and finding its inverse.

If a long only index declines by 10 per cent over a year, an unsophisticated investor might expect to receive a 10 per cent gain from an inverse index ETF.(take note Mr, Stewart of the WSJ) This is relatively unlikely, as the index returns only the inverse of each day’s return, rather than that of a year’s return. ...

In the US, the Financial Industry Regulatory Authority (Finra), the largest independent regulator for US securities companies, warned in June that these products were not suitable for retail investors who plan to hold them for more than one trading session.....

In July, UBS suspended sales of inverse and leveraged ETFs in the US, explaining in an official statement that “the short-term nature of these securities is generally inconsistent with the long-term view of investing that UBS advocates when building client portfolios”.
Maybe some wsj readers are UBS clients and therefore will be saved the opportunity to replicare Mr. Stewart's "experiment:.

interesting graphs


from a recent FT article. The really interesting graph is the center one which shows housing prices as a percentage of household income. Note how high the current level still is.
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Housing is highly sensitive to changes in interest rates, Few people think mortgage rates will fall in the near future from their historically low levels (aided by current fed policy). At a mortgage level of 6% housing has generally been priced at
1.4 to 1.5x household income vs the current 1.9x.

I don't make forecasts here but it is hard to see how we have reached the long term bottom in housing prices.

Sunday, November 1, 2009

Just Like in Lake Wobegon Where Every Child Is Above Average

"Top Money Managers" self report their performance to Barrons and over 70% are above average: