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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