Various experts (almost invariably connected to firms that market or manage these investments) tout the importance of having exposure to hedge funds and private equity in one’s portfolio in order to create returns in excess of the overall stock market.
Being the skeptic I am about such matters I was hardly surprised to find this article in the Financial Times
Private equity underperforms market
By Martin Arnold, Private Equity Correspondent
Published: November 22 2007 16:48 | Last updated: November 22 2007 16:48
Private equity has on average underperformed the stock market in the last decade, according to a detailed survey of the buy-out industry submitted to the European Parliament on Thursday…..The research – based on data from 6,000 private equity deals and about 1,000 buy-out funds – shows that average private equity returns have underperformed the benchmark S&P 500 share index by 3 per cent, after fees charged to investors.“This does not correspond with the stereotype of the industry making its investors extremely rich,” Mr. Gottschlag told the Financial Times. “Investors have not had much fun in this asset class, even though they have all been obsessed with gaining access to the best-performing funds.”
And talk about crude math, how about this:
Excluding fees and carried interest (a widely used profit sharing scheme), returns from private equity outperformed the S&P 500 by 3 per cent.
“So private equity is generating value somewhere, but its fee structure means the general partners capture double the out-performance they generate,” said Mr Gottschlag, who is also head of research at Peracs, an advisor to buy-out investors.
So yes, private equity is a profitable asset class…..for those that manage the private equity funds
Mr Gottschlag admitted that some private equity firms were consistently outperforming the stock market. But he was sceptical about the number of buy-out funds that say they are “top-quartile” in performance rankings.
And private equity seems like Lake Wobegeon where everyone is above average the Professor states:
“I have never met a general partner who was not top-quartile. So I wonder where three-quarters of the industry is hiding,” he said.And remember the data used came before the current period of tight credit where private equity firms have had to walk away from deals due to limited or expensive financing.
Monday, November 26, 2007
Friday, November 2, 2007
More Strange Advice on Investing
An article on safer alternatives to stock market investing in the Oct 28 NYT entitled:
Shedding Stock-Market Vertigo (but Still Making Some Money)
starts out logically enough ,mentioning some sensible alternatives including CDs and Treasury Inflation Protected Bonds.
Then the article veers off into the strange recommendation of actively managed bond funds. As we have noted before there is nothing particularly safe about these funds. The investor is simply giving his money to a bond “guru” who takes bets across the entire spectrum of fixed income investments. Much as with an actively managed stock fund, you never now what you own and what risks are lurking in the portfolio, particularly in the currently unstable bond market.
The article cites the recommendations of a Morningstar analyst (my bolds):
he has identified two — Metropolitan West Total Return and Pimco Total Return — as likely to benefit from credit market fears.
“They both have a history of opportunistic buying,” he explained. “Great managers love volatility.”
They may love volatility but is that what an investor really wants when he flees from “stock market vertigo”?
Mr. Peterson of Schwab likes Pimco Total Return and the Loomis Sayles Bond fund, which has international exposure, along with high-yield holdings intended to enhance performance.
Translation: they load up on credit, currency and sovereign risk to squeeze out higher returns .
Daniel J. Fuss, the Loomis fund manager, has excelled at finding the optimal mix of investment-grade and junk bond holdings, Mr. Peterson said. “Loomis is more of a credit analysis play,” he said. “They shift between investment grade and high-yield.”
This manager puts the conservative part of your portfolio in the riskiest types of bonds “high yield (junk) bonds. And with many forecasting a recession this is precisely what you do not want to own.
In all, his fund holds 22 percent in below-investment-grade holdings, along with roughly 17 percent in nondollar credits, chiefly in the Brazil real, the New Zealand dollar and the Mexican peso. These issues provide higher yield than dollar-denominated debt and would benefit from a continued decline in the dollar. This year through Thursday, the fund has produced a total return of 9.2 percent and has outperformed its multisector bond category average in each of the last five years.
Junk Bonds, Brazilian Real Bonds and Mexican Peso Bonds....Does that look like a portfolio designed to prevent market vertigo ? It looks to me like an accident ready to happen.
Once again it bears repeating. The only reliable way to reduce the risk of a portfolio is to increase the holdings of short term treasury bonds, treasury inflation protected bonds or investment grade bonds. Anything else is some kind of a bet on the direction of interest rates, credit spreads, currency risk, or sovereign risk. In fact a strong case could be made that even the investment grade bonds should be excluded from the list. Certainly a terrible choice would be an actively managed bond fund where you have no idea what risks the manager is taking.
Shedding Stock-Market Vertigo (but Still Making Some Money)
starts out logically enough ,mentioning some sensible alternatives including CDs and Treasury Inflation Protected Bonds.
Then the article veers off into the strange recommendation of actively managed bond funds. As we have noted before there is nothing particularly safe about these funds. The investor is simply giving his money to a bond “guru” who takes bets across the entire spectrum of fixed income investments. Much as with an actively managed stock fund, you never now what you own and what risks are lurking in the portfolio, particularly in the currently unstable bond market.
The article cites the recommendations of a Morningstar analyst (my bolds):
he has identified two — Metropolitan West Total Return and Pimco Total Return — as likely to benefit from credit market fears.
“They both have a history of opportunistic buying,” he explained. “Great managers love volatility.”
They may love volatility but is that what an investor really wants when he flees from “stock market vertigo”?
Mr. Peterson of Schwab likes Pimco Total Return and the Loomis Sayles Bond fund, which has international exposure, along with high-yield holdings intended to enhance performance.
Translation: they load up on credit, currency and sovereign risk to squeeze out higher returns .
Daniel J. Fuss, the Loomis fund manager, has excelled at finding the optimal mix of investment-grade and junk bond holdings, Mr. Peterson said. “Loomis is more of a credit analysis play,” he said. “They shift between investment grade and high-yield.”
This manager puts the conservative part of your portfolio in the riskiest types of bonds “high yield (junk) bonds. And with many forecasting a recession this is precisely what you do not want to own.
In all, his fund holds 22 percent in below-investment-grade holdings, along with roughly 17 percent in nondollar credits, chiefly in the Brazil real, the New Zealand dollar and the Mexican peso. These issues provide higher yield than dollar-denominated debt and would benefit from a continued decline in the dollar. This year through Thursday, the fund has produced a total return of 9.2 percent and has outperformed its multisector bond category average in each of the last five years.
Junk Bonds, Brazilian Real Bonds and Mexican Peso Bonds....Does that look like a portfolio designed to prevent market vertigo ? It looks to me like an accident ready to happen.
Once again it bears repeating. The only reliable way to reduce the risk of a portfolio is to increase the holdings of short term treasury bonds, treasury inflation protected bonds or investment grade bonds. Anything else is some kind of a bet on the direction of interest rates, credit spreads, currency risk, or sovereign risk. In fact a strong case could be made that even the investment grade bonds should be excluded from the list. Certainly a terrible choice would be an actively managed bond fund where you have no idea what risks the manager is taking.
Thursday, October 18, 2007
Fox Business News: Not Much Business News, But a Good Lesson About the Financial Media
I took a few brief looks at the new Fox Business Channel and was still waiting for the business news before I flipped over to CNBC. John Gapper of the Financial Times impressions are pretty much in line with mine.
Fox is for fun, not investment advice
By John Gapper
,,,,,For me, the highlight of the launch of the Fox Business channel on Monday was when the sound went off as Ivanka Trump displayed the jewellery collection she is selling at her new Madison Avenue store.
The Donald’s daughter was a guest on the first outing for Happy Hour, an evening show on the US cable channel filmed in the Bull and Bear bar at the Waldorf Astoria. The hosts were Cody Willard, a long-haired hedge fund manager (and FT contributor) and Rebecca Gomez, a pneumatic brunette in a short, turquoise dress……
As Fox Business took to the air, preaching its gospel of democracy and bullishness, its anchors were confronted by a 140-point fall in the Dow Jones Industrial Average, prompted by a Treasury-endorsed super-fund to bail out structured investment vehicles holding $400bn of collateralised debt obligations. After a stab at explaining what “it means for your mortgage” they moved on.
But Gapper points out maybe this fluffiness is not so bad after all. For if the more “hard news” approach of CNBC with Cramer and the Fast Money crew giving rapid fire buy and sell recommendations gives the impression that the advice is actually useful it is an illusion.
Cramer himself from an LA Times interview with reporter Tom Petruno
Petruno: Given the sheer number of stocks you suggest either buying or selling in any given show, do you worry that you're encouraging people to trade in and out, even though all the research says the vast majority of investors won't make money as active traders?Let's just say I struggle with it. . . .
Cramer In Year 1 I was much more oriented toward "stock of the day." And I didn't like that. In Year 2 I went away from that. In Year 3, this year, I'm trying to say, listen, there are broader themes, there are broader sectors, you can try to pick the best of breed in the sector.I go back to the fundamental idea that stocks can be interesting. And therefore if you're interested, you will be better off than if you just let the broker handle you. You'll be a better client and a better investor.
Petruno: But you agree that very few people can make a lot of money actively trading?
Cramer:It's a sucker's game
So the FT’s Gapper is bang on when he writes:
Even an investor who confines himself to buying company shares based on Mr Cramer’s stock tips is hopelessly outgunned. He may now be able to make a trade online rather than by phoning up a broker but he is up against a battery of hedge fund quantitative traders whose computers execute trades in milliseconds.
So what is the investor with a 401(k) plan to do? He should start by turning off the television set, or at least by treating Fox Business and CNBC as news and entertainment rather than investment advice…..
Buying individual shares on the basis of what an analyst says on the box – presumably long after he has told his institutional clients – is a mug’s game. The wisest things to do – spread your money across funds, particularly low-cost index funds, rather than individual securities; buy and hold; consult a fee-based adviser, etc – do not require you to watch talking heads and tickers.
Come to think of it, Fox Business is on to something. CNBC, despite its on-screen warnings not to take Mr Cramer’s stock tips over-seriously, has a professional mien. You could almost believe, watching it, that you are getting the inside track on what Wall Street is really doing.There is no such illusion during Happy Hour and that has a bracing honesty to it. You will not discover much about structured finance here but you can see Ivanka Trump in a Manhattan bar. At least you know where you are
Fox is for fun, not investment advice
By John Gapper
,,,,,For me, the highlight of the launch of the Fox Business channel on Monday was when the sound went off as Ivanka Trump displayed the jewellery collection she is selling at her new Madison Avenue store.
The Donald’s daughter was a guest on the first outing for Happy Hour, an evening show on the US cable channel filmed in the Bull and Bear bar at the Waldorf Astoria. The hosts were Cody Willard, a long-haired hedge fund manager (and FT contributor) and Rebecca Gomez, a pneumatic brunette in a short, turquoise dress……
As Fox Business took to the air, preaching its gospel of democracy and bullishness, its anchors were confronted by a 140-point fall in the Dow Jones Industrial Average, prompted by a Treasury-endorsed super-fund to bail out structured investment vehicles holding $400bn of collateralised debt obligations. After a stab at explaining what “it means for your mortgage” they moved on.
But Gapper points out maybe this fluffiness is not so bad after all. For if the more “hard news” approach of CNBC with Cramer and the Fast Money crew giving rapid fire buy and sell recommendations gives the impression that the advice is actually useful it is an illusion.
Cramer himself from an LA Times interview with reporter Tom Petruno
Petruno: Given the sheer number of stocks you suggest either buying or selling in any given show, do you worry that you're encouraging people to trade in and out, even though all the research says the vast majority of investors won't make money as active traders?Let's just say I struggle with it. . . .
Cramer In Year 1 I was much more oriented toward "stock of the day." And I didn't like that. In Year 2 I went away from that. In Year 3, this year, I'm trying to say, listen, there are broader themes, there are broader sectors, you can try to pick the best of breed in the sector.I go back to the fundamental idea that stocks can be interesting. And therefore if you're interested, you will be better off than if you just let the broker handle you. You'll be a better client and a better investor.
Petruno: But you agree that very few people can make a lot of money actively trading?
Cramer:It's a sucker's game
So the FT’s Gapper is bang on when he writes:
Even an investor who confines himself to buying company shares based on Mr Cramer’s stock tips is hopelessly outgunned. He may now be able to make a trade online rather than by phoning up a broker but he is up against a battery of hedge fund quantitative traders whose computers execute trades in milliseconds.
So what is the investor with a 401(k) plan to do? He should start by turning off the television set, or at least by treating Fox Business and CNBC as news and entertainment rather than investment advice…..
Buying individual shares on the basis of what an analyst says on the box – presumably long after he has told his institutional clients – is a mug’s game. The wisest things to do – spread your money across funds, particularly low-cost index funds, rather than individual securities; buy and hold; consult a fee-based adviser, etc – do not require you to watch talking heads and tickers.
Come to think of it, Fox Business is on to something. CNBC, despite its on-screen warnings not to take Mr Cramer’s stock tips over-seriously, has a professional mien. You could almost believe, watching it, that you are getting the inside track on what Wall Street is really doing.There is no such illusion during Happy Hour and that has a bracing honesty to it. You will not discover much about structured finance here but you can see Ivanka Trump in a Manhattan bar. At least you know where you are
Back After Extended Summer Hiatus ! Third Quarter Review
October 9, 2007
Quarterly Market Review
The third quarter experienced another of the increasingly frequent and intense short term stock selloffs. The S+P 500 index fell 11.9% between mid July and mid August. The declines in international markets, emerging and developed, were even more severe. Once again, the markets showed that the only thing that goes up in a down market is correlation. Domestic and international (developed and emerging) small cap and large cap stocks all moved in sync.
While the most apparent cause of the decline was the collapse of the subprime credit market and the housing markets in the US, UK and elsewhere it is difficult to cite a specific event that precipitated the market move. What is clear is that several interrelated factors make each market shock more volatile, more widespread and more violent than the previous one. Among these factors are:
The increase in leverage by hedge funds and private equity firms,
The proliferation of complex derivative instruments, poorly understood by both issuers and buyers.
Short term quantitative trading techniques implemented with leverage by hedge funds. These funds often follow very similar strategies and when they reverse positions trigger a cascade of trading exacerbating short term market movements.
The continuing integration of global markets with the consequence that a crisis such as the recent one related to mortgage lending in the United States can trigger selloffs in markets around the world.
The tendency of market participants to underestimate market risks during periods of stability, increasing leverage and holding of illiquid assets only to find themselves forced into panic liquidations when risk inevitably returns.
None of these developments (described in depth in the recent book Demons of Our Own Design by Richard Bookstaber) are likely to reverse. As a consequence, prudent investment management must include avoidance of leverage and illiquid instruments and recognition that the only sure way to limit the volatility of a portfolio is to raise the holdings of short term US government bonds.
By mid September the Federal Reserve reacted to the market turmoil and the prospective impact of the real estate crisis on the overall US economy and cut short term interest rates by .5%. Markets rebounded strongly and at the time of this writing the broad US market and the major developed and international stock indices are at record highs.
At the end of the quarter the pain of the selloff had been erased for the broad indices:
Listed below for each of the indices is the drop from July intraday high to August intraday low followed by the
third quarter return
S+P 500
-11.9%
1.91%
EAFE Developed Market Index (ishares etf symbol EFA)
-19.4%
2.09%
Emerging Market Index (ishares etf EEM)
-22.7%
13.52%
Reviewing the market action, the following trends emerged:
· Growth stocks strongly outperformed value stocks as investors moved away from financial stocks which weigh heavily in the value sector and instead moved to large multinational corporations which dominate the growth side. We adjusted our portfolios during the quarter reducing our small and value weighting and adding to large cap growth domestically and internationally.
· International and especially emerging markets outperformed US markets as expectations remain that the highest growth will be from outside the US.
· The global growth story continues to fuel rallies in commodities and commodity producers. Our portfolios continue to benefit from our long held positions in this area.
· REITS (real estate investment trusts ) suffered in reaction to the housing crisis, probably to a greater degree than warranted. Lower interest rates and higher demand for rentals should help many REITs, though the outlook for commercial real estate is a more uncertain. By the end of the quarter markets seemed to be recognizing this as REITs recovered from their worst levels. The domestic REIT etf (ticker rwr) ended the quarter with an ytd loss of 5.02%, while international REIT etf (rwx)was up 3.37% for the period. By contrast the etf for the homebuilder’s index (xhb) closed the quarter near its year’s low, down 34%
Going forward, the outlook for the US economy is at best uncertain. The open questions through the end of the year are:
· The performance US economy in the wake of the housing downturn. Consumer behavior in the holiday season will be a good indicator of this.
· Federal Reserve policy in response to developments in the financial markets and the overall economy.
· Will earnings from US multinationals be sufficient to offset any decline in domestic US economic activity?
· Will the growth from the developing world continue to fuel global growth?
· The “known unknown” a political or economic crisis that could have large reverberations on the financial markets
With the overall US market (Russell 3000 index)at the time of this writing up a bit over 10% ytd, developed international market (EAFE index) up 15% and emerging (MSCI emerging index) ahead by over 38%, I would be reluctant to forecast that the year will end with those indices much higher. The main driver in the extremely strong global stock market performance seems to be the flood of liquidity from outside the US particularly sovereign funds such as those from Dubai and China. This trend would be the key factor in extending gains further.
We feel comfortable with our current allocation:
· A reduction in weighting towards value stocks (with their high weighting in financials) and an increase in holdings in large cap growth domestically and
· A significant weighting in developed and emerging international markets (with a tilt towards emerging Asia)
· Weightings in energy and basic materials producers.
· Maintaining our allocation to domestic and international REITs.
Quarterly Market Review
The third quarter experienced another of the increasingly frequent and intense short term stock selloffs. The S+P 500 index fell 11.9% between mid July and mid August. The declines in international markets, emerging and developed, were even more severe. Once again, the markets showed that the only thing that goes up in a down market is correlation. Domestic and international (developed and emerging) small cap and large cap stocks all moved in sync.
While the most apparent cause of the decline was the collapse of the subprime credit market and the housing markets in the US, UK and elsewhere it is difficult to cite a specific event that precipitated the market move. What is clear is that several interrelated factors make each market shock more volatile, more widespread and more violent than the previous one. Among these factors are:
The increase in leverage by hedge funds and private equity firms,
The proliferation of complex derivative instruments, poorly understood by both issuers and buyers.
Short term quantitative trading techniques implemented with leverage by hedge funds. These funds often follow very similar strategies and when they reverse positions trigger a cascade of trading exacerbating short term market movements.
The continuing integration of global markets with the consequence that a crisis such as the recent one related to mortgage lending in the United States can trigger selloffs in markets around the world.
The tendency of market participants to underestimate market risks during periods of stability, increasing leverage and holding of illiquid assets only to find themselves forced into panic liquidations when risk inevitably returns.
None of these developments (described in depth in the recent book Demons of Our Own Design by Richard Bookstaber) are likely to reverse. As a consequence, prudent investment management must include avoidance of leverage and illiquid instruments and recognition that the only sure way to limit the volatility of a portfolio is to raise the holdings of short term US government bonds.
By mid September the Federal Reserve reacted to the market turmoil and the prospective impact of the real estate crisis on the overall US economy and cut short term interest rates by .5%. Markets rebounded strongly and at the time of this writing the broad US market and the major developed and international stock indices are at record highs.
At the end of the quarter the pain of the selloff had been erased for the broad indices:
Listed below for each of the indices is the drop from July intraday high to August intraday low followed by the
third quarter return
S+P 500
-11.9%
1.91%
EAFE Developed Market Index (ishares etf symbol EFA)
-19.4%
2.09%
Emerging Market Index (ishares etf EEM)
-22.7%
13.52%
Reviewing the market action, the following trends emerged:
· Growth stocks strongly outperformed value stocks as investors moved away from financial stocks which weigh heavily in the value sector and instead moved to large multinational corporations which dominate the growth side. We adjusted our portfolios during the quarter reducing our small and value weighting and adding to large cap growth domestically and internationally.
· International and especially emerging markets outperformed US markets as expectations remain that the highest growth will be from outside the US.
· The global growth story continues to fuel rallies in commodities and commodity producers. Our portfolios continue to benefit from our long held positions in this area.
· REITS (real estate investment trusts ) suffered in reaction to the housing crisis, probably to a greater degree than warranted. Lower interest rates and higher demand for rentals should help many REITs, though the outlook for commercial real estate is a more uncertain. By the end of the quarter markets seemed to be recognizing this as REITs recovered from their worst levels. The domestic REIT etf (ticker rwr) ended the quarter with an ytd loss of 5.02%, while international REIT etf (rwx)was up 3.37% for the period. By contrast the etf for the homebuilder’s index (xhb) closed the quarter near its year’s low, down 34%
Going forward, the outlook for the US economy is at best uncertain. The open questions through the end of the year are:
· The performance US economy in the wake of the housing downturn. Consumer behavior in the holiday season will be a good indicator of this.
· Federal Reserve policy in response to developments in the financial markets and the overall economy.
· Will earnings from US multinationals be sufficient to offset any decline in domestic US economic activity?
· Will the growth from the developing world continue to fuel global growth?
· The “known unknown” a political or economic crisis that could have large reverberations on the financial markets
With the overall US market (Russell 3000 index)at the time of this writing up a bit over 10% ytd, developed international market (EAFE index) up 15% and emerging (MSCI emerging index) ahead by over 38%, I would be reluctant to forecast that the year will end with those indices much higher. The main driver in the extremely strong global stock market performance seems to be the flood of liquidity from outside the US particularly sovereign funds such as those from Dubai and China. This trend would be the key factor in extending gains further.
We feel comfortable with our current allocation:
· A reduction in weighting towards value stocks (with their high weighting in financials) and an increase in holdings in large cap growth domestically and
· A significant weighting in developed and emerging international markets (with a tilt towards emerging Asia)
· Weightings in energy and basic materials producers.
· Maintaining our allocation to domestic and international REITs.
Thursday, June 7, 2007
This Adviser Gets Lots of Publicity....But Is His Advice Any Good ?
Florida financial planner Harold Evensky is a favorite of the media sure enough. But as I noted in an earlier blog some of his investment decisions leave me perplexed.
He was at it again in the WSJ’s monthly fund supplement.:
Mixing It Up
A Portfolio's Big Core
A financial planner recommends broad-market funds as a solid foundation, with the riskiest action in 'satellites'
By SHEFALI ANAND
June 4, 2007
Put the bulk of your money in broad-market-index funds, and use a small portion to try riskier investments.
That's the investing mantra of Evensky & Katz Wealth Management, a Coral Gables, Fla., fee-only financial-planning firm that works with wealthy individuals.
Sounds basic enough…but the devil is in the details and it seems at every opportunity other tan picking broad index funds, Evensky makes some questionable picksTHE JOURNAL REPORT
1
…To build the moderate-risk portfolio, Mr. Evensky says he uses a "core-and-satellite" approach. About 48% of the assets are invested in core stock funds, which represent the broad market and whose allocation isn't likely to change for three to five years. "The purpose of the core is to cost- and tax-efficiently buy the market," says Mr. Evensky.
Again, it sounds good but as we will see it simply doesn’t match what he actually does in some of his “core “ choices.
About 12% of the portfolio is invested in satellite holdings -- funds that provide exposure to niche segments of the market. These are essentially short-term bets that Mr. Evensky believes will deliver a high return over a 12-month period or less. These funds may have higher expense ratios, and they may be tax-inefficient, volatile or generally higher in risk than the funds used for core holdings.
Folks like John Bogle reckon that the above factors knock 2 -3 % off the funds after tax return and Mr. Evensky acknowledges it will generate higher volatility. More risk and a 2 -3% handicap from day one…go figure
The idea is that, net of expenses and taxes, the satellite funds "will do two percentage points better than the broad market," says Mr. Evensky. He calls these funds "the alpha generator," meaning an investment that will generate excess return.
This is an breathtaking assumption. In order to get to the 2 -3% after tax excess return over the broad market, the underlying assets (using Bogle’s assumption) of these funds will have to generate in pre tax , pre fee returns. I wouldn’t think the odds will be in one’s favor.
The model portfolio is tweaked for clients' other holdings, tax brackets and other factors.
Here is how the firm's current model portfolio for moderate risk breaks down:
CORE HOLDINGS: Most of the core stock funds track market indexes or are managed largely through computer programs that identify certain types of stocks, not by stock pickers looking for great ideas. For many years, Mr. Evensky used a mix of actively managed funds and index funds for core holdings, but in 2002 he concluded that, over the next 10 years, the U.S. market wouldn't deliver as strong a return as it had in the prior 10 years. So, to get decent returns, it was even more important to pay attention to the cost of funds his clients' owned, steering him more toward the low-cost index world.
In many broad areas of the U.S. stock market, Mr. Evensky says that, net of expenses and taxes, "we don't think there are managers that are going to do better than the index."
True enough, but there is no reason to think that this isn’t the case in ALL markets US and foreign
Nearly a fourth of the portfolio is currently invested in iShares Russell 3000 Index ETF, an exchange-traded fund that tracks the Russell 3000 index, which measures the performance of the 3,000 largest U.S. publicly traded companies based on total market capitalization.
About 8% is allocated to DFA US Small Cap Value Portfolio, a small-stock fund run by Dimensional Fund Advisors Inc. DFA runs a variation of an index fund, based on computerized screening of stocks that aims to identify groups of shares with certain risk and return metrics. Another 4% is in iShares S&P Midcap 400 Index, a stock index of midsize companies.
For foreign investing, Mr. Evensky allocates about 13% to Julius Baer International Equity, a fund that largely buys companies in developed countries. It is run by a stock picker. "We think that the manager can add value," he says
He may think so but there is little data to match his claim. His choice is particularly surprising since he is evidently one of the limited number of advisers that has access to DFA international funds that can exploit the historical outperformance of small and value stocks around the world.
The numbers don’t surprise me when I compared DFA’s international index funds with the Julius Baer active fund. It is most likely that all of the index funds would generate a lower tax bill than the Juliud Baer fund. This is most certainly true of the DFA Tax Managed Fund which outperformed the Julius Baer fund on a pretax basis for 1, 3 and 5 years. No doubt the after tax comparison would reflect even more poorly on the Julius Baer fund So even though Mr. Evensky thinks it’s important to put his clients into low cost funds, he puts them into the Julius Baer fund with a 1.19% fee and gets nothing from it vs the DFA index funds with far lower fees.
Data is as of May 31
| YTD | 1 Year | 3 Years | 5 Years | |||
| DFA Tax-Managed International Value Portfolio | 14.03 | 34.58 | 29.05 | 22.11 | ||
| DFA International Small Cap Value Portfolio | 14.44 | 31.52 | 30.89 | 29.26 | ||
| DFA International Small Company Portfolio | 14.01 | 28.82 | 27.96 | 25.64 | ||
| DFA International Value Portfolio | 14.08 | 35.14 | 29.33 | 22.67 | ||
| Active Fund Chosen By Evensky | ||||||
| Julius Baer International Fund | 13.36 | 31.37 | 28.84 | 21.72 |
But wait, things get even stranger as Evensky explains the “satellite portion of his portfolio>
SATELLITE HOLDINGS: These holdings are assessed every month and changed frequently. "That's where the best action is," Mr. Evensky says.
Currently, the team is betting on iShares Russell 1000 Growth Index ETF, an index of growth companies, which are those whose earnings are expanding rapidly. Mr. Evensky believes growth companies are going to regain favor with investors, though he has less confidence in them now, he says, as their performance lately has been relatively flat and their stock-market comeback not as quick as his firm had expected. In March, Evensky & Katz cut the allocation to this fund to 2.5% from 4.5%. On this one you’re just betting on your manager’s market bets as he flits in and out of a sector. Based on the quote, you make your own judgement.
Since September 2005, Mr. Evensky has been buying a fund that invests in short-term bonds of emerging markets, Pimco Developing Local Markets. He says this is a play on currencies and a source for yield, with the potential to gain from the improvement in the quality of many of these emerging-market bonds.
Here’s the description from the Pimco website
“The Developing Local Markets strategy involves investment in currencies of, or in fixed income instruments denominated in the currencies of, developing markets”
In other words, the fund invests in foreign debt, denominated in foreign currencies (taking sovereign and currency risk) to pick up a bit of yield. The fund holds 11% of its assets in polish debt 10% in Mexican.
The fund has an expense ration of 1.25% so just to stay even with a low fee bond index fund, the underlying assets need to outperform by a full 1% (quite a bit in bonds where the long term return is 5 -6%). The fund has no long term track record; the website lists a one year return of 12% and a year to date of 4.9%.
Big numbers, but given the risk compared to a US short term bond fund not much of an alternative for the fixed income portion of a portfolio. In fact the risk is probably closer to an emerging markets stock fund . Much like the stock fund the performance of this fund is dependent on the performance of the emerging markets economies and their currencies
Here’s Another one that struck me as odd
A recent satellite addition is Old Mutual Analytic Defensive Equity, which uses mathematical models to buy stocks world-wide, while using derivatives like options to hedge its market risk. "It doesn't fit any neat category," says Mr. Evensky, but he is convinced "it will generate that 2% alpha for us."
The fund has been around for a little bit more than a year and it’s one year return is 17.89. I have no idea where Mr, Evensky got this 2% number from unless the fund manager gave him numbers based on hypothetical performance of their system
Here’s another strange one
Not all of the firm's satellite bets pan out. For nearly two years, the model portfolio included a fund that bet against 30-year U.S. Treasury bonds, expecting that the fund would gain as long-term interest rates in the U.S. rise; when interest rates rise, existing bonds, which are paying lower interest rates, fall in value. But long-term rates haven't risen as fast or as much as the team had expected, so last month it decided to sell out of the fund. "If there is substantive change, we will revisit it," Mr. Evensky says.
The team is still deciding where to put that money, he says
This one is a very risky trade for a conservative portfolio, He likely used the rydex mutual fund designed to provide the inverse of the return of the long term treasury bond,
here are the ugly numbers:
| Annual Average Total Returns | |||
| Month End | Qtr End | ||
| 1 Yr | -0.14% | 1.66% | |
| 3 Yr | -0.87% | 0.42% | |
| 5 Yr | -3.75% | -5.37% | |
| 10 Yr | -2.95% | -3.50% | |
| SI (Inception date 03/03/1995) | -2.80% | -3.12% | |
| Fees and Expenses | |
| Total Expense Ratio | 4.66% |
| Risk Measurement as of 06/06/2007 | |
| 3-yr Beta Compared to Fund Benchmark | -136.98% In other words the fund is 36% more volatile than the long treas bond. |
In the past, Mr. Evensky has experimented with several other kinds of funds within the satellites, including a commodity-oriented fund and one that invests in real-estate investment trusts.
Interesting ,Evensky lists as satellite choices 2 sectors which most academics and industry researchers regard as asset classes that should be a permanent part of all portfolios. This is certainly the case for reits (and now that index funds and etfs are available, international reits). An asset class that long term data shows offers strong returns with limited risk relative to equities and bonds as well as diversification. A very strong case can be made for a permanent allocation to reits of 7-10% .
Here are some number on reits compared to the overall US stock mkt (Russell 3000):
| Monthly: 01/1979 - 04/2007 | ||||||||||
| YTD | 1 Month | 3 Months | 6 Months | 1 Year | 3 Years | 5 Years | 10 Years | |||
| Russell 3000 Index | 5.32 | 3.99 | 3.35 | 8.90 | 14.48 | 13.08 | 9.24 | 8.59 | ||
| Dow Jones Wilshire REIT Index | 3.55 | -0.07 | -4.87 | 6.17 | 26.57 | 30.78 | 22.61 | 16.02 |
There’s a bit of a strange choice on the bond side as well:
BONDS: "In general we are in fixed income to preserve capital, we are in stocks to make money," he says……
8% is assigned to PIMCO Foreign Bond Fund [U.S. Dollar-Hedged].
If the goal is to preserve capital why wander into a fund like the one above
From the website of Pimco here’s the strategy:
- Invests primarily in high-quality, non-U.S. intermediate-term bonds. As over half of the world's fixed-income securities are issued outside of the U.S., the Fund adds diversification to any bond portfolio.
- Tempers risk by investing primarily in investment-grade bonds and hedging at least 80% of its foreign currency exposure to protect against unfavorable currency fluctuations
So the fund can retain 20% of its assets exposed to currency fluctuations, it is also more exposed to interest rate fluctuations in numerous countries, the interest rate risk for each county must be monitored and managed. All in the portion of the portfolio designed to preserve capital rather than make money. And all (we guess), to pick up a little extra yield. The result was that in most periods, all that extra risk produced less than 1% of excess return vs an extremely low risk index of short term treasury bnds and investment grade corporate bonds.
| YTD | 1 Year | 3 Years | 5 Years | 10 Years | |
| US Corporate and Government Index 1-3 Years | 1.82 | 5.32 | 2.96 | 3.34 | 4.98 |
| Pimco Foreign Bond Fund | -0.99 | 1.60 | 3.85 | 4.32 | 5.75 |
I must say I am jealous of Mr. Evensky’s ability to get himself in both the nyt and wsj within a single month. I am also in a state of perplexity over his portfolio allocation
Tuesday, June 5, 2007
This doesn’t need much comment:...
From the WSJ June 4, 2007
Regulatory Spotlight
Brokers' Liability for Advice
June 4, 2007; Page R2
Call it the $276 billion question: That is the estimated amount of money in about 1 million fee-based brokerage, or "wrap," accounts. The fate of this money is up in the air after the U.S. Securities and Exchange Commission last month threw in the towel on a controversial rule.
The SEC said it wouldn't fight a March federal-court decision that abolished the rule, which shielded brokers from some liability for advice they gave to holders of fee-based accounts…….
The rule was controversial because it exempted stockbrokers who oversee fee-based accounts from a fiduciary duty when providing "incidental" advice tied to buying and selling securities.
A fiduciary duty requires acting in a client's best interest. The Financial Planning Association protested in court that stockbrokers were collecting the same fees as investment advisers for similar advisory work -- without having to meet the stiff fiduciary legal standard.
In the wake of the SEC retreat, some firms told financial advisers to stop offering fee-based brokerage accounts immediately,
Draw your own conclusions why that may be ....and hold onto your wallet.
Tuesday, May 22, 2007
Why You Can Rely On Financial Advice from Warren Buffett….But Not From CNBC
Many people I encounter challenge my assertion that indexing is the only rational approach for investing by pointing to “investing geniuses” like Warren Buffett. Ironically Buffett and his mentor Benjamin Graham have recommended index investing as the best strategy for most investors.
Buffett did so once again at the annual meeting of Berkshire Hathaway as reported by cbs marketwatch:
Chairman Warren Buffett reiterated his view that for most small investors who don't have time to research individual companies, cheap index funds are the best way to invest in the stock market.
"The best way in my view is to just buy a low-cost index fund and keep buying it regularly over time, because you'll be buying into a wonderful industry, which in effect is all of American industry," Buffett told CNBC anchor Liz Claman.
"If you buy it over time, you won't buy at the bottom, but you won't buy it all at the top either," the billionaire investor said.
…"If you have 2% a year of your funds being eaten up by fees you're going to have a hard time matching an index fund in my view," Buffett said. "People ought to sit back and relax and keep accumulating over time."
Then there is the supposed controversy over exchange traded funds vs index mutual funds. In fact the debate is not over etfs vs index funds but over investor behavior. It has two main elements.
1. The first part of the “controversy” is over the active trading of mutual funds. Yes one can trade etfs throughout the trading day, but no one requires that an investor do so. The problem is that too many people go ahead and trade the etfs on a short term basis. But that has nothing to do with the etf structure. Individuals trade in and out of individual stocks and actively traded mutual funds as well. The other difference is that you can’t trade mutual funds intraday.
Buffet himself realizes this:
"I have nothing against ETFs, but I really think an index fund that just charges a few basis points for management is pretty hard to beat," Buffett said. "You put it away, you have nobody encouraging you to trade it next week or next month ... your broker isn't going to be on you."
The CBS marketwatch report correctly points out that
Numerous academic studies have shown that individual investors have a bad track record at timing stock-market moves, often because they chase recent performance to their detriment, essentially buying high and selling low.
The father of index mutual funds John Bogle has also criticized etfs as encouraging trading:
"If long-term investing was the paradigm for the classic index fund, trading ETFs can only be described as short-term speculation," he wrote. He also criticized ETFs' movement to narrower market segments and warned that brokerage commissions and taxes can ratchet up investors' overall fees when they trade ETFs a lot.
But most of the press misinterpreted Bogle’s message as well. The fault lies in the investors’ behavior not in the financial instrument:
Bogle said( in a recent wsj piece) that if they are not traded, they can often match regular index funds. "In this format, used in that way, ETFs are solid competitors to their classic forebears,".
2. The second part of the controversy is related to the mass proliferation of etfs targeted at extremely small sectors of the market. For instance there are 3 “water” etfs others devoted to medical equipment, nanotechnology, individual countries, apartment reits etc etc. Imo no one can totally fault the etf companies for trying to make a buck and marketing new financial products.
The real problem is again investor behavior. Etfs are a a great instrument for creating a portfolio diversified among major asset classes (US and International Stocks, fixed income, reits and commodities), But when investors jump in and out of small sectors of the market using etfs they are taking the loaded gun handed to them by the etf industry with its etfs targeted towards speculative sectors of the market and shooting themselves. It is no more likely that individual investors will be successful trading in and out of sectors of the market than they were trading in and out of individual stocks.
But don’t leave it to CNBC reporters to point that out to you. The other day CNBCs Erin Burnett
interviewed a very intelligent advisor who uses etfs in constructing client portfolios, holding long term positions in the etfs that represent the major asset classes. When asked about the “etf controversy” he replied that several years ago enough etfs had been created to cover the major asset classes. To which crack cnbc reporter Burnet replied
“Do you only invest in etfs of asset classes like the S+P 500 or healthcare, do you have to be that broad to make it work “
No, Ms. Burnett, as any book on investing and asset allocation will tell you, healthcare stocks are not an asset class.
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