Sunday, February 27, 2011

Finding Winning Active Managers

I read an interesting article in the current issue of Morningstar's monthly magazine for advisors. The article compared the results of actively and passively managed mutual funds. The author asserts that a review of performance across all mutual funds does not support one approach over the other. He noted that there are more passive funds that produce performance around the overall average for comparable funds. (This is what we would expect.) Further active funds are more prone to performance both well below and well above the average for comparable funds.

I am a bit surprised that nowhere did the author mention the process involved in finding successful fund managers. It is well established that investors are not readily able to identify managers who beat their peers in advance. So, while there will certainly be managers who both underperform and outperform their peers, that is not the issue. Investors only benefit if they can identify these winning active managers beforehand.

Friday, February 18, 2011

Market Doubles

The Standard & Poor's 500 index has now doubled its crisis low of 666.7 which it hit in March of 2009. According to Birinyi Associates, this was the fastest climb of 100% since 1936 when the index took 501 days to jump from 8.06 to 16.15. This time it took 707 days.

The point? Stay in the market.

Thursday, February 10, 2011

Junk is Hot

The Wall Street Journal reported yesterday that the yield on high yield bonds fell below 7% for the first time in more than six years. Investors, fed up with low yields in bank products and bonds, have thrown caution to the wind and added riskier debt to their portfolios.

As a quick refresher, when investors bid up the prices of fixed income securities (e.g. bonds), the yield goes down. A 7% yield is what we would expect from investment grade debt in a more normal interest rate environment. However, the current environment is far from normal.

I find this interesting, because I am responding in a rather different way. I have begun moving all clients out of intermediate term debt. We were never in long term debt, as the risk-return characteristics are unappealing. I am now moving out of intermediate term debt. I am also shifting and even greater percentage of the fixed income portion of client portfolios to higher grade debt. While I rue the low yields in short term, high grade bonds, I am not willing to take the risks associate with longer maturities and lower credit risk.

The Journal reports that high yield or "junk" bonds are up 2.57% this already. They were up 15.2% in 2010 and 57.5% in 2009. The risk premium - the extra yield investors demand to own riskier investments - has fallen to 4.68% over the Treasury yield. The historic risk premium is about 5% above Treasuries.

My self-directed research suggests investors are not adequately compensated for taking the risk associated with junk bonds. Therefore, I do not include them in client portfolios.

Saturday, February 5, 2011

Time in the Market

With very little fanfare, the stock market has roared back from the lows of March 2009. The Dow Jones Industrial Average recently crossed back over 12,000. It is now just 20% away from re-touching the high of 14,400 in October of 2007.

Some investors might point out that it has taken over three years to reach this point and that expecting a 20% return in 2011 is being highly optimistic. True.

But what a recovery we have witnessed. The Dow is up 84%. Most of my clients' portfolios are not far from where they were before the market crashed.

Many investors fled the stock market in the midst of the economic crisis. I am sure that many of these people thought would get back when things looked more stable. Well, do they look stable today? Let' see. We have massive budget deficits at every level of government, a $14 trillion national debt, unemployment that is stubbornly well above 9% and a housing market that is still deeply depressed. Several European countries are in dire financial straits. There is also major unrest in Egypt that threatens to alter the landscape of the Middle East.

I have seen numerous examples of investors who have stood on the sidelines as the market made this dramatic retracement. These people will never be able to capture those gains. They were apportioned only to those who stood in the arena with flames all around and refused to flee.

Successful long term investing has nothing to do with "timing the market." It has a lot to do with "time in the market."