Morningstar announced the Second Half (2009) Box Score Report last week. This report tracks mutual fund manager performance across asset classes. Morningstar notes that, "after accounting for sensitivity to risk, size and style as well as costs, only about a third of active funds in the study had positive alpha over the past three years."
Alpha is a measure of a fund manager’s ability to create excess return relative to a benchmark. Investors are, presumably, willing to pay much higher fees for active funds (compared to index funds), because they expect the manager to beat the index.
Unfortunately, we know that very few fund managers accomplish this. Further, we do not know in advance who these managers will be.
Sunday, February 28, 2010
Friday, February 19, 2010
Deflation
The Department of Labor reported that the seasonally adjusted consumer price index rose 0.2% in the month of January. This was driven almost entirely by higher energy costs. Oil, which had fallen to $40 a barrel during the depths of the recession, bounced back 54% last year.
Core consumer prices, which exclude food and energy purchases, actually fell by 0.1% in January. The last time core prices fell was in December 1982. Economists surveyed by the Dow Jones Newswires were expecting an increase of 0.3% in the consumer price index and an increase of 0.1% in the core index.
Deflation is the decrease in the general price level of goods and services in the economy. It occurs when the rate of inflation falls below zero. We rarely talk about it, because it rarely occurs. The last major episode of deflation in this country occurred during the Great Depression. Not exactly an experience we wish to repeat.
This bout of deflation will probably last no more than a month or two. We can expect prices to begin to rise soon as the Fed begins to drain the economy of the massive amount of liquidity it offered in effort to stave off a second depression.
Inflation will be the far greater threat over the next several decades. It is very hard to imagine avoiding significant price increases as the supply of money declines, causing fewer dollars to chase the supply of goods and services.
Sources: The Wall Street Journal, Wikipedia
Core consumer prices, which exclude food and energy purchases, actually fell by 0.1% in January. The last time core prices fell was in December 1982. Economists surveyed by the Dow Jones Newswires were expecting an increase of 0.3% in the consumer price index and an increase of 0.1% in the core index.
Deflation is the decrease in the general price level of goods and services in the economy. It occurs when the rate of inflation falls below zero. We rarely talk about it, because it rarely occurs. The last major episode of deflation in this country occurred during the Great Depression. Not exactly an experience we wish to repeat.
This bout of deflation will probably last no more than a month or two. We can expect prices to begin to rise soon as the Fed begins to drain the economy of the massive amount of liquidity it offered in effort to stave off a second depression.
Inflation will be the far greater threat over the next several decades. It is very hard to imagine avoiding significant price increases as the supply of money declines, causing fewer dollars to chase the supply of goods and services.
Sources: The Wall Street Journal, Wikipedia
Sunday, February 14, 2010
Valentine's Day
Happy Valentine’s Day! I read today that Saudi Arabia pretty well bans Valentine’s Day by asking florists and gift shops to remove all red items in the days just leading up to February 14. Apparently the Saudis believe St. Valentine’s Day encourages immoral relations between unmarried men and women. Every year the Commission for the Promotion of Virtue and Prevention of Vice cracks down by raiding stores and removing offensive items. Saudi Arabia follows a strict interpretation of Islam called Wahhabism.
The story is a bit different here in the United States. Despite the crushing recession, Valentine’s Day spending is expected to rise 3.3% to $17.6 billion. We spend on flowers, greeting cards, candy, clothing, jewelry, romantic getaways and dining out.
Speaking of spending money, the online site kaChing asserts that investors pay 3.37% of assets per year for stock mutual funds. This is rather astonishing, given that the Investment Company Institute (ICI) suggests that the same mutual funds costs are 1.17%.
So, how does kaChing come up with its number? kaChing adds 0.94% for taxes and 0.2% for trading costs. Further kaChing averages the costs of each fund on the market, treating each of them as equals. The ICI weights each fund by the amount of assets it holds. Since large mutual funds tend to have lower expenses, the ICI’s method lowers the average.
Now let’s talk about kaChing. This web site allows members to invest by making trades that follow those made by “truly skilled investors we call Geniuses.” Members select a “genius” they wish to follow. They may follow their genius for free and make their own trades or, for a modest management fee, they may have Genius make the trades in their personal brokerage account. The fee is split between kaChing and the “genius.” These fees range from 0.25% to 3.00%.
These so-called geniuses all pursue active management strategies. You probably already know how I feel about active management.
The story is a bit different here in the United States. Despite the crushing recession, Valentine’s Day spending is expected to rise 3.3% to $17.6 billion. We spend on flowers, greeting cards, candy, clothing, jewelry, romantic getaways and dining out.
Speaking of spending money, the online site kaChing asserts that investors pay 3.37% of assets per year for stock mutual funds. This is rather astonishing, given that the Investment Company Institute (ICI) suggests that the same mutual funds costs are 1.17%.
So, how does kaChing come up with its number? kaChing adds 0.94% for taxes and 0.2% for trading costs. Further kaChing averages the costs of each fund on the market, treating each of them as equals. The ICI weights each fund by the amount of assets it holds. Since large mutual funds tend to have lower expenses, the ICI’s method lowers the average.
Now let’s talk about kaChing. This web site allows members to invest by making trades that follow those made by “truly skilled investors we call Geniuses.” Members select a “genius” they wish to follow. They may follow their genius for free and make their own trades or, for a modest management fee, they may have Genius make the trades in their personal brokerage account. The fee is split between kaChing and the “genius.” These fees range from 0.25% to 3.00%.
These so-called geniuses all pursue active management strategies. You probably already know how I feel about active management.
Thursday, February 4, 2010
Do Not Blindly Follow the Stars!
Do you ever use Morningstar to research and select funds for your portfolio? If so, you’re not alone. Morningstar is the undisputed leader in providing investors with valuable information about the returns, risks and costs of mutual funds.
So, how do you select a fund? Most investors naturally gravitate to the funds that have a 4 or 5 star rating. They know these funds have done well in the past or they would not have received one of Morningstar’s higher star ratings. Investors figure if a fund has done well in the past, it is likely to perform well in the future.
Is this true? Advisor Perspectives, an e-newsletter, recently published a study suggesting that these star ratings have little predictive value. In fact, the research indicates that 5 star funds are likely to underperform their peers. According to Morgan Stanley Smith Barney’s Consulting Group, the top 10% managers can repeat their success. But, the study also points out, the worst 20% of performers are also likely to outperform in the future.
These findings are consistent with the concept of “reversion to the mean.” This is the theory that performance eventually moves back toward the mean or average. If this is valid, an investor could actually pursue a strategy which entailed investing in funds that have not performed well recently. The expectation would be that these funds, assuming there were no clear reasons for their underperformance, would eventually outperform as they moved back to the mean.
We do know this for certain. Past performance does not guarantee future results. Be careful about relying on the stars to reach your investing destination.
So, how do you select a fund? Most investors naturally gravitate to the funds that have a 4 or 5 star rating. They know these funds have done well in the past or they would not have received one of Morningstar’s higher star ratings. Investors figure if a fund has done well in the past, it is likely to perform well in the future.
Is this true? Advisor Perspectives, an e-newsletter, recently published a study suggesting that these star ratings have little predictive value. In fact, the research indicates that 5 star funds are likely to underperform their peers. According to Morgan Stanley Smith Barney’s Consulting Group, the top 10% managers can repeat their success. But, the study also points out, the worst 20% of performers are also likely to outperform in the future.
These findings are consistent with the concept of “reversion to the mean.” This is the theory that performance eventually moves back toward the mean or average. If this is valid, an investor could actually pursue a strategy which entailed investing in funds that have not performed well recently. The expectation would be that these funds, assuming there were no clear reasons for their underperformance, would eventually outperform as they moved back to the mean.
We do know this for certain. Past performance does not guarantee future results. Be careful about relying on the stars to reach your investing destination.
Friday, January 29, 2010
The Triple Net Return
Since 1926 U.S. stocks have earned an average of 9.8% (Ibbotson). But what about inflation, expenses and taxes? Jason Zweig (a writer for The Wall Street Journal) calls this the net, net, net return. A recent survey of leading financial advisors found that they projected this long term future rate to be 6% on average.
In order for this to happen, Zweig points out that these advisors will have to deliver returns of 11-13% a year before costs. How likely is this? It’s not.
I am not sure how these advisors think the market will return more than the historical average return of 9.8%. There is a widely-shared view that equity returns are likely to be lower over the next few decades than they have been historically. The arguments for this include the expectation that millions of Boomers will shift from accumulation (buying equities) to distribution (selling equities) as they enter retirement. If there are fewer buyers for stocks, their prices will fall.
Let’s assume that the stock market does deliver 10%. A typical portfolio for a retired investor would be equally allocated to stocks (50%) and bonds (50%). If we assume that bonds earn 4%, then a weighted return would be 7%.
Let’s assume that inflation runs at 4%, expenses are 1%, and taxes are 30%. Depending on our method of calculation, our Triple Net return has become approximately 0%-2%.
This should be a wake-up call for investors approaching retirement.
In order for this to happen, Zweig points out that these advisors will have to deliver returns of 11-13% a year before costs. How likely is this? It’s not.
I am not sure how these advisors think the market will return more than the historical average return of 9.8%. There is a widely-shared view that equity returns are likely to be lower over the next few decades than they have been historically. The arguments for this include the expectation that millions of Boomers will shift from accumulation (buying equities) to distribution (selling equities) as they enter retirement. If there are fewer buyers for stocks, their prices will fall.
Let’s assume that the stock market does deliver 10%. A typical portfolio for a retired investor would be equally allocated to stocks (50%) and bonds (50%). If we assume that bonds earn 4%, then a weighted return would be 7%.
Let’s assume that inflation runs at 4%, expenses are 1%, and taxes are 30%. Depending on our method of calculation, our Triple Net return has become approximately 0%-2%.
This should be a wake-up call for investors approaching retirement.
Friday, January 22, 2010
Protecting Your Most Valuable Asset
What is your most valuable asset? …. Time’s up. … It’s your ability to earn an income.
As such, it should be protected just like all of your valuable assets.
The Wall Street Journal ran an article this week about disability insurance that is a good review of the basics. Here’s the link: http://online.wsj.com/article/SB10001424052748704561004575013073100310794.html?mg=com-wsj#
As a CERTIFIED FINANCIAL PLANNER™, I feel strongly that most people should secure private disability insurance. So, I disagree with the author’s comment that employer-provided insurance is “likely to be a better deal.” Yes, it is likely to cost less.
But it will be inferior in several other ways. (1) It will have a definition of disability that will render it less valuable than a private policy. (2) It will not be portable. So, if you change employers, the group disability insurance will get left behind. (3) If it does pay a claim, the benefit will most likely be far less than you need to maintain your lifestyle.
It may be tempting to think that, if you’re covered by an employer-sponsored group plan, you don’t need to give much thought to disability insurance. I would encourage you to consider carefully if this coverage truly meets your needs.
As such, it should be protected just like all of your valuable assets.
The Wall Street Journal ran an article this week about disability insurance that is a good review of the basics. Here’s the link: http://online.wsj.com/article/SB10001424052748704561004575013073100310794.html?mg=com-wsj#
As a CERTIFIED FINANCIAL PLANNER™, I feel strongly that most people should secure private disability insurance. So, I disagree with the author’s comment that employer-provided insurance is “likely to be a better deal.” Yes, it is likely to cost less.
But it will be inferior in several other ways. (1) It will have a definition of disability that will render it less valuable than a private policy. (2) It will not be portable. So, if you change employers, the group disability insurance will get left behind. (3) If it does pay a claim, the benefit will most likely be far less than you need to maintain your lifestyle.
It may be tempting to think that, if you’re covered by an employer-sponsored group plan, you don’t need to give much thought to disability insurance. I would encourage you to consider carefully if this coverage truly meets your needs.
Friday, January 15, 2010
Exchange Trade Funds Cross $1 Trillion
Exchange traded funds (ETFs) are growing in popularity. Blackrock reported that exchange traded funds held globally now contain in excess of $1 trillion. Blackrock, which bought the iShares business from Barclay’s PLC last year, is the largest provider of ETFs.
Exchange traded funds trade like stocks on major exchanges. The issuance and redemption process for ETFs makes them more tax efficient than conventional mutual funds. The first generation of ETFs was created as index funds and has very low internal costs. We use many ETFs to build client portfolios. … Today there are actively managed ETFs popping up like weeds in the neighborhood park. Unfortunately, the newer ETFs tend be more costly than the first ETFs.
The growth in the use of ETFs has been breathtaking. They grew by 45% in 2009 alone bolstered by the recovery of the financial markets and a movement away from traditional mutual funds. ETFs still lag far behind mutual funds by a large margin. The Investment Company Institute reports that conventional funds held $19 trillion at the end of 2008.
Incidentally, hedge funds hold $1.53 trillion according to Hedge Fund Research and separately managed accounts contain $527 billion according to Cerulli Associates.
Exchange traded funds trade like stocks on major exchanges. The issuance and redemption process for ETFs makes them more tax efficient than conventional mutual funds. The first generation of ETFs was created as index funds and has very low internal costs. We use many ETFs to build client portfolios. … Today there are actively managed ETFs popping up like weeds in the neighborhood park. Unfortunately, the newer ETFs tend be more costly than the first ETFs.
The growth in the use of ETFs has been breathtaking. They grew by 45% in 2009 alone bolstered by the recovery of the financial markets and a movement away from traditional mutual funds. ETFs still lag far behind mutual funds by a large margin. The Investment Company Institute reports that conventional funds held $19 trillion at the end of 2008.
Incidentally, hedge funds hold $1.53 trillion according to Hedge Fund Research and separately managed accounts contain $527 billion according to Cerulli Associates.
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