Wednesday, December 12, 2012

Where Do You Get Yield?

Yesterday I went to the IndexUniverse ETF conference in NYC for an all day meeting on ETFs.  This further convinced me that ETFs and more specifically, tactically managed ETF portfolios are the wave of the future.  There were a lot of great speakers and I came back with some good ideas but one issue that was on the mind of the presenters and the audience was where to get yield in this environment.  The consensus was that the bond market will eventually implode (something I always like to remind people who have only experienced a bull market in bonds during their investing lives) but it won't happen tomorrow.  But there was no good answer on where to get yield with 10 year Treasuries under 1.75%-that is of course because you are not getting paid for the risk you would have to take in any bond market. 

On the surface this seems like a good question and a valid concern but it really isn't.  There are three potential sources of return when you invest---dividends, interest, and capital gains.  If we ignore for a moment the tax implications of each (partly because we don't know what they are going to be) it doesn't really matter where return comes from as long as it comes.  Focusing entirely on yield---dividends and interest, in a low yield environment, forces investors to take way too much risk.  A tactical approach is a much better idea as there are times to focus on yield and times to focus on capital gains.  In an environment where the Fed is manipulating interest rates to keep them low for the foreseeable future then capital gains is really the only game in town when it comes to generating returns. 

Unfortunately, it is not as simple as just buying stocks and holding them.  Everyone is predicting low stock returns out into the future.  Ignore for a moment the fact that Wall Street has a poor track record of predicting anything and assume that this is true.  Does that mean that stocks just won't move?  No, it means we will have some up years and some down years and net/net we will end up pretty close to where we started.  For a buy and hold investor that is a disaster.  For a tactical investor who can stay in harmony with market trends it creates a ton of opportunity to generate returns. 

What if on the other hand we are on the verge of a great bull market (which, after we get through this deleveraging period I think is highly likely)?  Then both tactical and buy and hold will generate capital gains, tactical will just do it with less risk. 

So the question should never be---where do I get yield?  The right question is always---where do I get total return?

Friday, December 7, 2012

Danger Lurks Inside the Bond Boom

Interesting article in the Wall Street Journal about corporate bonds and how many corporations now have higher dividends on their stocks than yield on their bonds.  It also talks about how many bond managers are moving into equities or equity like investments.  This is another consequence of the Fed's QE policy which forces many investors into stocks but could have a number of dangerous consequences down the road when interest rates increase and if stocks take a tumble.

Monday, December 3, 2012

Scrounging for Income

Scrounging for Income

Another article this morning about one of the hottest topics in investing these days---where to find income.  Just like all things that generate "sales sizzle" for Wall Street to push on individual investors, this topic is filled with danger.  Investors need to remember a couple of key points:

1. Total return comes from three sources---interest, dividends, and capital gains.  Tax wise there may be differences in the source (depending on what deal Congress reaches) but at the end of the day all money is green no matter where it comes from.  Focusing on only one area, like dividends or interest, can lead to disaster. 

2. Wall Street is pretty good at paying people for taking risk.  If investors just focus on dividends and/or interest, typically the investments that have the highest payouts are the riskiest.  You can find 6,7,8%+ yields these days, but at the risk of losing 30% or more of your money.  From a risk/reward standpoint that doesn't make sense.

3. Bonds have had a massive bull run over the past few years.  For that to continue, interest rates need to go down, which is unlikely as short term rates are already pretty much at zero.  If interest rates eventually rise, bonds will go down in value.

If investors insist on pursuing income, the best approach is to be tactical.  Should they buy high yield bonds, emerging market bonds, closed end funds, dividend stocks?  Sometimes yes, sometimes no.  A true tactical approach can shift to whatever area(s) are in an uptrend and avoid large losses when another area enters a downtrend. 

Thursday, November 29, 2012

Are the Odds in Your Favor?

One of the biggest problems with traditional buy and hold investment strategies is that markets are not static.  During uptrends the odds of making money are largely in the investors favor while the odds of losing money are low.  However, during downtrends the odds of losing money are high and the odds of making money are low.  That doesn't mean that an investor can't make money when the odds are against him and it doesn't mean that an investor can't lose money when the odds are with him.  In any uptrend there will be plenty of down days, weeks, and months.  In any downtrend there will be plenty of up days, weeks, and months.  So, in an uptrend a buy and hold investor won't make money all the time, but if they stick with their strategy they will make money overall.  If we only had uptrends in markets then buy and hold would be a valid strategy but that is not how markets work.  In a downtrend a buy and hold investor won't lose money all the time, but if they stick with their strategy they will lose overall.  During the days, weeks, or months when they can make money they assume they are following a smart investment strategy, but this is not the case as it is never smart to invest in such a way that stacks the odds against you.  Over time this is why most investors end up going nowhere.

A good analogy to this is in Blackjack.  Blackjack has a certain set of "rules" (when to hit, when to stay, when to double down, etc) that if you abide by them give the card player pretty much equal odds with the house.  Anyone who has played Blackjack before knows there is always someone at the table who doesn't play by the rules, they hit when they aren't supposed to or stay when they should hit.  Every once in a while this person wins.  Does that make what they are doing smart?  Not at all.  Over time if they follow this strategy it puts the odds substantially in the house's favor. 

The key to investment success if reallly quite simple, always keep the odds in your favor.  Take the most risk when the odds are in your favor and reduce or eliminate risk when they are not.  You won't win all the time.  Sometimes it will be emotionally difficult to stay on the sidelines during an upside correction in an overall down market.  If you keep the odds in your favor over time you will end up much better off than the traditional buy and hold investor who sometimes has the odds on his side and often doesn't.

Tuesday, November 13, 2012

Monday, November 12, 2012

The Fiscal Cliff: Much Ado About Nothing?

Elections have consequences and this one will have consequences for what happens with the Fiscal Cliff.  Wall Street immediately sold off after  election results that looked like more of the same gridlock but this election might actually have been a pretty good scenario for avoiding the Fiscal Cliff.  While the Republicans maintained their majority in the House they lost seats and were expecting a much better outcome across the board in many winnable elections.  While the Democrats kept the White House and the Senate, and picked up seats, this was far from a landslide or a mandate.   In their post election rhetoric both sides look willing to deal.  Republicans seem to understand that some sort of tax increase, no matter how it is ultimately packaged, is inevitable.  Democrats seem to understand that they need to compromise with the other side and may not get everything they want.  What type of agreement we ultimately get is anyone's guess, here are a couple of ideas:

1. No "tax increase" on the wealthy but a phasing out of loopholes that is expected to generate somewhere near the same amount of revenue.  This would allow the Republicans to stick to their no tax increase pledge while basically being the same as a tax increase.

2. A smaller tax increase on the wealthy than the Democrats want.  This would allow Republicans to say they held the line somewhat.  This could also be sweetened with some sort of agreement to tackle the tax code and/or entitlements.

3. We could actually go off the Fiscal Cliff at year end, then in January have a retro-active deal.  Any deal in January could be spun as a "tax cut" as rates would have risen and a deal would bring them back down (even though they would still be higher than December).

At the end of the day the stakes are too high and the public has spoken.  Both sides will figure out some agreement that allows them to save face with their base and claim some sort of victory.  Whether this turns out good for the economy longer term is anyone's guess.  We still have a lot of problems that need solving and it is doubtful they will be addressed. 

Of course I could be wrong and there could be no agreement, what happens then?  That is the beauty of being tactical.  We don't move based on predictions, we follow market trends.  If the Fiscal Cliff is not solved we will just move to Treasuries, Gold, bonds, and/or cash and wait out the turmoil.  If it does get solved we will participate in any rally that ensues.  Either way we are prepared.

Monday, November 5, 2012

Is Tactical Practical?

There was an interesting article in the Wall Street Journal this weekend questioning whether tactical asset allocation has merit anymore (after a ton of articles following 2008 questioning buy and hold).  The author points out that a buy and hold portfolio of 60% stocks and 40% bonds would have outperformed tactically managed portfolios over the past three years so maybe tactical isn't practical.  

We have talked about this in other posts but to reiterate, you have markets that are in an uptrend, markets that are in a downtrend, and markets that are choppy.  Buy and hold rides the market up and rides the market down.  Tactical asset allocation stays in harmony with market trends.  When stocks are going up it will invest in them, when they start to go down it will get out of them and into cash or whatever else is going up.  In an uptrend a tactical portfolio and a buy and hold portfolio will look pretty similar.  In a downtrend, the buy and hold portfolio will ride the market down while tactical will not.  Choppy markets are the worst kind of markets for tactical as there are no real trends to grab onto.  The end result could be an up market, like this year and 2010, or a basically flat year like 2011.  Buy and hold portfolios ride the market up and down and end up wherever the market ends up.  This is of course assuming the investor can stand the volatility---a buy and hold investor in the S&P 500 would have had to hold on through the following:

May 2010 down 7.99%
June 2010 down 5.23%
August 2011 down 5.43%
September 2011 down 7.03%
May 2012 down 6.01%

Source: Morningstar

Because tactical asset allocation does not try to predict markets (nobody can do that), choppy markets with large up months and large down months are very difficult to navigate as there is no real trend to grab onto.  So is tactical practical?  If every year going forward the market was going to be choppy and we would never have another 1973-4, 2000-2, or 2008 again then maybe not.  Of course that is not how markets work, we will always have up markets, down markets, and choppy markets.  A buy and hold portfolio may make money in up and choppy markets but it will give it back in the down markets.  Tactical will not beat buy and hold every week, month, year, or three years.  But, over time, a good tactically managed portfolio will always blow away a buy and hold portfolio because it will hang onto most, if not all, gains during a down market.

Tuesday, October 23, 2012

The Modern Portfolio Theory Cliff

I have been reading a lot about correlations of asset classes increasing since 2007ish.  Of course this is something I can easily see with my own eyes as it seems like every day in the market is either a risk on day (buy any kind of stock or commodity) or a risk off day (buy Treasuries).  Increasing correlations present another problem for Modern Portfolio Theory (MPT).  Most practioners assume that asset classes like large stocks, small stocks, international stocks, value stocks, growth stocks, commodities, and high yield bonds are not that correlated (meaning combining them in a portfolio actually gives you diversification) and that correlations will remain constant over the investment period.    This presents a couple of problems:

1. Correlations are not constant, as evidenced by increasing correlations lately.

2. Taking a straight line correlation ignores the most important type of correlation there is, underwater correlation, or how correlated asset classes are during a drawdown.

Two assets may appear to be uncorrelated when you look at a long time period, for example stocks might appear to be relatively uncorrelated with oil.  However, during an economic decline stocks will generally suffer, as will oil because of a decrease in demand.  So having these two assets could help some during bull markets but could just give me two different ways to lose money during a down market. 

One time when increasing correlations could help is during a bull market.  If my entire portfolio is correlated to stocks then my entire portfolio might be increasing during a bull market.  This may seem to be helpful but my 9 year old son, and just about anyone else, can make money in a bull market.  Where diversification is supposed to help is in a down market.   Increasing asset class correlations plus a down market is a recipe for disaster.

The solution:  Diversify by methodology, time frame, and security basket, basically have different return streams that are uncorrelated on an underwater basis.

Another Study Showing Trend Following Works

A Century of Evidence on Trend Following

Great study done by AQR showing that trend following has produced consistent profits since 1903.   Some powerful points made by the study:

1. If you look at the ten largest drawdowns in a classic 60/40 portfolio since 1903, a trend following portfolio (as designed in the study) would have had positive returns in 9 out of 10.

2. Trend following works very well in Bear Markets because:
"The intuition is that the majority of bear markets have historically occurred gradually over several months, rather than abruptly over a few days, which allows trend-followers an opportunity to position themselves short after the initial market decline and profi t from continued market declines."
The paper also rightly points out the many trend following strategies have had trouble over the past few years.  While this is not out of the norm looking back to 1903 it still makes sense to explore the reasons why.
Trend following does best when there are consistent longer term trends, the investor can get in after a trend has been verified and hold on until the trend reverses.  If you look at just the monthly returns of the S&P 500 over the past 3 years, the risk on/risk off markets created by the European crisis have made it difficult to follow a trend following strategy.  For example in 2010 February through April the market had a great run, only to be down 7.99% in May and down 5.23% in June.  We see the same pattern in 2011 and 2012 where it looks like an uptrend is forming, only to be followed by a quick reversal.   Depending on the time frame the trend follower is looking at, he or she might get into the market because of  a large up move just in time for the reversal (of course this argues for varying your time frames). 
Have markets fundamentally changed so that trend following is no longer viable?  Not at all.  It is human nature to create trends.  Markets are not rational or efficient.  When investors see something going up they pile in.  It is only the complexities of the European situation over the past couple of years that has caused trendless markets.  This will either pass, paving the way for a market rally, or drag us down into a massive market decline.  Either way, trend following wins.

Friday, October 5, 2012

Combining Factor Investing & Relative Strength

I get Morningstar Advisor magazine free every month.  I usually find little value in it as most articles are buy and hold drivel but this month they had some interesting articles devoted to factor investing.  Numerous studies have been done that identify certain factors that have outperformed the market:

1. Value investing
2. Momentum
3. Smaller stocks
4. Low Beta Stocks

Momentum is obviously something that has always interested us.  As has value, since it is not correlated with momentum.  We are constantly studying ways to apply value across asset classes and see how it can be combined with momentum strategies (perhaps the subject of another post one day).  The others have never really had any interest to us as they may outperform the market but they also will get creamed when the market goes down.  Momentum is the only one of these factors that can be tweaked to avoid large losses.  However, the articles got me thinking about combining relative strength (buying the one asset out of a basket of assets that has the strongest performance over a period of time) with factors.  So I decided to study whether this would work.  I tried to find ETFs or mutual funds to represent each of the factors that have been around a long time (I had some trouble with this and more work needs to be done to find stuff that has been around longer).  I settled on the following:

Momentum- Powershares Tactical Leaders
Low Beta- SEI Managed Volatility
Value- iShares Large Cap Value
Small Cap- iShares Russell 2000
Tactical- PIMCO All Asset (Threw this in there as well to provide a little diversification)

I designed a simple relative strength system that would rotate monthly among the best performing fund and would be in cash if nothing was in an uptrend.  I was able to go back to 3/2007 for a common history but since we needed time to determine relative strength my first trade wasn't until 2/25/09.  Here are the results from 2/25/09 to 10/4/12:

Average Annual Return: 21.11%
Maximum Drawdown: -15.37%
Worst Month: -7.16%
Sharpe Ratio: 1.32
MAR Ratio: 1.37

The performance numbers and MAR are very attractive but the drawdowns and worst month are a little high for my taste.  I also really would have liked to see what this would have done in 2008.  That being said, there is definitely enough here for further study and refinement.

Thursday, September 27, 2012

A Great Contrary Indicator

Fidelity's stock funds eclipsed by bond and money market assets

Individual investors usually have the worst timing.  They tend to get into bull markets near the top and get out of bear markets near the bottom.  All in all this looks like good news for long term stock market bulls.

Friday, September 14, 2012

Avoiding Momentum Crashes

I spend a lot of time reading research papers on areas of tactical asset allocation (momentum, trend following, counter trend following, etc).  Lately I have read a few papers on avoiding momentum crashes.  Since our firm uses a lot of momentum strategies, this is a subject near and dear to my heart.  Momentum crashes are primarily a phenomenon related to individual stocks, which we don't really use, but the research is interesting nonetheless as it confirms my own findings about combining momentum with trend following.

Momentum strategies with individual stocks usually involve either buying high flying stocks, or a combination of going long high flying stocks and shorting weak stocks.  Both strategies have shown remarkable performance over the years as momentum is a powerful force in every market.  However, these strategies also have a propensity to crash every once in a while.  High flying stocks can get way beyond where they should trade and can, and do, have spectacular falls.  Long/short investors have also seen times when the dogs did well and the high fliers reverse.  We use momentum with index ETFs and funds and we don't really go short anything.  While indexes do get frothy, they don't do so to the same extent that individual stocks do.   However, momentum investors in indexes can still suffer drawdowns by buying the strongest index in a bear market---in the land of the blind the one eyed man can still lose money.

The fix to this is to combine momentum with trend following.  The terms are often used interchangeably but they are different concepts.  Momentum involves buying the strongest asset classes, sectors, etc, regardless of direction.  Trend following involves only buying assets that are in an uptrend.  By combining the two and buying the strongest areas of the market only when they are in an uptrend you can increase the returns and decrease the risk of a plain momentum strategy (not to mention blow away buy and hold).

As an example we have a momentum model we use to trade the S&P 500.  It can only be in the S&P 500 when it is in an uptrend.  Backtested results of this system from 9/29/03 to 9/14/2012 are as follows:

Average Annual Return:  10.35%
Maximum Drawdown: -8.67%
Worst Month: -4.02%
Mar Ratio: 1.19
Sharpe Ratio: .82

If I take the same model but remove the trend following component, so that the S&P 500 doesn't need to be in an uptrend to buy it, we get the following results:

Average Annual Return:  9.14%
Maximum Drawdown: -14.24%
Worst Month: -11.82%
Mar Ratio: .64
Sharpe Ratio: .60

While this model clearly outperforms buying and holding the S&P 500 it markedly under performs the model that uses a trend following filter.  

Wednesday, September 12, 2012

Keeping Portfolio Volatility Constant

We are always interested by ways to reduce portfolio risk while potentially increasing returns.  Risk parity is a strategy we have previously written about that can accomplish this, volatility stabilization is another.

Let's say an investor has a simple portfolio that is invested 100% in the S&P 500 at all times.  While the investment is always the same, the risk varies.  Anyone who watches the market understands that there are times when it is riskier than others.  So our mythical investor will have periods where risk is greater than others.  Volatility stabilization seeks to keep risk constant over the entire investing period.  There are a number of ways to apply this, but at its most basic an investor would do the following:

1. Determine current market volatility.  This can be done with a ratio of a past standard deviation to current standard deviation, Bollinger Bands, etc.

2. During times of high volatility positions in the investment(s), in this case the S&P 500 are decreased.

3. During times of low volatility positions in the investment(s) are increased.

4. Leveraged ETFs or mutual funds could also be used to amplify returns during times of low volatility.

Our early testing on this has been positive so far as we are seeing an ability to reduce risk and/or increase returns.

Monday, August 20, 2012

The New Retirement

I was recently interviewed for a podcast on retirement for, below is the link.  I am at about 4 minutes in:

Different Markets Require Different Strategies

My 13yr old son loves wearing shorts and a t shirt.  He loves this so much that he wears shorts no all year round, no matter how cold it is outside.  He does this for two reasons:

1. That is the style now
2. He is 13 and just doesn't know any better

He reminds me a lot of how individual investors behave.  They follow a traditional asset allocation/buy and hold approach regardless of what the market is doing.  This works fine in a bull market (just like wearing shorts and a t shirt is fine during the summer), along with any other strategy for that matter, but gets you crushed in a down market.

In reality there are three different types of markets, each requiring its own investment strategy:

1. So easy a caveman could do it market----these are the markets that go up in a straight line that even a caveman could make 20% (apologies to any cavemen reading this, if you can read that is).  1995-1999 would be a great example.  In this type of market anything that has you invested would work very well.  This could be asset allocation or a trend following tactical strategy.

2. Bear market----this is a market that goes down a lot.  2000-2002 and 2008 would be great examples.  Any strategy that has an investor fully invested would get crushed in this type of market.  This is just like my son wearing shorts in the dead of winter, he feels comfortable because everyone is doing it but he is freezing his butt off.  In this type of market the only strategy that works is being tactical as any good tactical strategy would have an investor in cash and/or bonds.

3. Risky market----This is usually a very volatile type of market that could produce some returns but is at great risk of becoming a bear market.  2011 and 2012 (so far) are good examples here.  The market has gotten some gains but the risk is still immense.  A fully invested strategy in this market could work out ok but the risk is not worth it.  This is like my son wearing shorts in the fall, if he gets a warm day he is ok but it could also get real cold.  Tactical is still the way to go in this market.  A good tactical strategy may trail a fully invested strategy if the market is going up in the face of great risk (albeit with much less volatility) but it will protect the investor  if the risky market turns into a bear market.

Monday, August 6, 2012

Tough Year for Flexible Money Managers

There were two articles in the WSJ this morning about the troubles some active managers are having this year.  This first focused on global macro hedge funds and the second focused on go anywhere global mutual funds. Here are the links if you are a subscriber:

This is not surprising as global macro hedge funds and go anywhere global mutual funds follow similar strategies----looking anywhere in the world for returns.  The fact that they have under-performed the market this year doesn't mean they are flawed, it is a reflection on what type of market we have had----choppiness (large up days or months, followed by large down days or months) and the immense risk.

Choppy markets have made it difficult for many managers to find areas to invest in, either using some sort of trend analysis, value based analysis, etc.  The risk has also most likely forced many managers to take a conservative approach.  

Bottom line is that if I was an individual investor, in the face of the risk of this market, I would still feel much more comfortable with a global macro fund or a go anywhere global mutual fund than an index fund or an active manager who is just a closet indexer.

Monday, July 23, 2012

Why Not Just Go To Cash?

There was an article in the WSJ today on how investors are bidding up shares of dividend paying stocks because investors look at them as defensive.  Here is the link if you are a subscriber:

I have written about dividend stocks before and probably will again.  The bottom line is this, if you want to be defensive you move to cash, that is the only thing where you have a "guarantee" that you will not lose any money.  Why don't investors do this?  Two main reasons:

1. Sales sizzle-----Wall Street gets compensated on getting people to act and to do that you need some sales sizzle.  Dividend stocks have that now, most yield more than Treasury Bonds.   This ignores the fact that if the market drops 10-20% you will probably make money in Treasuries and get crushed in dividend stocks.

2. Wall Street clings to the theory that you always need to do something------Instead of moving to cash during times when the risk outweighs the reward, Wall Street feels that it needs to do something to justify fees (I would argue that moving to cash and protecting money during times of distress is the ultimate way to justify fees).  Therefore, they hold their nose and try to find things that are less bad than others.  If the market goes down 30% and they only lose 20% that is a success.

Bottom line is this, don't fall for the idea that you have to do something and don't fall for sales sizzle.  Sometimes the best course of action is to just hold cash.  It is boring, but the key to making money in the market is to avoid large losses and cash is one of the only things that can promise this.

Monday, July 16, 2012

Matthew Tuttle Interviewed by Donald Giannattasio

Matthew Tuttle Interview About Tactical Asset Allocation

I Want Tax Free Income

I often get questions from people who either "want" tax free income or wonder if Municipal Bonds will help them save on taxes.  What I often find is that when an individual investor "wants" something it is because somebody convinced them that they need it.  Usually, that somebody is trying to sell the exact thing.  Municipal Bonds are an easy sell, they provide:

1. Income that is free from Federal taxes and free from state taxes if you buy Munis in your state.
2. They are not as volatile as stocks

In this environment who wouldn't want an investment that is tax free and doesn't fluctuate like stocks?

However, if you look at these issues in more detail Municipal Bonds end up not looking that good.

First, lets look at tax free income.  If I gave you the choice between a bond that would pay interest of $100k that was taxable or a bond that would pay interest of $100k that was tax free which would you want?  Easy answer, all things being equal you choose tax free.  Now I know what you are thinking, Muni's typically yield less than other types of bonds so you have to look at tax equivalent yield (TEY).  So in my example above, lets say I gave you the choice between $100k taxable or $70k tax free.  To get the TEY you divide the $70k by 1-your tax rate, if you are in a 35% tax bracket then the $70k is really work $107k, so the Muni bond is better right?  That's what the salesman wants you to believe but we are still missing the most important issue----how much money do you have in your pocket at the end of the day.

The return from a bond is more than just interest payments, it is also capital appreciation or depreciation.  If I earn $100k of interest but lose $500k of principal then I have a net loss of $400k.  When looking at any investment their are three key questions you need to ask yourself:

1. Can I lose money?
2. If so, how much?
3. Am I being paid enough to take that risk?

As of 7/16/12 the yield on the Merrill Lynch 7-12 yr tax exempt index is 1.78%.  Forget about TEY for a minute and think about this, I am being paid 1.78% tax free to take the following risks:

1. My bond(s) might go bankrupt.  Look at all the states declaring bankruptcy and the problems that states are having with their budgets.
2. Interest rates will increase making my principal go down.

These risks are very real possibilities.  Is 1.78% tax free worth it to take these risks?  No.

Monday, July 9, 2012

Target Date Funds---Hazardous to Your Wealth

Another article in the WSJ this morning on target date funds, here is the link if you are a subscriber:

Here are some of the key points:

Despite that uncertainty, money is flowing into target-date funds at a brisk pace. Their assets now total around $400 billion, more than five times the amount at the end of 2005, according to Morningstar.

 In 10 years, target-date funds could represent half of all the assets in U.S. 401(k) plans and other defined-contribution plans, says David Bauer, a partner at asset-management consultant Casey, Quirk & Associates, Darien, Conn.

The idea makes sense on the surface-----older investors who may be closer to needing to withdraw money can't afford to sustain large losses so target date funds naturally get more "conservative".  However, in practice this doesn't work for a number of reasons:

1. Life expectancy is too long-----If I retire at 65 and have all my money invested "conservatively" I could still live another 30-40+ years.  Add inflation into the mix and this is a recipe to run out of money.

2. What is conservative?  Is investing a bunch of money into bonds at these yields conservative?  I don't think so.  Long term interest rates can't go much lower but they can go a lot higher.

3. Nobody should subject their portfolio to large losses, at age 65 or 20, that is why for the average investor nothing significant ever happens with their money---they get good returns in the up years and then give it all back in then some in the down years.

4. The market doesn't care how old you are----moving money based on your age makes no sense, move it based on market dynamics.  During a period like 1995-1999 when making money in the market was easy a 65 year old has just as much a right to earn 30% a year as a 30 year old did.  During 2000-2002 and 2008  a 30 year old has just as much right to be protective as a 65 year old does.

Wednesday, June 20, 2012

That's Not What You Get Paid For

I don't usually listen to CNBC but just happened to have it on in the car today.  Maria Bartiromo was interviewing a money manager who went to 100% cash ahead of the Fed announcement.  The first words out of her mouth were "That's not what you get paid for".  

That is what is wrong with the financial services industry and media.  Protecting clients from large declines is exactly what we SHOULD get paid for.  Anybody can make money in an up market.  The reason the average investors hasn't made any money (if they are lucky) the past 10 years is that they give back all of their gains in down markets. 

Saturday, June 2, 2012

Wall Street Journal Weekend Reading

Same Returns, Less Risk

How Much Gold Do Investors Need, Zero

Is Now The Time to Buy Junk Bonds

The first article is about risk parity.  I believe that risk parity is the future of asset allocation so I am happy that the WSJ is addressing it but for it to be optimal it must be combined with tactical asset allocation.  A buy and hold approach is better with risk parity than it is with Modern Portfolio Theory but it is still flawed.  However, having a number of tactical models and weighting them by risk parity is the optimal way to build a portfolio.

The other two articles are the typical is now the time to buy X stuff.  Gold was up yesterday so should you buy it?  Junk bonds were hot early in the year now they are not so should you buy them.  The answer is simple, buy what is in an uptrend and sell what is in a downtrend.  Could this be the bottom for Gold?  Maybe.  Could the bottom be much further away?  Maybe.  It is much safer to stay in harmony with market trends than it is to try to pick market bottoms.

Friday, June 1, 2012

Where is the Safe Haven?

As we end an awful month for the market may investors are looking for safe havens to protect their money.  The way to find safe havens is easy, just follow the trends.  We hear a lot of great narratives about how investors should be buying gold, but the biggest gold ETF, GLD, was down 6.34% last month according to Morningstar.  By my definition a safe haven doesn't go down as much as the market. Does that mean gold won't eventually be the place to be?  No, at some point it could (and very well might be because it can act as a surrogate currency and certainly would be better than owning Euros or Drachmas) but unless you can call the bottom it makes no sense to invest until the trend turns around. 

That leaves Treasury Bonds (or cash if you are content to protect and don't care about making money) as the only safe haven.  The largest long term Treasury ETF, TLT, was up 9.02% last month according to Morningstar.  Treasury yields also told us that the rally we saw in the market a couple of days ago wasn't real as the market rallied but yields barely budged.

This trade is not for the faint of heart, it is based purely on fear and that can change on a dime.  Also, for long term buy and hold investors (which doesn't work but people still try to do it anyway) Treasuries at these yields don't make a lot of sense.

Tuesday, May 29, 2012

Bond Market: Buy or Bubble

Bond Market: Buy or Bubble

I was on Fox Business News on Friday to debate whether or not the bond market is a buy or in a bubble.  At the end of the day it all depends on your time frame.  Short term, bonds are in an uptrend so if you are a tactical money manager, which we are, you want to invest with the trend.  However, when/if Europe gets its act together and the Fed stops manipulating rates that trend could change in a big way.  I do believe that eventually shorting longer term treasury bonds will be the trade of the decade. 

If you are a long term, buy and hold, investor (which you shouldn't be) then I wouldn't touch bonds with a 10 foot pole, too much risk for so little return.  If you want safety go to cash.  Buying long term treasuries at this point is like trying to pick up pennies in front of a steamroller.

Wednesday, May 16, 2012

Advisors Eye Alternatives, Question Buy-and-Hold Approach

There was just an article in talking about the 2012 Natixis Global Asset Management U.S. Advisor survey.  Here are the highlights:

  • 49% of advisors are uncertain that the traditional 60/40 allocation between stocks and bonds is still relevant
  • 23% said the traditional approach isn’t close to meeting the needs of investors in contemporary markets
  • 38% of advisors that have been in business for more than 15 years no longer believe that the traditional 60/40 allocation is the best way to pursue returns and manage risk
  • Advisors were twice as likely to say that new approaches are needed compared to those who favor the status quo (46% vs. 22%).
What I have to say about this is simple---to the advisors questioning traditional strategies---what took you guys so long?  To the others---good luck with that.

Monday, May 14, 2012

A Rare Speed Bump in Commodities' Long Run

Saw this in the WSJ this morning.  I do not argue that commodities are in a downtrend right now, what we need to be careful of is how we define a trend.  The article talks about the uptrend that commodities have been in since 1999, which they have been, but a lot has happened between the lines.  Fortunes could have been made or lost based on what happened and how you were positioned during this 10yr+ uptrend.  We used to be able to define trends in terms of decades but these days, with increased volatility, we need to define them in terms of weeks and days. 

Monday, May 7, 2012

How To Play the Bond Market Now

Above is the link to an article in the WSJ this morning about how to play the bond market now that interest rates are at extreme lows.  With rates this low we know two things---1. At some point they will go up, 2. You can't earn much interest in bonds at these rates. 

The article presents a number of the old standby ideas---diversification, higher yielding bonds, and emerging market bonds.  The real answer of course is to take a tactical approach to bonds.  Be in the sectors of the bond market that are in an uptrend and be out of the ones in a downtrend.

Saturday, April 21, 2012

When Investing Trends Won't Die

When Investing Trends Won't Die

Story in the WSJ this morning about how investors could get burned betting on things getting back to normal.  The trades mentioned were the VIX, an increase in interest rates, and natural gas, but the list could go on and on.  Trying to invest against the trend can make you a tremendous amount of money if you hit it right but that happens infrequently and is usually a result of luck, not skill.  It is tempting to try to get into something on the low and we have all heard that the way to make money is to buy low and sell high.  However, this is much easier said than done.  Any gains you can make from lucky trades are often swamped by the losses from the times when the trend persisted.  So unless you have a crystal ball a better approach, one that does not rely on luck, is to stay in harmony with market trends----buy high and sell higher.

Saturday, April 14, 2012

Long/Short Funds

Good article in the WSJ about Long/Short mutual funds that attempt to reduce risk by allowing short exposure. 

Stock Funds For the Timid

While I like the idea of these types of funds, investors need to do their homework as with anything there will be some great, good, bad, and awful ones.  The article talks a lot about higher fees which to me isn't a big deal as long as you get what you pay for.  Most traditional mutual funds are closet indexers so paying them 1% or more has never made any sense to me, you can just buy the index instead for much less.  However, if a fund can avoid some or all of the big losses in the market than it is worth paying much more for. 

The bigger issue is that the best long/short stock pickers will almost always gravitate towards the hedge fund space because that is where the money is.  You need extra skill here as shorting is much more difficult than just mirroring your benchmark.  Of course we still think tactical is the way to go but a good long/short fund or two can definitely do better than traditional style box mutual funds.

Thursday, April 12, 2012

A Tactical Approach to Core & Satellite

Core & Satellite portfolio construction arose out of the failure of Modern Portfolio Theory (MPT) to protect portfolios from downturns.  Many advisers now understand that MPT doesn't work, it just appears to work during an up market (along with everything else).  The obvious solution is a 100% tactical approach but for many going from 100% buy and hold to 100% tactical is too much to ask (even though it is a better way) hence the development of Core & Satellite.  The idea is to mantain a 60-80% buy and hold core that would be in an index fund that tracks something like the S&P 500 or the Russell 3000.  You could also include an international index fund and bonds.  The remainder of the portfolio would be the satellite which would include defensive and opportunistic investments. 

While this beats MPT, you are still subject to massive losses in a down market.  A major improvement on this idea would be a 100% tactical Core & Satellite Portfolio.  To see how this works we did the following:

1. Created a core that puts 40% in a tactical strategy that rotates between the S&P 500 (SPY) and bonds, 10% in a strategy that rotates between the MSCI EAFE (EFA) and bonds, and 10% in a strategy that rotates between Emerging Markets (EEM) and bonds.
2. Created 4 satellites and put 10% in each.  Satellite one rotates among a basket of 2x levered index funds or ETFs, Satellite two rotates among a number of different asset classes, Satellite three rotates among a number of defensive assets----Gold, Swiss Franc, etc, and Satellite four is a VIX hedge.

We ran the numbers using TradersStudio software from 4/19/05 to 4/11/2012.  We did not include commissions as I can buy and sell most of these without them.  We also did not includes fees or taxes.  The results are as follows:

Average Annual Return: 16.04%
Maximum Drawdown: -8.79%
Best Month: 10.35%
Worst Month: -3.90%
Sharpe Ratio: 1.3065
MAR: 1.8249
2008 Return: 14.80%

Saturday, March 31, 2012

Beware Those VIX Plays

Beware Those VIX Plays

Good article in the WSJ this morning about the risk of some of the ETN VIX products, like the one that lost something like 60% this month.  These are not buy and hold products by any means but they can be powerful if used correctly.  Correctly means holding them for short term periods to hedge a portfolio of stocks or stock based ETFs or funds.  The three key components of making this strategy work are which VIX product to buy, how much of the VIX to hold, and when to buy and sell.

1.  Which VIX product to buy?  Stay away from the levered versions, the VIX is already very leveraged, getting 2x leverage on a leveraged product is a license for disaster.

2. How much to hold?  This is best done using a risk parity approach so that the risk of your VIX product is balanced with the risk of the rest of your portfolio.  The riskier your portfolio the more of the VIX you need.

3. When to buy and sell?  You need to use a tactical approach and you need to be nimble.  Trying to buy the VIX during a market uptrend is another license for disaster.

Is It Time to Dial Back the Risk

It's Time To Dial Back The Risk

There was an article in the WSJ today suggesting that investors should dial back the risk.  If you look at the numbers this might actually be a decent idea.  For the first part of the year "riskier" areas of the market outperformed----International developed stocks, emerging markets, and small caps---for example.  Last month the S&P 500 did well but those areas lagged quite a bit.

Saturday, March 24, 2012

Why Treasuries Won't Crater

Why Treasuries Won't Crater

Article in the WSJ today about investors tweaking their bond holdings vs. overhauling them.  Since Treasury yields have backed up there has been a debate about whether the long anticipated bear market in Treasury bonds is here.  At the end of the day it doesn't matter if you just stay in harmony with bond market trends.  Last year Treasuries were in an uptrend so you should have owned them (and made a ton of money in the process).  This year other areas of the bond market are stronger-----investment grade corporates, high yield, emerging markets, and even dividend paying stocks.  As long as that trend continues those are the types of areas bond holders should focus on.  If Treasury bond prices resume an uptrend then you can shift back there.

Monday, March 19, 2012

Head For The Hills?

This from the Wall Street Journal Today:

Head for the hills—at least if you put much stock in the dark art of technical analysis. Three influential market-timers believe the end is nigh for the stock-market rally.

Joe Granville, who single-handedly sparked a large drop in the Dow industrials in 1981 with his "sell everything" warning, sees a potential drop to 8,000 in the Dow this year. Granted, his calls since that big one have been a bit more miss than hit.

Elliott Wave theorist Robert Prechter, also known for incredible prescience but premature bearishness, is even more pessimistic, seeing a drop below 2009 lows.

Last but not least is Charles Nenner, who advised Goldman Sachs for years and now provides services privately to hedge funds. Some of his recent calls have been eerily accurate, and his coming ones are the most specific. He advises selling stocks after the S&P 500 hits 1,449 or by April 19, whichever comes first. If stocks then fail to break back above that level, it would confirm a multiyear bear market with the Dow eventually hitting 5,000.

Predictions make for great fun but nobody can predict the market.  Sometimes it appears they can as you have a 50/50 chance of getting it right, the market will either be up or it will be down.  Instead us trying to predict where the market is going  investors would be better served just staying in harmony with market trends.

Monday, March 12, 2012

Why Stocks Are Riskier Than You Think

Why Stocks Are Riskier Than You Think
Great article in the WSJ this morning about the problems with buy and hold and normal asset allocation.   The only part I don't agree with is the using TIPS and some of the risk reduction strategies, this will protect from large losses but it will also protect from gains.  Stocks are a great place to invest, just not all of the time.  The answer is a tactical portfolio filled with non correlated tactical strategies weighted by a risk parity approach.

Thursday, March 8, 2012

Should You Be Buying Dividend Paying Stocks?

There has been a lot of press lately about the merits of buying dividend paying stocks.  The so called experts have decided that the next few years in the market are likely to be mediocre so why not get a return from dividends?  Setting aside the fact that nobody knows what the market is likely to do this post will compare a couple of different strategies:

1.       Buying a dividend stock ETF,  iShares Dow Jones Select Dividend Index (DVY)

2.       A relative strength strategy that rotates among a group of dividend paying stocks

3.       A relative strength strategy that rotates among asset classes—US Stocks, International, REITs, commodities, and bonds

I did a comparison of each of these strategies over the past 5 years ending 3/7/12.  The comparison does not include any fees, commissions, or taxes.  For the DVY I just assume you buy and hold it.  For the relative strength dividend stock strategy we start with a basket of 10 high yielding stocks---Verizon, AT&T, Merck, Pfizer, GE, Intel, Johnson & Johnson, Dupont, and JP Morgan.  Each month we use our proprietary relative strength analysis to buy the top five stocks in equal weights.  For the relative strength asset class strategy we have a basket that includes bonds, US stocks, international developed stocks, emerging market stocks, REITs, and commodities.  Each month we use our proprietary relative strength analysis to buy the top four asset classes in equal weights. 

Results are below:

5 yr   Avg Annual Return
5 yr Sharpe Ratio
2008 Performance
Buy and hold DVY
Relative Strength Dividend stocks
Relative Strength Asset Classes

Buying and holding the DVY was the worst of the three strategies, mostly because of the awful performance in 2008.  While the dividend stocks didn’t do as poorly as the S&P 500, losing over 32% still stinks.  The relative strength strategy did a little better but still lost a bunch in 2008.  The best by far was the strategy that rotated among asset classes.  The key take away from this simple study is that every asset class---dividend stocks, gold, bonds, etc--- has merit at different times.  A strategy of buying and holding any asset class can be extremely dangerous.  Instead, investors should stay in harmony with market trends and buy the asset classes that are in an uptrend and sell the ones that aren’t. 

Tuesday, March 6, 2012

Designing Portfolios-How to Allocate Among Asset Classes or Models

In the old days deciding how to allocate a portfolio came down to a decision on stocks vs. bonds.  With all the new ETFs and other investments out there it is becoming more and more difficult.  Now investors have access to commodities, currencies, alternative strategies, etc.  There a number of ways to decide how to allocate among these different areas, including but not limited to:

1.      Traditional Modern Portfolio Theory (MPT)—Here an investor uses some sort of optimizer that either has past returns, correlations, and volatility of a number of asset classes or some prediction of future ranges for these variables.  The optimizer then creates the “optimal” portfolio mix.  The drawbacks of this approach are apparent to anyone who suffered through 2002 and 2008 as asset classes that weren’t that correlated or volatile, became correlated and volatile.  MPT works in an up market (along with everything else) but suffers horribly in a down market.

2.      Core and Satellite- This approach typically has a fixed core of around 80% that is in an index fund or a mix of index funds to get market returns.  It will then have around 20% that will be used to be opportunistic or defensive.  If the investor has a solid strategy for the satellite portion then this can be better than MPT but the large index exposure will still suffer horribly in a down market.

3.      Balanced portfolio—This is the simplistic 60% stocks/40% bonds approach.  The idea is that stocks and bonds are uncorrelated so the bonds can cushion the portfolio in a down market.  While bonds can provide some cushion the inherent problem with this design is that stocks are much more volatile than bonds.  So bonds may go up in a down market but stocks will go down much more than bonds will go up.

4.      Risk Parity---This is an approach that is gaining a lot of favor in the institutional marketplace because it typically needs to use leverage.  In a risk parity approach, asset classes, or in our case tactical models, are weighted by risk so that each asset class or model contributes equally to portfolio risk.  When done using uncorrelated assets or tactical models this can significantly smooth out returns.

5.      Equity Curve Feedback—In this approach you monitor the returns of each asset class, or in our case each tactical model, money is then taken away from the asset classes or models doing the worst and moved towards the ones doing the best.  This is in contrast to the rebalancing done with MPT portfolios where you sell your winners to buy more of your losers.

6.      Leveraged Space---This is something new we are working on so expect to see more in the future.  Basically this is the Optimal F approach that specifies how much should be allocated to one asset class or strategy taken to the portfolio level.  So far this looks like a very promising way to reduce risk while still generating attractive returns.

Tuesday, February 28, 2012

Do It Yourself Model Gaining Ground on Advisers

Do It Yourself Model Gaining Ground on Advisers

What a shock, after not protecting investors from declines in 2002 and 2008 and spouting the same old modern portfolio theory that has never worked, that investors would start deciding to go on their own.

Thursday, February 16, 2012

Was 2011's Most Successful Hedge Fund Actually a Pension?

Was 2011's Most Successful Hedge Fund Actually a Pension

Interesting article in aiCIO about how a Danish Pension fund made 20% in 2011.   Interesting to me in the fact that they use a risk parity approach vs. the traditional asset allocation approach.  One telling quote:

Out of habit, I ask him about what asset classes worked well in 2011? He laughs and says: “Liz, you know it’s not about the asset classes, but the risk allocation…”

Wednesday, February 15, 2012

Reversal Coming?

We are big believers in staying in harmony with the market trend so we don't try to get out at the top, but we do keep track of various signals that tend to be good indicators of market movements.  We haven't seen any of these signals in months, untl today.  Today we saw an anticipatory set of signals without a confirmation, that together are a fairly strong indication of a reversal.  

1. Intraday high prices of the market have increased to a 21 day high while the advance/decline oscillator is negative.  This unusual event is read as a very strong bearish signal that is often  followed by an downward price movement. 

2. The new high/new low indicator has reversed to the downside.  This is a reliable bearish signal that  is often followed by an downward price movement.

3. An upturn in the VIX.

  In this sideways market a downtrend could start shortly. 

Here's a Reality Check for Investors Considering Tactical Funds

Morningstar wrote a critique yesterday about Tactical Mutual Funds.    Here's a Reality Check for Investors Considering Tactical Funds.  While they do make some valid points there basic conclusion that people don’t need to add tactical funds to their portfolios leaves the average investor with the same asset allocation advice that got them crushed in 2002 and 2008 and that has made them no money for the past decade.  This is not surprising of course as Morningstar’s business model is built off asset allocation and traditional mutual funds that fit neatly into a style box. 
They do make some valid points in the article because there are a number of mutual funds and money managers who would call themselves tactical that really are not.  Tactical asset allocation quite simply is about being in harmony with major market trends, moving based on verification—not prediction, being willing to go to 100% cash for as long as needed, and avoiding the large long term loss.   The tactical mutual fund landscape is filled with funds that try to predict markets and funds that claim to be tactical but are only willing to make minor shifts in allocations.   There are also a number of “tactical” funds out there purely because of the marketing sizzle with managers that have no real experience investing tactically.   So there is no wonder why most of these types of funds would have unimpressive performance. 
At the end of the article the advice moves to outright dangerous:
Tactical funds maintaining exposure to multiple asset classes such as MFS Global Multi-Asset GLMAX may be more suitable as core holdings.”
“Clearly, the funds that take advantage of the flexibility to invest 0%-100% of assets in any asset class ought to be viewed as opportunistic holdings and kept to a much smaller portion of a portfolio, so they won't skew an investor's overall asset allocation or subject them to outsize losses if that fund's tactical bet goes very wrong.”
This is actually the other way around.  Funds that maintain exposure no matter what the market is doing expose investors to outsize losses as they ride the market downwards.  The funds that can go from 0-100% at least give investors the opportunity to get out before a bad market turns into a really bad market.
The bottom line is that traditional asset allocation and using the Morningstar rating system to pick funds doesn’t work and hasn’t worked.  It also exposes investors to way too much risk.  True tactical asset allocation that stays in harmony with major market trends would have protected investors in 2002 and 2008 and is the only way to manage money that works.

Friday, February 10, 2012

VIX Jumping

The VIX (volatility index) has jumped 10.4% so far today on a less than 1% pullback on the S&P.  Shows that maybe the pros are getting a bit nervous.

Monday, February 6, 2012

Risk Parity Funds WSJ

Risk Parity

Interesting article in the WSJ about risk parity funds this morning.  We are big believers in the approach but as the article points out there are some problems---high use of leverage, large exposure to bonds in a low rate environment, not taking macro risks into account. 
To some critics, the funds' assumptions about risk and their use of leverage are lingering concerns. Leverage can backfire on investors if not managed properly. Some watchers also believe the bond rally is coming to an end, which could hurt risk-parity funds' returns as well.
We have developed our own risk parity strategy using tactical asset allocation (expect a research report out about this shortly) that addresses these concerns.  We also use the risk parity concept in a few of our strategies.

Itchy Investors Ramp Up The Risk

Itchy Investors Ramp Up The

The longer the Fed leaves interest rates low the more it hurts people who save money in CDs and bank accounts. 

The Federal Reserve is presenting a broad swath of conservative investors, from retirees and college savers to banks and insurance companies, with a tough choice: move into riskier investments or continue coming up short from low-risk investments that aren't even keeping pace with inflation.
A better choice for conservative investors is to adopt a tactical approach that stays in harmony with major market trends. 

Friday, February 3, 2012

Volatility Responsive Asset Allocation

Volatility Responsive Asset Allocation

Interesting paper from Russell that dovetails on some of our research.  They apply volatility to a fixed asset allocation and find that using volatility to adjust weights between stocks and bonds beats the fixed allocation.  A better approach is to use volatility to switch between a trend following strategy (trend following works best in a straight up or down market and suffers in a choppy market) and a counter trend strategy (counter trend works best in a choppy market and can get hurt in a straight up and down market). 

Emerging Markets Picking Up

  Lately emerging market stocks have been picking up from a relative strength standpoint.  Below is a  performance chart of an emerging market ETF, an international developed ETF, and an S&P 500 ETF.

                                                    1 Week         1 Month    3 Months    12 Months

Emerging Markets (EEM)              2.42%            13.76%      6.13%         -5.54%
International Developed (EFA)      1.28%             7.15%        4.92%         -9.95%
S&P 500 (SPY)                              0.61%            5.69%        7.64%          3.71%

Source: Morningstar

Wednesday, January 25, 2012

The Fed Shafts Retirees

The Fed just announced its intention to keep interest rates low at least through the end of 2014. This has, and will have, a number of implications for the markets and the economy. Retirees who supplement their income by investing in fixed income investments will be particularly hard hit as CD rates and rates on lower risk bonds will likely stay low for some time. This way of supplementing retirement income used to work when people didn’t live as long and interest rates were higher. Now it is time to put that idea in the waste basket, longer life expectancies plus low interest rates equals disaster if you want to live off interest from fixed income.

Monday, January 23, 2012

Retirees Just Got a Pay Cut

For years most financial advisers have been recommending that their clients can take 4%/year out of their portfolios. So a retired client with $1mm could supplement other sources of income with $40k/yr out of their investments. Now many advisers are starting to rethink 4% due to what has been going on in the market and their forecasts of lower rates of returns going forward.

The whole 4% rule was bound to break at some point, it puts tremdous strain on a portfolio to have to earn the 4% you are taking out and keep pace with inflation. Add in a double digit loss here and there and you have a real problem. A much better approach is to set aside 5-7 years of income into a conservatively managed tactical portfolio and leave the rest growing (also tacitcally managed to avoid the double digit losses) untouched for 5-7 years. Then you start the whole process over again.

Monday, January 9, 2012

Does Total Freedom Boost Returns

Does Total Freedom Boost Returns?

Interesting article in the WSJ this morning about tactical mutual funds. The author correctly points out that they are hard to evaluate because there is no "tactical" category and funds with freedom have completely different methodologies. Readers of my book "How Harvard & Yale Beat the Market" know that we favor these "skill based" mutual funds vs. the "style box" based funds that are basically closet indexers. However, buyers still need to beware, when a mutual fund is just mirroring an index the manager doesn't need great skill, but when they have flexibility to invest in anything anywhere, then they need to be better. A lot of these funds will come out due to the marketing sizzle with managers who are not up to the job.

There are also many definitions of tactical. Most of the mutual funds that we have seen that claim to be tactical make moves based on prediction, which is problematic at best. It is also highly unlikely that they will move to 100% cash if there is nowhere else to invest. To us, true tactical is being in harmony with market trends, moving based on verification, not prediction, and the willingness to be in cash for as long as you need to be.

Sunday, January 8, 2012

Bond Bets Paid Off----LAST YEAR

From the WSJ this weekend:
Last year saw better returns for bonds than for stocks on average—and that shaped the comparative performance of target-date funds for retirement.

Funds geared to recent retirees or older workers, because of their bigger bond holdings, generally did better than the stock-heavy funds for younger workers. (According to Morningstar, the average U.S.-stock fund returned a negative 2.4% in 2011, while international-stock funds lost 13.3% and taxable-bond funds had a positive 4.6% return.)

Among various companies' target-date lineups, some of the strongest returns came from Invesco's Balanced-Risk Retirement series. Those funds hold more bonds than most peers in an effort to equalize risks taken in stocks, bonds and commodities.

What happens to these older workers and retirees when interest rates start increasing and bonds start getting killed? Go back to work, drastically cut expenses, etc. Target date funds that change allocations by age make no sense and are dangerous. Older people run this risk of not making enough and younger people are taking way to much risk during market declines. Allocations should be based on market dynamics, not age.

Thursday, January 5, 2012

Wall Street Research is Still Biased

Interesting article in the WSJ today about an internet analyst at Citi who has been drawing hot IPOs to his firm. This just serves to highlight the fact that even after the changes that were made in 2003, Wall Street research is still biased and always will be.

Companies that chose Citi as a lead bank on their IPOs last year tended to get a favorable rating from Mr. Mahaney. On Citi-led deals in 2011, he awarded three "buy" ratings — for Active Network Inc., Bankrate Inc. and Zillow—and one "neutral," for Groupon Inc. He initiated coverage on four non-Citi led IPOs, with three "hold" ratings and one "buy."

The three Citi IPOs he rated "buy" have underperformed the market by an average of 5.7 percentage points; the non-Citi IPO stocks he rated "neutral" have done worse, underperforming by an average of 45 points.

Where to Put Your Money in 2012, Maybe Not

Just read an Op Ed in the WSJ from Burton Malkiel about where to put your money in 2012. At least he starts off admitting that it is virtually impossible to make short term forecasts:

Presenting an annual investment outlook is a hazardous task. At the start of 2011, investors were warned to eschew the bond market. Pundits described the low yields of U.S. Treasuries as a "bond market bubble." In fact, if you had bought 30-year U.S. Treasury bonds at the start of the year when they yielded 4.42% and held them through 2011, when the yield had fallen to 2.89%, you would have earned a 34% return.

Meanwhile, U.S. stocks stayed flat, Europe and Japan declined by double digits, and emerging markets suffered even greater losses. Last year again demonstrated that it is virtually impossible to make accurate short-term predictions of asset returns.

He then goes on to predict low returns for bonds, 7% for stocks, and says that emerging markets are the place to be. He may be right, he may be wrong, only time can tell. However, one could have easily made this same prediction, as I am sure a lot of people did, 10 years ago. Instead we saw stocks do nothing and bonds surge. Since I don't know what is going to happen in 5 minutes I certainly can't predict the next 10 years. The better course of action is to stay in harmony with market trends.

He ends his Op Ed with some more advice about making sure that you keep investment fees low. In a world where everyone is doing the same asset allocation investing then this makes sense, the only way you can do better is to either be more tax efficient and/or have lower expenses. However, this misses the big picture---what is the point of saving 1% in expenses when you are losing 30% of your money?