Wednesday, November 27, 2013

Why traditional diversification is ‘downright dangerous’

Just was an article on CNBC.com and couldn't believe the title:



That is probably going to cost them some advertisers but a lot of the article actually make sense.  They quote Burton Malkiel, who wrote a random walk down Wall Street, which is basically the desk reference guide of the index and buy and hold crowd, as saying that because of what is likely to happen to bonds that the 60/40 portfolio is now dangerous.  

The only thing I take exception to in the article is this quote:

Any norm at all ignores another fundamental investing precept—that your allocation needs to change to suit your personality and stage of life—a more important concept now than 70 years ago, because people live longer and plan their own retirements.
Markets don't care about your personality or stage of life.  Your allocation should change based on the trends in the markets.

Saturday, November 23, 2013

A Broken Clock is Right Twice a Day

The Wall Street Journal had a story this morning about how stock market strategists are taking a cautious approach going into 2014.  That would matter if they could actually predict the market, which they can't.  From the story:

Wall Street strategists have a reputation for being stock-market cheerleaders, helping to boost sales of stocks at their brokerage firms. Since 2000, stocks have returned an average annual gain of 3.3%, well below the 10% predicted by strategists. And in every year they have predicted stocks would rise, missing all four down years. 
At the same time, however, stocks have outpaced analyst forecasts in seven of those years, with one year, 2005, in which forecasts essentially hit the nail on the head.

So, they missed all the down years and only really got it right in 1 of 10 years, a .100 batting average.  What about this year?

 Strategists had started off 2013 calling for a moderate rise in stocks, although the forecasts were for a better one than they are now expecting for 2014. At the beginning of 2013, the average forecast from strategists at 15 banks was for a 7.7% gain, which would have left the index at 1532, according to Birinyi.
Not even close.

Friday, November 22, 2013

Smart Beta

With the ever increasing popularity of ETFs it is not surprise that we are starting to see a whole new class of index products that are differentiated from the basic indexes that we are all used to, like the S&P 500.   Traditionally indices have been market cap weighted, meaning larger companies will have a larger allocation in the index.  I am sure there is a reason that indices started as market cap weighted, I just don't know what it is.  There is no rule that this is a better way, it just is what it is.   Now we are starting to see more and more "smart beta" products.  These ETFs slice and dice indices in a bunch of different ways, for example some equally weight all stocks in the index, others focus on low beta stocks, others focus on high beta stocks.  All will claim that their way is better than the standard market cap weighted index.  Maybe they are but a few things you need to be aware of in evaluating these products:

1. Wall Street lives on continual money in motion and continual selling of new products.  Once something becomes commoditized, like market cap weighted index funds (we don't need another S&P 500 ETF or another Russel 200 ETF for example) then Wall Street will come out with a new twist, not always based on what is better, but based on what it can sell.

2. We have tons of history through different market cycles on market cap weighted indices, we don't have it on smart beta.  Most of these products are developed through backtesting, which there is nothing wrong with, but done the wrong way can result in curve fitting (basically blindly finding something that beat market cap indices in the past and just assuming it will in the future).

We use some of these products and will continue to evaluate others so I do believe that they add some value to the current investment landscape, but just like with everything Wall Street comes out with investors need to tread with caution and do their homework.