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From the NYT, a Wall Streeter Comes Clean

Great piece about a former Goldman banker admitting it was all a lie...after he gets cancer.

- Christopher

A Dying Banker’s Last Instructions

New York Times

There are no one-handed push-ups or headstands on the yoga mat for Gordon Murray anymore.

No more playing bridge, either — he jokingly accuses his brain surgeon of robbing him of the gray matter that contained all the bidding strategy.

But when Mr. Murray, a former bond salesman for Goldman Sachs who rose to the managing director level at both Lehman Brothers and Credit Suisse First Boston, decided to cease all treatment five months ago for his glioblastoma, a type of brain cancer, his first impulse was not to mourn what he couldn’t do anymore or to buy an island or to move to Paris. Instead, he hunkered down in his tiny home office here and channeled whatever remaining energy he could muster into a slim paperback. It’s called “The Investment Answer,” and he wrote it with his friend and financial adviser Daniel Goldie to explain investing in a handful of simple steps.

More...

 

The Secret Is Out: The Best Predictor of Future Performance

One day in India, I met a fortune teller on the street that was predicting the future by means of a parrot selecting tarot cards from her old wooden table.  It did not cost that much so I gave it a go. As it turns out, the parrot's prediction was accurate. I'm glad I did not spend a lot of money gaining insight into my future as my instincts tell me that the quality of the parrots performance probably would not have improved had I spent more money.

As it turns out, it appears the same truth holds for predicting future performance of mutual funds. A study released by Morningstar no less, shows that using low fees as a guide would have given investors better results than even Morningstar's own star-rating system.

How Expense Ratios and Star Ratings Predict Success

This study may further validate our strategies for building investment portfolios which hold some of the lowest cost mutual funds available.  For our client portfolios, the average mutual fund expense ratio is approximatley 0.40% with no 12b-1 fees and no loads (commissions). 

The Wall Street Journal article citing this study reports: "Morningstar found that in aggregate, low-cost funds had better returns than high-cost funds across all asset classes, during various periods from 2005 through March 2010."

"Low Fees Outshine Fund Star System" WSJ 8/9/2010

The study's author, Russel Kinnel, states “If there’s anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds....Expense ratios are strong predictors of performance."

For those of you looking for that "Five Star Manager", look no further. If this study is any guide to your investment decisions, Trovena has already found the "Five Star Manager" investments, and they are in our client portfolios.

By the way, the parrot told me I would help people and live a happy life.

Roth IRAs - To Convert or Not

All of a sudden, it seems like everybody in the wealth management world is talking about Roth IRAs and Roth conversions.  In fact, an article in Financial Planning magazine--one of the trade magazines in our world--recently proclaimed 2010 "The Year of the Roth."

What's the big deal?  Roth IRAs are interesting to professionals for several reasons.  With traditional IRAs (and qualified plans like 401(k)s), the money goes in untaxed, and you pay ordinary income taxes whenever you take money out of the account--which might be years in the future.  The Roth reverses this; your contribution is made with after-tax dollars, but then there's no tax whenever the money is distributed.  If you believe (I personally make no assumption about future rates. History has shown this to be impossible to predict.) that tax rates are going to go up in the future, then paying taxes now and eliminating future taxes provides a net gain.

It could get better.  Having money in a Roth account gives you a lot more control over your tax bracket in retirement.  For instance, you might take out just enough from your IRA distributions to fill the 15% bracket, and then take the rest of your living expenses out of your taxable accounts and Roth.  Another version of this kind of planning might help higher-income retirees avoid the brackets where Social Security income is taxed. This flexibility certainly argues for a partial conversion.

Another interesting thing about Roths is that, unlike traditional IRAs, they don't have any minimum distribution requirements once you turn age 70 1/2.  So long as the money remains in the account, both Roths and traditional IRAs give you the benefits of tax deferral, which eliminates a significant drag on the growth of your money.  If you can afford to keep your money in the Roth account, and take retirement income from other sources, then the deferral can go on longer.

The Morgan Report: 3rd Quarter 2010

Good advice is not intended to make you feel good. Good advice is meant to help you avoid mistakes. A quote from a recent Wall Street Journal article that references new studies on investor behavior:

 “...suggest that investors are doing what feels good, rather than what most experts believe is right.  If you fall into that category, you may want to toughen up and learn from the mistakes of others.”

WSJ “To Be A Winning Investor, Know the Risks” Chuck Jaffe, October 11, 2010

Looking at client investment returns this quarter, it is evident investors are not making the mistake of others but reaping the benefits of our expertise. We respect the confidence you place in us and work hard to maintain your trust. Fortunately, you have access to superior institutional investments unavailable to the vast majority of financial advisers.

Most importantly, it’s good advice and superior portfolio construction that have helped my clients capture returns available in the market.

Active Investment Management Fails Again

Below is a story from the WSJ that perfectly illustrates one of the major problems with active investment management (trying to beat the market by foretelling the future). The story focuses on DE Shaw, a firm that, since its inception in 1988, focused on letting a computer decide when to buy and sell securities. I guess they had good (or lucky) results prior to 2006.

All of the sudden, in 2006, the managers decided to abandon the computer-as-crystal-ball concept and invest in raw land in New Mexico?????? What does a firm who purports to have a computer that knows the future about stocks and bonds know real estate development? Apparently nothing as they are soon going to lose all of their clients' $100 m investment on this boondoggle.

We call this "manager risk" or the risk that your active (the opposite of an active investment manager is a passive one who simply accepts the market rate of return rather than betting on certain outcomes) investment manager goes haywire and invests in something entirely different than you expected. The solution to this problem is to use a passive manager and to have a written investment policy statement (IPS) to guide your advisors.  The IPS constrains investment managers to certain asset classes and performance standards. To me, the DE Shaw affair is another nail in the coffin of the scam that is active investment management.

- Christopher

 

D.E. Shaw Land Bet Proves a Quant's Quagmire

By LINGLING WEI

For more than 300 years, a huge swath of land in what is now New Mexico endured the rise and fall of empires, the arrival of settlers and development of the surrounding area into the city of Albuquerque.

But the Atrisco Land Grant, handed down by Spain's king and queen in 1703, has never seen anything like the real-estate disaster now gripping hedge-fund firm D.E. Shaw & Co.

Known for its obsession with computer-driven investing, the New York company surprised many real-estate deal makers in late 2006 by teaming up with developer SunCal Cos. to buy the 55,000-acre property—twice the size of Boston—for $250 million.

The two companies planned to create a new town with residential, commercial and industrial areas. But the nationwide real-estate slump left the project stuck on the drawing board. Last month, lenders led by U.K. bank Barclays PLC foreclosed on the property. D.E. Shaw and SunCal have only a few weeks to come up with the money needed to pay off the lenders, or else the hedge-fund firm could see its roughly $100 million investment wiped out.

Read the full article...

Emerging Markets - Emerging Ideas - Emerging Solutions

Emerging markets play an important role in a well diversified portfolio.  Risks exist when investing anywhere and especially in emerging markets where higher perceived political risk is an important factor.  Volatility can be high, but the potential for return relative to risks and the possibility of reducing correlation (and thus risk) of an overall portfolio, can be an added benefit. 

What is an emerging market?  The term was coined by Antoine W. Van Agtmael of the International Finance Corporation of the World Bank in 1981. It is generally defined as an economy with low to middle per capita income. These countries happen to constitute about 80% of the global population that represent about 20% of the global economy.  It sounds pretty straight forward but believe it or not, China and Peru can both be classified as emerging market economies!  So, it’s obvious that how you implement your emerging market strategy is critical due to risks and widely varying characteristics of countries that can be included in this category.  How then, is the best way to invest in this asset class?

Emerging markets play an important role in a well diversified portfolio.  Risks exist when investing anywhere and especially in emerging markets where higher perceived political risk is an important factor.  Volatility can be high, but the potential for return relative to risks and the possibility of reducing correlation (and thus risk) of an overall portfolio, can be an added benefit. 

What is an emerging market?  The term was coined by Antoine W. Van Agtmael of the International Finance Corporation of the World Bank in 1981. It is generally defined as an economy with low to middle per capita income. These countries happen to constitute about 80% of the global population that represent about 20% of the global economy.  It sounds pretty straight forward but believe it or not, China and Peru can both be classified as emerging market economies!  So, it’s obvious that how you implement your emerging market strategy is critical due to risks and widely varying characteristics of countries that can be included in this category.  How then, is the best way to invest in this asset class?

401(k) Fee Lawsuits Are Up: Is Your Plan Vulnerable?

If you run a business and have a retirement plan, you are most likely a fiduciary with responsibilities that include:

• Acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them;
• Carrying out their duties prudently;
• Following the plan documents (unless inconsistent with ERISA);
• Diversifying plan investments; and
• Paying only reasonable plan expenses.

As a fiduciary there is also potential liability. "Fiduciaries who do not follow the basic standards of conduct may be personally liable to restore any losses to the plan, or to restore any profits made through improper use of the plan’s assets resulting from their actions."                                                    - United States Dept. of Labor, "Meeting Your Fiduciary Responsibilities"

A recent article in CFO Daily News explains how there has been a recent spike in employee lawsuits due to excessive 401(k) fees.                     401(k) Fee Lawsuits Are Up

At Trovena, we have helped hundreds of clients develop, implement, and administer retirement plans as a fiduciary partner.  Our superior investment strategies and focus on lower expenses and fees go a long way in helping business owners uphold and defend the responsibilities of a plan fiduciary. 

Please contact us for a second opinion on your existing plan or ask us how to properly structure a new plan.  A much better plan than hoping you will not be held personally liable due to issues you are not aware of.

Some Good News for Investors

I edited Larry Kudlow's blog a bit to de-politicize it for my purposes. I thought what Mr. Kudlow had to say about the economy was spot on so I'd like to share it with you.

- Christopher

The Business of America Is Business- Larry Kudlow

Corporate profits are at all-time highs and bond rates in the Treasury market are virtually at record lows. That’s a good combination for stocks, and it helped trigger a 255 point rally in Wednesday’s trading. What’s more, a surprisingly positive read on the ISM August manufacturing report delivered a strong blow to the double-dip recession pessimism that has plagued investors for many months.

Without question, the jobs picture is going to remain cloudy. There’s just too much uncertainty over the economy and the tax-and-regulatory threats coming out of Washington. Businesses can’t be sure about the costs of hiring. Meanwhile, over in housing — our other weakest sector — an inventory glut threatens further price declines.

But make no mistake about this: Businesses, at least the publicly owned ones, are in very good shape. U.S. firms scored a record $1.2 trillion in profits during the second quarter and are sitting on roughly $2 trillion in cash. Our private-sector companies are resilient, and they have recovered significantly from the economic plunge.

And while their hiring is still behind schedule, they have begun the process of investing in equipment, software, and other capital goods. Business investment in the June quarter rose 16 percent above year-ago levels. This is all to the good. Healthy businesses are crucial to the stock market as well as the overall economic outlook.