Trovena Weblog

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.

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.

Investing Mythbusters

This article is an attempt to dispel some myths in investing that are held by many investors and may have a critical impact on building your personal wealth.  It all starts with a television show.

I am a fan of the TV show Mythbusters.  It’s amazing how many myths people take for granted despite their experience and education.  Some myths are proven valid. For example, one show proved that a home water heater, without the proper safety mechanisms in place, can in fact explode and shoot up in the air 560 feet at a speed of 350 miles per hour.  Most myths are proven false. Case and point for those of you who like accuracy in your action movies, a person cannot  free fall for over ninety seconds from a height of 4,000 feet.  It actually takes only thirty one seconds.  So we’ll let the director have some creative license as thirty one seconds isn’t much time to build up tension or develop humorous dialog. 

All of these findings were were of course subject to strict scientific methodology and since all of us like charts and graphs, I have included those findings here.

The Morgan Report: 2Q 2010 Review

Report Entry: Tuesday July 6th, 2010

A definition of perspective is as follows: 

“The appearance of things relative to one another as determined by their distance from the viewer.” 

Volatility in the market has more than doubled since mid-April as measured by the VIX index (measures the volatility of the S&P 500).  I’m sure that was something most investors knew without looking at VIX.  

According to the Bureau of Economic Analysis, real gross domestic product the output of goods and services  increased at an annual rate of 2.7 percent in the first quarter of 2010. In the fourth quarter of 2009, real GDP increased 5.6 percent.  There was a deceleration in real GDP in the first quarter primarily reflected decelerations in private inventory investment and in exports, a downturn in residential fixed investment, a deceleration in nonresidential fixed investment, and a larger decrease in state and local government spending that were partly offset by an acceleration in personal consumption expenditures.

Recent market declines followed reports that showed the U.S. pending-home sales plunged 30% in May right after the homebuyer tax credit expired, and that the Institute for Supply Management’s June manufacturing index dropped more than expected.  There have been further concerns about recent increase in jobs claims, European and U.S. debt concerns, and a very strong “June Gloom” in San Diego.  

On the flip side, value or contrarian investors will see these price declines as an opportunity to purchase lower priced stocks following the principle of buying low and selling high. And, there are countering signals in different sectors indicating stabilization and potential growth.

So the market is reflecting the concern that we may be in for a long haul recovery and potentially a double dip recession.  As an investor, these are no small matters as we continue to evaluate what to do with our hard earned money.  

What is the best thing to do today? Every day we are overwhelmed with ‘great’ ideas.  Gold, currencies, options, bonds, China, Brazil, plastics; you get the picture.  Also, friends usually have some ‘smart’ person they know who has the secret to beating the market consistently; their personal version of Bernie Madoff.  (continued)

A Positive Outcome

 

This morning I woke up thinking about some emails I needed to get out, then scanned the Wall Street Journal. Oil spills, market volatility, political scandals, iPads, and military maneuverings hovered on the computer screen daring me to crawl into my hole.  I remembered how all this news can be daunting especially for clients who have put their trust in all of us here at Trovena, to help them with their lives.  My next thought was that I was sure everyone could use a break from all this and should have a nice three day weekend to enjoy.  What to do?  Beach, barbecue, time with family, I’m looking forward to it. 

So I will do all that, and enjoy it.  I will also spend a moment honoring my dear friend, roommate in flight school for two years, hero, thinker, leader, and jokester, Lt. Patrick K. Connor.  I cannot even scrape the surface of the unique bond we had as friends and fellow Naval Flight Officers.  But I can tell you we worked hard, played hard, and we were once young and invincible.  On February 2nd, 1991, Pat was shot down along with his pilot LCDR Barry T. Cook in their A6 Intruder in the Persian Gulf during a strike mission against Iraqi warships.  One of the highest honors I’ve had was the privilege of speaking about him at his memorial service.  The best figure I could paint of Patrick at that time was that of Marcus Aurelius.

Last year I had breakfast with his father, mother and brother.  It was a fine reunion, warm and stoic.  It brought home a couple of lessons that I have lived through.  You never know what will happen today, and whatever does happen, life will go on.  On that note, it’s best to be prepared for yourself and those you love.  It’s tempting to look at the news and get paralyzed with an overwhelming perception of doom and gloom but life will go on and we all can help create a positive outcome. So, I will enjoy this Memorial Day weekend, recharge the batteries, and get back to the business at hand on Tuesday; helping people create a positive outcome. I hope you do the same as well. 

The European Bailout

European Bailout Synopsis:

The European Union in cooperation with the International Monetary Fund announced a €750 billion ($955 billion) bailout plan to contain the sovereign debt crisis in Europe. This came on top of a €110 billion bailout package for Greece announced last week. The European Central Bank simultaneously unveiled a plan to purchase public and private debt to “ensure depth and liquidity in those market segments which are dysfunctional.” If necessary, the US Federal Reserve has promised additional support in the form of US dollar swap lines to reduce strains in short-term dollar funding markets globally.

 

The Breakdown:

 

I.    €60 billion from an EU emergency fund –the European Stabilization Mechanism– funded by all 27 European Union members.

II.     €440 billion of loans and guarantees from the 16 members of the Euro Zone who share the common currency.

 

III. €250 billion from the International Monetary Fund (IMF).

IV. Purchasing of public and private debt by European Central Bank (ECB) –no amount specified.

V.     US Federal Reserve reopening US dollar swap lines with foreign central banks –no amount specified, but original swap lines were nearly $600 billion US dollars.