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Thursday, March 26, 2015

Index Investor or Hedge Fund Investor...Who is Smarter ?

Seems a better simpler strategy is available tot the little guy is better than the complicated one available to big hitter "qualified investors" and their genius managers

Two headlines recently at the WSJ

Are Index-Fund Investors Smarter?

One of the keys to running a hedge fund is learning how to say you don’t.
Grappling with years of uneven performance, image problems and deep-pocketed clients who have publicly distanced themselves from the industry, hedge-fund managers are taking pains to avoid the moniker.

Asset Allocation in Two Minutes

I wrote in an earlier post how "Robo Advisors" come up short by not sufficiently getting to understand a clients circumstances before recommending an asset allocation.

Over at future advisor...they promise: asset allocation in two minutes. Plug in your age and retirement age and it triggers a detailed portfolio allocation.

Seems to prove my point.

Wednesday, March 25, 2015

Do You Think You Know How to Pick Actively Managed Mutual Funds ?,,,The "Experts" Don't

From the economist Buttonwood blog

Nobody knows anything

WHENEVER one writes about the failure of active managers to beat the index, someone is bound to pop up online and argue that people don't pick fund managers at random. Select the right fund managers and all will be well. But how? Relying on past performance does not seem to work. Logic would also suggest that it cannot be easy to identify the best performers in advance; if it were, then why would anyone give money to the underperformers?
Many pension funds and endowments hire investment consultants to help them choose fund managers (one estimate is that 82% of US pension plans use such services, and consultants advise on $25 trillion of assets). The consultants employ highly-educated workforces, have decades of experience and charge hefty fees. But an award (the 2015 Commonfund prize) has just been granted to an academic paper that concludes
we find no evidence that these (the consultants') recommendations add value, suggesting that the search for winners, encouraged and guided by investment consultants, is fruitless...
 , while one can be willing to accept that there are smart fund managers who can outperform the market, the trick is identifying such managers in advance. This process seems as difficult as identifying hit films in advance; in that business, as William Goldman wrote once "Nobody knows anything". 

The Economist also had a recent article specifically on large cap actively manged funds

BETTING on red gives the punter an 18-in-37 chance (in Europe) or 18-in-38 chance (in America) of success in roulette. Parcel out your money carefully and you might have a diverting 20 minutes or so until it's all gone, with a few wins along the way. If the odds were just one-in-four, then the whole game would be much more discouraging.
But those have been the chances, over the last 20 years, of largecap US mutual funds beating the market. It has happened in just five calendar years..... investors buy a US largecap fund to get exposure to largecaps, not the other stuff. To the extent that managers go off piste, that can only be justified if they reliably outperform. They clearly don't.
This explanation only makes the lesson clearer; if you want an exposure to US large caps, buy a US largecap index fund with low fees.
Of course, many people will ignore this advice. They see an index fund as a boring commodity product; they want the best in class, a manager that can outperform. And no active manager will admit that he (or she) is likely to underperform. But it is remarkable how few will put their money where their mouth is.

Do You Know What Your Mutual Fund Owns..And What it is Really Worth ?

The NYT reports on the growing number of mutual funds that own stakes in non public tech statrt ups. 
The retirement accounts of millions of Americans have long contained shares of stalwart companies like General Electric, Ford and Coca-Cola. Today, they are likely to include riskier private stocks from Silicon Valley start-ups like Uber, Airbnb and Pinterest.
Big money managers including Fidelity Investments, T. Rowe Price and BlackRock have all struck deals worth billions of dollars to acquire shares of these private companies that are then pooled into mutual funds that go into the 401(k)’s and individual retirement accounts of many Americans. With private tech companies growing faster than companies on the stock market, the money managers are aiming to get a piece of the action.
Fidelity’s Contrafund includes $204 million in Pinterest shares, $162 million in Uber shares, and $24 million in Airbnb shares. Over all, there were 29 deals last year in which a mutual fund bought into a private company, and they were worth a collective $4.7 billion, according to CB Insights. That was up from six such deals, worth a combined $296 million, in 2012. T. Rowe Price was the most active

These non public companies are illiquid, difficult to value and the investor can actually only realize profits when the company goes public. In other words, at least parts of major mutual funds have left the world of publicly traded stocks into the far different investment marketplace of venture capital. I doubt too many investors are aware of the difference.

 Since these start up companies are not public the requirements for publicly available financial disclosures don’t exist. And based on the type of measures used in the public equity markets the valuations are astronomical, This means any disappointments in performance of the business or surprises in any of the financial metrics could lead to a large rapid decline in value. And of course even those valuations are based only on the data voluntarily provided by the company. For example Uber owned by these funds has encountered regulatory issues and other controversies in various part of the world. 

As a group small cap growth publicly traded stocks(growth meaning high p/e or other valuation measure) are the worst performing category of the stocks.  They are often referred to as “lottery tickers”..since a few wind up generating high returns but many many more disappoint.

A strong case could be made that these non public small companies with high valuation are even riskier.

Barrons gives some more specific information about this trend  here   

 As of the Boston fund(Fidelity) giant’s latest filing, its $113 billion Fidelity Contrafund (ticker: FCNTX) alone owned $162 million worth of Uber and $142 million of file-hosting company Dropbox. T. Rowe Price Group (TROW) had about a dozen funds on the list, including the $46 billion T. Rowe Price Growth Stockfund (PRGFX), which recently had a $63 million stake in rental marketplace Airbnb and $74 million in Dropbox. Rounding out the list were funds from BlackRock (BLK), Franklin Resources (BEN), and Vanguard Group, among others.

I looked at the information on the Fidelity and T Rowe Price websites at information on the funds losted above. 

The following appears for the contrafund on the Fidelity website
Investing in securities of companies whose value FMR believes is not fully recognized by the public. Investing in either 'growth' stocks or 'value' stocks or both. Normally investing primarily in common stocks.

The TROWE Price Growth Stock fund has the following on the TROWE website hard to see how Dropbox and Airbnb match this description::
This fund provides long-term capital appreciation potential by focusing on established growth companies with proven performance records. These companies are typically financially sound and represent a wide variety of industries. To enhance return potential, the fund also has the ability to invest in foreign companies.

Bottom line: 

Unless you check carefully your mutual fund may own types of securities you didn’t expect it to hold.

And since some of the securities you fund may own are not traded securities with open market prices you may not really know what your fund shares are worth.

Strong Dollar Winners and Losers

Although we have had a pause, the US dollar has strengthened over 20% against the Euro in the past 12 months

Who wins and who losses from the move ?

Losers: Large cap multinational coroporations

Worst hit from the strong US dollar are US multinational corporations. Their large sales overseas means large declines in the US dollar value of their earnings.

As the WSJ reports:

Analysts have sharply reduced earnings estimates; smaller, domestically focused firms gain allure

Analysts, citing the dollar’s strength as a key factor, are predicting that profits at S&P 500 firms for the first quarter will show their biggest annual decline since the third quarter of 2009.
As a result, investors are keeping a continued bias toward U.S.-based stocks that do less business abroad, such as shares of small companies that tend to be more domestically focused, and on companies outside the U.S. that stand to benefit from a weakening of their home currency as the dollar strengthens, particularly European manufacturers

The speed of the move means that these corporations have been caught by surprise not implementing the currency hedges they often put in place.
. It is the large cap multinationals that take the biggest hit, Many of these are in the S+P 500 others in both the S+P 500 and large cap indices such as the Russell 1000.

Winners are European multinationals. They benefit in two ways: their foreign earnings in dollars are worth more in Euros and their prices are they charge for therio goods and services can be more competitive in selling to foreign markets as their goods are priced in Euros/their costs are in Euros. After a long period of underperformance European stocks have outperformed US stocks as the Euro has weakened. Year to date Eurozone stocks (ETF ticker FEZ) have outperformed the S+P 500 by 7.7% vs 2% the hedged European ETF (ticker HEDJ) is up 19.6%.

Large Cap vs Small Cap US Stocks. Small cap companies tend to be more domestically oriented and thus less affected by the lower Euro. After underperforming  with a return of 5% (etf vtwo) for small cap vs 13.1% for large cap (IWB) in 2014, the trend has reversed year to date with small cap at 5.2% year to date and large cap 2.6%.

Wednesday, March 11, 2015

The "Gurus" are Buying European Stocks

I have been writing and investing based on the view that Europe and Germany in particular was undervalued vs the US for over 2 years And have written about adding currency positions to those positions over the last 12 months.

 As the more performance chasers join those that already own European stocks the better fior those "early birds"as they push prices higher.

At some point disciplined investors who got in early  will be rebalance and some of the gains sold off "selling high" as the performance chasers "buy high" I dont know whether the "gurus' are performance chasing or investment geniuses  but they are buying European stocks.

I came across this interesting article from Guru Focus

Which Regions And Sectors Are International Gurus Buying?

March 06, 2015

Warren Buffett said in an interview published on 2/25/2015 in the newspaper Handelsblatt that his holding company Berkshire Hathaway is definitely interested in companies in Germany. “Germany is a terrific market, lots of people, lots of buying power, productive, it’s got a legal system we feel very good with, it’s got a regulatory system we feel very good with, it’s got people we feel very good with - and customers,” Buffett said.
George Soros, one of history’s most successful financiers, has been selling US holdings to buy European stocks. It is said that he has moved about $2 billion into companies in Asia and Europe, according to a person familiar with the strategy.

Robert Shiller, who popularized the cyclically adjusted price-to-earnings ratio (commonly known as Shiller P/E), is also thinking about exiting US stocks and getting into Europe. He said in a television appearance on 2/18/2015 “I'm thinking of getting out of the United States somewhat. Europe is so much cheaper.” Specifically, Shiller has already purchased stock indices in Spain and Italy.
The US stock market was up more than 30% in 2013, the best year since the go-go years of the 1990s. 2014 was another strong year for the market. The S&P 500 index was up more than 13%. Since the market recovery in 2009, the stock market has been up for 6 consecutive years. The US stock market appears to be really high. Maybe it is the time to find some real bargains in the international markets. 

Among the 12 international gurus, 9 funds have their largest holdings in Europe, 2 funds have their top holdings in Asia, and one in UK/Ireland. 3 funds have their second largest holdings in Europe, 4 funds in Asia, and 5 in UK/Ireland. Asia and UK/Ireland divide the third largest holding regions

About that Annual Letter from Warren Buffet for 2015

Many many individual investors think they can "be like Warren". The evidence keeps accumulating that going forward it may be even more difficult if not impossible than it was in the past.

 Berkshire has gradually shifted from being an investment vehicle that owns traded shares to a collection of wholly- or partly-owned businesses, such as Heinz, a food manufacturer. Listed equities now make up only 22% of Berkshire’s assets, down from 72% in 1994. Mr Buffett offers a barnstorming defence of Berkshire as a conglomerate, which he says is sprawling, “and constantly trying to sprawl further.” It buys businesses to hold on to them for ever, avoids getting involved in weak or hard-to-understand companies, gives managers autonomy, ignores the advice of investment bankers and keeps central overheads lower than a limbo stick. Berkshire’s head office employs just 24 people.

One recent example has been his swapping of his shares of Procter and Gamble in exchange for taking direct control of Duracell

Why is this change so important ? Because when you are purchasing businesses you are (legally) doing so based on what would be insider information and illegal in the case of publicly traded companies. The companies that Buffett acquires are under no legal obligation to report their finances to any prospective investor...just those it is interested in looking at to buy/invest in the company. So stock picking skills are irrelevant to 78% of how Berkshire now invests. 

One can speculate on why this is but it would seem that Mr. Buffett is finding it harder and harder for an investor to outperform a broad index of stocks. With the broad access to information and the growth of ETFs it is no longer the day when rolling up your sleeves and kicking the tires one could easily find undiscovered values among publicly traded companies particularly among major blue chip companies. Of course size plays a factor as well Berkshire is so big that it is difficult to build a stock position that would have significant impact on its returns.

Mr. Buffett has also used a bit of sleight of hand in reporting performance:(economist again)

Mr Buffett used to argue that Berkshire’s book value per share, rather than its share price, was a good proxy for its long-term worth. But the group’s book value has stopped outperforming the broader stockmarket—in fact it has underperformed it in five of the past six years So now Mr Buffett has begun to argue that book value is no longer such a good measure, and to give greater prominence to Berkshire’s share price. This sort of goalpost-moving is a habit of lesser conglomerates than Berkshire, and is hardly a promising sign.

With private investments making up the overwhelming part of Berkshires portfolio (and thus not have a verifiable market price) it would seen a strange time to move the goal posts.

Although Berkshire has had phenomenal performance vs the S+P 500 in the past it has underpeformed the index for the last 5 years 11.75% vs 15.12%.

Perhaps there are signs that like his mentor Benjamin Graham towards the end of his career he concluded that outperforming the market was getting harder and least in part due to the easy accessibility of financial information on public companies.

Once again this year Mr. Buffett has written about the virtues of indexing.

He recommended 2 books in his letter this one from John Bogle the pioneer of indexing and sitll itts most influential champion.

and this great classic which an entertaining debunking of Wall Street

Not on the list ..his mentor Ben Graham's classic books The Intelligent Investor or Graham and Dodd's Security Selection geared towards stock picking

Over at the WSJ Bret Arends makes an excellent case on why Buffett and Bogle are wrong not to recommend a global portfolio:

It’s a good question today whether the neutral investor should even have half of a stock portfolio in the U.S. According to the International Monetary Fund, the U.S. accounts for 22% of the world economy when measured in U.S. dollars, and still less when measured in purchasing power terms. The U.S. economy, at $18 trillion, is slightly smaller than that of the European Union. Even when you take account of America’s deeper financial markets and the global nature of its blue-chip companies, it’s hard to get to 50% — let alone 80% or 100%
Today, unlike in 1970, you have an embarrassment of riches when it comes to overseas options. It’s hard to see why an allocation of, say, 1/3 U.S. stocks and 2/3 International stocks is wrong.

But I should note that Arends is not totally correct about Buffett I did find this:

Warren Buffett said in an interview published on 2/25/2015 in the newspaper Handelsblatt that his holding company Berkshire Hathaway is definitely interested in companies in Germany. “Germany is a terrific market, lots of people, lots of buying power, productive, it’s got a legal system we feel very good with, it’s got a regulatory system we feel very good with, it’s got people we feel very good with - and customers,” Buffett said.