The Everyman Hedge Fund

My latest Seeking Alpha exclusive has been posted. The excerpt;

Barron’s had an article over the weekend called Attack of the Hedge Fund Clones. The concept has grown in terms of AUM and proliferation of funds. ETF provider IndexIQ was early to market in the ETP space and now there are a lot of funds offering some version of absolute return or hedge fund replication. There have also been plenty of traditional mutual funds that have come into the space.

And the link, I hope you can check it out.
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Personal Finance Hobgoblins

The Trader Column in this week's Barron's devoted a lot of pixels to personal finance issues which is somewhat unusual. The first bit was in making the case for Financial Engines (FNGN) with some grim retirement-preparedness stats.

The article rightly notes that many portfolio short comings are "self inflicted." I might use the word behavioral but it is the same difference, people are often their own worst enemy when it comes to their finances and portfolios for things related to poor spending decisions and occasional panic selling or panic buying.

Barron's cited an unnamed study that concluded "nearly three-quarters of 401(k) participants are not on track to meet their retirement goals" and "based on their present performance, they won't replace even half their current income in their retirement years."

I'm not sure what the best number is to consider for average 401k balances as there have been numbers ranging from the 20's (thousands) up to $100,000. In terms of confronting our more immediate problems the country should probably care most about the average balance for people 55 and older, then make a priority of educating the hell out everyone between 40 and 55 while just providing normal education of financial literacy for people under 40.

Not that I know, but isn't there a Czar for financial literacy or wouldn't this come under the purview of one of the Czars? I'm thinking the cost for building a couple of spreadsheets for mass distribution would be pretty cheap--of course they wouldn't even need to build them as they already exist. As far as teaching financial literacy in highschool I think they could build a list of 20 learning points such that each one can be discussed each morning for three minutes (attention span) and then each one repeated once a month all school year, every school year starting in ninth grade.

The other personal finance topic in the column was about reinvesting dividends noting that 42% of US equity market returns from 1926 forward come from dividends. The 42% cited is a number that has been kicking for years and while I wonder whether the events of the last three years could have changed it slightly it still makes the point that dividends are quite important.

As far as actually reinvesting the dividends to buy more shares one dividend at a time; if you do this with taxable money (as opposed to an IRA of some sort) make sure you are a meticulous record keeper.

That little bit of caution out of the way I certainly have nothing negative to say about reinvesting dividends but I prefer to target an above market yield without reinvesting. Among other things if a portfolio yields 3% and that 3% goes back into the stocks or funds they came from then it potentially throws the asset allocation out of balance requiring sales at some point. More practically the cash from dividends can help with any income needs which some clients have and also be available for new additions to the portfolio.

On this topic someone somewhere asked why I feel it is difficult to have a portfolio yield 4%. He said that his portfolio yields 8% and he cited the names he owns to get this yield. My context was that 4% is difficult from a diversified portfolio that takes in holdings with many types of attributes. Either this person understands the risk he is taking or he doesn't. If I can get 100-125 basis points of dividend yield beyond the S&P 500 then I am pretty pleased.

The way I think of it, that much extra yield can mean taking a little less risk in the portfolio. As a building block, if the market were to have 10% total return every year for the next ten years (it won't be that linear this is just an example) with 2% of that coming from dividends then getting the same 10% with 3% coming from dividends would be a better risk adjusted result. Put another way it would be a smoother ride.There is an element of diminishing return in there as at some point a higher yield becomes riskier than a lower yield. I think a portfolio yielding 9% would really be putting people through the wringer.
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Sunday Morning Coffee

This week's Barron's featured the final installment of the Barron's roundtable which included Marc Faber's picks. I find his commentary in this event to be most useful for what I'm trying to do in terms of learning about new (to me) niches or maybe learning a little more about a niche I've already started to study.

Faber touched on two areas of interest to me. The first was publicly traded exchanges with his pick of Oslo Børs which appears to trade in Norway with ticker OSLO and on the US pinksheets with ticker OSBHF. The reason I say appears is that Yahoo Finance which has Norwegian stock quotes on the home market doesn't have a listing, it does for the pinksheet shares, I also could not find it on the Oslo Børs site. BigCharts does know the Norway listing and I would think Faber would know whether or not he did own shares, BTW he said it yields 10%. I was able to find a page on the company site with financial information that I will try to look at later today.

Zooming out a little bit, I've banged the drum a few times about an ETF devoted to global, publicly traded exchanges, such a fund would be heavy in the US exchanges I imagine--there are funds with exchange exposure but they also take in other parts of the sector like asset managers. Broad financial exposure will be unattractive on a fundamental basis, in my opinion, for a long time. Given the severity of the meltdown and the factors causing it I think it will be years before things have a shot at being healthy. I am talking US banks, European banks and even insurance companies, as I've been saying all along there will be trades in these along the way and that won't change but the fundamentals seem a long way from being right.

Our financial exposure has been the same for a while with one Australian bank, a Canadian bank, a bank from Chile, one publicly traded US exchange and an index provider. These are all individual stocks, at times this has been a great grouping and at other times a fair grouping. In theory, instead of individual stocks these could all be replaced with ETFs if they existed. It might be difficult to have an Australian financial sector ETF or one just for the Canadian financials but my mix could be replaced with a commodity based economy financial sector ETF which would include those three countries and obviously our exchange could be replaced with a global exchange ETF--there are enough of those to populate an ETF.

Some of the ideas for ETFs that have come up before (cement ETF, toll road ETF, fishery ETF, airport ETF, frontier market financial ETF and whatever else) certainly might have trouble catching on but the idea behind the idea, that being specialized exposures for a diversified portfolio, is certainly not new. Many of the stocks in these little niches have been around for a very long time and have better valuations than plenty of US stocks.

Back to Faber, he also mentioned Chiang Mai Ram Medical which is a Thai hospital which could be a part of the medical tourism theme that I started writing about a year and a half ago. There does not appear to be a five letter designator for US trading but anyone so inclined could get a trade done, depending on their brokerage, and this would create a ticker symbol (again assuming there is not one already). I think this theme is important, if you look up the company on Google Finance you'll find a little info and a list of other related companies.

If it is legitimate to build a portfolio of individual stocks, and (changing examples) if a medical tourism stock could be valid in a portfolio of individual stocks then a fund that owned a diverse selection of them would also be valid.

Plenty of people knock this thinking which is fine for them but I think the last decade provides ample evidence of the need to expand investment horizons in order to have a shot at adequate returns. It is not that difficult to realize that a theme has real demand behind it or that a particular country has a low debt load, favorable demographics and whatever else might make it a favorable destination. Being able to see this and choosing not invest seems very illogical, especially when the alternative might be to hope that what worked in the 80s and 90s will work again.
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The Big Picture for the Week of January 30, 2011

After a week or so of lead time things in Egypt obviously escalated on the ground in Cairo which appeared to have a meaningful impact on equity prices in Friday's session.

Of most interest to me was that despite the slide in gold this year, at the point of genuine political uncertainty gold went up. As I've noted before we own gold because no matter the price today I expect it will go up tomorrow should there be some sort of external shock. I think the current events in Egypt would count as an external shock.

Gold going up in this circumstance is a matter of relying on the markets "working" they way they are supposed to which cannot be perfect but it is a little reassuring that to see gold react this way. We got an even larger pop from our holding in Suncor (SU) as anything that remotely threatens middle east oil makes the Canadian oil sands look more attractive.

Not surprisingly most everything else went down a lot on the day including our exposures to Chile, Israel, Brazil and a couple of thematic ETFs. I'm not terribly concerned with how long this takes to play itself out so much as understanding (and reiterating for clients) that for as long as the Egypt story does go on there will be certain market segments in a diversified portfolio that struggle. It is also useful to remember that if this were to turn into something that lasts a couple of weeks taking 10% out of the market (not my expectation) that there would be nothing unprecedented about it. And if this is not the event that scares the market for two weeks and 10% then in the future there will be an event that does.

As a side note I was puzzled by Bob Pisani's continual updates on the Market Vectors Africa ETF (AFK) which he said is 20% invested in Egypt as this story evolved during the week. I saw him give this same general update about AFK numerous times but what about the Market Vectors Egypt ETF (EGPT)? Wouldn't something that is 100% Egypt tell a more complete story than something that is 20% Egypt? I actually emailed him to point out the existence of the fund (as I'm sure many people did) but I never heard any mention of it from him. Maybe I missed it but this was pretty funny in an odd sort of way.
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Well, The Market Is Up 95%

The US stock market is up 95% in less than two years. No matter anything else in terms of perceived fundamentals, Fed action, ongoing threats the fact remains that the market is up 95% from where it was in March 2009. Whether or not people should feel better it is also true that many people do feel better about the market. I've never believed that a lot of people sold out at the bottom and missed the entire rally, I don't believe it is that cut and dried, and so seeing your portfolio come back by some large chunk, even of not 95%, is going to make you feel better one way or another.

Against this backdrop it is somewhat surprising how many new defensive ETFs have recently come out or have been filed for. There has been the WisdomTree Managed Futures ETF (WDTI) which an absolute return product, RBS has come out with two ETNs that are essentially long the index when it is above the 200 DMA and out when it is below (there is a large cap version and more recently a mid cap version), iShares filed for minimum volatility ETFs and after coming out with the Cambria Global Tactical Allocation Fund (GTAA) AdvisorShares is coming out with the the Active Bear ETF (HDJE) which will sell short individual stocks.

Frequently new products come based on the short term sentiment of the market as evidenced by past debuts of certain commodity and metals ETFs throughout the commodity bull market, and the number of traditional mutual funds that promised to hedge the downside after the bear market was well under way.

As I have mentioned quite a few times, some exposure to a fund that should have some sort of zigzag effect is a worthwhile hold with the proper understanding that during a raging bull market it will be a drag on the portfolio. When the market was near what turned out to be the low I commented repeatedly that the time to get out of stocks or load up on defensive funds was not after a huge decline, that it was unfortunate for anyone learning they had the wrong asset allocation but it was too late for gutting a portfolio. The time for lightening up (the context being people who freaked out two years ago but managed to hold on) would be after, say, a 95% rally. Of course people who were freaked out might very well forget what two years ago felt like--this is quite common, people somehow forget that markets go down and how afraid they were when it did go down.

Maybe we should take the recent wave "defensive" funds as a contrarian indicator that the market will go much higher from here. To paraphrase myself from when the market was in freefall, the odds of a large rally are less after a large rally. In very late 2008 I wrote a 2009 outlook post for Seeking Alpha where I got filleted for applying that same idea to large declines as I thought a very large rally was coming. That was a little easier because of how one way the fear was versus now where while the mood on Wall Street is pretty decent, the mood on Main Street is pretty lousy.

Perhaps the best thing now is for people who were freaked out before to take a good look in the mirror. Anyone who rode all 56% down with the SPX or worse by virtue of portfolio composition at the time, now has much more in their portfolio. If this is you and you freaked out, were desperate and were bargaining with yourself should you now think back to what that was like and revisit what your ideal target asset allocation should be? Doing this now is better than waiting until the next large decline and I promise you there will be a large decline at some point in the future.

The best course in my opinion is a normal equity portfolio with some objective trigger point for defensive action but of course this requires being able to sleep at night no matter what is going on. After a 95% rally, specifically predicting a large correction is less important than not panicking should one come along and catch you off guard. You may not be able to trade around a correction that scares people but you can be mentally prepared.
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Making Use Of All Tools Available.

Long time readers will know about some of the building blocks I believe in for portfolio construction which include a mix of different tools, a higher dividend than the S&P 500 (most of the time), building a portfolio at the sector level and a lot of foreign exposure. Every now and then I like to build a sample portfolio on the blog that might promote thinking about the task a little differently. As an FYI I don't own any of the following personally or for clients. For each sector I picked one ETF and one stock. As one of the drawbacks with ETFs is often lower dividend yields I'll try to make up for that with some of the stock selections.

Financials;

WisdomTree International Real Estate Fund (DRW)--In many circles real estate is considered part of the financial sector. This fund went down less than the Financial Sector SPDR (XLF) and is a little closer to its pre crisis level but still has a long way to go. It paid out a massive dividend at the end of 2010 that is not likely repeatable. The info page pegs the 30 day SEC yield at a more realistic 3.45%. While I personally think RE fundamentals stink, if that turns out to be wrong this fund should capture the effect.

Banco de Chile (BCH)--We own another Chilean bank. I've spelled out the Chile story many times before and the big banks seem to be good proxies for the story. The trailing yield is 4.6% and the stock is way above its pre-crisis high.

Technology;

iShares S&P Global Clean Energy Index Fund (ICLN)--This might be a stretch as only 57% could be considered technology but I think the objective combined with the weighting would at least elevate this to being a maybe for technology. There is going to be progress on this front that is certain. The variable will be how much progress but if there is meaningful progress then this fund should benefit.

Nvidia (NVDA)--Barron's just did a write up on this over the weekend so this would be an easy one to at least learn the story. This one has no dividend but there are several chip stocks with large dividends including INTC, MXIM and MCHP.

Health Care;

PowerShares Dynamic Healthcare Sector Portfolio (PTH)--This fund avoids large exposure to the usual domestic suspects and since inception in 2006 it has meaningfully outperformed the Healthcare Sector SPDR (XLV) which is very heavy in the usual domestic suspects. PTH does give prominent weightings to a couple of insurers which could be problematic.

Abbott Labs (ABT)--I got taken to task just a little on this one recently. It yields 3.76% and has a long track record for raising dividends.

Energy;

Global X Uranium ETF (URA)--Take the time learn about what the demand for uranium is likely to be over the next ten years. For 2011 it is not clear to me that it will be a world beater unless the price of oil goes up a lot which if it did then URA would probably also go up a lot. One important point is that this fund will be very volatile.

Petrobras Preferred (PBR.A)--This is probably a contrarian name because of ongoing political threats and a recent dilution. The preferred and the common correlate very closely but the preferred yields a little more at 3.45% than the common.

Industrials;

First Trust ISE Water Index Fund (FIW)--There are several water ETFs and often these funds are heaviest in industrial stocks as is the case here at 58%. I've been writing about water for years now and think it will prove out to be the most important resource story of the new decade.

Siemens (SI)--This is obviously a German company which yields 2.87%. While I want no part of big Western Europe, Germany is probably the healthiest of the bunch. SI has correlated closely to iShares Germany (EWG) for a long time but has pulled away meaningfully over the last two years.

Consumer;

EG Shares Emerging Market Consumer ETF (ECON)--I'm blending together discretionary and staples as this fund targets about a 50/50 mix between the two. It came out of the blocks quickly and has tapered off in the last month. I think the consumer story on the ground in most of these countries is investable and this fund obviously does that.

Lorillard (LO)--Tobacco is usually a good way to add yield to a portfolio. LO yields 5.99% and had performed inline with some of the other tobacco stocks.

McDonald's (MCD)--This is kind of an easy way out for being so familiar but it yields 3.45% and is down some from its high.

Telecom;

Emerging Markets Telecom & Infrastructure Fund (ETF)--This is actually a closed end fund that I have mentioned before. The word infrastructure was recently added to the name of the fund and confusingly the symbol is ETF but that is not the fund's fault as it predates the exchange traded boom by many years. The trailing yield is 2.8%, it trades at a discount to NAV and over the last couple of years has outperformed a couple of the bigger telecom ETFs. Despite the word infrastructure added to the name, telecom stocks still dominate the most recent reported holdings.

As far as individual stocks in this space, according to BNY Mellon there are 37 NYSE listed stocks in this sector (the total of fixed line and mobile) and while Portugal Telecom (PT) might not be a great hold there might be a compelling case for some of the others on that list. Or for a domestic stock there are of course several of those including AT&T (T) which yields 5.99%.

Materials;

First Trust ISE Global Platinum Index Fund (PLTM)--The fund is heavy in South Africa and Canada with the largest holding being from Russia. There are a ton of specialty ETFs in this sector covering a lot of ground from metals of all sorts to agriculture to chemicals and even China. Most of these are quite volatile.

Cemex (CX)--If there is ever a cement ETF this stock will probably be featured prominently. It has done poorly for quite a while now and although I would prefer one of the cement stocks with a five letter ticker I'm avoiding those for this post so I guess that this is just a reminder that cement can be part of this sector and some of the stocks have done quite well.

Utilities;

PowerShares Small Cap Utilities Portfolio (XLUS)--I'm putting this in the mix as a reminder that PowerShares has a suite of small cap sector funds. XLUS has soundly outperformed XLU, the large cap fund from SPDR, due in part to small caps having generally outperformed large caps. In eyeballing the holdings XLUS appears to have a much different volatility characteristic than the large cap utilities funds you may be more familiar with.

For a stock here someone willing to delve into the pinksheets for a foreign name could find all sorts of toll roads and airports to collect some yield with low volatility. Again the BNY Mellon site can be a good place to go for research ideas, there are 21 NYSE ADRs, there are also the US large cap utilities or to go a little more specialized there are also water utilities.

Hopefully some of the above is new to you and to repeat we don't own any of the names mentioned. There are all sorts of market segments that are easily accessible, again this post did not get into the difficult to access spaces, to build a diversified portfolio. A mix that includes ETFs and individual stocks allows for managing all sorts of portfolio effects including single stock risk which I why I believe in using both.
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State Of The Union Address

Politics aside, seriously, politics aside has there ever been an emptier State of the Union address? I was expecting a lot of empty we oughtas but there was barely even that. No joke, am I remembering past speeches incorrectly? I can't believe how empty this was.
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What Should Come Next In ETFs? Part Deux

Well I was not expecting a followup to yesterday's post, well not today anyway, but it is appropriate. Perhaps coincidentally to yesterday's post or perhaps not I had a conversation with a honcho at one of the ETF providers and while the conversation needs to be confidential there were a couple of broad ideas that emerged and one concept that I stumbled across that could be useful in terms of how to think about ETFs.

While we should not expect a Taiwanese Table Tennis ETF anytime soon I got the sense that the vetting of new ideas for possible funds is a very time consuming and ongoing process. That fact is great for end users. They are very concerned about bringing a fund to the market that would end up not having any utility. Obviously not every fund will end up being useful but where this one company is concerned, they do not want to waste time or money on something that has no audience.

True to the post yesterday about iShares soliciting ideas for new funds (it was not someone from iShares that I spoke with) they are open to ideas from end users and I got the sense on the phone call (so corroboration of the iShares advertising) that most providers do want this sort of input. In the course of the conversation I tossed out yesterday's idea about a frontier market financial sector ETF and while I don't know that we will see that anytime soon either I believe I am fair in saying it was not the single dumbest idea he'd ever heard.

In this context there were a couple of comments yesterday that are worth addressing. One reader professed a general dislike for country funds because so many of them are heavy in financials. The reader is of course correct that many country funds are concentrated this way. I think this circles back to a point made many time before which is that ETF is simply one way in, there are of course others. Take the example of the iShares Switzerland (EWL) which is 20% financials. As a substitute for EWL I don't think an investor would be acting reckless beyond all reason buying Nestle (NSRGY) instead. Nestle is is the largest holding in EWL at 21%, correlates to EWL quite closely most of the time but separated noticeably in 2007 during the early stages of the financial crisis.

In a given instance an ETF will be your best way in to a niche and in another instance it could be a common stock. At this point I would think investors looking to build a narrow based portfolio would expect the answer to be one or other not one at the exclusion of the other.

This leads to another point. I've been talking about a fishery ETF and the Norwegian stocks in that niche for a couple of years now. The chart to the left shows one of the names in the group in blue versus the OBX index from Norway and the PowerShares Food Portfolio (PBJ). I've talked before about why the space might generally be attractive but it is difficult for most investors to access trading (BTW Schwab offering access is less than meets the eye due to a $50 fee) and it may not be easy for many people to get comfortable buying a Norwegian fishery company. Buying Nestle (completely unrelated company of course) is going to be easier for more people than a Norwegian fishery.

It is not clear to me that a do-it-yourselfer has access to analyzing many companies in the niche and selecting one of the many tradeable choices. In that light, an ETF, should it ever list, becomes the access in terms of being cheaper, avoiding being overly exposed to some unpredictable fish illness that takes out an entire fish farm and only requires a familiarization with some large holdings not diving into what might be an unfamiliar reporting process in company filings. I have no idea what the next 12 months holds for fishery stocks but the long term theme is valid and for many people an ETF would be the only realistic shot of getting in which of course makes them a democratizing force.

Another reader commented that I was trying to hurt people because despite my saying narrow themes, he says the word narrow means thinly traded which means people are subject to tax consequences from fund closures. He seemed to imply that stocks are the only way to go. Um, if the AUM and volume are not enough for you then I doubt you would buy the fund.

No matter how useful or not that the EG Shares Emerging Market Consumer ETF (ECON) might be it would not have a long life if it had not attracted such a large asset base with trading volume so quickly. Conversely if the HealthShares Ophthalmology ETF had somehow attracted $300 million in assets on 500,000 shares a day it would still be with us. An absurdly narrow (in terms of thematic focus) fund with a lot of assets and volume is not a realistic threat to close.

In making decisions for client portfolios I have ruled out funds for having too little volume. There are existing funds that I think are a great idea but if the volume we would need to buy across the board is greater than the average daily volume, note we are a pretty small firm, then chances are I need to figure another way in. This is not that difficult; if a fund is too small for you, don't buy it.

On an unrelated note I have found a true black swan--this is the real deal. The San Diego State University mens basketball team is ranked fourth in the nation behind Ohio State, Pitt (lost last night to Notre Dame) and Duke. This is even a black swan for the butcher (readers of the book will know the reference).
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If You Ever Want To Retire, Don't Follow This Advice

The above was the original title of my latest exclusive post at Seeking Alpha that I hope you can check out. Here is the excerpt;

I read what I’ll call an odd blog post with a unique idea for retirement investing. As much as I disagree with the post there was a nugget or two that could be very useful. The post in question is by Kurt Hemmerling who opens up with the admission that the forthcoming framework was rejected to be published as a book.

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What Should Come Next In ETFs?

In the last few days there have been a couple of posts touching on the idea of what direction the ETF industry might go in; one from Mebane Faber revisiting a wish list from four years ago and the other by Richard Bloch from Zecco noting that iShares is soliciting ETF ideas.

The line in the sand for me is plain vanilla exposure versus very complex exposures. Every week we get a new VIX product to consider. The calculation of VIX is a very objective calculation of option prices. However the things that influence those option prices is very subjective and prone to changes. This makes VIX complicated. So any fund comprised of VIX futures or using some sort of strategy with VIX futures stands to be much more complicated for the end user. Since inception the VXX ETN is down 92% in almost a straight line with a one for four reverse split along the way. In that same time the actual VIX index is down more like 65%. Complicated.

This is not to say that a double short ETF is not also potentially complicated but I believe much less so. If the VIX index is up 4% today there is no certainty as to what a futures based fund will do today. There might be a probability of some result but no certainty. However if the NASDAQ drops 4% today there is a specified result that should occur in a double short NASDAQ ETF, it should be up 8% and the odds are overwhelmingly in favor of that occurring. Even so there is some reliance on something working the way it is supposed to but less so than with a VIX product.

I am also partial to products using the Diversified Trends Indicator. This is a rules long short strategy that uses futures. We've had good luck with this in mutual fund form and recently WisdomTree came out with the strategy in ETF form that I'll be writing about this week at TheStreet.com. Rules based creates a probability of outcomes even if not a certainty that I think makes for much easier investing.

As far as equity ETFs I would like to see funds that offer access to narrow themes like the recent Global X Uranium ETF (URA) or the Market Vectors Rare Earths/Strategic Metals ETF (REMX) or take a more focused approach like maybe a frontier market financial sector fund. The emerging market financial funds are dominated by markets that I personally don't care for; I've said repeatedly I don't want exposure to Chinese financials for example. The banks from smaller emerging and frontier markets frequently are better holds--well better than Chinese banks for my money.

With fixed income funds I think there needs to be more specialization with foreign exposure. The Japan heavy funds that exist now have not been problematic thus far but at some point I would expect them to be dangerous holds. They are heavy in Japan because Japan has the most debt outstanding. I don't know when the yen will be problematic, maybe never, but this is an issue to be very aware of. As I have pointed before there are all sorts of indexes that exist for this space in terms of individual countries--licensing an existing index would seem to be much easier than creating one from scratch.

With commodities I suppose people want more in the way of physically backed funds as opposed to futures based and apparently a physically based copper ETF will be in the US soon. One thing I don't quite understand with these is how storing a nominally cheap commodity--something that costs a few bucks a pound--can possibly be economical. I believe there is a copper ETF already trading in London so this issue has probably been addressed. Physical storage of agricultural commodities could also be problematic for spoilage but I've not heard much about proposed funds in this regard.

The industry will of course evolve, will of course offer plenty of new products many of which will go nowhere but some of which will prove out to be transformational is a positive way. The best thing we can do for ourselves is to stay informed and be selective.
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Sunday Morning Coffee

Felix Zulauf at the Barron's Roundtable: In the U.S., annual consumption of meat is 130 kilograms (286 pounds) per capita. In the European Union it is about 100 kilos. In China it is 55 kilos, and it was 39 kilos 10 years ago. In India it is at only seven kilos, so there is a long way to go. In 1980 Taiwan was at a development stage similar to China's today. Since then, Taiwanese meat consumption per capita has doubled from 43 kilos to more than 90 kilos. By 2030, China's meat consumption could be 85 to 90 kilos.

It takes about six kilos of grain to produce one kilo of beef. It also takes 4,000 gallons of water. If I had a good water play, I would discuss it here. On the supply side, available land is diminishing. We can't get water to some land.

Hectic weekend, normal blogging should resume tomorrow.
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The Big Picture for the Week of January 23, 2011

Joseph Shaefer had a post up at Seeking Alpha on foreign investing that offered a lousy acronym (sorry Joe) but a great discussion topic for building the developed-foreign part of an equity portfolio. To read the article he favors Australia, Switzerland, Norway, Britain, Singapore, Canada, New Zealand and Sweden. I generally agree but am less sanguine on Britain and would add Denmark and Israel to the list.

While I have said a few times that I think terms like emerging and developed are losing their utility, that is the context of Joseph's post so I will stick with them for today.

All of Joseph's country picks have ETFs available which makes the concept precisely accessible for people who would rather not pick individual stocks. For Australia there is the iShares Australia ETF (EWA) and IndexIQ Australia Small Cap (KROO), iShares Swizterland (EWL), Global X Norway (NORW), iShares United Kingdom (EWU), iShares Singapore (EWS), for Canada there is iShares Canada (EWC) and IndexIQ Canada Small Cap (CNDA), iShares New Zealand (ENZL) and iShares Sweden (EWD). EWA is a personal holding and a few clients own it.

The biggest concern with building a portfolio of country funds (the assumption is that the countries have been researched and a decision to buy has been made) would be that the sector mix creates an enormous overweight or an extreme underweight. In this instance all that is required is a little spreadsheet work assuming a simplistic weighting of the funds. We benchmark to the S&P 500 so the sector weights in the SPX will serve as the benchmark for this post.

There are eight countries and ten ETFs (two ETFs for Canada and two for Australia). I did the work on two versions. One where I used the large cap iShares funds for Australia and Canada and one where I used the IndexIQ small cap funds for those countries. In the version with the two large cap funds the biggest overweights are in financials and materials. The largest underweights were tech, healthcare and the two consumer sectors. The rest were reasonably close. In the version with the small cap funds the financial exposure came down to be inline with the SPX and materials increased into a larger overweight, the changes in the other sectors only being slight.

I was surprised that there were not more extreme sector variances. Of most interest was the materials sector. The way I built the two versions materials were 11.3% in the large cap version and 15.1 in the small cap version versus 3.58% for the S&P 500. In looking at the list of countries obviously several of them are commodity based including the UK by virtue mega cap companies like BHP Billiton which is cross listed which is 15% in materials. Anyone interested in taking on a double digit weight in materials stocks (or funds) needs to assume that they are taking on more volatility (most true even if there are some materials stocks with low volatility) than the S&P 500 which is neither bad nor good, it just is. Clearly some investors would be just fine with a more volatile portfolio but it is important to understand the characteristic of the sector--well that applies to every sector doesn't it?

The idea of simply implementing someone else's work is a very bad idea but reading Joseph's article is time well spent in terms of what leads him to his conclusions and as I own many of the countries he isolated I'm on board with most of it. Obviously "emerging" markets have a role in a diversified portfolio (I don't think he is saying otherwise) for someone with a normal tolerance for volatility along with themes and at least a few domestic stocks.
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Steve McQueen & Bond ETFs

Awhile back the ETF provider now known as Guggenheim listed an ETF line called BulletShares for corporate bonds which allowed investors to access a specific maturity date such that with the BulletShares 2014 Corporate Fund (BSCE) the bonds held in the fund would all mature throughout that year and the fund would close when the last bond matured. This offers more precise management of average maturity in a bond portfolio than other funds do.

As a practical matter if I really wanted to target 2014 I might go with the 2015 fund because the 2014 fund starts liquidating due to maturation as soon as January 15, 2014. I would also add that buying individual issues that are investment grade is not terribly difficult beyond trying to minimize the chance that something you buy today isn't going to get called tomorrow. And as a more general warning the fixed income ETF space is evolving such that the ETFs can be more liquid than what they own which can cause the market value to stray from the fund's IIV (IIV is the ETF equivalent of NAV).

The reason to mention BulletShares at all is they are now coming out with junk bond funds with the same sort of maturity structure as the existing funds. I received a couple of emails on these that gave the impression that they would be out yesterday but I don't think that was the case (no info on the Guggenheim website and neither Yahoo Finance or Google Finance recognized them).

Per the emails there will be four junk bond ETFs. The fund targeting 2012 will have ticker BSJC, 2013 will be BSJD, 2014 will be BSJE and 2015 will be BSJF. The site for the index provider has information for underlying indexes going out every year until 2021 so perhaps there will be more funds later. To be clear, the point of this post is not that you should run out and buy a junk bond ETF right away, Jeffrey Gundlach thinks now is a bad time for this space, but to point out the space is evolving for the better.

The BulletShares concept, despite not getting a lot of attention, is actually one of the more important developments with bond ETFs, in my opinion. The bond market has been distorted by a combo of desperate policy and the fundamental risk currently embedded in the US economy and while I think the best way to navigate this problem is with a healthy dose of individual issues not everyone is comfortable with this which is where funds can obviously come in.

We see precision with some funds in some segments like lately with the TIPS space but with other segments the maturities are a range of years but it is the same number of years perpetually targeted. For example a 7-10 year treasury ETF will always target 7-10 years so if somehow the yield on a 7 year treasury was 6% today buying that ETF would not lock in that 6%. If one year later a seven year treasury is yielding 2% then the fund you bought will be yielding something close to 2%. The bullet share structure goes a long to minimizing that effect but, big but, if the 2016 fund yields 6% today but a bunch of cash comes in six months from now requiring the purchase of more bonds then the difference in rates six months from now could be significant enough to change your yield. I believe this is still a better way to go fund-wise but not perfect.
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Learning From Tunisia

Charles Kirk kicked off yesterday's daily email with a quote from Seth Klarman from the Baupost Group as follows; "The best investors in the world do not target returns; they focus first on risk." The quote appeals to me intellectually and it is also relevant to what is going on today in Tunisia and spilling over to other nearby countries.

The crew over at ETF Database had a pretty thorough recap of the situation and the apparent spillover to Egypt and the Market Vectors Egypt ETF (EGPT). For the last three days EGPT is down 8.18% with most of that coming at the open on Tuesday. In looking at a few other funds that could be considered as being close (eye of the beholder) the WisdomTree Middle East Dividend Fund (GULF) was down 1.61%, the Market Vectors Gulf States ETF (MES) down 1.25% and the Market Vectors Africa Fund (AFK) was down 2.6%.

The Tunisia story is still unfolding as is whatever the collateral damage will be. The ETF Database article has some tie ins to financial conditions and to the extent this is about the problems facing the poor people in Tunisia it could be similar for people in proximate countries (more of an acknowledgment of the possibility than an analysis of the situation).

In the world of niche or specialized investing this sort of thing happens occasionally and obviously any fund or stock you own in the affected niche will go down; there is concern that Tunisia will have some spillover into Egypt. Circling back to the Seth Klarman quote above it is very unlikely that one could see turmoil in Tunisia causing an Egypt ETF to go down a lot--this is sort of a wildcard that is not reasonably analyzable. However given that there is no end to the types of unanalyzable events that could impact your holdings your best chance to prevent being truly hurt by this sort of thing is with proper diversification.

This takes me back to ten or eleven years ago when people thought owning a search engine, a network equipment maker, a B2B (remember those?) and Infospace made for a diversified portfolio. It turned out that a grouping like was only diversified on the way up (humor attempt). At some point there will be a nasty decline in emerging market stocks and it is a good bet that when it happens it will take commodity related stocks down at the same time.

Or there will be declines that take down other related segments and what matters here is not that some niche you favor gets pasted every so often but what the overall fallout is in your portfolio. If you had a 4% weight in EGPT you are less likely to question the merit of the country out of fear and sell in a panic than if you have 10% in EGPT. Whatever the prospects for Egypt are for the new decade it is unlikely that they are much different with the Tunisia news. But if it turns out that this really is a game changer then a moderate weighting simply causes a drag on the portfolio not the need for a whole new financial plan.
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How to Stop Worrying and Love ETFs

I have another Seeking Alpha exclusive posted. Here is the excerpt;

An in-depth investigation at one of the stock market television networks has uncovered that some ETFs have large weightings in individual stocks, which at times can be problematic for fund holders. It turns out that investors should look at what these ETFs actually own. Needless to say, this is blowing the lid right off the ETF industry.

I hope you can check it out.
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Wednesday Twofer

Yesterday at the gym I saw a guy on the treadmill with a Walkman-like device that looked older than the one pictured to the left. He had cassettes and everything to pop into that thing; truly old school.

While this is not the most efficient way to listen to music while you work out, it was the size of a small phone book, and does not take advantage of recent technology (my iPod is the size of coin) it gets the job done for this guy. As a side note am I the only who is amazed something this old would still work?

Back when (I think) this baby was brand new there were no ETFs and while mutual funds certainly existed, it was still early days for 401k plans and so traditional mutual funds played less of an everyday role than they do now.

There was also far less awareness or need for foreign investing. Information was obviously much tougher to come by as the internet had not become a utility in every house yet. Twenty five years ago we would have never heard of something like Zhejiang Expressway and probably would not have even found anything after driving to library. Today, after finding the name in an article, you can plug the name into Google, get a link to the home page which is in English and be looking at the financials within 30 seconds.

If you like the idea of a Chinese tollroad but do not want an individual stock then maybe you would instead buy the iShares Emerging Market Infrastructure ETF (EMIF) which has 4% in Chinese toll roads or buy the iShares Infrastructure ETF (IGF) which although only has 1.5% in Chinese toll roads has about 10% in toll roads from various countries. Both EMIF and IGF are in our ownership universe.

The above is just an example but breaking new portfolio ground has been important for the last ten years and will continue to be so which for some folks means things like toll road stocks from Asia and for other folks very specialized ETFs. Both are now accessible through innovation and evolution.

Back in the mid 1980s a portfolio of Philip Morris, Pepsico, IBM and Texaco did the job but that type of mix is nowhere near the one way bet it used to be and the ability to realize this and take advantage of modern tools available makes life and investing easier. We own the modern version of Philip Morris for clients and in my wife's Roth Ira.

Next is this screen grab of the Yahoo Finance widget I have on my desktop taken yesterday afternoon. On it I track the S&P 500 one ETF for each of the sectors (these funds are not necessarily ones I use in any client accounts) along with a few other things. It is an easy way to quickly know what is going on at the sector level during the day and whether foreign might be having a good day.

Needless to say that at that moment something was wrong. I do not know if it was a glitch at Yahoo or somewhere further up the line, but the data is clearly erroneous. This sort of thing happens in markets now and then with the most famous example being the flash crash from last May.

During the actual flash crash I made fun of it being a panic and that these things come along. Whatever is pictured to the left here, although after hours, is just as obviously erroneous. Just as there were no $50 ETFs really only worth a penny last May the Rydex Euro ETF did not go up 133% after hours yesterday. Both are equally silly and hopefully you recognize this sort if thing the next time the market has some sort of malfunction.
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Frontier Markets

I meant to get to this before but a while back Dow Jones redid their country classification such that they now recognize countries as being frontier (apparently this is new for them). This is interesting and you can see below how they divide up the countries as being developed, emerging or frontier. Peculiarly Vietnam is missing from the list.

Lately I've been working with the idea that these labels are worthless. I believe the financial crisis has rendered them useless or at least almost useless. If you look at the list, what does Ireland being listed as a developed market do for you? What priority is this fact in your decision to either include Ireland in your portfolio or to avoid it? As opposed to the label wouldn't you be more concerned about their debt load, ability to service the debt, the likelihood of more bailouts, the fate of the banks, the real estate situation, the unemployment rate and probably a few other things?

On January 1st Estonia adopted the euro as its currency. It was able to do so because it met all the criteria set out for a country to in fact adopt the currency. Although the wisdom adopting the currency could be questioned it is likely to be a huge benefit for them in terms of trade and the country has one of the smallest debt loads in the world.

Candidly, aside from not knowing of a way to invest in Estonia, I have no idea whether it would make for a good investment or not but a cursory glance at, in this case, Ireland versus Estonia very quickly leads us to believe that Estonia is on firmer footing, not that Ireland couldn't be a great trade, and far more worthy of research time.

Looking at other names on there, Qatar is sitting on a mountain of natural gas, Slovakia has very cheap labor, Argentina seems likely to be involved in the world's food solution, Poland may also soon qualify to adopt the euro, Pakistan has a huge and young population and they are large producers of certain crops.

All of these countries have their positive attributes and their risk factors. Ultimately these need to be weighed against each other and a decision made about whether the country is investment worthy, this conversation assumes a willingness to go narrower than global funds.

If anything, time spent assessing developed, emerging or frontier is time wasted. If you draw the conclusion that a particular country stinks as an investment destination is there a scenario where you would buy in? The more important point is that from a diversification standpoint owning countries with different attributes will play are larger role in determining your result than the above labels.
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Active Management With Passive Investment Products

I took advantage of the day off to do a little extra writing with another Seeking Alpha exclusive that takes issue with another SA author's conclusions about how to use ETFs. The excerpt;

A recent article on Seeking Alpha by Tim Ayles made an unusual argument (unusual relative to the last few years) for actively managed mutual funds and ETFs. The building blocks of his argument include that active managers failing to “beat their index” does not necessarily matter; he would be ok with a fund that lags if the active manager of the fund takes less risk than the market. He only mentions beta as a means of assessing how much risk a fund takes, but beta is more about volatility, and risk and volatility are not necessarily the same thing.

Here is the link to the entire article, I hope you will check it out.
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Coach Calipari Dishes Out Financial Advice

The other night on ESPN there was a "town hall" with among other people John Calipari who is the basketball coach at the University of Kentucky. Coach Cal is a master recruiter and over the years has been glad to take kids in knowing they would only be there one year before going on to the NBA. As a result he has had more exposure to future NBA players than most other college coaches.

At one point in the town hall the conversation turned to personal finances for the players and Coach Cal seems to feel an obligation to try to teach the players about some basics of how to handle their money. He says that the first $1 million should go into the bank and not be touched. After that you take care of whoever needs to be taken care of (family-wise). Back to that first million, he said if you leave it alone, then in seven years you have $2 million.

He then went on to say that with that $2 million you can live on $200,000 without ever touching the principal. First I think he is to be commended for being aware of these issues and trying to pass along awareness to his players.

It would better though if actually knew a little more about this before telling young people over whom he has lifelong influence how to manage their money. He obviously assumes perpetual 10% return and that a 10% withdrawal rate is safe. I do like the idea that these kids should sock away their first million... or more.

Moving out a little, one element embedded into Calipari's comments is over confidence of how numbers work, assumptions about the smoothness of returns and failure to recognize that in life there are occasionally financial events (this can refer to good things too) that compromise the potential success of any financial plan.

Quite frankly the number of things that can go wrong are endless. How many stories of personal financial failure have you heard in your life? While I won't go into to detail I have disclosed my parents made some catastrophic (related to personal finance) mistakes and while part of their story is familiar there are other dynamics that are unique to them, well at least somewhat unique. People can get done in by bad luck, illness, unfortunate timing (like maybe some who retired in 2000), family circumstance and on and on.

I think that the number of things that can go right is far fewer than what can go wrong and while I've never articulated it this way before I think focusing on the types of things that can go right, figuring out what those are and then giving yourself the best chance to benefit from what can go right.

Obviously I am going to say that things you can control that can go right include savings rate, living below your means, some sort of earned income in a post "retirement" career and respect for how numbers work. Someone who takes a 7% withdrawal rate could easily cruise on through without any financial problems but is does show a lack of respect, in a manner of speaking, of how these numbers tend to work. The more you take out the less chance for having your financial plan succeed so really this is about probabilities as it is possible for a 2% withdrawal rate to fail.

To the extent that there is no limit to the different ways that financial plans fail, the 2011 Dakar Rally (the big trucks are my favorite) ended over the weekend and less than half of the over 400 entrants finished the race.

How many different stories of failure do you suppose there were at the Dakar?
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Sunday Morning Coffee

Today starts something new with Seeking Alpha. They are now paying for exclusive blog posts based on CPM and they've asked me to be involved. There will still be six or seven regular blog posts here every week, same as it has always been but there will also be a couple of exclusives to Seeking Alpha; two- four per week. The way it will work is that I will excerpt the SA exclusive with a paragraph or two and then provide a link to the complete article. Today's excerpt;

Yesterday as I was doing my Saturday reading and watching various games I saw an ad on one website touting Two Stocks To Hold Forever! I did not click on the ad so I’m not sure what they were selling but the concept of forever stocks, or ETFs, is interesting. I don’t really have stock picks to just hand out but there are some themes or other niches that I think will be crucial over the next decade or even longer.

In a recent interview I pointed out that I think water will be the most important resource related theme for the next ten years. By now you probably know about the mounting tension between China and India over the possibility that China could dam the Brahmaputra River.

The link to Seeking Alpha for the rest of it. I hope you will check it out.

One goal of the blogging is to have it create a viable, auxiliary income. You've probably gleaned that I am very conservative financially in terms of savings rate and how risk is taken. My primary job pays a fine wage but the idea of a second source of income, in my case the writing, being sufficient to pay the bills is very appealing as a fallback should something unforeseeable ever happen. A third source for us, potentially could be my involvement at the Fire Department. I do some work now that I could get paid for but choose not to. A change in our circumstance, in the context of unforeseeable, and this could help out as well.

Tying into past posts these are things I love doing, have been willing to do for nothing and have figured out how to make enough from them to take the burden off our portfolio were we using our portfolio to live on. As I have said before, if there is something in the realm of hobby or interest that you love doing and would do for nothing then chances are you can figure out whether or not there is a way for you to turn it into a paying gig. It may be there is no getting paid for your hobby but no one would know, either way, better than you.
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The Big Picture for the Week of January 16, 2011

The US market is off to a strange start in 2011 continuing a nice run that started months ago. At the same time the economic data seems to point more toward malaise in terms of jobless claims, retail sales, certain components of the CPI and just about any number you can find that relates to housing. Sentiment seems to be a mixed bag depending on the survey in question.

If you read sites like Bespoke Investment Group or other number crunchers then you may know that the equity market is setting records or on the verge of setting records for number of days above certain moving averages, days without a large decline and other things that are sort of below the surface. It is important to understand that this is occurring at a time while the Fed is targeting asset prices; I read one sarcastic post during the week that said the Fed should just buy SPX futures directly and cut out the middle man. Regardless of the morality of this or any causality we may think is there the Fed's policy includes targeting asset prices and the stock market is going up.

At the same time the fundamentals appear to me to stink. I've said many times that the stock market can go up at any time for no reason at all including against a backdrop of what appears to be lousy economic fundamentals. While there are of course positives here and there we need to understand that some portion of the recovery needs to be attributed to the desperate measures that our government has taken and will apparently continue to take in an attempt to revive the economy. Any recovery thus far has been far more sluggish than previous recoveries. Another throw in here is the muni market, that iShares Muni ETF with ticker MUB that we looked at a few weeks ago has been getting pounded.

All this makes for a confusing and abnormal situation. Whatever actions you take (or don't take) are done against an abnormal backdrop. This is not something I would lose sight of. Earlier in the week I was reading an article at Seeking Alpha written by prominent gloom and doomer (prominent at SA, I've never heard of him otherwise). He has been making dire predictions every year using words like collapse and creating a general framework for the end being nigh. Interestingly the comments were very aggressive for how wrong he's been in 2009 and 2010 (I did not look to see whether he was around in 2008 but if he was then he could have been thought of as being correct for that year.

I am not sure why every single datapoint must confirm the end of life as we know it or conversely we must take the optimistic spin on every datapoint. Every day of your life there has been a bull case for the market and a bear case and this will always be. In March 2009 the bull case turned out to be the SPX being 25% below its 200 DMA (one take on events). In 1998, so with many months of booming stock market remaining, valuations were starting to build the bear case.

A couple of commenters on the doom and gloom post noted that this guy, an investment manager of some sort, has missed an 88% rally for his clients. There is no way to know if portfolios match the blog posts but marrying a position in this manner is simply unnecessary and counter productive. I draw some pretty negative conclusions about the underlying economic fundamentals of the US and the malignancy of the desperate measures taken and I have been quite clear about that but if ever there was an instance in our investment careers where don't fight the fed ruled the day, wouldn't that be now?

The bear case could turn out to be 100% correct but not play out in doom and gloom for years or somehow, some way the bear case could turn out to be completely wrong (far from my base case but anyone can be wrong about anything). Opinions are one thing but positioning your portfolio for either complete annihilation of the free world or money perpetually falling from the sky are both huge bets that most of us should not be placing.

After yesterday's rough post, some very positive news from here on the mountain. On New Year's eve a blue tick hound that we did not know mushed across our property (we had two feet of fresh snow on the ground and the dog avoided the driveway I had shoveled). Our dogs told us we had a visitor, Joellyn and I went out there but the dog was scared of us and kept moving on. Joellyn found a Craig's List post about two lost dogs but we only saw the one. We communicated with the owner right away to let him know but he had not been plowed out yet (he lives much farther back in than we do). We got the notice of the lost dogs posted on the Walker Website; I think most people here would expect Joellyn would be involved in looking for a lost dog.

So Thursday morning a nearby neighbor called and said the dogs were headed down to our place. Joellyn was gone, I ran out there and lo and behold both dogs, Jake is a heeler and Cleo the hound, came around the corner and were right in front of me. I could not get them to come to me but as they were leaving I got the above picture (they are on the road just past where the shade ends). While I was out not getting the dogs, the neighbor called the dogs' owner. He drove over and I spent some time looking with him as he was calling for them but no dice. He stayed out a long time, I ran into him much later when I went down to the firestation in the afternoon--still no dogs.

Well shortly after a I saw him Thursday afternoon the dogs came home. They had been gone for two weeks. He called us on Friday to let us know. If you're not a dog person then the story may not mean a whole lot but we were pretty excited.
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Real Life Encroaches

My buddy who took this picture in Iraq a few years ago died in Afghanistan earlier this week. He and I worked together for years during a different phase of my career and we were part of the same social group that would go camping on the Mogollon Rim every year.

While I am saddened by this my mind takes me back to fun working together and the annual camping trips.

We all spend a lot of time on the stock market and investing and while it is a passion of mine it is not more important than things like health and family or in my case going to fight the occasional wildfire. After six and half years of blogging and taking in comments on those posts it is clear that some folks put their portfolios a little higher up on the list. Hopefully that doesn't lead to regret for them later.
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Gooooood Morning...Laos?

The other day the Wall Street Journal had a writeup on the new stock exchange in Laos. Laos as an investment destination? While I'm sure it will be a while before Laos Telecom lists and ADR on the NYSE the opening of an exchange is a start.

To read the article, apparently the thing here is excess hydroelectric power that they can sell to its neighbors in South East Asia. For now there are only two stocks on the exchange, a bank and a hydroelectric company. Presumably there will be more companies, I mean look at that building, there's got to be room for a few more stocks in all that office space--a little humor.

There are other countries that are also in the earliest stages of capital market formation. As another example Mongolia is a resource rich nation that is drawing a lot of FDI and there are a couple of Mongolian stocks listed elsewhere, mostly Hong Kong I believe, but the actual market is only open one hour a day.

While a Laotian stock may never list on the NYSE it could list in Hong Kong and for all we know exporting hydroelectricity could turn out to be a gold mine for any related companies and should they list in Hong Kong they would be accessible.

The other day a reader at Seeking Alpha left a comment saying that country selection is a crap shoot. If you believe that then these sorts of posts are not for you obviously but I think the numbers are compelling and the mindset of what is being sought needs to be correct.

In terms of managing an investment portfolio with a longer time horizon foreign exposure is intended to offer diversification. My premise here has been that better diversification comes by selecting countries with as little in common with the US as possible; different economic cycles leading to different stock market cycles.

Isolating what countries are least like the US is a matter of simple research; Wikipedia can work here along with a visit to the central bank of web site of the country. From there I would look under the hood of any ETF that might exist and learn a little about some of the bigger companies in the market. Here I am not necessarily talking about analysis to buy the stock just some basics like how many customers a phone company has or how many manufacturing facilities a company have, number of stores for a retailer; that sort of thing. The above also needs to include some understanding of the politics in the country as well.

From that point there needs to be some way of keeping tabs on the country presumably with the intention of getting in at some point.

Looking back at the last decade, I've referenced data from Bespoke Investment Group countless times on this point, there were plenty of countries that had normal or better than normal results and isolating some of them was far from a crap shoot. If a country has a manageable debt situation, prospects for growth, prospects for social improvements or has something the world needs (doesn't just have to be commodities, it could be labor, innovation or other demographic attributes) then at the very least you have a tailwind to the country.

What this will not do is offer shelter during a worldwide panic. As I said before the crisis, some countries can go down at different times or by different amounts thus smoothing out the ride. Of the countries I write about most frequently the best examples here were Norway, Brazil and Chile. To be clear country selection is no substitute for defensive action taken objectively.

From where I sit country selection contributed mightily to whether people had anything close to a normal decade and I believe will do so again in this decade and this means being willing to learn a little about countries you've never thought about before, maybe even Laos.
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I'm The Only One Who Thinks This, But Still

The other day IndexUniverse noted that the PowerShares FTSE RAFI US 1000 Portfolio (PRF) celebrated its fifth anniversary. The article also noted that the fund had doubled the return of the S&P 500 since its inception returning 23.1% versus 11.99% for the S&P 500--those numbers include dividends.

When PRF first listed I wrote this article about it for TheStreet.com. I drew a conclusion about the fund that seemed odd but still it is what I saw; to me this struck me as looking a lot like the Russell 2000 in terms of comparing the back test to other indexes. Upon publishing this article Rob Arnott, the brains behind the RAFI process, called my house to tell me I was wrong. What could I say?

As time went on the correlation between PRF and the Russell 2000 seemed to persist. I mentioned this later on the blog and long time reader RW suggested I look at the Russell 1000 Value Index which is tracked by an ETF with ticker IWD. This of course made sense and I hadn't thought about it since that last blog post.

I hadn't looked at the fund in quite a while but the IU article made me curious to see what the fund had done. Five years is not insignificant. Long term holders appear to have gotten a small cap effect. I'm sure anyone who has held the fund would not complain as PRF has delivered a superior result to SPY or IWD and for the trailing twelve months PRF looks a lot like IWD but this just seems like a weird thing to me.

The small cap effect could easily be just my seeing what I want to see but it I think it could be argued that PRF seems to take on different characteristics at different times. This is a fundamentally weighted index fund. Other fundamentally weighted index fund providers include RevenueShares and WisdomTree. This makes me wonder if any of their broad based funds do something like this.

To the extent this blog is about process, process sometimes includes stumbling across what might be an anomaly and trying to figure it out. For now I have no conclusions just an ongoing observation that I'm still trying to sort out. Any ideas?
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David Jackson Asks, I Try To Answer

David Jackson, the founder of Seeking Alpha left the following question on a post of mine;

Can you be more specific about the broad-based ETFs you have in mind? I wasn't clear whether you are referring to broad-based US equity ETFs like the total market ETFs (IYY) and (TMW), or global ETFs like (VEU).

My unedited answer;

I could sum up by saying the broader you go the more you give up in the context I mean. The broader you go the greater the likelihood that whatever you buy will have a higher correlation to something like SPY. So as far as foreign goes something like EFA blends away the various attributes of the component countries. EFA has a higher correlation to every country fund I've ever looked at. One big reason to invest in foreign is to capture diversification for your US holdings, to me this means finding countries with as little in common with the US as possible which gets blended away in EFA.

As for domestic (US as this is where I'm based) and buying things like SPY, or the Russell 1000; my thoughts all along have been that these types of indexes won't work for the foreseeable future. That has been correct for a while and I believe will continue to be the case as my thesis has been the US is a less compelling investment destination such that the broad averages will have price appreciation below "normal," not an Armageddon scenario mind you, but maybe in ten years we look back on 3-5% annualized not 9% or whatever number we used to get.

Investors had a chance to add a lot of value to US portfolios during the last decade by building portfolios at the sector level but avoiding or underweighting sectors that grew to be larger than 20% of the S&P 500 (tech ten years ago and financials six or seven years ago) which is something I wrote about frequently before the crisis. Unfortunately with no sector that large now my opinion here is based more on a weak outlook for the US (too much debt, seriously damaged housing market, terrible employment picture, entitlement programs and the desperate measures taken by the Fed and the US gov't thus far.

I've navigated the last seven years (which how long I've been in this part of the business) on the premise that success will come from making sector decisions, country selections and incorporating themes into client portfolios. I expect this, that is making very narrow decisions, to continue to be the way to go for a long time into the future.

Now for something completely unrelated but fascinating (to me anyway). The new season of Alaska State Troopers started on Sunday Night on the Nat Geo channel; no DVD coming for this post.

One of the segments was about the little village of Diomede which is on a tiny island that off of Nome and on the Bering Strait. Apparently 117 people live there, what you see pictured to the left is the town. In the winter it is possible to walk out over the Strait two miles to Russian soil, or maybe just ice.

There are plenty of difficult ways to get on in life but the idea of being a 45 minute plane ride from Nome is difficult to imagine but still fascinating. When the show was filming there the temperature was about 50 below.

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Hey Abbott!

There was a peculiar exchange on CNBC the other day between Mark Haines and a guest touting Abbott Labs (ABT) as a value stock. Haines asked why anyone would want to buy such a stinker of a stock noting that it has lagged badly since the March 2009 low. It is essentially flat since then versus a 43% lift for the Healthcare Sector SPDR (XLV) and an 88% lift for the S&P 500.

The guest was making a value case for the name and simply concluded that he thinks the market will recognize the value in the name at some point and that they will be rewarded for the pick. Later in the day another analyst said he liked Cisco (CSCO) for the valuation. Cisco seemed to be capturing the effect off of the March low, actually outperforming the Tech Sector SPDR (XLK) until a few months ago when it started to rollover and lag before blowing up with an almost 20% drop in mid November. Over the last ten years it has lagged XLK most of the time and is down 43% from where it was ten years ago versus a 21% decline for XLK in that same time period. Maybe Haines would call this one a stinker too?

I don't really know anything about Abbott and I know a little about Cisco but both create a point of understanding about the potential folly of stock picking. I am a big believer, obviously, of including individual stocks in a diversified portfolio but clearly some picks work out and some do not. Picks can work or not work for a multitude of reasons many of which are not foreseeable. Buying a stock primarily because it is a compelling value is a very difficult thing to do. It is easy to understand that a stock is "cheap" by some objective measure but the difficult part is assessing when the value gets recognized. It can also be difficult to discern why a stock is cheap. Cisco and Intel have been cheap for a long time. Are they value stocks or value traps? You may have an opinion but it is a reasonable question.

The above tends to be more of a bottoms up process for stock selection. The way I pick stocks is from the top down. Top down picks frequently come from country or theme selection. If you correctly pick a country that then goes up 50% it will be very likely that a large cap stock (still properly researched) with a large weight in the benchmark index for that country will go up a similar percent. There can be no guarantee of course but you have a pretty easy to understand tailwind. Conversely, are you willing to bet that you can find some stock in Portugal that will do well for the next year or two? I certainly would have no reason to think I can find a stock that does well if Portugal goes down a lot this year.

As I believe in top down I would obviously make that sound more compelling but plenty of investors do very well with bottom up stock picking but I think this is the more difficult path. The more top down tailwinds you can correctly isolate the easier time you will have with your portfolio and perhaps even more importantly the more headwinds you can correctly isolate the easier time you will have with your portfolio.
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Sunday Morning Coffee

A few weeks ago I was interviewed for an article on CNBC.com about investing in farmland. To read that article but none of my blog posts I came across as a cockeyed optimist without a care in the world about this riskless, one-way trade. A lot of context did not make the the article as published. Farm investing via capital markets is not a riskless, one-way trade. There are quite a few considerations to investing in these stocks, specifically the ones I mentioned as they are the ones I try to follow and understand.

One thing I mentioned in the interview, not mentioned in the final article, was that despite part of the story here being the search for assets not correlated to stocks most of the farm stock got pasted during the financial crisis. The theme is perfectly valid. Although kind of muddied I said the demand for better diets is constant which creates a long term tailwind but these things offered no shelter and I don't expect them to offer shelter the next time the stock market has a bear market decline. I have unyielding faith in the theme but not so the equities; if I ever buy one of these for clients it will just be one name probably at a 2% target weight. Note that I have researched several names, they've done well in the last couple of years but am not ready to commit client money here and am not sure when or if I will.

There is also an important thing to understand, or at least appreciate, about the running of these businesses. They are not just massive plots of land that get farmed every year forever. Many of the companies are very transaction oriented, buying and selling land and cattle. Some of these transactions are about growth and some are about strategy and forecasting. A string of getting these decisions wrong will hurt the stock price, or at least that should be the expectation. Another tie in for this topic is the extent to which science plays a role. Decisions get made about using certain land this year then perhaps giving it a year off to replenish, there are also decisions made for various reasons to grow different crops on specific acreage. There is also science involved in yields and attempts to increase efficiency. Oh, and how does one mitigate weather?

The point of the above is to create awareness of the potential complexities in the business and while we might be able to learn about these things buying one of these stocks is a show of faith in the management of the company you select to generally make these decisions correctly.

On a related note a reader has asked twice why I don't like agricultural commodities which doesn't quite capture my thought process. We own MOO for most clients and I've spent a lot of time on these farm stocks so I like the space. From there then we are talking about the best way in. The actual commodities might be the best way in, I prefer equities which may or may not turn out to be the best way to go. I've been very consistent with wanting no more than mid single digits in actual commodities generally preferring the equities in many spaces.

Over long periods of time equities tend to go up despite the occasional bad decade. I am generally more comfortable with companies being able to manage their businesses more efficiently over time leading to more predictable price movement than I think can be counted on with actual commodities. Some exposure serves to help manage the correlation of the portfolio but as I have said before too much exposure to the diversifiers and you end up with a portfolio where equities end up being the hedge which is not where I want to be. I prefer a "normal" equity portfolio hedged with modest exposures to a couple of diversifiers.
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The Big Picture for the Week of January 9, 2011

The other day I made a reference to Robby Gordon racing in the 2011 Dakar Rally with the same two wheel drive Hummer H3 that he drives in the race every year. I noted there must be an investing analogy there somewhere and maybe I figured it out.

The first picture is of the Hummer in a place where it shouldn't be stuck on top of an enormous rock. The second picture down below is a closeup of the front end of the Hummer on the rock. Other than the money he must get, I said I don't know why he drives this vehicle in the event every year.

I am clearly no expert but this seems like the wrong tool for the circumstance faced. In investing there are tools at our disposal for the circumstance faced, choose the correct tool and your chance of success increases, choose the wrong tool and your chance of success decreases. Selecting the correct tools is a top down decision that comes with understanding the big macro picture. Key to this point is time spent and having some introspection that your general beliefs may be incorrect.

For many years the wrong tools have been broad based index funds. I've been making this point ever since I started this site and I believe it will continue to be the case for many years to come. The logic in 2004 for this point was the US as a less compelling investment destination, Europe flat out stinking and Japan nowhere close to having things figured out and I don't think this has changed. If these things have indeed not changed then broad based index funds will continue to be the wrong tool.

Interestingly I used to get a lot more push back on the idea that broad based index funds are the wrong way to go which either means the broad based index crowd is getting smaller or they have collectively stopped reading my stuff.

The other day I mentioned a conference call for planning the sector ETF panel at the Inside ETF Conference next month. In our discussion the moderator asked for our take on the extent to which most advisors use sector ETFs although I think the implication was narrow funds, not just sector funds. I think there was of sort of consensus that most advisors do use sector funds but I disagreed. Using broad based funds is easy to do, doesn't require a whole lot of work and should not do much worse than the market which is a defensible position.

A long time ago I was an institutional equity trader. One of my colleagues left to start her own advisory firm planning to use actively managed mutual funds, make the occasional change in holdings and she was convinced that this would not blow anyone up. She felt this would be a fine living. I found out second hand that the tech wreck crushed her client accounts. I have no idea if it put her out of business or not but this serves as another example of wrong tool for the circumstance. Actively managed mutual funds with broad mandates often fall into the same problem as broad based index funds as managers tend to follow the market--how many actively managed funds got caught with too much tech ten years ago?

Success, however you define it, requires adapting to the current environment not relying on the same thing for every environment. I am certain there is a race where a two wheel drive Hummer is the best vehicle but that race is not the Dakar. By the way Gordon didn't finish day four of this year's race.
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Single Stock VIXs?

Bill Luby from the Vix And More blog stumbled across what I think can be very useful if it catches on. The Chicago Board Option Exchange will start calculating a VIX like index for five individual stocks. Specifically a "VIX" will be calculated for Amazon (AMZN), Apple (AAPL), Google (GOOG), Goldman Sachs (GS) and IBM.

From Bill's post and the CBOE announcement it seems like the intent is to provide information for options traders to base decisions or at least contribute to the decision making process. I saw nothing to imply that these single stock VIXs will themselves become tradable instruments.

In the last few motnhs, or longer, we have seen a slew of ETPs tied one way or another to the VIX index. It seems like they are marketed as tools for speculation and tools for hedging. I have no interest in using them as hedges because unlike an inverse fund it is not a certainty that if the market goes down 2% today that a VIX fund will go up. Likely is not the same as certain. Also VIX has a lot of moving parts and its relationship to the S&P 500 index ebbs and flows over time. And we have even gotten to the various issues with the ETPs.

This does not mean there is no utility here because there is. Also with the single stock VIXs should they proliferate--obviously we are only talking stocks with active options markets we could see this spill over to some active ETFs as well. One example of the utility I can envision is that if there were to be a dramatic change in the VIX-like index for a stock or ETF you own, without much price change you could take that as a warning. This would be evidence of the market thinking something was going on (good or bad) and could serve as a catalyst to spend extra time on a holding to try to figure it out.

For example the other day Chile announced a program of buying dollars with pesos in an effort to cap price appreciation of the peso. This has hit both the bank we own for some clients and the ETF we own for other clients (the ETF a little more). If VIX-like indexes existed for these two they might have warned of something coming. For me this is likely more to be more for informational purposes than to trade (I'll take all the information on all of our holdings I can get) as a spasm like this doesn't invalidate what I believe is a multi year, decade long even, investment theme but some folks would trade off of such a warning.

This sort of innovation, regardless of whether we see more single stock VIXs and ETF VIXs, is evidence of the evolution of capital markets and investing in capital markets. Products and information, when used correctly, make us more knowledgeable, give us access to more sophisticated portfolios, give the opportunity for better risk adjusted returns and a better chance for having enough money when it is needed.

I've mentioned countless times the number of markets or specialized niches that had normal decades in during the oughts. These markets and niches have been investable all along but the ETFs now make the access much easier. Anyone with exposure to these places and themes probably did just fine during the last decade and just fine combined with a proper savings rate can get the job done.
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