New Rogers Index

Jim Rogers has put his name on a new index that is a joint venture between CITIC Carbon Assets Management from Hong Kong and Banco Bilbao Vizcaya Argentaria that will be called the Rogers Global Resources Equity Index. It will own equities in energy, agriculture, forestry, mining and alternative energy. I was not able to find any real composition detail anywhere, the industry information came from an appearance that Jim made on Asia Squawk Box on Monday morning.

The only other detail item I could was that it has 200 constituents. It could have some utility as being a unique index if each of the five industries have an equal weight or somehow weighting is modified to avoid Exxon Mobil (XOM), BP and BHP Billiton (BHP) dominating the fund.

The announcement of this index addresses a point I've been thinking about lately which is whether it makes sense to combine energy and basic materials into one sector called resources (or any other suitable name). From the end user standpoint it can make portfolio construction a little easier. The two sectors add up to 16.5% of the S&P 500 so as is, anyone building at the sector level would probably need to make one decision about how to weight energy and another about how to weight basic materials. Obviously if they were blended into one sector there would be only decision to a make on sector weighting.

A little deeper there then are decisions about how to build each sector. Within the materials sector there are many themes or niches to consider like platinum miners in South Africa, fertilizer companies from all over, chemical companies, cement companies, quite a few things in Australia, rare earths, molybdenum miners, quite a few things in Canada, quite a few things in Latin America and still there are more. That is a long list for 3.5% (the sector's weight in the SPX) of a portfolio. It would still be a lot even if you doubled up to 7%.

With energy there are mega cap integrated oil companies, exploration and production, oil service, coal companies, uranium companies, geothermal and again there are others but they fit in a little easier into energy's 13%.

The biggest obstacle, well maybe it is not an obstacle, is that the two sectors don't correlate as highly as I would of thought. I plugged in several related energy and materials funds (XLE and XLB for example) into ETFReplay's correlation tool and for each one I looked at they each correlated closer to SPY than to each other and I'm not sure if that is a positive or a negative--obviously it is not a obstacle for this new Rogers index or a couple of other ETFs that don't get too much attention or volume like the Jefferies TR/J CRB Global Commodity Equity Index Fund (CRBQ).

If the idea of combining the two sectors together does hold water then it helps make portfolio construction a little more efficient where building at the sector level is probably appropriate but maybe not with multiple holdings for each sector.
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The Big Picture for the Week of February 27, 2011

One of the building blocks for successful country selection over the last few years has been to pick places where a middle class is ascending where there previously had been no middle class. I believe this theme will have legs for many years to come and is powering much of the spending that must be done (improved infrastructure and improved services) which will result in consumer spending that will be done (improved diet, other staple items and maybe even aspirational discretionary purchases).

If it is true that destinations where a middle class is ascending makes for an attractive investment or at the very least creates a tailwind then it stands to reason that countries where the middle class is shrinking are at the very least facing substantial headwinds. This link from Mother Jones which comes via Zen Trader has all sorts of grim statistics about the wealth gap in the US.

One hot topic here has been the extent to which higher prices at the pump have offset stimulus action and then this most recent leg up creating a new "tax" on consumers with economists trying to quantify the impact. Deutsche Bank's analysis has been making the rounds, I found it at Pragmatic Capitalism, which says that a $10 increase in the price of crude leads to $0.25 per gallon and that every penny per gallon collectively costs consumers $1 billion.

While I do not believe tab A can fit into slot A so neatly as implied in Deutsche's analysis it certainly creates a framework for beginning to understand the magnitude of the problem. If filling the tank for a typical vehicle has gone from $40 to $55 and the typical commuter needs to fill his tank twice a week then the extra $120 per month seems meaningful based on average incomes, high indebtedness and meager savings rates. And if the extra $120 is simply being added to credit card balances (which seems plausible) then the problem is worse. While $100 oil is probably not permanent today I believe the path for increased global demand is pretty clear and $100 as a permanent floor will not be an abstract concept.

The portfolio implication here is a point I've made before. The US is trying to hold on to the top spot which is far more difficult than it is to move up from some lower spot in the pecking order to a slightly higher, but still low, spot. We should have no expectation that middle class life in Brazil will look too much like middle class in the US as we think of it but better home construction (construction could improve and still be below US standards), reliable electricity, 30 channels of cable TV (compared to the hundreds we have in the US), decent roads, and more protein in their diets would be life changing and require astronomical sums of money to make happen.

It makes sense to spend time finding these tailwinds and figuring out how to access them for a diversified portfolio where narrow decisions are appropriate.
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Friday Tidbits

First up is an IPO of Hutchison Port Holdings Trust which is part of conglomerate Hutchison Whampoa which will list in Singapore. The actual ports are in Hong Kong, Shenzhen and Macau but the listing, as mentioned, is in Singapore. The trust structure can be thought of as being like a REIT and this one will yield 5-6%.

If you've been reading this blog for a while you know I think China is an important investment destination but also a very complex one. Our exposure is something of an underweight by way of the country's weight in a couple of thematic ETFs. While I continue to believe banks, manufacturers and reverse mergers should be avoided I think things like ports, toll roads, energy and staples items are a good way to go. Chinese don't have to speculate on real estate but there are things that they essentially have to do or money that has to be spent which is where I will continue to look.

There was an article on Seeking Alpha yesterday titled Your Ira Doesn't Have To Be Boring. The post was so bad I'm not going to link to it, I'll just say your IRA probably should be boring.

SPDR came out with two new ETFs. One is an emerging market bond fund denominated in local currency ticker symbol EBND and the other is an emerging market dividend fund ticker EDIV. Both are me too funds with some differences and some similarities. If you have interest in these spaces you should add these to the list of options to consider.

Speaking of new ETFs, FactorShares listed five so called spread ETFs. They capture two times the performance difference of two different asset classes so for example the FactorShares 2X S&P 500 Bull/USD Bear (FSU) captures a combo that benefits when the SPX outperforms the US dollar. As I understand it on first glance the USD wouldn't have to go down for FSU to go up it would just have to go up less than SPX but it would be better if USD did go down. FSU would also do well if SPX went down 1% and the dollar went down 2%.

Note that these are levered and have a daily reset. I would imagine there will be contango issues for a couple of them which after a closer look (that I haven't taken yet) might be a benefit for a couple of them. Conceptually, the hedges available here are valid but it is a good bet that people will use them incorrectly and it remains to be seen if this will work inside of an ETF. If it does work it will be just what the doctor ordered but for very few people. While I have no interest I will be curious to see how they trade. The crew at ETF Database reports that these can be traded commission free at Interactive Brokers. Maybe in a year or two all ETPs will be commission free?

We executed a trade on Wednesday buying Ecopetrol (EC) for larger accounts where suitable. For some clients it was a partial swap out of Wisdomtree International Energy ETF (DKA) and for other clients it served as a rebalance to increase energy exposure. Relative to the last couple of days we got a lucky entry point.

More importantly, the country is becoming more relevant in the world economic order, is sitting on a lot of oil, is a modest oil exporter, EC is about 3/4 of the sector in Colombia, yields 2.4% based on trailing dividends (you can never be certain with dividends for foreign stocks going forward) and was down 23% from its high when I bought it. I've mentioned the name several times before, have been watching/learning it for a while and finally stepped in.

And closing out on a blogging related note Adam Warner wound down the Daily Options Report a couple weeks ago noting that it had run its course. Adam's knowledge and humor made him just about the best blogger out there, I've said that several times along the way. When I first started blogging, someone told me it is very difficult to keep a blog updated. Over time that has morphed into being very difficult to not keep the blog updated. I think this may have been the case with Adam. Either way congratulations.
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Lazy Portfolio Evolves?

As our week long conversation about efficient portfolio construction progresses, it could also be thought of as a discussion about Lazy Portfolios. Yesterday I got an email informing me that RBS came out with a Trendpilot ETN for gold, symbol TBAR (IndexUniverse also had an article about it). This is the third fund in the lineup and I think there could be more coming. There is one for the S&P 500 with symbol TRND and one for the S&P 400 with symbol TRNM. I wrote about TRND and TRNM for theStreet if you want more details but basically the ETN replicates long exposure to the underlying when the underlying is above its 200 DMA and replicates t-bills when the underlying is below its 200 DMA.

Before getting into strategy, these are notes issued by a bank that is 80% owned by the UK government and while I don't think the central bank has propped them up only to later allow them to fail the facts of the issuer remain. Additionally, employing the 200 DMA strategy under the hood of the ETN is not plain vanilla, although it is plainer than if they were doing this in an ETF.

That out of the way, we have been talking for the last few days about very simplistic portfolios for people just starting out (the idea being you might be a person of influence on investing in your various social or professional circles) but we could also be talking about lazy portfolios too.

I've mentioned using the Schwab Large Cap ETF (SCHB) and the Schwab Small Cap ETF (SCHA) for certain accounts for being very cheap and because the commission is waived. In yesterday's post I posited that a portfolio consisting of SCHB, SCHA and the not-yet-listed Guggenheim ABC High Dividend ETF would allow for broad asset exposure along with the active decision of having avoided Europe and Japan. The fees for two of the funds (the Schwab ones) would be microscopic and there'd only be one $9 commission. This concept implemented as a lazy portfolio offers no defensive protection; the active plan of going defensive would make the portfolio un-lazy, so to speak.

Replacing SCHB with the large cap Trendpilot ETN would create a defensive strategy with in the mix but still allow for lazy to prevail. The mix would still have US large cap, US small cap along with (hopefully) broad exposure to Australia, Brazil and Canada. There would be two commissions to implement the portfolio and the Trendpilot expense ratio is 100 basis points when it is long the underlying which is huge in the context of a low fee portfolio and the last ten years notwithstanding this will be long the underlying the vast majority of the time. Some big chunk of the portfolio going on defense (referring to the portion allocated to the Trendpilot) would go a long way to missing the full brunt of down a lot; not the full drawdown, just a chunk of it which could be a difference maker.

Obviously I do not know if the Trendpilot is the answer. Clearly I am favorably disposed to the strategy but the product is brand new and I think the innovation is, at the very least, helpful and we know the ETP industry will continue to innovate thus democratizing many concepts that have not been easily accessible to people before.

Felix Salmon has had a string of articles lately really questioning why any individual participates in the stock market, here is one of his latest. It is a worthwhile exploration but the conclusion should not be avoid the stock market so much as maybe be skeptical of it and figure out how to use it in such a way as to give yourself the best chance you can of getting what you want from it. To the extent this makes sense to you on some level, then your course of action will likely include strategic implementation of investment products.
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Narrow Exposure Getting Easier to Implement

In keeping with the theme of efficient investing (fee-wise), there is a tie in to new ETFs that occurred to me. In response to my saying yesterday that in some accounts I use a broad foreign fund that avoids Europe and Japan a reader asked if I meant a fund that targets Australia, which is the case but that is not the only developed market I like.

A while back I mentioned a filing for the Guggenheim ABC High Dividend ETF, this is still a filing and may never become a fund. The A in the name stands for Australia, B for Brazil and C for Canada. If it also included Norway it would cover a lot of bases but still the three makes for a very good combo in terms of foreign exposure that avoids Europe and Japan. Additionally the fund could also cover emerging for anyone willing to own Brazil as a proxy for all of emerging.

So someone with an account at Schwab could buy SCHB and SCHA (we own both for some accounts) for domestic exposure and this ABC ETF for both developed and developing foreign for $9 in commission while having actively avoided parts of the world that even if you don't think the fundamentals stink you are least buying countries with more diverse fundamental attributes--that being commodity based countries versus the US being service based.

This grouping would provide better diversification, IMO, than something like EFA for the reasons stated above but would of course make the portfolio more vulnerable to meaningful commodity price declines. As the ABC fund is just a filing we don't know what will be in it but if it is heavy in Brazilian banks then it might make the idea less appealing. This from the FT talks about the potential for a subprime crisis in Brazil. Subprime is not the right word IMO but that the country could be over indebted as a middle class ascends is easy to envision and a big reason why I've never been very hot on the Brazilian banks. They might do very well but will do so without me. If the ABC fund were 5% Brazilian financials then I would not be overly concerned. At 20% I would absolutely stay away.

The point here is really about the evolution of cost efficient portfolios being able to cover some specialized ground without having to buy 30 individual stocks. This provides democratization for increasingly more effective but still broadly diversified portfolios for people just starting out when portfolios are generally their smallest. An ETF portfolio comprised of four funds where a couple of the funds can be had commission free (allowing for DCA) and where a couple of things can be avoided makes for a good start to an investing career and is starting to come together as innovative ETFs proliferate.
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Portfolio Construction Philosophy

Seeking Alpha contributor David Van Knapp asked the following question on my post the other day about efficient portfolio construction in relation to account size;

Roger, do you have a template for general asset allocation, one that perhaps serves as a starting point (with variations for individual circumstances)? I find myself wondering about narrower and narrower slices of asset classes (or within asset classes), and when does it reach a point of diminishing returns or ridiculousness?

Trying to answer this requires mentioning my starting point which is constructing portfolios for other people and then navigating through cycles with these portfolios. We get paid based on assets under management so aside from being in the clients' interests to minimize fees where possible it is in our best interests as well. I believe this line of thinking also pertains to drawdowns during declines but that is a little more philosophical.

The starting point is the equity/fixed income targets which in most instances will be determined by one of my colleagues as the primary point of contact for the client. Focusing on the equity portion of the portfolio we have three types of accounts based on size.

The type of account I write about most frequently is the large account where I have no concerns about the commission drag from buying 30-40 stocks/ETFs. This is subjective as some might be ok doing this with a $100,000 and some would be uncomfortable with that many positions in a $1 million portfolio. This is in the eye of the beholder, there is no single right answer.

As to David's question about when narrow gets ridiculous, this too is in the eye of the beholder. As a matter of philosophy I view part of the task of navigating cycles as tweaking the portfolio as needed to alter things like cap size, foreign exposure and yield among other things to manage the volatility of the portfolio and try to catch any cyclical tailwind. To the extent this is successful or not is measured by stats that are easily available in the software we use (I would think this would be available to any RIA). I believe this is important in terms of smoothing out the ride and I believe this is much easier to do with narrow exposure which means individual stocks or narrow ETFs. I mention this as I realize the typical do-it-yourselfer may not spend too much time on doing this. I just realized I've not used the term risk adjusted return in this paragraph which is of course what I'm talking about.

To the extent David's question is about position sizing, long time readers know I target most stock positions at 2-3% of the portfolio. The reason for that sort of number is that I believe this is large enough that should a stock with that target weight go up 50-100% in a year it is enough to have a noticeable impact on the overall portfolio; obviously a stock targeted at 3% that doubles would add 300 basis points to the overall portfolio which can be a lot even in a year like 2010 where the SPX was up 15%. If a stock targeted at that weight blows up it would be a drag of course but not require a re-write of the financial plan. As one quick note in a portfolio of 30-40 stocks the odds of at least a couple of names going up a lot is quite good even if it is not the names that might be expected to go up a lot.

This too can be a little fuzzy as I know some people think that a stock needs to be weighted at 10% of the portfolio in order to make a difference.

We have what I would call a midrange portfolio where the size makes 30-40 equity holding not so great for the commission drag. In these portfolios there might be 14-20 holdings most of which are ETFs. In thinking about ten large S&P 500 sectors each sector would have 1-3 holdings; for example one ETF for utilities, telecom and maybe energy and the other sectors have two or three holdings where the financial sector might have three holdings including one individual stock.

From the top down the mid range captures much of the effect but will yield a little less and miss out on a couple of stocks we own. For example our position in Vale (VALE) is easily captured in just about any materials ETF but our position in Novo Nordisk (NVO) is not. The proliferation of narrower ETFs makes picking exposures a little easier but 18 holdings is not 34 holdings.

The third type of portfolio is mostly about broad asset class investing. It is these portfolios where the two Schwab ETFs mentioned the other day come into play along with an emerging market ETF, a developed foreign ETF (one that avoids Europe and Japan) and a gold ETF. Depending on the dollars in the account there might also be one or two thematic ETFs.

Embedded in all three strategies is the focus of an entire stock market cycle, if not longer. I've written about the defensive action we take hundreds of times so I won't repeat that today other than to say we are trying to add value over a period of years not months so the above is tailored toward that goal. In the really big picture the job of an RIA is to give clients the best chance possible of having enough money when they need it, prevent the occasional freak out and try to effectively communicate the strategy being employed and why.
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Interesting Political Theory

Thomas Donlan raised an interesting (and I think non-partisan) idea in this week's Barron's editorial. In talking about the political battle that will ensue over the budget and cutting spending and debt and all of that he essentially said that both sides understand the issues and know what they need to give in on in the name of compromise but that there is a problem with knowing how to sell these needed actions to their constituencies. It might be like knowing your wife has an ugly dress on but not knowing how to tell her.

This is a very interesting idea. On the one hand politicians are not that dumb, they do understand the dynamics and some of the numbers. On the other hand this theory, if true, makes them look even more focused on just one thing; getting reelected. I don't know how much water the theory holds but there is some truth here and if you read the editorial it seems like there are implications for social security benefits.

I've said many times I expect nothing in terms of social security and maybe even no medicare either so if benefits start getting cut in the next couple of years or ten years from now; I've not thought about that aspect of it. The more important thing will be the impact on people who as a function of indifference don't realize that benefits could be cut (I say could be cut here as I realize some people don't think they will be cut and maybe they turn out to be right somehow). As getting religion or spreading the gospel has come up in the last couple of days, the future of entitlement payments is something people need to get religion about.

Here is one more pitch for an idea from a couple of weeks ago. I think IRA and 401k contribution limits should be removed, sort of. If the most you can put into a 401k is $10,000 (not sure the exact number I have a SEP) then you should be able to put in as much as you want, reducing your taxable income by the full contribution, with any amount above your "limit" counting toward reducing your social security benefit paying the full FICA tax as you go. As I said before I could see 10% of the population taking advantage of this so they'd pay the full boat, get little to no entitlement payout and have a much larger nest egg. I think a 10% reduction in the number of people collecting would be very meaningful.

Maybe this line of thinking is wrong but I can't see how something big doesn't give and a lot of people get hurt financially because of it...due to no fault of their own (I hate that saying).
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Sunday Morning Coffee

As I was reading Barron's I saw a banner ad for the Credit Suisse Merger Arb Liquid Index ETN (CSMA). I wrote about this somewhat favorably (other than the ETN structure) for theStreet.com when it first came out so I was curious to see how it had done versus a couple of contemporaries.

The chart compares CSMA in blue to the long tenured Merger Fund (MERFX) in yellow and the Index IQ Merger Arbitrage ETF (MNA) in red. I grabbed the chart from Morningstar because it accounts for the dividends in the chart but not so with MERFX in this chart. Smoothing out the dividend would have MERFX having a smoother ride to the same result. MNA has been a noticeable laggard.

I believe the lag in MNA is attributable to the fact that it does not short the acquirer it instead shorts broad indexes (either ETFs or futures contracts) in the belief it can capture the effect. The chart goes back to CSMA's inception which may not be enough time but MNA has also lagged MERFX going back to MNA's inception. The democratization of the strategy via retail products is a good thing but it makes sense to give funds that are not plain vanilla, like these, a little time to show what they might do. I expressed a little skepticism about MNA in the TSCM article linked above but should have stressed it a little more.

With the market up 100% from the March 2009 low and everyone feelin' groovy these funds are getting less attention than they probably should at this point in the cycle.

On a different note I stumbled across this link titled Live Every Baseball Fan's Dream Job. Major league baseball is going to hire someone to watch every game for the entire 2011 season, blog about it and do some other things like media appearances.

Basically someone will get paid for watching baseball. While it sounds fun it does not sound easy but I think it speaks to a point I make repeatedly about post retirement careers (or pre retirement careers) and find something you love to do, would do for free and figuring out how to get paid for it.

To this point I got an email, somehow related to my role with the fire department, with results for some sort of fishing competition down south somewhere. Top ten results were posted for two different competitions and of the 20 names posted, 15 of them won more than $2500. The big winner was awarded $32,000. How far do you think $2500 goes for someone with a modest lifestyle? I'm sure there are expenses incurred with this but you get the point.

The only limit here is imagination. I promise you that whatever it is you most like to do in your leisure time, someone has figured out how to make some sort of living at it. Perhaps not a lucrative living, that might be unrealistic, but someone with a modest lifestyle can relieve a decent chunk of their portfolio's burden implementing something like this not to mention the health benefits of staying actively engaged.
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The Big Picture for the Week of February 20, 2011

Long time reader WH made an interesting comment yesterday in response to the idea in yesterday's post about the extent to which low savings rates and overspending are obstacles to financial plan success. He noted from the Felix Salmon article I linked to that Felix said that whatever the market does in your investing career you will probably do a little worse. WH noted the extent to which various fees and expenses associated with investing could be the biggest impediment to success.

This sort of inefficient investing is certainly a huge obstacle but I don't think it is the biggest thing getting in the way of success. Intuitively, living a $100,000 lifestyle on $50,000 portfolio and repeated panic selling would seem to be more harmful.

Disirregardless (hat tip to my buddy Mikey who just became a father for the fourth time) of whether inefficiency is the biggest impediment or not, we all can benefit from a little more efficiency. One way to do this is the various free ETF trading programs that now exist. TD Ameritrade has about 100 ETFs, Fidelity has now 30 iShares funds that can be traded for free, Vanguard ETFs can be traded for free at Vanguard and Schwab ETFs can be traded for free at Schwab.

Below is the list of Schwab ETFs, there will probably be more than you think;

Schwab US TIPS ETF (SCHP)
Schwab Short Term US Treasury ETF (SCHO)
Schwab Intermediate US Treasury ETF (SCHR)
Schwab US Broad Market ETF (SCHB)
Schwab US Large Cap ETF (SCHX)
Schwab US Large Cap Growth ETF (SCHG)
Schwab US Large Cap Value ETF (SCHV)
Schwab US Mid Cap ETF (SCHM)
Schwab US Small Cap ETF (SCHB)
Schwab US REIT ETF (SCHH)
Schwab International Equity ETF (SCHF)
Schwab International Small Cap Equity ETF (SCHC)
Schwab Emerging Markets ETF (SCHE)

Clients below a certain size own SCHB and SCHA and that is the point. Below a certain size it becomes even more important to minimize the number $8-$10 commissions. The Schwab roster of ETFs covers a lot of asset class ground. Someone with less than $50,000 could build the majority of their portfolio from that list and then add three or four things for narrower exposure and only have a commission drag of $36. Obviously this would be mostly a broad based portfolio but that is just fine for someone who would rather not spend a ton of time on this. The investor I have in mind might want to layer on one country fund, something like gold and maybe one stock they feel comfortable with. This seems pretty realistic to me, especially if they can be diligent savers, they can DCA in to these funds.

While the Schwab program is a more overt asset grab the TD Ameritrade program goes farther in terms of actually helping people (make no mistake, it is in asset grab too) by including quite a few iShares single country funds in its list of 101 ETFs. I would note that the expense ratio in the Schwab funds is lower than most of the funds in the Ameritrade program. Again though the program helps increase efficiency WRT to fees which becomes more important the smaller the accounts get and people just starting out will usually have smaller accounts, but now can get pretty good asset class diversification.

I should clarify one thing from the above paragraph. Spending $300 to implement a $1 million portfolio is not really an issue IMO but that would be a colossal drag on a $55,000 portfolio.

True to yesterday's post maybe today's post can count toward spreading the gospel to people who come to you for this sort of advice.
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Friday Randoms

A few days ago Danish bank Amagerbanken went under. This news may or may not turn out to be significant but I think it is worth paying attention to. Back in February 2007 HSBC made news that was mostly ignored when it reported problems with subprime lending in a US unit (I believe the unit was Household Finance). The stock got hit for it but it was early days in the unfolding of the financial crisis.

The news about Amagerbanken seems small by itself and while it resulting in a domino effect of more failures across Europe might be a low probability it still makes sense to be very wary in this part of the market. Surprising to me is that the bank is in Denmark but actually there have been ten other small Danish banks to go this same route due to solvency issues after writing down loans.

Just as investing in tech has been more complicated in the last ten years than in the ten years before it so too will investing in bank stocks be generally more complicated for a while.

Felix Salmon seems to have picked up on an idea I've written about many times over the years in a post he title The False Promise of Compound Interest. He talks about how lumpy savings rates tend to be and the importance of saving as much money as you can while spending less. Long time readers will also know how important I think it is to find post retirement work that you love doing and would be willing to do for free.

I make no claim of originality on this as Nassim Taleb might say these are things your grandmother told you but to the extent more people understand how important these steps are and as more people communicate this (Felix obviously has a much larger audience than I do) the better the chance that people get religion here; getting religion might actually be the best way to think about this.

Here's something interesting...every so often Cambodia comes up as a new investment destination. I believe I've heard Mark Mobius talk about the country in past interviews. There is a Cambodian company listed in Hong Kong that traded on the US pinks as recently as this week. The company is Nagacorp, the pinksheet designator is NGCRF and the company operates hotels and casinos in Cambodia. The CEO was interviewed on CNBC Asia earlier in the week. Apparently this is a booming business in Cambodia and this is a very large company there. The stock has been trading in Hong Kong with ticker 3918 for almost five years and aside from participating the global decline that started in 2008 the stock has not been that volatile (to be clear I'm not saying this has been like a t-bill ETF), the PE ratio is around ten and based on last year's dividends the stock yields 5%--but the dividend history is lumpy, consistently paid, but lumpy amounts.

Lastly, IndexUniverse is reporting that the First Trust CEA Smartphone ETF (FONE) will begin trading today. Some have picked on this as a concept for a fund but there are plenty of niche funds like this. How different is this conceptually than the First Trust ISE Copper Index Fund (CU)? CU trades decently and has accumulated some assets. If an investor wants smartphone exposure this fund now gives a choice between the various stocks and a fund. Obviously there are investors who would never buy a stock so now they will have a fund choice to evaluate and buy (or not) which I don't think is a bad thing. If the construction of the fund stinks then the marketplace will make that clear.
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Index Investing

This post is going to frame out a thought I've made before but with a little more specificity. The title of the the post is Index Investing which I am differentiating from being a mostly passive indexer. Someone who is a mostly passive indexer does not believe value can be added with stock selection, country selection or sector selection. Note that I am saying mostly passive with the idea that mostly passive will rebalance. At the Inside ETF Conference a lot of people seemed to think that truly passive wouldn't even rebalance.

So the above would be more along the lines of an indexer as most people think of the term. Index Investing as I am trying to frame it is using indexed products to build an active strategy with exposures of varying narrowness (depending on comfort levels with very specific themes).

One of the advantages of ETFs over traditional mutual funds (and I guess we should now say actively managed ETFs) is that in terms of looking forward (I think of portfolio construction as combining knowledge of market history with what appears to be going on now to make a forward looking analysis) you know what a given ETF will look like six months from now. For better or worse the EG Shares China Infrastructure ETF (CHXX) will always be heavy in real estate stocks. At times this will be a positive and other times a negative but the exposure will be there--well unless all the stocks in the segment go to zero.

From the conference last week (again) there was an underscoring that professionals are reticent to pick individual stocks (I think at least a few individual names is very important but that is a different story) but see the need to go narrower than SPY and EFA. Assuming there is a preference for not outsourcing completely to a collection of actively managed funds and without single stocks then narrower indexes become an answer.

The Market Vectors Rare Earth/Strategic Metals (REMX) will always be volatile materials exposure--the general attributes and exposures in a fund are going to be the same in the future as they are today. Building a portfolio requires analysis and ongoing work. The consequence for being wrong about the analysis and ongoing work for a single stock is obviously worse than being wrong about that stock when it is a component of an index.

As a microcosm, yesterday BHP Billiton (BHP) was down 1.33%, perhaps as fallout from the earnings report. BHP is the largest holding in both the iShares Global Materials ETF (MXI) and the iShares Australia ETF (EWA) yet those funds were up 0.62% and 0.97% respectively. If you own either fund, both are in our ownership universe, you need to have an inkling of what is going on at BHP and want the exposure. Sticking with the example, BHP might be a great hold but the consequence for the exposure was obviously muted yesterday as the ETFs each had a pretty good day.

If the idea in this post seems obvious then you are somewhat ahead of a lot people. Occasionally it is worthwhile to go over what might be obvious for some because I know it is not obvious for everyone.

The picture is from Jerome, Arizona last weekend.
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Firefighting and Investing

Yesterday we had a meeting at the fire station about various things (I am the assistant chief of our local volunteer fire department) and something interesting came up that offers a corollary to investing.

There are several reasons I enjoy my involvement with the fire department including that fighting wildfires is completely different than anything I've done during other times of my life, there is no end to the learning and I like being able to help people. There is also camaraderie with the other firefighters.

The picture is of a piece of equipment called a Gated Y Valve. Gated Ys are are pretty standard in general but this one is different for us. The ones we've been using take water in (from below the way the picture is oriented) at 1.5 inch diameter and out the two at 1.0 inch diameter. The one pictured above reduces from 2.5 inches to 1.5 inches and this is new for us.

The potential utility here would be to push water through a 2.5 inch hose for 200-300 feet (maybe more depending on the water source) to an area where we can't drive to and then flank the fire off of each end of the Y. And while we would lose some pressure along the way we'd have more water in a difficult to reach area than with what we do now. There is still more learn which, circling back to the top is one of the reasons I enjoy the task so much.

This gets us to being an investor (or not) in a very pessimistic post by Felix Salmon. The general tone is that the typical 401k investor is hopelessly in over his head with regard to constructing a portfolio out of too many funds to choose from to being emotionally ill-equipped to navigate market cycles. Actually Felix says that having a 401k doesn't make you an investor necessarily. Although he did not use this word maybe having a 401k simply makes you a participant.

Felix addresses the need to save a lot of money (I'm obviously on board with this) along with very simplistic (for purposeful effect) ideas about to construct a 401k. For many people, their 401k will be their only savings vehicle of any consequence and we know that balances on average are far too low to do the heavy lifting they need to do. A few days ago I mentioned that one could argue that 401k plans are still in the experimental phase as we have not seen a lot of people retire and live off of them for extended time periods yet.

The answer is education but the first obstacle is indifference on the part of most people. The various behavioral issues come once the indifference has been recognized and overcome. How many friends do you have on Facebook? If you are reading this site you obviously have the requisite interest but how many of your friends do not? Most of my friends are not very interested, they might be saving adequately but they are not terribly interested.

Back to the new Gated Y Valve. The interest for me in learning about firefighting is the same for me as my day job. Both are important, in different ways to our (our meaning my wife and I) future. To the extent the 401k is so important to so many people it would be logical that more people would take suitable interest in their financial futures but if people were logical then behavioral issues would not be such an impediment to success.

Reading stock market blogs is evidence of trying to provide your own solution for your financial future. It is unlikely that all of society will take this on with the attention needed but certainly the number of people willing to make this effort can increase. I know some readers are the go to person for these questions among friends and coworkers which helps promote financial literacy and so maybe this grassroots type of thing can also be part of the solution. Maybe more people can take the ball in this context and run with it some.
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Interesting Comment Thread

The Seeking Alpha version of my post over the weekend about the US' standing as an investment destination drew a couple of (for lack of a better phrase) anti-emerging-market-investing comments which was surprising and interesting given that I never said "emerging markets" in the original post.

One bit of context is that I believe the term emerging markets has lost most if not all of its meaning. All countries have their positive attributes and their vulnerabilities and good diversification means blending different attributes together in such a way as expectations are favored but without being overly exposed to some negative event--for example if all you own are commodity based countries you will get pasted during the occasional commodity price correction.

One interesting thing is that there is a tone that I am too bearish on the US. Two years ago I was too bullish yet my thesis has been the same the whole time, actually it has been the same since before the financial crisis started.

As I quick recap I have felt that taking in the entire fundamental story, the US will be a less compelling investment destination. I have never been in the Armageddon/dollar going to zero/hyperinflation/complete tearing of the social fabric camp. The headwinds that have come and will continue to come will, IMO, result in equity market growth that is below "normal" when looked at over a period of many years. If we used to get 10% average annual return, I think it will be something like 3-5% over the next ten years. As I said, this has been my base case for a long time.

It is not clear whether this little bit of anti-emerging sentiment (there have also been outflows from funds) is simply because of the lag coming out of the gate in 2011 or something else but in those comments there seemed to be a lack of acknowledgment of what has happened over the last ten years with emerging versus the US. Clearly it would be a mistake to simply extrapolate but if you can buy into the idea of looking at history and combining that with what appears to be happening today to make a forward looking analysis then I think the space in question merits a decent position.

As time goes on I become more convinced of the importance of investing for a stock market cycle (or longer)--this really is an on your own mat issue. Over the last five and ten years many of the markets in question here have dramatically outperformed (you can reference Bespoke's country results for the previous decade) the US market and while clearly there was an element of hot money flows, fundamentals also mattered and whereas the fundamentals in these places are still healthy, but not without risk factors, it is reasonable to give the benefit of the doubt in a reasonable proportion.

I realize not everyone wants to think in five year increments but the context here is the ultimate goal of giving clients the best chance at having enough money when they need it which I believe minimizes the need to beat the market in a given quarter or given year and I am far from alone with this idea.

The picture comes via Barry Ritholtz and is the new Ferrari Hatchback!
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Sunday Morning Coffee

Alan Abelson had this observation about the proposed merger between NYSE/Euronext (NYX) and Deutsche Boerse (DBOEY);

All of which suggests to us that whatever the likely virtues of the proposed German-American combo, the benefits to the individual investor do not loom prominent among them.

Slightly bigger picture the publicly traded exchange group is a space I generally think highly of. Aside from being financial infrastructure, capital markets are evolving rapidly as a middle class ascends in countries where there has been no middle class, or I should say investor class. The exchange in Brazil recently listed shares, you already know that the exchanges from Peru, Colombia and Chile are merging, you may have forgotten that the exchange in Singapore (SPXCF) is trying to merge with the Australian Stock Exchange (ASXFF), at the same time as the news about NYX came this week it looks like the exchange in Toronto (TMXGF) will merge with the London Stock Exchange (LDNXF).

The exchanges play an essential role in their respective countries but Abelson's comments are also very true. That the exchanges, large banks, brokerages and the like do not put the interest of individual investors high on their priority lists does not have to be so bad if you realize they do not necessarily have your interests in mind. These sorts of conflicts are beyond our control. I find little use in trying to swim up this stream. Realizing this deck is stacked against you, to mix metaphors, allows for proceeding with a better chance for success with your investment policy and financial plan.
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The Big Picture for the Week of February 13, 2011

Gregor MacDonald had a post up calling shenanigans on the idea that the US economy is recovering. I would note that if you believe the statistics as reported then the US economy has moved from a recovery on to expansion; the idea here is that GDP took back the 2007 high and is now growing past that figure.

Back to Gregor who notes that the employment situation is still a huge drag I would also note housing is also still a huge drag. What I think we are seeing is evidence of a fairly rapid evolution of the American economy. To the jobs situation, the last couple of recessions have been followed by what was comparatively poor job recoveries with the current event being the worst of the last three. The housing numbers make for a different situation as there was/is a price correction of a gross excess. While I am not devoted to reversion to the actual mean, a long drawn out working off of the excess seems logical. There is still a long way to go WRT to writedowns and foreclosures. It is possible that there will be little to no decline from here but many years before prices get bid up (so reduced price volatility) but either way a healthy housing market is a long way off.

I guess I believe in the new normal or at least some version of it. This is evident in my long running idea of the US as a less compelling investment destination.

Now comes the discussion about the Fed's desperate and extraordinary action to try to stimulate demand and other forms of risk taking. Some have tried to quantify the impact the Fed has had on the economy and the stock market and while deriving a theory about exact numbers here is beyond my analytical skill I do believe things would be much different (that is much worse) without the intervention. Lack of natural demand is very unhealthy.

Another point I have made often is that anything can go up in price at any time, even when it shouldn't. Some sort of snapback off the March 2009 low was perfectly logical in terms of being normal market behavior. At some point (eye of the beholder) the 23 month move lost its logic--like maybe last August?--but continues to move higher anyway.

I continue to believe in a longer term thesis and believe that the US' fundamentals are far inferior to many other investment destinations. If I turn out to be correct about this over the next stock market cycle or even the next decade there will still be stretches where US equities do well--even entire calendar years. We know that the last decade was a bad one for US stocks but 2003 and 2009 were great individual years for returns. As great as those years were investors were still far better off for the decade elsewhere and I continue to believe this to be the case.
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ETF Stuff

Tom Lydon echoed a sentiment of mine in an interview on CNBC the other day. The context was that although there are about 1000 ETFs now there are another 800 in registration and Tom said this will mean more work for investors. The way I usually say this is that ETFs make for easier access not easier work.

In yesterday's post I stumbled across what might be an interesting idea for constructing the foreign equity portion an ETF portfolio;

A combination of ABC High Dividend, Global X Andean ETF and a tech country fund would offer better diversification in my opinion than EFA or some similar fund.

To be clear that ABC fund is just a filing at this point and there is no tech-country fund (although ETFs for Taiwan and Israel could create the effect). In past posts I've gone on about the importance of avoiding certain parts of the world and favoring others. This proved out to be important and I believe this sort of thing will be important going forward. The above example would meaning learning enough about certain countries to decide to avoid them and then learning enough about other countries to chose to invest in them. I think ruling out EFA would require learning about four countries (Japan, UK, France and Germany) and the positive side of that example would require learning about at least eight countries.

Drawing conclusions along these lines requires work and selecting investments (funds or stocks) requires work as in time spent learning and then monitoring. This should be an obvious statement but I'm not sure in practice this is always what people do. There is a reason why so many people lag the market--actually there are multiple reasons but incorrect conclusions due to lack of time spent or other analytical mistakes id the context here. Another big issue is obviously behavioral mistakes.

The conference earlier this week focused on educating advisors about the product and while a lot of attention was paid to mechanics and the importance of various asset classes but I think more time collectively needs to be spent on various analytical processes, both initial and then monitoring. There is plenty of content on the internet to help with this including places like Seeking Alpha but the time needs to be spent.

As an example, in the panel I sat on there was an audience question about solar stock ETFs. Assuming the person is not purely a technician time needs to be spent looking under the hood drawing conclusions about the Chinese exposure, assessing how important (or not) the subsidies issues in Europe could be and probably a few other things to settle on before buying this space (I think this is a lousy theme, we all should have solar but there are way too many obstacles IMO). If you've spent a decent amount of time on this then I doubt you're saving too much time versus analyzing individual stocks.
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Indepth Analysis Of Egyptian Political Consequence

"Not so fast my friend."
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Thursday Tidbits

Cullen Roche said "I have been one of those prudent savers who now feels punished. But here I am learning that prudence is for losers." That second sentence might be a little tongue in cheek but the first sentence is interesting. Are people who are savers being punished, should they feel like they are being punished? This point has been raised a few times during this time of bailouts or as Cullen says capitalism without losers.

As someone who is a saver (I think) this is more about what is going happening on your own mat (yoga term whereby you don't worry about what person next to you is doing in yoga class). There is a lot of psychic value in saving. One, there can be a little charge from watching balances go up from actually moving the money and two, there is a lot of value in having less to worry about financially. Having no debt or very little debt and a healthy emergency fund is not about being rich but more about a healthy margin for error and should reduce the number of things people might worry about financially.

Olly Ludwig from IndexUniverse shared a very interesting quote/joke from the Inside ETF Conference; Somebody told me last night, in strict confidence, as we shared cocktails aboard one of those yachts at events like this that never leaves its moorings, that if the mutual fund industry had managed to sink that yacht, it might have succeeded in obliterating the ETF industry.

This speaks to how small the industry is and maybe speaks to it's potential, hopefully in a good way.

Guggenheim has filed for a couple of very interesting funds for investors not very comfortable with narrowly focused ETFs. One is the Guggenheim ABC High Dividend ETF which will own Australia, Brazil and Canada. The other is the Guggenheim BMAC Commodity Producers ETF. The idea of building funds that focus on equities from countries with similar attributes, in this instance commodity based, is interesting and allows for foreign investing, without picking individual countries but still bypassing Japan and the big countries in Western Europe.

Many of the existing broad foreign funds and the narrower sector ones are already heavy in Europe. Another area that this concept could target could be technology based economies. Taiwan and Israel come immediately to mind and there probably are a couple of countries that could be added in as well.

A combination of ABC High Dividend, Global X Andean ETF and a tech country fund would offer better diversification in my opinion than EFA or some similar fund.

One last item from the Inside ETF Conference. Early Tuesday morning there was a session with Rob Arnott, Bill Bernstein and another guy I've never heard of who is a law professor who wrote a book about an outlandish investment theory that you may have heard before but either way lacks an understanding and appreciation for so many real world things as to make the concept laughable in my opinion.

The basic idea is that young people should borrow money to invest in the stock market as a means of discounting future savings. He talked about doubling up on margin with whatever your initial investment that can be made. Another example he gave, if you know you are going to inherit money you should borrow that amount to get it invested.

Among other things he relies on stocks becoming less risky over time. If you are unfamiliar with this idea basically it means that the longer the time horizon the more likely that a large drawdown is to be recovered. I don't think this was refuted too often before 2000. I've read several articles in the last few months or so that question the validity in a compelling fashion. Obviously in writing a book and coming to speak about this he naturally had stats to back his assertion.

The specifics, rationale and logistics for this are wildly flawed. People in their twenties not in the business already rarely have enough financial awareness to understand buying on margin (not that the couldn't learn but they too frequently lack the interest to learn about any investing). Obviously anyone implementing this idea in October 2007 would have been faced a negative equity situation come March 2009 (actually there would have been selling along the way via margin calls).

One element of this calls for a young person correctly assessing his future income prospects. How realistic do you think that is? Anecdotally I would say this is not realistic at all. As far as investing money (that you don't have) that you will inherit he had a slide that actually side that said (Dis)count your chickens before they hatch. Do you see any folly with investing money that you should get in the future?
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"Safe and Predictable" May Not Be

A comment popped up on an old post on Seeking Alpha whereby a retired reader shared he had 40% of his portfolio in ten MLP and he was looking for feedback. I think this is a clear case of not really understanding the risk being taken. Vehicles that are generally high yielding and that generally have a predictable volatility profile make for a good hold—no doubt about it.

However, every so often the “safe and predictable” parts of the market do run into trouble, sometimes serious trouble. The point here is not to try to predict some sort of meltdown in the MLP space because the probability of such a thing is quite low but if it happens then the reader in question will get crushed.

An example I’ve used to make the point involves Amazon (AMZN). If you put 100% of your portfolio into AMZN in May 1997 at $1.50 and then sold it all in April 1999 at $105.00 you obviously would have had one of the greatest trades of all time but it also would have been a wildly risky trade. The word “wildly” would actually understate the risk taken. In this instance there would have been no negative consequence for the risk of putting everything in to AMZN but “no negative consequence” is not the same as not having taken the risk. Taking risk can work out fantastically well sometimes and sometimes not but people get into trouble for not realizing the risk they have taken.

The reader is taking a big risk with his retirement portfolio, this is undeniable. What we don’t know is whether he will ever have to face a negative consequence for taking that risk. Unfortunately this is a behavior that repeats over and over. With every scary event people find out the hard way they had too much exposure to the wrong part of the market.
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ETF Conference--Day Two

Some observations and comments made in presentations and other tidbits.

Part of the kickoff this morning included a quote from Susan Thompson from Blackrock and who is serving as Chairperson of the event. She said 2010 was the best of times because the industry's AUM grew to over $1 trillion and it was the worst of times because of the flash crash.

IndexUniverse gave a presentation about a new product/service that takes data sorting, and analytics to a whole new level. Part will be free and part will cost money (as I understand it). In the opening of this session Matt Hougan said that "evaluating ETFs is hard." While the information they will provide is going to be unique (trust me on this) and useful, investors will still have to do the work of looking at the holdings (the new IU service will help with finding the info) and make some sort of informed, qualitative decision. An example I used in a conversation with someone was if there was a REIT ETF with 20% in Prologis (PLD) and one with 6% in Prologis, would he take the time to learn a little about the name and have that influence his decision.

Dan Waldron from First Trust made an interesting comment in a session called ETFs, Mutual Funds or Both? He said it is not a choice between ETFs and mutual funds but instead is a choice between beta or alpha with idea being that index replication would mean ETFs but attempting to add alpha would mean mutual funds. His firm has rules based, quasi-active ETFs that are bridge between the two. I would add that beta (so ETFs) can be used to generate alpha. Interestingly there was no mention of individual stocks in this session.

Nasdaq OMX has a list of what it calls Alpha Indexes that seeks to capture the spread between an individual stock and the S&P 500. If Google goes up 25% and the SPX goes up 10% then this index would go up 15%. There is also one that compares TLT to SPY and another that compares EEM to SPY. The hedging implications here are very interesting conceptually with a couple of tweaks. That these exist shows that the industry is spending a lot of time on innovation--more time than we may realize compared to the amount of new product that comes out.

On a related note Dow Jones has a bunch of fixed income indexes for Chile, Brazil, Mexico and even a couple for Peru. I of course would be most interested in Chile but I have come to learn that there are many obstacles in making this type of index into an investable product, so much so that it may not happen with smaller destinations like Chile.

On yet another related note I went to dinner with a bunch of the gang from WisdomTree along with a couple of other guests. Part of the conversation included some serious questions directed at me about various things they are considering offering. As this was in the idea stage for them, they were talking to me as an RIA not a blogger so it would not be cool to give details but the depth of the questions revealed that they are exploring all sorts of things and want end user input. This is similar to conversations I've had here with some other people in similar positions with other firms. This is encouraging to know this attitude exists and while the obstacles in the way of some interesting concepts may never be overcome the firms are trying to innovate and create new access.

One question I've asked several other presenters and sponsors here is what their perception is of the advisor community's understanding of the product in terms of how to analyze and implement. I've gotten a wide range of answers some encouraging and some discouraging but there is a consensus that there lot more educating still to be done.

Flying home today.
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ETF Conference

It was a pretty easy (direct) flight from Phoenix to Fort Lauderdale and I got in early enough to sit in on a little bit of the ETF 101 panel and the Advanced ETF Workshop and was there long enough to make a couple of interesting observations.

In the ETF 101 panel Matt Hougan made a comment about brokerage firms having 500 analysts following individual stocks but maybe only five analysts focusing on asset allocation with ETFs. Matt can envision this flip-flopping such that in the future there would be far more analysts covering ETF asset allocation as use of individual stocks will be de-emphasized in the future.

I would actually go the other way on this and say that the proliferation of specialized ETFs targeting narrow segments makes stock analysis very important. To use a previous example, anyone buying the Global X Lithium ETF should take the time to learn a little about SQM and one way for a broker at Merrill or Morgan Stanley to do this would be to look at the report from the firm's analyst covering the stock.

If this holds any water then chances are the pay for stock analysts would plummet if, taken to an extreme, their major function is to support ETF portfolio construction. While it is not clear what direction this will take, the turnout at this conference is huge and underscores the growing role the product is playing in all corners of the industry and it is fun to watch it unfold.

From the Advanced ETF Workshop I would focus in on a comment by an audience member. His comment was along the lines of thinking he had begun to understand what ETFs were about but that the panel's discussion made him feel like he didn't know very much at all.

If confusion exists about ETFs I think that it might be attributable to the incorrect way they are portrayed in various segments of the media. Many people seem to think ETFs are an asset class that must be studied to be understood.

This line of thought is not precisely correct and in my opinion muddies the waters. ETFs are not an asset class, they are access to asset classes, access to broad indexes or access to specific niches. The first step should be figuring out what should go into the portfolio (asset classes, broad indexes, specific niches or anything else) via some sort of top down or bottom up process (I prefer top down).

If an investor want to access the water theme they can pick an ETF, an individual stock or a traditional mutual fund (per Google Finance there are a bunch of traditional funds which surprised me). This step of choosing one of the three ways in certainly requires understanding the pros and cons of all three types of vehicles and then picking the best for your circumstance. Presumably the mutual funds in this space are actively managed and that might be appealing. An actively managed water mutual fund is always going to be a proxy for water which makes active management less problematic in terms of portfolio construction-it will always be in this theme. Other people may prefer a volatile stock like some sort of meter company or DGW which is a Chinese company. Another type of stock here could be a high yielding utility. Each of those types of stocks held individually would probably offer a different effect to a portfolio than either type of fund; DGW would probably always be more volatile and a high yielder would probably always yield more than a fund.

It doesn't have to be more complicated than that where the ETF context is funds that track baskets of stocks.

The first picture is of the beach right behind the hotel and the second picture is the view of the game at the Super Bowl party that IndexUniverse threw last night. The TV did not have that line across it as shown in the picture thank goodness.
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Sunday Morning Coffee

A reader asks;

You seem to cite CNBC and Barrons frequently and occasionally the WSJ. You do mention other investment blogs like Seeking Alpha etc. It seems as if you only refer to the mass media in your commentaries.

I can't think of very many instances of you referencing books/articles like the Graham's Intelligent Investor, academic papers from Fama and French, Security Analysis, articles from the Journal of Financial Planning, or authors of other works relating to finance/investing.

I'm just curious why. Do you read much and if so could you share your reading list? Do you feel academic works are irrelevant?

In terms of the things I read I have mentioned this before and I don't think it is a particularly unique list of things. On a daily basis the list includes Seeking Alpha, the FT, the WSJ, Bloomberg, IndexUniverse, Credit Writedowns, Barry Ritholtz, a little bit of Mish, various links I stumble across from various places which often includes Ambrose Evans-Pritchard, sometimes the Globe and Mail, anything from or about Jim Rogers, Marc Faber, Jeremy Grantham and others like that and there are others that are not coming to me at the moment. Obviously I read Barron's and John Mauldin on the weekend.

The more interesting part of the comment is about academic works. I've been in the business in one way or another since 1984, have always had a keen interest relative to people I've worked with and always spent a lot of time trying to learn relative to other people I've worked with.

I have read some of the "classics" but not all of them. Intuitively no approach or belief can always be correct for all times. As an example I do believe the market is efficient except for when it isn't. It is easy to believe that the market generally prices in all known information but to the extent the market represents the sentiment of the masses, the masses (the herd) will not always be correct. I've also mentioned in the past that I've observed that fast declines caused by panics often retrace much of the initial decline immediately (no claim of originality on that one); the current events in Egypt as an example.

The idea of something being correct except when it isn't makes intuitive sense to me so I go with it.

For the way I look at things and prefer to do things, unwavering devotion to the classics doesn't fit. It might be correct to think of the classics as building blocks but with more weighting to actual experiences in terms of going through cycles, panics, booms and the like. Real world events seem to not fit squarely with certain aspects of academia or theory. Total reliance on fully invested diversification in 2008 did not work out very well. Some point out that bonds did well in 2008 but I would say more like US treasuries did well in 2008, a reasonably diversified bond portfolio didn't do as well.

I also spend time reading people that I think of as "great thinkers." It is not so important to agree with everything they say in order to learn. I've learned much from Nassim Taleb but disagree with plenty of things he says.

Clearly what is right for one person does not have to be right for another. I believe this supports the idea of taking little bits of process from many places to build your own process which is exactly what I've done.

The picture is where I will not be staying as I fly to Florida today for the Inside ETFs Conference put on by IndexUniverse.
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The Big Picture for the Week of February 6, 2011

A heckler left a stupid comment (that I did not allow to be published) on a post from 2005. And while the comment was stupid the post was interesting and one I did not remember. The post was short, here it is in its entirety;

CNBC Asia had a very interesting interview with Vernon L. Smith who won the Nobel Prize for economics in 2002.

I have to admit I am not familiar with Mr. Smith or his work. Among other things now he is on the Board of Advisors for LGT Capital Partners (aka the Bank of Liechtenstein). His interview was about behavioral finance and the mistakes that individual investors make. He said investors often assign emotion to the market as the market is good or bad and that too often people end up chasing the market. He said sometimes the market goes up and sometimes it goes down and that if normal volatility bothers you, you should own index funds.

He is a big believer in diversification and does not think that short term trading makes sense to do because it is too difficult.

As I say I was not familiar with him before I saw the interview but it appears I have stolen all of my material from him except for the ponytail and the bolo tie (humor attempt).

I imagine I posted it because it made a lot of intuitive sense to me, and it still does. It got me thinking about over time things that change and things that don't with regard to investing and enduring in the market. The original post is almost six years old which is not an insignificant length of time. It may not be enough time to be right about something but it is enough time to be wrong.

It could be reasonably argued that the world is a much different place than when that post was first published. We've hopefully all learned a few things in that time. Perhaps the last few years reinforced a few things for you and maybe you've given up on a few ideas that proved out flawed one way or another. If you isolated flaws, were they flaws of expectations?

The notion of diversification got beat up pretty good because "all correlations went to one" leaving no place to hide. This was one I got right. Nothing is going to escape a real worldwide panic like we had in 2008 and into early 2009. I've spelled out the details of this enough that I won't repeat other than to reiterate the importance of proper expectations. From the top down when just about everything is going down that means just about everything is going down. That may seem snarky but it isolates the idea that in a real bear market hiding out in "quality dividend paying stocks" or foreign stocks will not reasonably offer positive returns. You might be lucky enough to go down less but being up 10% in your portfolio is not a realistic expectation for a down 30% world.

Kareem tweeted yesterday that he is "100% cancer-free." Not too shabby.
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Global X Andean Fund

Global X launched its Andean ETF with ticker symbol AND. It is 49% Chile, 29% Colombia and 22% Peru.

This is an important and attractive part of world, in my opinion. I'll have more on this later. Apparently there are no Bolivian toll road stocks in the fund.

Short post, I have to head to Phoenix for the day.
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It Turns Out It Would Be Really Easy to Issue Foreign Bond ETFs

For a while I've been writing about the importance of foreign fixed income exposure in a diversified portfolio, how we integrate this space into our client portfolios and how easy it would be for ETF providers to make real inroads here in offering exposure. What exits now are some broad based funds that are usually heavy in Japan because Japan has issued the most debt (kind of market cap weighted by total debt issued). There are a couple of emerging market bond ETFs that are better holds, IMO.

Well it turns out that iShares offers a lot of foreign bond ETFs in other markets. For example in Canada iShares offers seven ETFs that own Canadian bonds. iShares UK offers more funds than can be counted in GBP and euros in all sorts of fixed income categories. I am aware of one other iShares site, that being for Hong Kong but there are no bond ETFs available on that site.

It might be a case where the company may not want to commit the capital to seeding US versions of these funds which would be reasonable given that embracing truly new segments of the market can be difficult for many investors (there are many advisors who still use an OEF equivalent of SPY, IWM and EFA). The solution here might be some sort of blurring of the lines between exchanges such that anyone so inclined could buy the iShares DEX Universe Bond Index Fund which has ticker XBB in Toronto but apparently no pink sheet symbol for US trading.

This would of course be a big evolutionary step but not completely unprecedented, it is pretty easy to buy Canadian common stocks through Schwab and they are about the worst for accessing foreign stocks and of course Fidelity, Interactive Brokers and eTrade offer access. There are different rules for funds but it seems to me to be a legal solution that if implemented intelligently would be much less capital intensive than seeding a bunch of new funds.

In my opinion this is something that is going to evolve such that the access is made available one way or another. For now it may be a demand issue in that I think there is failure to recognize the need by too many people but the exposure is important even if people are slow to realize.

On a possibly related note, IndexUniverse reported that iShares had filed in the US for a foreign preferred stock ETF that is 73% Canadian issues.
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It Would Be Worse If You Didn't Know

On Monday I tweeted rhetorically whether the Fed was bigger than Egypt as US equities seemed to have shrugged off whatever might be the consequence from the Egypt story. This was confirmed by an even bigger lift in the market on Tuesday. As a quick clarification the Fed is literally bigger than Egypt but I am talking shorter term sentiment. There are several odd things at work as the market appears to have moved on so quickly from this story that it is amusing.

In general, events like the one in Egypt and whatever it may spill into come along every so often, markets over react for a few days because "this one" is different, the market realizes it is not different and then shrugs it off. This is often a process that takes several days not the one trading session, last Friday, which makes me wonder if the market could be underestimating the significance. I still don't think this is a permanent game changer but I do think this should be worth more than one down day.

ETF Trends had a post titled Egypt ETFs Lure Investors in Droves. The Market Vectors Egypt ETF (EGPT) had very little volume until a few days ago but since then the volume has gone berserk from tens of thousands of shares to either side of a million shares per day. This clearly shows that the willingness to speculate, as if we need any reassurance, is alive and well. The one way nature of the trading for the last few months is also evidence of willing speculative behavior which is of course what the Fed wants. The targeting of asset prices as the Fed is doing is an encouragement to speculate and this is far from a unique thought.

A blog I read on Seeking Alpha called The Housing Time Bomb refers to this as robots controlling the market and he reasonably concludes "why anyone would invest their life savings in something as ridiculous as today's robot controlled stock market is beyond me."

There is no reasonable denial that things are distorted by desperate policy attempting to stimulate the economy and one way to stimulate the economy is to target asset prices (not a belief statement on my part, just noting one of the current dynamics at work). The totality of the last eleven years (returns plus policy) will obviously cause some investors to swear off stocks forever for the reasons that The Housing Time Bomb says and some he doesn't but there are some important things to consider in addressing this question or maybe other questions of just how much exposure to have in stocks.

The most important thing is that we are now eleven years past what many people think of as normal stock market behavior which is a pretty long stretch in this context. Part of behavioral finance is that people get worn out to the point of giving up at precisely the wrong time. On a smaller picture level a distorted market is not a good thing but not knowing it was distorted would be worse.

If you are worried about some sort of meltdown because of all this, one answer is to pick some sort of objective trigger point to take defensive action. It would be better to do this now while you are probably feeling pretty good. Also valid would be to allocate more to countries that had close to normal decades in their stock markets, have healthier economies and where desperate actions are not being taken. There are plenty to choose from.
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The Concept of a "Number" for Retirement is Completely Bogus

Early in the day yesterday Carrie Pomerantz-Schwab from Charles Schwab INC and Barry Rand from AARP came on CNBC to talk about a new partnership to help people better prepare for retirement. In citing all sorts of grim statistics about how unprepared people are for retirement one in particular got me thinking, maybe flipped the switch on something. They said that only 55% are confident they know how much they will need to retire. Not know they will have enough but, as I read it, simply know what number they need to shoot for.

The math here is easy; the income you think you need in today's dollars divided by 0.04 (assumes the 4% rule) and then do a little spreadsheet work to figure for a reasonable rate of inflation and then maybe an extra cushion for one-off events. That would tell you what you need.

Do you observe any problems or flaws in the above paragraph? It relies on being generally correct about three predictions for the future, depending on your age--the distant future. There is more than a little folly embedded here. On the first assumption; you don't know what your life will be like in the future. On the second assumption; most people don't know more than economists and economists are wrong an awful lot. The third assumption also ties into the vagaries of life.

The last ten years has been a great lesson about the folly of stock market return assumptions. The US stock market had "bad" decades in the 1930s, 1970s and the 2000s. Once is an accident, twice is a coincidence and three times is a trend (I attribute that one to Chris Berman). If you are retiring at the end of the 1990s (and presumably reducing equity exposure or volatility a little) or the end of the 2000s is a matter of luck; the vagaries of life.

I guess I am saying more attention needs to be paid to the variables involved. This does not necessarily mean trying to predict your future so much as take to heart that every assumption could turn out to be very wrong. An annualized return of 5% versus an assumption of 6% combined with inflation of 4% versus an assumption of 3% doesn't sound like too much of a difference but it would be a dealbreaker.

I don't know what the stats are about how many people used to get pensions versus how many people now will not but we know that defined benefit plans are well on the way to extinction in business (and maybe on the way to failure for the various public pensions) to be replaced by defined contribution plans. There have not yet been that many people who've retired with 401ks and the majority of those who have did so in the last decade when domestic equity returns were lousy. In a way there is an argument to make that says defined contribution is an experiment that may or may not work out and there is evidence that the odds for success are not great.

So far this post probably seems like a downer but I don't view it that way. In this instance we have a better chance of overcoming obstacles by really understanding what the obstacles are. A financial plan is a roadmap that is crucial in that it gives you something to measure against just with no guarantee for success.

Long time readers will know my philosophies (if that is the best word) related to living below your means, saving aggressively and finding a way to make money after you "retire" doing something you love and would do for free.

As far as investing around so much long term uncertainty, this can be as simple or as complicated as someone wants to make it. At the moment that the portfolio becomes an income source it has a certain value. The value at the time may be what you hoped for or not but there is no amount of hoping that can change the value or the reality that goes with that value. Understanding this form of potential denial like pulling $10,000 out of a portfolio that can only sustain $5000 can stave off one type of problem.

There are countless ways to have success in the stock market, this blog is about one belief on how to do that, but we have less control over our long term result than we do over our savings rate. Over the long term most people will be lucky to be somewhat close to whatever the market does during their investing lifetime. If you are worried about what the US market might (not) do during the remainder of your accumulation phase then maybe the answer is to pick another market or another few markets. After all what is the S&P 500 if not a country fund?
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