Lowell Herr's  Instablog

While I am a strong advocate of "do-it-yourself" investing, there are situations were a money manager is useful. How does one select a manager? Here are a few suggestions.

1. Seek a trusted friend and ask them who they use as a money manager. Ask around.

2. Is the manager certified? In "The Bogleheads' Guide to Investing" there are nearly two pages of professional designations. Look for someone who has passed the Certified Financial Planner (CFP) exam.

3. Don't use a stock broker as a money manager. There is a conflict of interest between giving advice and selling stock or actively managed mutual funds from the brokerage house.

4. Look for a fee based only manager.

5. If the manager is going to charge a percentage of the money managed, check the rate schedule. The larger the amount of money under management, the lower the percentage. Be wary if the percentage exceeds 50 basis points or 0.50% per year. If the fee is 90 or 100 basis points, look elsewhere for a manager unless unusual servers are provided.

6. What kind of reporting is provided? If the manager is unable to provide Internal Rate of Return (IRR) results for the portfolio, look elsewhere. The TLH spreadsheet, when used properly, provides this information.

7. Ask the money manager what they are using as a portfolio benchmark? Is the benchmark customized to fit the portfolio? If not, why not? The TLH spreadsheet provides this information.

8. Will the money manager work with you to build a portfolio that will meet your risk requirements? Once more, the TLH spreadsheet will not only provide portfolio volatility information, but will do it using a semi-variance calculation where only the downside volatility is of concern. For more information research the Sortino Ratio on this blog.

9. Before you hire a money manager, read a few of the Top Ten Investment Books recommended on this blog.

On page 167 of Mebane T. Faber and Eric W. Richardson's book, "The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets" we read, "Our research has shown that returns are lower and volatility is higher when asset classes are below the 10-month moving average." What investor is not interested in reducing portfolio volatility while increasing returns. And possibly more important, reducing losses. This philosophy is what is behind the ITA Risk Reduction (ITARR) model we are testing with the Maxwell and Euclid portfolios.*

The 10-month simple moving average Faber and Richardson discuss in their book is equivalent to the very familiar 200-Day Simple Moving Average. Instead of the 200-Day SMA, I will be using the slightly faster 195-Day Exponential Moving Average (EMA) for each asset classes used in the Maxwell and Euclid portfolios. Readers will find a detailed explanation of the EMA elsewhere on this blog. Should I expand the ITARR to other portfolios, the same rules will apply. As a review, here are the ITARR rules. These simple rules can be implemented by any investor.

1. Buy Rule: Buy the index ETF when the price of the ETF moves from below to above the 195-Day EMA of the ETF.
2. Sell Rule: Sell the index ETF when the price of the ETF moves from above to below the 195-Day EMA of the ETF.

On the Sell Rule, proceeds will be moved to a money market fund or to a treasury holding such as IEF or TLT. After a Buy or Sell move, we do not pay any attention to that ETF (or other investment vehicle) until more than 30 days pass. This "neglect" rule is applied for several reasons. 1) We want to avoid the wash rule. 2) We can avoid TDAmeritrade's high commission fee if we do not trade within a 30-day period. 3) We minimize the whipsaw problem if we neglect the ETF or index fund for 30 days.

In general, we will examine all ETFs held in a portfolio at the end of the month to see where they are positioned. However, assume we are tracking an asset class such as domestic REITs where our investing vehicle is VNQ. While writing this blog, I checked in at StockCharts to observe VNQ as I knew it was getting very close to its 195-Day EMA. On 10/21/2011, VNQ closed at $55.16 while the 195-Day EMA listed at $55.18. VNQ is positioned to move from below to above its 195-Day EMA. Assuming VNQ rises today (10/24/2011) above its 195-Day EMA, we will buy a full position in VNQ and then neglect it for 30 days.

Disclosure: I am long VTI, VEU, VWO, VNQ, RWX.

Vanguard's REIT ETF, VNQ, is part of every portfolio I track and due to its importance merits close attention. I track a number of technical indicators for each ETF in the portfolios and here are a few of them. One of the first metrics I examine is my own "Delta Factor" which is a reversion-to-the-mean projection of how well an ETF is expected to perform with respect to the broad market. The current projection for VNQ is positive, but not sufficiently strong to recommend a 'Buy.' As a 'Hold' candidate, it is not projected to do much better than the total U.S. Equities market.

A second indicator is the price of VNQ as measured with respect to its 195-Day Exponential Moving Average (EMA). The price of VNQ remains well above its 195-Day EMA, confirming the "Delta Factor" indicator. A third factor is the Relative Strength Indicator (RSI) as shown in this reference. It is the second graph from the top. Alert points occur when the graph charges above 70 or dips below 30. VNQ is close to 50 or a 'Hold' position. This indicator is frequently early, one reason why I would not rely on it in isolation. The same is true for the "Delta Factor" projection. We now have three technical indicators reinforcing each other.

A fourth indicator is the Moving Average Convergence-Divergence (MACD) graph or the third from the top. This indicator is currently showing a weak signal. The MACD was developed by Gerald Appel in the 1970s and interested readers should investigate how the three EMAs work with each other to create this graph. Right now I classify this metric as negative, but the actual signal was generated earlier in the month.

A fifth indicator, and one I pay least attention to, is the Chaikin Money Flow (CMF) as show in the same link provided above. The CMF recently moved into negative territory, another weak signal confirming what we see with the MACD.

A sixth indicator is the relationship between the 13-Day EMA and the 34-Day EMA. That signal recently turned negative with the 13-Day EMA line passed from above to below the 34-Day EMA.

Overarching these six indicators is something called the Bullish Percent Indicator. In this Point and Figure (PNF) graph we are looking at the condition of the broad market to see if it is overbought or oversold. Which is in control - supply or demand. The current condition is neutral as approximately 50% of the stocks in the NYSE are a buy while 50% are a sell. This confirms the earlier 'Hold' signals discussed above.

Based on these technical indicators, VNQ is currently an ETF that qualifies as a 'Hold' candidate in portfolios made up of ETFs.

Disclosure: I am long VNQ.