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Former analyst for Connecticut General and current serial entrepreneur with over 40 years experience building companies. Background includes a masters degree in economics from the University of Connecticut and experience taking several companies public. Educational and professional experience... More
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  • Proof that the Modern Portfolio Theory Should be Declared Dead

    For the past sixteen years, Dalbar, Inc. has published its Quantitative Analysis of Investor Behavior (QAIB), which is the company's official survey of actual investor returns from mutual funds. The QAIB is developed based on an analysis of data received from the Investment Company Institute, and reports the actual average returns an investor realizes from mutual funds (which are significantly different than those advertised by mutual funds). In its 2010 report, Dalbar blames investor behavior, not the mutual fund industry, for 20 years of shockingly low returns, but surprisingly declares that the Modern Portfolio Theory is dead. Dalbar's latest report can be found here.

    In our opinion, Dalbar has been functioning as an apologist for the mutual fund industry - the company reports accurate data (i.e. the low returns that investors actual receive from investing in mutual funds) but then bends over backwards to make tortured arguments, which try and rationalize the mutual fund industry's failure to add value. While the low returns reported in the 2010 QAIB are no surprise, Dalbar's admission that Modern Portfolio Theory is dead is long overdue and shocking to say the least.

    Mutual Fund Investors' Low Returns

    The quantitative analysis part of the report shows improvement of returns for investors as compared to the numbers reported in 2009, but the numbers will shock most investors. For the 20 years ending December 31, 2009, investors' annualized returns by fund type were:  equity 3.17%, fixed income 1.02%, and asset allocation 2.34%.  All returns are before an inflation correction of 2.80%, which leaves investors with 20 years real equity annualized return of 0.37% and negative annualized returns for fixed income of -0.78% and asset allocation -0.46%. 

    For the 20 years the S&P 500 annualized return was 8.20%.  Mutual fund investors that invested in S&P 500 Index funds beat actively managed funds by 5.03 percentage points of annualized average return.  Why?  Dalbar's 2010 QAIB report blames investors for the poor returns: "The problem is, investors aren't rational and they don't buy and hold.  They jump in and out of the market."  To support this assertion, data is presented that shows the typical mutual fund investor has a holding period of three to four years. However, Dalbar doesn't mention that the S&P 500 outperforms a changing universe of active money managers 70% of the time, which makes the recommended buy-and-hold strategy for actively managed mutual funds a loser.

    Modern Portfolio Theory is Dead

    Modern Portfolio Theory is the foundation of the mutual fund industry. It's widely advertised as the way investors should allocate capital to be in tune with the best money management practices.  Modern Portfolio Theory says investor returns are determined by the level of risk the investor assumes.  So, like selecting a radio station, dial in the level of risk and get the expected return.  Simple! 

    We quote from QAIB 2010:

    "In spite of catastrophic losses in 2008, the belief in Modern Portfolio Theory ("MPT") has remained inexplicably strong.  MPT is grounded in the observation that asset classes are predictably uncorrelated.  Based on the theory risk can be mitigated by diversifying into uncorrelated asset classes.  However, unless the correlations of the various classes are predictable, the mitigation of risk is lost.

    Investors expect to be rewarded for the level of risk they are taking in a particular market.  Investments results in 2008 showed clearly that correlation of asset classes varied unpredictably and with no warning.  This brings into question the very basis of MPT and its ability to forecast an efficient frontier.

    The Achilles' heel of MPT is that it simply cannot be reduced to a mathematical model or relied upon as the sole basis for the management of investment decisions..."

    It's a tough case for actively managed mutual funds using the Modern Portfolio Theory when you have at the table 20 years of S&P 500 Index Fund averaging annualized real returns of 5.40% and mutual funds achieving a real equity annualized return of 0.37% and negative annualized returns for fixed income  and asset allocation of -0.78% and -0.46% respectively.  To sell the investor that by allocating capital to each of these asset classes the investor can, based on the risk of each asset class, forecast an "efficient frontier" (optimal portfolio) to achieve a target rate of return is not a likely outcome. The dial on the radio is broken!  But before it broke, Modern Portfolio Theory caused investors to lose trillions of dollars.

    Disclosure: No positions
    Apr 27 10:44 AM | Link | 3 Comments
  • George Soros Bets on Inflation and A Weaker Dollar
    Soros Fund Management LLC, 4Q SEC Form 13-F, December 31, 2009, filed February 16, 2010, reports a total portfolio of $8.849.3 billion and 716 securities.   The portfolio weightings are a good insight into the macro economic trends that are driving George Soros’s investment strategy.
    Oil and Gas investments of $2.078.1 billion in $millions are: Suncor Energy (NYSE:SU), $252.9; Weatherford International (WFI), $132.3; Plains Exploration & Production (NYSE:PXP), $193.0; Hess Corp (NYSE:HES), $348.7; Petroleo Brasileiro SA Petrobr (NYSE:PBR), $368.7; Petroleo Brasilerio SA Petrobr (PBR-A), $249.5; and Interoil Corp (NYSE:IOC), $214.5. Total portfolio weighting for oil and gas 23.5%.
    Gold investments are primarily the SPDR Gold Trust (NYSEARCA:GLD), $664.1, and direct equity investments in gold miners, like Freeport-McMoran Copper & Gold (NYSE:FCX), of $66.8 for a total gold investment of $730.9 and weighting of 8.3%. Precious metals investments other than gold are nominal.
    George Soros’s oil and gas and gold investment of $2.809.0 billion weights the portfolio 31.7% for those assets.   Both of these sectors will benefit from inflation and/or the depreciation of the U.S. dollar. (The positive price impact of random international crises on the price of oil and gold is a free insurance policy for this natural resources and gold strategy.)
    On Friday, the U.S. Treasury sold $13 billion of 30-year U.S. Treasury Bonds at a yield of 4.679% compared to the forecasted 4.702% rate. Direct bidders bought 29.6% of the government securities, which was the highest direct bidders participation since February 2006. The low 4.679% rate and high direct demand for the 30-year Treasury Bonds reflect institutional investor expectations for a low inflation environment in the future. 
    By putting 31.7% of his assets in gold and in oil and gas, George Soros placed a $2.809.0 billion bet on inflation and a weaker dollar. Americans can hope that his bet won’t pay off and root for the buyers of 30-year government securities, however in light of U.S. Government’s ever increasing size, budget deficits, debt and push for big government programs, any house would place the odds in Soros’s favor.

    Disclosure: Long SU
    Mar 17 12:11 PM | Link | Comment!
  • PepsiCo to Increase Annual Dividend On Its Common Stock By 7 percent from $1.80 to $1.92 per year and authorize a $15.0 billion Share Repurchase
    PepsiCo. (NYSE: PEP) ($66.07, 3/16/10) on March 15, 2010, announced its 38th consecutive dividend increase and the repurchase of up to $15.0 billion of common stock through June 30, 2013 (see Pepsi site here). PepsiCo has an addition $6.4 billion available from a 2007 authorization for the repurchase of common stock by June 2010.
    This past year, we ( rated PepsiCo as a Four Star stock, which means it had been selected by our model at least four times during the last ten years, but did not make the cut for any of the current year’s portfolios. Additionally, to get a Four Star rating the company’s fundamentals must not exhibit any red flags.
    During the past 20 years, PepsiCo made it into our portfolios five times; the average holding period was 1.4 years, and the average annual return was 16.81% (dividends reinvested). However, if we had bought PepsiCo in March 1989 and held it for 20 years, the annual return would have been 11.71% (not a bad return by itself).
    Compared to the S&P 500 TR Index (total return dividends reinvested), which had an annual return of 8.32% for the same 20-year period, PepsiCo is a big winner. In our opinion, the odds are that PepsiCo’s returns will be greater than the 9.5% over the next ten years, which means that it may be returning to our portfolios someday soon.

    Disclosure: Long PEP
    Tags: PEP
    Mar 17 12:08 PM | Link | Comment!
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