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  • Investors Dump Stocks, Markets Rise?
    It's been a choppy year for US stocks. Even so,  the S&P 500 is up over 6% year-to-date. The Dow Jones Industrial Average is up almost 7%.

    Who is buying these stocks? Not big corporate pension plans, according to a story in the Wall Street Journal.  Not mutual fund investors, according to fresh data from TrimTabs.

    The data crunchers over at TrimTabs Investment Research highlight a pattern of mutual fund investors continuing to move out of US equity-focused funds, while loading up on global equity funds.  Last week marked the sixth in a row that Global Equity funds as a group have gained total assets, according to the Sausalito, CA-based firm. US funds, though, lost assets for the 23rd straight week.

    TrimTabs CEO Charles Biderman argues that the trend for US funds is likely to continue, since many investors are still well underwater on their US stock funds. According to his research on mutual flows monthly inflows, the average price paid by investors for stock funds over the last decade was equivalent to 1434 on the S&P 500, which today is just 1185 even after its recent gains. "Investors are loath to put new money in when they have a loss on their existing investment," Biderman explains.

    The current Federal Reserve policies pushing interest rates down, have created a more attractive opportunity Biderman says, to invest with cheaply borrowed money in better growing emerging markets. "The Federal Reserve is paying people to buy stocks," he says. "The Fed is giving away money and investors are taking that money and buying non-US stocks." Rising money supply will continue the trend, he predicts:  “The dollar’s decline has juiced the returns investors have earned on non-U.S. equities, and we expect the dollar to continue to drop as the Fed prints more money.”

    The WSJ piece outlines a sharp reduction in corporate pension plans equity holdings overall:  From over 70% of their holdings in the mid 200s to just 45%, according to the Center for Retirement Research at Boston College. That promises a further drag on US equities moving forward, as these companies start to have to fill in the shortfalls they won't get from stock appreciation with cold hard cash.

    So mutual fund investors and major corporate pension plans are not buying U.S.  stocks. So really, who is?

    Disclosure: No positions
    Oct 21 4:04 PM | Link | Comment!
  • Diversification in Pictures

    If a picture is worth a thousand words, when it comes to the payoff of diversification, a chart or two may prove even more valuable.

    The principles over at MyPlanIQ, a firm specializing in sorting through corporate 401k plans and offering suitable portfolios from the funds on offer, have put several together. They show what portfolio theory teaches: that adding more asset classes to a portfolio improves its performance over time.

    Here is a comparison of the performance of portfolios of increasing diversity from 2009 to the present. (Click chart to enlarge):

    In the graphic above, the lowest orange line is a portfolio consisting of three index funds tracking different asset classes : 40% in Fixed Income, 30% in US Stock, 30% in International Stock.

    Green is slightly better with four funds: 40% Fixed Income, 20% US Stock, 20% International Stock, 20% REIT.

    Gray is better still, with five funds: 40% Fixed Income, 15% US Stock, 15% International Stock, 15% REIT, 15% Emerging Markets Stock.

    Blue is tops with six funds: 40% Fixed Income, 12% US Stock, 12% International Stock, 12% REIT, 12% Emerging Markets Stock and 12% Commodities.

    As the graph shows, the more assets, the better the returns.

    In the short term, as the diversification and returns rise, investors seem to be better compensated for their investment risk. Over one year, the Sharpe Ratio ranges from 83% in the portfolio of 3 asset classes, up to 105% for the portfolio of six. Higher is better.

    Over a longer stretch, the risk-adjusted returns of all portfolios comes down. Looking back to 2001, the four-sector portfolio, for example, has an annualized return of 6.62% and a Sharp Ratio of  40.29%.

    The very best performance over the ten-year period comes from the five-asset portfolio, with a 7.71% average annual return and a Sharpe Ratio of 44.93%. The six-sector portfolio has a slightly lower 7.61% annualized return but a better 49.7% Sharpe Ratio.

    Which seems to imply that diversifying pays, but there may be a diminishing return at some point.

    Here is a chart of the same group over the longer time horizon, stretching back to 2001. (Click chart to enlarge.):

    Disclosure: No positions
    Oct 21 4:00 PM | Link | 1 Comment
  • Your Fund Manager is No Albert Pujols, and Other Lessons from Larry Swedroe's Investing Tales

    Corporate 401(k) plan sponsors pick bad funds for their plans, according to a 2006 study. Then the participants in the plans compound the problem, again picking funds headed for a fall.

    Why? Because though the Securities and Exchange Commission mandates that funds put in any piece of marketing the disclaimer that past performance is not indicative of future results, it seems no one believes them.

    In chapter 15 of his new book, Wise Investing Made Simpler, CBS MoneyWatch columnist Larry Swedroe acknowledges a logic to our apparent fiscal recklessness.

    He starts with the example of Albert Pujols. Pujols had a fantastic rookie year with the St. Louis Cardinals. Then he tacked on eight more, to rack up, Swedroe writes, the greatest first nine years of any batter in the history of baseball.  No one would attribute 9 out-of-sight years to luck. Any general manager would have snapped up Pujols given the chance.

    Similarly, a business looking to fill a management post looks at how each candidate has performed in previous roles.  If you need surgery, you go to the surgeon who's done many, many successful operation.

    In most walks of life, past performance is indicative of future results.

    So it's logical we'd think that would also hold true for fund managers. Unfortunately, according to this study, we're wrong. The research conducted by Edwin J. Elton and Martin J. Gruber of New York University, and Christopher R. Blake of Fordham University, examined 43 401(k) plans from 1994 through 1999. Over those five years the 401(k) plans added 215 new fund options for participants and dropped 45 funds from their plans.

    The authors found that the funds added had a strong track record, and those dropped had poor recent performance.  The new funds promptly underperformed those that had been given the heave-ho. Swedroe writes:

    When a plan deleted a fund and replaced it with a fund with identical objectives, the deleted funds about 2.5 percent per year over the next three years

    The funds investors -- i.e. us -- have to choose from are a bad lot, but we manage to make things even worse, the academics found, by repeating plan manager's mistake and constantly chasing yesterday's good performance. Rather than stick to an asset allocation plan and rebalance it periodically, we pour new cash into last quarter's top performers.

    (P.S. There's a big price paid for all this. In their abstract of the study the three authors note: "We find that, for 62% of the plans, the types of choices offered are inadequate, and that over a 20-year period this makes a difference in terminal wealth of over 300%.)

    Swedroe  is an avowed fan of indexing as the most effective method of investing for individuals. No one should be surprised that this book is an attempt to convince investors of the wisdom of doing less. But whether you're sold on this philosophy or not, there are interesting connections drawn in this book between how we behave in most of our daily lives and how we behave when we put on our investor hat.

    In an early chapter, he contrasts a child's method of learning how to ride a tricycle without banging into a wall with investor's moth-like attraction to stock picking.  In another, he compares driver's dubious self-confident assessment of their own skills to investors' inflated opinion of themselves. In a 1965 study by two psychologists, 2/3 of drivers said they were at least as competent as usual, though all had ended their last trip in an ambulance. Police reports indicated almost 70% of them were directly responsible for their accidents.

    The conceit of this book, and its predecessor, Wise Investing Made Simple, is that it's true-life stories (often horror stories) that really stick in people's minds.

    In this book, Swedroe uses story telling in an attempt to convince investors to get out of their own way, and ends the chapter on 401(k)s with the well-known quote from comic character Pogo, "We have met the enemy and he is us."

    Disclosure: No positions
    Oct 21 3:53 PM | Link | Comment!
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