MDCigan

Headed For a Normal 20-30% Correction

"When people look backwards to see whats coming they often forget that our markets today have evolved. I am in no way saying that large corrections are no longer possible; what I am saying is that any analysis that reads "we will see big corrections because we saw them before" is overly simplistic. So, what was "normal" in the past is not necessarily what we can expect in the future. It seems obvious but when everyone's looking for explanations and making predictions it is easy to forget that past results are not indicative of future performance."

This is certainly within the realm of possibility, but I think this is highly problematic. IMO, the primary tool for making forward-looking decisions and considering possible future scenarios is past historical experience and past quantitative data. If one starts with the premise that the past is meaningless, then where does that leave you? It leaves you at basically making hunches and guesses based on absolutely nothing. My thought is the past represents a combination of both fundamentals and human psychology. I believe human psychology never changes so the cycles of the past are likely to be repeated in the future in a similar (but not exact) way.

Complacency Runs Deep: Time To Sell

"What you should not do is panic, says Jeffrey Kleintop, chief market strategist at Boston's LPL Financial Services via e-mail. His "Five Reasons Not to Panic" include *********"it's just another 5-7% pullback*******, the temporary unwinding of the yen carry trade is nearly over, profit worries are overblown, subprime losses are unlikely to cause a financial crisis, and no one will be left to sell." Keep in mind that "volatility is back," he says."

Interesting comment here from this strategist. In behavioral finance, one of the typical mistakes we humans make in investing decisions is the "recency effect". We tend to overweight more recent experience and discount the distant past. I can't help but wonder if after May-July 06 and Feb 07 the market has "trained" many to assume every quick 5% pullback is absolutely a dip to be bought before a march to new highs. It would be ironic if this particular instance turns out to be trap for all those making that assumption. Be careful.

Judging Fund Performance: Part 2

"At this point, each investor needs to ask himself or herself whether there is evidence that the managers’ skill has generated the impressive trailing performance or, alternatively, simply an aggressive investment policy, along with a tolerance for taking on some risky positions—such as 10+% in Russian wireless. Is there evidence for sufficient incremental value (beyond asset allocation) to merit the fees that these funds charge and expense that they incur on the basis of their high turnover?"

Good article, and certainly food for thought. My question I would pose to you is what exactly constitutes "manager skill"? Is it just individual stock-picking with basically identical sector weights to the S&P 500, or can manager skill also be part of determining when to have substantial overweights in sectors like utilities, materials, energy, etc.

I think it is fairly easy (as you demonstrate) to do a backwards looking analysis to determine a fund's performance could have been replicated with particular sector and asset class weights using low-cost ETFs. But how would you have known to use that SPECIFIC sector/asset class composition at that point in time? Perhaps the manager skill is knowing when to overweight what sector and when to get out of that sector.

Take your example of CGMFX. I've actually wanted to buy this fund for a long time, but unfortunately my broker does not offer it. I've studied the fund and the manager's investment approach and an integral component of his "skill" is making big sector and industry bets based on top-down analysis. At one point, the fund was loaded with homebuilders, and was responsible for strong performance. You could have done a backwards analysis sometime back demonstrating replicating his performance by purchasing the homebuilder ETF, XHB. But he dumped all the homebuilders before they crashed, and therefore captured the gain and missed the losses. Would a static portfolio based on backwards analysis still be holding XHB?

I think there is more to analyzing a mutual fund then just trying to decompose what sector and asset class are driving returns because you have to also try to understand the manager's thought process behind it. Managing a portfolio is a dynamic and not static process so the sector and asset class weighting could be changing quite frequently.

Vanguard's Jack Bogle on Rebalancing: Don't!

"Fact: a 48%S&P 500, 16% small cap, 16% international, and 20% bond index, over the past 20 years, earned a 9.49% annual return without rebalancing and a 9.71% return if rebalanced annually. That’s worth describing as “noise,” and suggests that formulaic rebalancing with precision is not necessary."

I'm not sure this really proves anything against rebalancing. First off, the set of asset classes used isn't very diverse. If you used a more comprehensive set of asset classes with more negative correlation like REITs, commodities and precious metals, emerging markets, etc. in addition to just U.S. large-cap and U.S. small-cap, I'd bet the results would be ALOT DIFFERENT in favor of rebalancing.

Secondly, you would want to test different rebalancing strategies in terms of time frame. There is alot of evidence to suggest there is momentum at the 1-2 year time frame, and mean reversion at the 3-5 year time frame. Perhaps rebalancing less frequently then annually would do even better.

As much as Mr. Bogle is respected in the industry, I think it is important to remember he is biased, and I would not accept anything he says at face value without further investigation of the issues.