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Lenders have been doling out increasingly large sums of money and accepting increasingly crummy conditions and meager returns on their loans. Remember those "low-doc" loans that got subprime home buyers in trouble -- the ones that required minimal proof of ability to repay? These are their corporate cousins. Waves of money are coming at the markets from investors around the world. Bond and loan buyers have to put this money to work, even if the deals are shoddy. In the last year alone, they bought up $148 billion in new junk bonds from U.S. issuers, the largest sum in history by more than half for such high-risk debt. The fuller answer tunnels into the Street's cynical heart, and why it has always been so profitable to work there: Hedge-fund managers, buyout artists, and bankers get paid for short-term performance. The long-term consequences of their actions are, conveniently, someone else's problem. People inside the big banks are eerily candid about the credit cycle creeping to an end. They also candidly admit they don't want to get caught missing the next big deal. Their banks, and their own bonuses, might suffer. So they ply ahead. The incentives are just as clear for hedge-fund and other money managers: The more money they put to work, the more 2% management fees they collect. And if they can outpace the market, there's 20% of the profits in performance fees for the taking, too. "The fabulous profits we have been able to generate," Carlyle's Mr. Conway said in a letter to his employees, resulted in large part from the availability of cheap debt. The bankers, he added, "are making very risky credit decisions." As they say in "The Lion King," Hakuna Matata. No worries. Consider the idea of "covenant lite." That is the term the Street has attached to bank loans that subject borrowers to few of the usual performance requirements that have been standard in the past. A borrower's earnings might falter or receivables balloon, and a lender's only recourse is a ponderous shrug. Debt buyers have taken on $41 billion of such 'lite' loans during 2007, a figure greater than the last 10 years combined, says Standard & Poor's. Covenant lite represents 37% of institutional loans written this year, compared with just 1% in 2005. "Stupendous" is how S&P put the supply and demand. Another record is being set for Payment-in-Kind notes, which typically substitute interest payments with company shares or more money later. The term reputedly dates back to when debtors would replace "kyn" -- Old English for "cattle" -- for coin. The debt markets "have reached a point where we can't go any further," says S&P analyst Steven Miller. "Some of the deals introduced into the market [this year] felt like they were at the edge of a cliff, leaning over. With someone holding their belt loops." Turmoil in the bond and stock markets the past couple of months could be a signal that this will soon come to an end. The problem is that those words have been uttered for the past two years. Since then, corporate defaults have dipped to their lowest levels in more than 10 years. Low defaults and high profits suggest companies could bear much more debt, which could sustain still more issuance. "If you tried to call the end, you'd be really poor waiting for it," Mr. Miller says. Structural changes in the way people buy and sell debt adds to the appetite. The Street's soothsayers say this has fundamentally changed markets, by spreading risk far and wide, like a rake shaping a deep sand trap into a large, shallow one. Banks themselves have generally ceased their role as gatekeepers. They're now in the shipping business, not the storage business. They parcel out to other investors the big loan packages they cut, typically as much as 95% of the loans they originally underwrite. These are sliced and packaged into products and gobbled up by hedge funds, insurance companies and institutional investors hungry for anything with a sizable yield. The slicing is supposed to disperse risk in a way that minimizes exposure to any one large default. The changes give comfort to a market that has shown precious little sign of cracking. In such conditions, chasing bad deals might be entirely rational, says Princeton economist Dr. Markus Brunnermeier. "You can sell off loans very easily in the market. If others continue to go on, then you can stay on. You try to forecast when the others are getting out. You don't focus on the fundamentals. You focus on the other players." This is why no one person has an interest in withdrawing from the market, he explains. Nobody wants to fold his cards first. "We haven't had a hard shock to the credit markets since 2001," says Moody's Senior Credit Officer Matthew Noll. "It's yet to be seen how the new shock absorber actually takes the shock." In other words, don't worry about how these times will end. Just know that everyone will be getting paid until the day arrives. And no one will have to give it back. No worries, indeed.
“As investors are forced to confront the reality of a growth slowdown, they’re likely to pay less attention to the economically sensitive names,” said Jack Caffrey, equity strategist at JPMorgan Private Bank. This means that the best-performing sectors in recent years — like energy and basic materials — probably won’t be the market leaders once this dust settles, Mr. Caffrey said. What will replace those sectors? He argues that the answer is likely to be stocks that don’t require a strong economy to produce decent earnings growth. One place to look is in health care, a traditional growth-oriented sector that has been a market laggard over the past five years. “The economics and valuations for the sector are pretty compelling,” said Jeffrey J. Schappe, chief investment officer at BB&T Asset Management. And history is also on the sector’s side. Since 1986, health care stocks in the S.& P. 500 have had the highest correlation to rising stock market volatility, as measured by the Chicago Board Options Exchange Volatility Index, or VIX. That’s according to a recent analysis by Merrill Lynch. In other words, health care stocks are likely to perform best in a rocky market. What other types of stocks may outperform the broad market? Mr. Schappe argues that it now makes sense to take a more defensive stance. And another defensive-oriented sector with high correlation to market volatility is consumer staples. These are products that households need, like soap, toothpaste and razor blades, rather than products that people just want. Mr. Schappe, though, argues that this is “not a time to simply batten down all the hatches.” Investors are likely to covet stocks that can produce decent earnings growth, and according to Thomson Financial, the sector that is expected to produce the biggest earnings gains this year is technology. To be sure, tech companies are sensitive to the underlying economy. But Mr. Caffrey notes that the sector — which has been among the worst-performing groups over the last five years — is in the midst of a product upgrade cycle. Moreover, corporations with tons of cash on hand are looking for ways to lift growth in productivity. One easy way to capture that is through improved technology. The theme of a slowing economy is also likely to drive interest away from small-cap stocks and toward the blue chips, Mr. Schappe said. Why? For starters, the S.& P. 600 index of small stocks has far greater exposure to economically sensitive sectors — such as consumer discretionary stocks, basic materials and industrials — than the S&P500 index of large-cap equities. Conversely, the small-stock universe is less exposed to defensive sectors like health care and consumer staples. But it’s also the case that investors have made tons of money in small stocks over the last six years. If they decide to take some of those profits off the table amid rising volatility, market leadership will have to swing to the large caps. “A lot of times,” Mr. Schappe said, “what causes a group of stocks to outperform isn’t that people are passionate about them — it’s simply a case of investors being forced out of another group of stocks.” Whatever the reason, don’t be surprised if large-cap stocks shine for the first time since the late 1990s.
Other types of mutual funds pursue track commodities and mimick hedge funds. Today, ordinary investors can diversify in ways that were once the sole preserve of wealthy individuals and institutional investors. That doesn't mean you ought to rush to buy these new funds. First, ensure the costs involved are reasonable - and make sure you have the stomach for what could be a rough ride. "You can clearly diversify a portfolio much better than you used to," says Scott Greenbaum, a financial planner with Life Goals Asset Management. "But it has a good side and a bad side. Having so much choice can be paralyzing. People also tend to pile into the wrong sectors at the wrong time. It's become much easier to chase performance." For years, Wall Street experts argued over which was the better strategy, actively hunting for winning stocks or simply replicating the market averages. Market-tracking index funds have won that debate. But today's big question is over how to index. Index funds now account for 17% of stock-fund assets, up from 9% in 1999. But almost all that growth has come from exchange-traded index funds, rather than conventional index mutual funds, according to Vanguard Group's Bogle Financial Markets Research Center. And ETFs, which trade on the stock market just like a regular stock, are really a different breed. Index mutual funds typically offer exposure to large swaths of the market and weight the companies they own by their stock-market value. ETFs, by contrast, frequently focus on narrow market segments and some weight their companies by untraditional measures, such as dividends and sales. Once again, this means more choice for investors. But it also means we have more ways to shoot ourselves in the foot.
For proof, consider some research completed last year by Thomas McGuigan of Burns Advisory Group, a financial planning firm, coupled with some data on investor returns. McGuigan set out to settle the debate of whether active or passive management is superior - at the time, he relied heavily on active managers in his own practice - and came away from his research sure that most actively managed large- and mid-cap mutual funds underperformed their benchmark passive strategies. In each category, however, McGuigan also found that some active managers beat the benchmark, but that few did so consistently. Moreover, it was "difficult, if not impossible" to predict which managers would get the job done. "There was a high price you paid for being wrong, for picking a fund thinking it would be the one to outperform the benchmark, and then having it fall short," McGuigan said. It prompted McGuigan to change the way he worked with customers, moving more toward the traditional index-fund investor. "I came to the conclusion that lower-cost, lower-turnover funds - broadly diversified global investments - were the way to go," McGuigan said. "We can still select managers we like for one reason or another, but we lowered costs, and we improved performance as a result." It is a strategy that index-fund investors live by, which is why McGuigan was concerned when he read a Morningstar report this year showing that the average investor in index funds actually captured just 79% of the return that they should have gained (so if the index was up 10%, the typical investor gained 7.9%). Indexing is designed to be a buy-and-hold strategy; while numerous studies have shown that investors in all funds tend to earn less than the fund does - because they buy in after a fund has shown big gains and sell out when a fund hits rock bottom - McGuigan was surprised to see that indexers lagged their benchmarks by so much. He figured that a rapid indexer would know better than to jump around. His conclusion is a simple equation, one that explains the real reason many investors are better suited to actively managed funds regardless of the cost-turnover benefits of indexing: Real investor returns = actual investment returns +/- investor behavior. "The second part of the equation is so important, because investors constantly hurt themselves," McGuigan said. "So the important thing is that investors believe in what they are doing. If they believe in passive investing, they need to believe it enough to stick with it; if they believe they can pick better managers, they need to give those managers a chance." So the issue is not so much active vs. passive - or a mix of the two - as it is, "Which can you stick with when the going gets rough?" No matter which type of fund you buy, declines are inevitable; but if you can pick a good performer, active or passive, and stick with it to get the same results that the fund actually delivers on paper, that is when you will have a portfolio that has a real chance of helping you reach your financial goals.
This picture of a highly bifurcated stock market is painted by data from Ford Equity Research of San Diego, which tracks around 4,500 publicly traded companies in the United States. Among companies that have been publicly traded for at least seven years, 55% have higher price-to-earnings ratios today than they did in March 2000. The bulk of these pricier issues are in the smaller-cap sectors. Among the very largest companies, the average P/E ratio is now just a third of what it was seven years ago. If investors focused only on the broad stock market averages, however, they might conclude that the entire market is undervalued. According to Standard & Poor’s, the P/E ratio of the S&P500 currently stands at 17, based on trailing 12-month operating earnings. The comparable ratio at the end of March 2000 was 31.1, almost double the current level. The S&P500 is a capitalization-weighted index, and it is in the higher cap stocks where the P/Es have fallen the most. According to Ford Equity Research: the 50 companies in the S&P500 with the smallest market caps have an average P/E ratio that is much higher than it was seven years ago, while the ratio for the 50 largest-cap stocks in the index is significantly lower. According to Ford Equity Research, the average P/E ratio among the 50 largest-cap companies is now 19, about a third of the average of 60.7 for the biggest 50 in March 2000. The average market cap for the 50 largest companies is now $123 billion, versus $153 billion in March 2000. Contrast those numbers with those for the 50 smallest companies in the index which have an average P/E ratio now of 30.7, versus 20.3 seven years ago. And their average market cap is now $3 billion, versus $1 billion. In other words, the smallest-cap stocks in the S&P500 are significantly more overvalued today than they were seven years ago. Yet their higher P/E ratios barely affect the ratio for the index as a whole. That’s because the combined market capitalization of the 50 largest stocks account for nearly half the market cap of the entire S&P500, while that of the 50 smallest stocks add up to just 1.2% of the total. “Investors who pay attention to the P/E ratio of cap-weighted indexes such as the S&P500 therefore need to exercise great care when drawing conclusions about stocks’ relative valuations,” Richard Segarra, director of research at Ford Equity Research, said. “At best, the P/E ratios for such indexes shed light only on their largest-cap stocks; we should avoid drawing any inference from a cap-weighted index’s P/E ratio about the valuations of its smallest-cap members.” An investor who emphasizes market sectors according to relative P/E ratios would have a very different portfolio today than in March 2000. Back then, he would have favored small caps over large caps — and been handsomely rewarded for this choice. The trend is seen in the annualized total returns since March 31, 2000, of three Dow Jones Wilshire indexes: 10.1% for the U.S. Microcap Index and 7.2% for the U.S. Small-Cap Index, but only 0.5% for the U.S. Large-Cap index. Today, that investor would favor large caps over small caps. Not only is the average P/E ratio of large-cap stocks only a third as high as it was in March 2000, it is nearly 10% below its average level of the last five years. There’s no guarantee, of course, that large caps will outperform small caps over the next five years — but there’s a good argument to be made that they will.
ETFs based on commodity indexes can offer a less bumpy, more familiar ride. Yet while such funds became more popular with investors last year, they remain a tiny sliver of investors’ total assets, even those handled by professional money managers who could be expected to have a broad view of diversification. Heather Shemilt, a managing director at Goldman Sachs who is head of its commodity investor business, says she thinks that a modest 3% to 7% invested in commodities would be about right for an institutional investor’s portfolio. Just the same, many clients own far less than that or none at all. But there is an easy way to get a shot at commodity-like returns, without investing directly in commodities or their indexes. Investors can buy shares of the natural resource companies that produce commodities. The prices of these stocks do not necessarily move in lock step with those of commodities; many other factors can also influence share prices. Nor are investors in these stocks free from worry about losing a large chunk of capital quickly. Their risks may be spread out, but there are plenty of them. To many investors, the similarities may ultimately matter more than the differences. Demand for commodities, particularly demand from China, is widely regarded as the reason for higher commodity prices and higher sales and earnings for natural resources companies. Many experts, like James Rogers, co-founder of the Quantum Fund and developer of the Rogers International Commodity Index, see commodity prices and natural resources stocks continuing a bullish stampede; despite some recent weakness, they’ve been running together for years. Consider a comparison between the Goldman Sachs Commodity Index, which tracks the market for energy, metals and agricultural commodities through futures contracts, and the Goldman Sachs Natural Resources Index, which follows shares of companies that produce commodities. Over the last five years, the natural resources index rose 18% a year, on average, versus around 15% for the commodity index. Companies in the natural resources index also had the edge in how they produced their returns. Though the gains of that index have slowed recently, it has not experienced anything like the nerve-fraying 30% plunge in the commodity index that started last summer, prompted by declining oil prices, and ended earlier this year. Investors have many familiar choices for playing the sector’s stocks — far more than they do when they hold commodities directly. As is the case in real estate, electronics and other specialties, they can gain exposure to natural resources producers through dozens of specialized mutual funds. The average fund in the sector returned 23%, annualized, over the three years through Thursday, according to Morningstar. “This is not a well-understood sector,” explains Fred Sturm, portfolio manager of the Ivy Global Natural Resources fund, who has two decades of experience in that sector. “So a fund manager has the opportunity to add value.” Investors still need to pick their funds with care. Many natural resources funds are highly concentrated in energy stocks, which tend to be very volatile. Investors may also take a more hands-on approach. They can try holding one fund that is heavily invested in energy and another in metals, or they can assemble their own natural resources stock portfolio. David Kiefer, managing director of the Jennison Natural Resources fund, says he thinks that a committed investor could do it with 7 to 15 stocks. One of the most likely candidates for any natural resources portfolio might be Transocean. It is one of Jennison’s largest holdings, as it is for several other funds, like Van Eck Global Hard Assets and BlackRock Global Resources — among the best- performing mutual funds over the past five years. Transocean’s ticker symbol, RIG, goes to the heart of its popularity. It is a huge offshore drilling services company, and, says Derek van Eck, manager of the fund that bears his name, “everybody is looking for oil in the water.” Similarly, he recommends Southwestern Energy, which, he says, is “a play on growth in exploring for oil, natural gas and shale because it has attractive domestic leases.” Companhia Vale do Rio Doce, a miner of nickel and other metals, based in Rio de Janeiro, which acquired Inco last year, is his top non-energy stock. Mr. Sturm of Ivy Global said he thought a natural resources portfolio should account for about 10 percent of investors’ stock holdings, and he suggested that those interested in starting such a portfolio include the oil giant ConocoPhillips and Barrick Gold, the mining stock. But he cautioned that investors in natural resources stocks could be in for a rough ride. “The sector has an inherent volatility,” he said, “so investors need to have a long-term perspective.”
Suppose you are drawing Social Security benefits and covering additional expenses by making withdrawals from your IRA account. At year-end you withdraw $1,000 for a charitable donation. What happens? The charity gets your check for $1,000. But the withdrawal caused your taxable income to rise by $1,000. Unless other deductions total at least $10,700, that $1,000 won't provide any tax benefit. Many middle-income retiree households don't have enough deductions to itemize. So your tax bill will increase by your marginal tax rate. For many retirees, that's 15 percent, or $150. Increasing your income by $1,000 may also cause some of your Social Security benefits to be taxed. This doesn't start at lofty incomes. For example, a couple with $36,000 in Social Security benefits can have only $14,000 of income from other sources before triggering Social Security benefit taxation. The next $1,000 of income will cause $500 of benefits to be added to taxable income. This will increase the income tax bill by $75, a total of $225. It can get worse. If this couple withdraws more than $26,000 from their IRA, each additional $1,000 withdrawal will trigger taxation of $850 in Social Security benefits. They will have to pay $150 on the additional $1,000 and $127.50 more on the $850 in Social Security benefits, a total of $277.50. Giving $1,000 to charity can cause the retired couple to pay an additional $225, or more, in taxes to the federal government. Whether you are a Republican or a Democrat, I think you'll agree that's not how it's supposed to work. That's the mess both parties have made of our tax system. The Tax Scenario with a Gift Fund Consider a retired couple with $36,000 in Social Security benefits and additional income from IRA accounts. Like many retirees, this couple doesn't itemize deductions. Charitable giving adds to their taxable income and provides no tax benefit. They can enjoy lower taxes and greater spendable income by making a one-time donation of $66,000 (or some other amount) to a charitable gift fund. When the charitable gift fund is established, the withdrawal of the money from the IRA creates a taxable event. But the taxable income would be offset by an itemized deduction in the same amount, so there would be zero taxes (except for any benefit the couple would have gained by using the standard deduction over itemizing). Once the fund is established, your tax situation changes. The couple makes annual gifts from the fund, not from income. Suppose they make an annual gift of $5,500. Once they have made the gift, their nest egg will produce less income, lowering their income tax bill. As a consequence, the retirees may fulfill their desire to donate $5,500 a year but have as much as $3,595 more to spend (or give) each year – because they created a charitable gift fund. The retired couple, in other words, can donate $5,500 and spend an additional $3,595 a year on themselves. They can give both benefits, $9,095, to charity. Or they can do something in between. Withdrawing $5,500 from a $66,000 charitable gift fund may looks excessive; it reflects an 8.3% withdrawal rate. The choice is deliberate. Using Bill Sholar's www.FIRECalc .com, I found that a gift fund portfolio that is at least 66 percent equities has about a 60% chance of surviving for 15 years. If you visit the life expectancy probability calculator on the Vanguard Web site, a 65-year-old man has about the same chance of living for 15 years – so the odds are about equal that a life (or death) event will cause charitable giving to be re-examined. Fidelity Investments started the first charitable gift fund 16 years ago, allowing donors to give cash or securities, get an immediate tax deduction for the value of their donation and have the money managed by Fidelity. Fidelity charges a fee for operating the fund, as well as fees for managing the actual assets, but donors are saved the cost of establishing a personal foundation. The Fidelity CGF now boasts over $3.5 billion in assets contributed by 39,000 donors. Many financial services companies have established their own charitable gift funds, with Vanguard and Charles Schwab being the next largest at $1.25 billion and $1.1 billion, respectively. Once a donor account is established, donors can instruct the fund to issue checks to any qualified charitable organization. The minimum initial donations for the Fidelity, Vanguard and Schwab gift funds are $5,000, $25,000 and $10,000, respectively.
For starters, Wall Street experienced a much more severe short-term drop during the most recent turbulence than it did last spring. The Dow industrials plunged 3.3% on Feb. 27, the biggest single-day loss for the benchmark index, in percentage terms, since March 2003. And history has shown that when stocks drop by 2% or more on a single day after a long period of relative calm, the decline often signals the start of a new era of rising volatility. Since 1959, volatility in the S&P500 has risen 33%, on average, in the 12 months after similar 2% declines, said Sam Stovall, chief investment strategist at S&P. David Kovacs, head of quantitative research at Turner Investment Partners, says he is convinced that “this is not another head fake.” This time around, he said, “there is a higher probability that volatility will increase, leading to a greater likelihood for a real correction.” Why? At least two things have changed since last spring. For starters, economists back then were simply talking about potential problems in the housing market — problems that might spill over into the larger economy. And the Federal Reserve was still raising short-term interest rates to keep inflation at bay, though the full effects of those rate increases had not yet been felt. Nearly a year has passed since those predictions of a potential housing meltdown. And there is ample evidence that at least a portion of the housing market — the so-called subprime market, which caters to borrowers with poor credit histories — is in a real crisis. The share prices of many subprime mortgage lenders have tumbled in recent days on fears of rising defaults. Fremont General has announced its intention to exit this high-risk market. New Century Financial said Thursday that it had stopped accepting new loan applications while it negotiated with banks that had cut off its access to billions of dollars in funds. Mr. Kovacs said the crisis among subprime lenders gives investors who are embracing risk something to be truly scared about: an old-fashioned financial crisis, similar to the savings and loan debacle that caused a major market sell-off in the early 1990s or the Asian currency crisis that set off volatility on Wall Street in the late ’90s. But it is not just housing that is upsetting this stock market. Investors who have largely ignored risks in recent years have been leveraging their bets globally by borrowing Japanese yen and investing the proceeds in an assortment of higher-yielding assets. These include high-risk investments like emerging-markets stocks and commodities, which have been leading the global bull market of late. But now that risk is becoming a four-letter word on Wall Street, these assets have started to come back down to earth. And they could drop even more if investors continue to unwind their positions.
Treasuries certainly soared during the long stock market swoon that ended in 2003. When stocks bottomed out in March that year, the Standard & Poor’s 500-stock index was down 47.58% from its peak three years earlier. Treasuries, meanwhile, returned 34.11%, including interest payments, according to Merrill Lynch. But there is no guarantee that Treasuries will skyrocket in price again if the stock market falls in coming months. Martin J. Mauro, Merrill’s fixed-income strategist, said the sharp rise in Treasuries that ended in 2003 was largely a product of aggressive rate-cutting by the Fed, as well as the sheer length of that stock market decline. Generally, Mr. Mauro said, bonds’ response to a stock sell-off depends on why stocks were weak in the first place. “An inflationary environment would be bad for both stocks and bonds,” he said. “But this time around, investors are worried about corporate profits and the health of the economy. And that’s when lower-quality bonds behave more like stocks.” He said, however, that higher-quality bonds — like Treasuries and investment-grade corporate bonds — usually did well in those market conditions. In the five trading sessions ended on Wednesday, more than $3.6 billion flowed into mutual funds and ETF’s that invest in bonds. That was more than twice the net inflows to bond funds a week earlier, and about 60% higher than the average weekly inflows in February, according to AMG Data Services. William H. Gross, chief investment officer of Pimco, said the markets were waking up from a mentality that had been induced by a relatively long period of low volatility in the riskiest stocks and bonds. He listed concerns on which investors have focused in the last two weeks: the sell-off in Chinese equities, weak demand for durable goods, shaky subprime mortgages, a rising Japanese yen, and even the mention of recession by Alan Greenspan. “When all of those come together,” Mr. Gross said, “it shakes up the perception that nothing could go wrong.” Gross has been “very bullish” for some time on investment-grade bonds and predicted that the Fed would soon start cutting interest rates, which would benefit existing bondholders because bond prices and rates move in opposite directions.
We Stay Busy If we want to get ahead at work or we want to whip the garden into shape, we get busy. Activity doesn't just seem virtuous. It also gives us a comforting sense of control, especially if we're dealing with a crisis. But in the financial markets, staying busy is a bad idea. The wisest course is to keep activity to a minimum. We Work Hard Athletes who train hard are more likely to win. Students who study conscientiously are more likely to get good grades. What about investors who diligently research their stocks? They'll probably earn mediocre returns. The fact is, the markets are full of savvy investors, all hunting for cheap stocks. Result: If there are any bargains to be had, they don't stay that way for long. Indeed, much of the time, share prices are a pretty good reflection of currently available information. "If you put in more effort, you'll end up with worse results," reckons Terry Burnham, co-author of "Mean Genes" and director of economics at Boston's Acadian Asset Management. "It's not the work. It's the action that comes out of the work that's the problem." Every time we buy a supposedly bargain-priced stock, we incur commissions and other trading costs. In addition, if we trade in our taxable account, we may trigger big tax bills, further denting our returns. We're Optimistic Unrealistic optimism is something you want to check at the door when you enter the financial markets. Being optimistic about your investment abilities will lose you money. We Look to the Past Need to buy a refrigerator, find a new doctor? For advice, we'll often turn to folks who have recently grappled with these issues -- and that's usually a smart strategy. But with investments, relying on what's recently worked well can be a disaster. In the financial markets, your backward-looking brain decides it likes a particular stock or a particular asset class. The problem is, others with similar backward-looking brains reach the same conclusion. Now, you've got an investment that's popular -- and that makes it a bad investment. By definition, popular investments are overpriced. We Buy Quality When we shop for a new computer or a new stereo, we typically assume that greater sophistication is better, that reputation is worth something and that a product's price bears some relationship to its quality. But Wall Street is different. If a mutual fund charges high fees, it is more likely to lag behind the market. If a company is widely admired, its shares may be overvalued. If an investment product is deemed sophisticated, it's often difficult to figure out how it will really perform. We Play to Win We want to get that promotion, or to have a greener lawn than our neighbors. It's un-American to try to be average. Yet, in the financial markets, aiming for average is the surest way to come out ahead. We can't all outperform the market, because together we are the market. That's why I favor building a globally diversified mix of index funds.
In addition, while U.S. and foreign stocks have grown closer in the past decade, according to Mark Keller, chief investment officer of A.G. Edwards Inc.'s Gallatin Asset Management unit, emerging markets and smaller foreign companies may still be less likely to move in concert with U.S. stocks. "You get more [diversification] the smaller you go," he says. Of course, there is a downside: "You also increase your risk." For investors who really want to be sure they won't be stung when the market has a down day, highflying, exotic investments may not provide the same protection as that good, old-fashioned portfolio workhorse: bonds. "The best diversifier in events like last week -- or last May" -- when emerging markets also tumbled -- "is having a balanced portfolio between stocks and bonds," says Fran Kinniry, a principal at Vanguard Group.
Recently we decided to look further into this. We decided to see if we could quantify and potentially profit from the behavior. We looked at over seven million trades going back to January 1995. We then broke these trades down to the day of the month, meaning we asked "if we bought every stock today, how would we have done over the next 5 trading days?" We did this for every day of the month for every stock that was trading in a longer-term uptrend, meaning above its 200-day moving average. The average gain for all days (meaning you randomly bought a stock and held it for five days) when it was above its 200-day MA from January 1995-September 2006 was 0.27%. As we start approaching month end, the average gains rise significantly. On the 23rd day of the month, the average gain for these stocks more than doubles. On the 24th it triples. On the 25th it almost quadruples! And this type of behavior holds through the end of the month. In spite of a strong upward move in stock prices over the past 12 years, stocks on average have "lost money" for the six consecutive days from the 3rd through the 8th. Money spent is money spent, and it looks like the fund managers spent their money near the end of the previous month. And now let's look at what happens after a stock drops the previous day. The returns for those stocks go up even more near months-end. And if the stock has dropped two days in a row, the gains become extreme. On the 25th and the 26th, the stocks which have dropped two days in a row have risen more than 1.5% on average over the next 5 trading days. After a stock has dropped two days in a row going into the 25th, 26th and 27th day of the month, more than 60% of the stocks have closed higher five trading days later.
2. If five people all have the winning number in the lottery, and the prize is $2 million, how much will each of them get? 3. If you have $200 in a savings account. The account earns 10% interest per year. How much would you have in the account at the end of two years? More than 80% correctly answered question No. 1. But only half had the correct answer to question No. 2. "And more distressingly, only 18% correctly computed the compound interest question, which was posed to only participants who got one of the first two questions right," Lusardi and Mitchell wrote. The answers: (1) 100, (2) $400,000, (3) $242. The first year, the account earns $20 in interest. The second year, the account earns $22 in interest, because now it holds $220. Lusardi and Mitchell noted that a survey by the state of Washington found that "most respondents did not know the inverse relationship between bond prices and interest rates" and "more than one-third did not know that stocks had returned more than bonds over the last forty years, and many did not know about risk diversification." In introducing their paper, Lusardi and Mitchell described how "workers and retirees have increasingly been asked to take on an unprecedented degree of responsibility for their retirement and other saving, as defined-benefit pensions decline and government programs face insolvency in one country after another." If that responsibility is not combined with economic know-how, the outcome could be ugly. Financial Literacy and Planning: Implications for Retirement Wellbeing Annamaria Lusardi and Olivia S. Mitchell In a module on planning and financial literacy for the 2004 Health and Retirement Study, respondents were asked: - Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow: more than $102, exactly $102, less than $102? - Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account? - Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.” The compound interest question has a 67% correct response rate; this is such an easy question that we find it rather astounding that one-third of the sample cannot respond correctly, particularly because the sample include older respondents (mostly respondents in their 50s and 60s). The inflation question has a higher correct response rate, with three-quarters (75%) answering correctly that they would be able to buy less after a year if the interest rate were 1% and inflation were 2%. By contrast, only 52% of the respondents understand correctly that holding a single company stock implies a riskier return than a stock mutual fund. Regarding interest compounding, only 9% took responded to the question with the "did not know" answer, but over one-fifth (22%) gave an incorrect answer. On the inflation question, 10% did not know, while 13% gave a wrong answer. The question about stock risk elicited the most Did not Knows: 34% of the sample did not know, while a smaller fraction (13%) gave a wrong answer. Only one-third (34%) of respondents correctly answer all three questions. Lack of literacy and financial sophistication can have important consequences. For instance, Laurent Calvert, John Campbell and Paolo Sodini (2005) in “Down or Out: Assessing the Welfare Costs of Household Investment Mistakes.” show that households with greater financial sophistication are more likely to participate in risky assets markets and invest more efficiently. Marianne Hilgert, Jeanne Hogarth, and Sondra Beverly (2003) in "Household Financial Management: The Connection between Knowledgee and Behavior" demonstrate a strong link between financial knowledge and financial behavior. Such findings extend beyond the US: for instance, David Miles (2004) in “The UK Mortgage Market: Taking a Longer-Term View” shows that UK borrowers display poor understanding of mortgages and interest rates. Dimitris Christelis, Tullio Jappelli, and Mario Padula (2005) in “Health Risk, Financial Information and Social Interaction: the Portfolio Choice of European Elderly Households” use SHARE surveys conducted in several European countries to show that respondents there also score low on financial numeracy and literacy scales. The three questions we term the retirement planning calculation questions are as follows: - Have you ever tried to figure out how much your household would need to save for retirement? - Did you develop a plan for retirement saving? - How often were you able to stick to this plan: Would you say always, mostly, rarely, or never? Fewer than one-third of the sample respondents (31%) indicated that they actually attempted to do a retirement saving calculation; these we call the simple planners. The small size of this group confirms Amamaria Lusardi’s analysis ("Information, Expectations, and Savings for Retirement" - 1999, “Preparing for Retirement: The Importance of Planning Costs” - 2002, “Planning and Saving for Retirement” - 2003) of previous Health & Retirement Study survey waves, where she found that many people say they have given little thought to retirement even when they are just a few years away from leaving the workforce. Our results also confirm findings from the Retirement Confidence Survey and TIAA-CREF, which indicated that few undertake retirement planning even among the educated {in studies by [1] Paul Yakoboski and Jennifer Dickemper (1997) in “Increased Saving but Little Planning. Results of the 1997 Retirement Confidence Survey” and [2] John Ameriks, Andrew Caplin and John Leahy (2003) in “Wealth Accumulation and the Propensity to Plan”} Olivia Mitchell (1988) in “Worker Knowledge of Pensions Provisions” and Alan Gustman and Tom Steinmeier (1999) in “Effects of Pensions on Savings: Analysis with Data from the Health and Retirement Study” found that workers display little knowledge about their Social Security and pension benefits, two of the most important components of retirement wealth. Only 58% of those who tried to develop a plan actually did so, while another handful “more or less” developed a plan (9%). Furthermore, of the subset of of those developing a plan, only one-third (38%) was always able to stick to its plan, while half were “mostly” able to stick to their plans. In the sample as a whole, this represents a meager 19% overall rate of successful planning. If not you - then who? If not now - then when? You may be asking why a financial or investment site like this would dwell a bit on stats like this. So I should offer a reason. I spend a good amount of time on the investment message boards at Yahoo, Motley Fool and Investors Village. I run across a lot of dumb questions. And it is stats on illiteracy like those above that should give one a perspective. There are just not that many people who 'get it'. I have quietly thought that so many posters were without a clue, but when viewed in the light of the above stats, those clueless posters are so far above average. And it makes me thankful for my financial gifts, and my intellectual gifts. And the above stats really make me thankful that I have found a few net buddies who correspond with me. Those who exchange views with me. Those who have opinions that I respect, and who respect my opinions. These stats make me a bit more tolerant of the gaps in others knowledge. Those who with some tutoring can 'get it' too. And the above stats also make me angry with a government, a press or media, and corporate environment that, while on the one hand places increased responsibility on individuals for financing their retirement while at the same time allows a populace of illiterates to exist without resources to improve their literacy. And without a sense of immediacy in their need to improve their literacy. That sucks! And if you lack a bit of anger on this topic, then borrow a bit of mine. And after coming to the realization that I 'get it' not just a small bit more than average, but by a HUGE bit more than average, it now get me even more angry with the quarterly earnings reports we receive from corporate America that almost requires a BBA in accounting to understand. And add to that the write-ups we get from the brokerage analyst. Too many words and too many numbers - too little simple pieces of insight. It ain't easy being an investor. And we need to create a world where it is easier. We need to vote for officials that will make it so. We need to be responsible to our brothers and sisters - to aid them into their trip into this brave new world. We need to demand better communication from those companies in which we invest - and from the brokerages which hope to earn our commisions.
The study, “Portfolio Efficiency With Performance Fees,” was written by Mark Kritzman, president and chief executive of Windham Capital Management, a money management firm in Boston. Mr. Kritzman also teaches a graduate course in financial engineering at the Sloan School of Management at the Massachusetts Institute of Technology, and his article grew out of work begun by a few of his graduate students there. The article appeared in the Feb. 1 issue of Economics and Portfolio Strategy, a newsletter for institutional investors, published by Peter L. Bernstein. Hedge funds are largely unregulated and therefore are free of the restrictions that keep most mutual funds from pursuing untraditional investment strategies like selling short and investing in complex derivatives. As a result, hedge fund managers argue that they can produce impressive returns regardless of whether the stock and bond markets are going up or down or are trendless — a feature that would be particularly welcome in turbulent weeks like the last one. But because hedge funds typically become subject to greater regulation once they have more than a small number of investors, in most cases they are limited to a few very wealthy individuals. Mr. Kritzman’s article focuses on the effect of the fees that hedge funds charge. In addition to a percentage of assets under management, hedge funds typically also charge a percentage of their profits. The standard fee arrangement in the industry, known as “2 and 20,” is to charge 2 percent of assets under management and 20 percent of profits above a predetermined benchmark, like the London Interbank Offering Rate, or Libor. Mr. Kritzman found that the combined impact of such fees is so high as to greatly reduce the attractiveness of hedge funds. Consider a hypothetical portfolio that Mr. Kritzman put together. He divided it equally among 10 imaginary hedge funds, each of which he assumed would earn a long-term annualized return of seven percentage points above Libor, before fees — an assumption that he says is realistic. Mr. Kritzman calculates that the 2-and-20 arrangement would cost this portfolio 3.8 percentage points a year. Given Libor’s current level — about 5.4% — this implies that the hedge-fund basket would have an after-fees return of 8.6 percent, annualized. In an interview, Mr. Kritzman said the fees’ effect on the portfolio was so sizable because of the “asymmetry penalty” resulting from the 20 percent cut of profits that the hedge funds earn. The funds do not share in investor losses — but they reap a large share of the profits. To illustrate how these fees can add up, Mr. Kritzman conducted another experiment. He tried to determine how much a rational investor should allocate to this hypothetical portfolio of 10 hedge funds, when also given the opportunity to invest in a stock index fund and a bond index fund. Calculating the optimal allocation required Mr. Kritzman to make a number of assumptions about the two index funds, like how much they would earn, how volatile their returns would be and how their returns would correlate with each other and with those of his hypothetical group of hedge funds. Once those assumptions were made, it was a matter of simple math to calculate which allocation produced the greatest long-term return relative to the amount of risk incurred along the way. Mr. Kritzman found that, given these assumptions, the investor should allocate nothing to the basket of hedge funds and everything to the two index funds. It might appear as though Mr. Kritzman assumed too low a return for his basket of hedge funds. Data from Hedge Fund Research, a company that tracks the industry, shows the average hedge fund to have gained 10.6% annualized, after fees, over the 10 years ended in December, in contrast to the 8.6%, annualized, that is implied by Mr. Kritzman’s assumption. But he said his assumed return was reasonable because of a tendency of poor-performing hedge funds not to report data to firms that monitor the industry. WHAT role did high fees play in his finding that an investor should allocate nothing to hedge funds? Mr. Kritzman recalculated the optimal allocation, assuming that hedge funds earned only a flat 2 percent of assets under management. (That fee would still be roughly a half percentage point more than that of the average actively managed stock mutual fund.) Using that assumption, he calculated that the optimal allocation would be much different: 74% to the hedge fund basket and 26% to the index funds. What about so-called funds of hedge funds, which have lower minimums and are therefore available to less-affluent investors? Mr. Kritzman says he finds it difficult to justify any allocation to funds of hedge funds, because they earn fees above and beyond those earned by the hedge funds in which they invest, typically 1 percent of funds under management and 10 percent of profits above a benchmark. The bottom line, Mr. Kritzman said, is this: “Because of fees, the optimal allocation to a group of hedge funds is a lot lower than you might think it should be.” Monthly Employment Stats
In the service-providing sector, health care employment rose by 33,000 in February, as job growth continued throughout the component industries. Over the year, health care employment has increased by 340,000. Employment in professional and business services continued to trend up in February (+29,000) with small gains occurring in most of its component industries. Over the past 12 months, this industry has added 460,000 jobs. In February, employment in services to buildings and dwellings grew by 11,000. Temporary help services employment was little changed over the month and over the year. Elsewhere in the service-providing sector, food services and drinking places added 21,000 jobs in February. Over the year, food services employment has risen by 348,000. Employment in the information industry was up by 13,000 in February. Within financial activities, depository credit intermediation added 4,000 jobs. Over the month, employment was essentially unchanged in both wholesale and retail trade. Air transportation lost 7,000 jobs. In the goods-producing sector, construction employment fell by 62,000 in February after posting a gain of 28,000 in January. Unusually severe winter weather conditions in some areas of the country in February likely contributed to job losses in the industry. Employment declined in both residential (-21,000) and nonresidential (-25,000) specialty trades, and heavy construction lost 10,000 jobs. Employment in residential specialty trades has been declining since February 2006. Manufacturing employment continued to trend down over the month (-14,000). Job losses occurred in wood products (-4,000), semiconductors and electronic components (-3,000), and textile mills (-3,000). Machinery added 5,000 jobs in February. In mining, employment rose by 4,000. The average workweek for production and nonsupervisory workers on private nonfarm payrolls fell by 0.1 hour to 33.7 hours in February. Weekly hours for factory workers were unchanged at 40.8 hours, while factory overtime hours increased by 0.1 hour to 4.2 hours. The index of aggregate weekly hours of production and nonsupervisory workers declined by 0.3% in February to 106.4 (2002=100). The manufacturing index decreased by 0.1 percent to 94.7. Average hourly earnings of production and nonsupervisory workers on private nonfarm payrolls increased by 6 cents, or 0.4 percent, in February to $17.16. This increase followed gains of 3 cents in January and 8 cents in December. Average weekly earnings were up by 0.1 percent in February to $578.29. Over the year, hourly and weekly earnings rose by 4.1 and 3.8 percent, respectively.
Quick Facts, Stats & Opinions Fees Fall for International Investors Kim & Lucchetti, WSJ 3-27 Although average annual expenses are typically higher for international funds than U.S. stock funds, the boom in international ETFs gives investors access to lower-cost options. This month, Vanguard launched a new index fund, with expenses ranging from 0.15% to 0.40%, providing exposure to 95% of the investible developed and emerging markets outside the U.S. In January, XTF LP, a New York money manager specializing in ETF portfolios, launched a new "country rotation portfolio" that invests in 13 ETFs that track developed foreign countries. And last year, WisdomTree Asset Management Inc. launched 14 international ETFs, with annual expenses ranging from 0.48% to 0.58% a year, tracking countries in developed international markets, such as Japan and Europe. By contrast, average expenses for foreign mutual funds are 1.59%, according to Morningstar. Inverse ETFs SeekingAlpha 3-06 With what at first looked like a spasm in the market now displaying all the markings of a full-blown correction, it could be time to consider inverse sector ETFs. ProShares has a slate of ultra ETFs that tracks eleven Dow Jones US indexes: Basic Materials, Consumer Goods, Consumer Services, Financials, Health Care, Real Estate, Industrials, Semiconductors, Oil & Gas, Technologies and Utilities. The ultra ETFs are meant to deliver 200% of the performance of the underlying index. These ETFs come in two flavors: long and short (the short funds are often referred to as inverse). The short ETFs go up when the underlying index goes down. The long funds go up in concert with the underlying index. For Financial SPDR ETF (XLF) the inverse is ProShares UltraShort Financials ETF (SKF). For Technology SPDR (XLK) the inverse is ProShares UltraShort Technology ETF (REW). For Industrials SPDR (XLI) the inverse is UltraShort Industrials (SIJ). For Basic Materials SPDR (XLB) the inverse is ProShares UltraShort Basic Materials ETF (SMN). For iShares Dow Jones US Real Estate ETF (IYR) the inverse is ProShares UltraShort Real Estate ETF (SRS). The December Low Indicator The Kirk Report 3-02 The infamous December Low Indicator is now in play. According to Stock Trader's Almanac: "When the Dow closes below its December closing low in the first quarter, it is frequently an excellent warning sign. The December Low Indicator was originated by Lucien Hooper, a Forbes columnist and Wall Street analyst back in the 1970s. Hooper dismissed the importance of January and January’s first week as reliable indicators. He noted that the trend could be random or even manipulated during a holiday-shortened week. Instead, said Hooper, “Pay much more attention to the December low. If that low is violated during the first quarter of the New Year, watch out!” Twelve of the 26 occurrences were followed by gains for the rest of the year – and full year gains – after the low for the year was reached. Hooper’s “Watch Out” warning was absolutely correct. All but one of the instances since 1952 experienced further declines, as the Dow fell an additional 10.7% on average when December’s low was breached in Q1. Only three significant drops occurred when December’s low was not breached in Q1 (1974, 1981, and 1987)." Every year, American workers fail to use about a third of their allotted vacation time, according to recent data. And, increasingly, they tend to use what time they do take in short spurts of a week or less, according to a report in 2006 by the Society for Human Resource Management and Careerjournal.com. A worker may leave vacation time on the table for many reasons, but they generally boil down to a few: business pressures, particularly on senior executives; a reluctance to appear nonessential; a desire to be paid for unused vacation days down the road; and often, the feeling that one’s workplace is anti-vacation. (Kelley Holand, NY Times 3-25) Investors demand an extra 2.92 percentage points in yield on average to own junk bonds instead of U.S. government securities, down from 3.33 percentage points a year earlier. The spread was 2.49 percentage points Feb. 22, the lowest in 9 1/2 years, according to Merrill Lynch & Co. Inc.'s High Yield Master II Index for the United States. (Parris Kellermann, Bloomberg News 3-18 ) The Fed will cut its target overnight lending rate by 25 basis points to 5 percent in the fourth quarter, according to the median estimate of 75 economists surveyed by Bloomberg. (Parris Kellermann, Bloomberg News 3-18 ) Real-estate investments suffer serious and sometimes prolonged downturns. If you bought a house in Los Angeles in 1990, just as the real-estate market turned downward, you would have had to wait a decade for your home's value to return to what you paid. If you bought in Dallas in 1986, as the oil boom went bust, your home wouldn't have appreciated at all before 1998. (David Crook, WSJ 3-12) Asset totals for ETFs jumped fivefold to $422 billion in the half-decade through the end of last year. Last year's exchange-traded growth represented more than 40% of all dollars placed in ETFs since 1993. More than 150 new products were offered last year, bringing the total number of funds to 357; some 300 are registered to start in 2007. (John Wasik, Bloomberg 3-11) In its quarterly "Flow of Funds" report, the Federal Reserve reported that household net worth -- a measure of a household's assets minus its liabilities -- grew $1.4 trillion in the fourth quarter to $55.6 trillion, up 2.4% from $54.3 trillion in the third quarter. The fourth-quarter gain was due mostly to financial assets including stocks, bonds and pensions that grew 3.2% to $42.1 trillion. For example, the Standard & Poor's 500-stock index rose 8.8% in the quarter. Household real-estate holdings eked out a 0.9% gain between the third and fourth quarters, ending the year at $22.6 trillion. (Conor Dougherty, WSJ 3-08) Minyanville.com analysts have noted that household debt is now 130% of total income, up from 100% in 2001 and 70% in 1986. And the household debt-service ratio [the ratio of debt payments to disposable personal income] as of the third quarter was 14.49%, just off the record reached in the second quarter, according to the Federal Reserve. (David Gaffen, WSJ 3-08) The mere fact that stocks have declined isn’t enough to boost shares in coming days, notes Michael Panzner, trader and author of “Financial Armageddon.” In the past 30 years, he notes that there have been 99 five-day declines of 5% or more in the Standard & Poor’s 500-stock index. However, “big downside runs don’t necessarily represent the no-brainer buying opportunities that some bulls claim.” What’s more important is when the downturn happens. If it’s nearer to recent highs in the index, the subsequent performance isn’t likely to be as good. Mr. Panzner notes that when the last day of the five-day decline ends with the market still within 10% of a 52-week high, the next 20 trading days produces a 1.6% increase in the market. That’s only a little better than median 20-day returns in the last 30 years. On the other hand, when the market isn’t within 10% of a 52-week high, the performance is much better: The median subsequent 20-day return is 4.53%. “The odds that you can make money from the long side over the course of the following month appear to be substantially higher when the market has already been suffering beforehand,” he says. (David Gaffen, WSJ 3-08) As a rule, junk bonds are a good buy when yields are five percentage points or more above the yield on 10-year Treasury notes. Conversely, when the yield gap is closer to three percentage points, junk investors really aren't getting adequately rewarded for the risk involved -- and they could be in for rotten returns. Where do we stand now? As of late last week, the spread was right around three percentage points, with junk yielding 7.5%, versus 4.5% for 10-year Treasurys. (Jonathan Clements, WSJ 3-04) Margin debt — the sum investors have borrowed against their accounts at New York Stock Exchange-member brokerages — reached a record $285 billion in January. That raised some red flags because the previous peak was $278 billion set in March 2000, at the zenith of that era's bull market. (Tom Petruno, LA Times 3-04) Hedge Fund / Private Equity News Briefs More than 80 hedge funds with peak assets of $35 billion called it quits in 2006, according to Absolute Return. In its latest survey, the magazine, a sister publication of Hedge Fund Daily, found that the top 10 hedge funds according to assets represented more than two-thirds of the total, with Amaranth Advisors by far the biggest loser when the $9.1 billion fund shut. Nine of the top 10 closures had assets of more than $1 billion at their height, while no hedge fund that closed in 2005 hit that. In other results, Absolute Return found that nearly one-third of the shutdowns (27) were in U.S. long/short equity, while fixed income, high-yield funds, long/short biotech equity funds each had six that went under. (HedgeFund Daily 3-21) Investors in top private equity funds of funds enjoy returns close to those who invest their money directly into individual buyout and venture funds, Private Equity Intelligence has found. In a study of nearly 750 FOFs, PEI discovered that median returns rivaled those of direct investments, based on a tracking of all p.e. fund benchmark – thereby debunking the theory that FOFs are poorer performers, and lending support for the value of the extra layer of fees they charge. "If an investor devotes as much time and effort to selecting and gaining access to the right managers," Stephan Schaeli of Partners Group told Financial News, "then it’s obviously better to invest directly. But investors new to the asset class often underestimate the amount of work involved in that." Nor are they guaranteed access to the best funds anyway. "Often, people know who the top managers are but that’s different form being able to gain meaningful allocations to their funds," Schaeli noted. (HedgeFund Daily 3-16) As far as hedge funds that suffered major declines when the stock market tumbled last week are concerned, heavy losses are business as usual for their chosen strategy – managed futures. That’s putting a positive spin on an event that surely would send investors reaching for the antacid. "While not entirely welcome," Philippe Bonnefoy, chairman of Swiss Cedar Partners Investment Management, told Bloomberg News, " this kind of drawdown is normal for [the managed-futures] strategy at a turning point in the market. Bonnefoy expects there will be a recovery but it will "take a while," comparing the market to a large ship trying to make a turn. The key word "normal" cropped up in an investor letter by Winton Capital founder David Harding, who wrote that the decline is "a normal, if unwelcome, feature" of the strategy. Assessing the damage, one can see how mighty Man Group’s AHL Diversified Futures Fund has fallen – 8.2% in one week – while less dramatic but at least as painful were the -5.9% decline at Winton Capital’s Futures Fund for the month of February and the 4.1% shrinkage at Transtrend BV last month. The message these and other firms that recorded losses is trying to make is this: The downturn is only temporary, and good things come to those who sit tight in their investments. (HedgeFund Daily 3-08) Forgive mutual fund managers for the hang-ups they may have about hedge funds. Bloomberg News reports that the managers and other institutional investors are feeling a disconnect from the folks with the good ideas because Wall Street analysts are now spending the lion’s share of their time chatting up with the ones most likely to generate the most fees, namely hedge funds. Laments Steve Roukis of Matrix Asset Advisors, who recalls a time not too long ago when he had half-hour phone calls with analysts, "You have to call at off-peak hours, like early in the morning," even for a few minutes of time. Hedge funds appear to have captured Wall Street’s practically undivided attention because, according to BN, citing figure from Greenwich Associates, HFs generated last year about $33 million in stock-trading commissions – double of that by mutual funds and other investment managers. BN says that explains why top analyst Michael Gambardella of JPMorgan Chase, for example, can spend half his day talking to hedge funds. And that can ultimately hurt mutual fund performance because without sufficient analysts’ insights, MF managers won’t be able to make the best informed decisions. Fee-generation became a major factor for research departments after 2003, when 10 major securities firms coughed up $1.4 billion in fines because of some of shenanigans of analysts who colored their research reports in a way that would generate investment-banking fees. On top of that, today there are 16% fewer analysts at the top 10 securities firms. (HedgeFund Daily 3-07) Home Page Previous Factoid Top Sites
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