The Bull Market’s 5th Anniversary

Posted on March 6, 2014 | Investor Update

Investor-Update

This Monday, be sure to say “happy birthday, bull” as the current bull market will turn five years old. Since bottoming on March 9, 2009, the S&P 500 has gained nearly 200% on a total return basis. This is quite the reward for someone who braved the fear and pessimism that was occurring back then and bought a stock index fund, such the SPDR S&P 500 (SPY).

Also take time on Monday to reflect on your emotions, portfolio decisions and tolerance for risk during the last bear market. Yes, I realize it was a dark period you’d as soon forget, but this is a useful exercise. The level of pessimism and fear was very high: Bearishness in our weekly Sentiment Survey reached a record level of 70.3%. Banks were failing left and right, credit was extremely tight, and well-known financial firms were imploding. There was even speculation about General Electric (GE) going bankrupt.

What was your reaction to the negativity? Did you pull out of stocks and equity funds completely? Partially? Were you concerned the economy was about to fall into the abyss? Did you think further stock market losses were coming? Or did you open your wallet and start buying stocks?

If you were terrified, don’t feel alone. Many people were. A key problem with many economic theories is the assumption that humans are rational, profit-maximizing individuals. As behavioral science shows, we’re emotional, impulsive and overly focused on the short term. Our minds are programmed for survival, not Mr. Market’s ever-changing moods.

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Make Your Investment Expenses Count

Posted on February 27, 2014 | Investor Update

Investor-Update

Over the years, various surveys have shown that investors aren’t aware of what expenses their portfolios are incurring. Compounding matters, I’ve observed situations throughout my career where investors are focused on comparatively small costs without giving much consideration to the potential benefits that can be realized from incurring them. It’s important to be aware of both.

I’m bringing this subject up because in our March Stock Superstars Report, which will be published tomorrow, we discuss the costs of tender offers, offers to purchase some or all of shareholders’ stock in a company. If asked, I doubt many investors could articulate them. Yet, Helen of Troy (HELE) shareholders could be looking at a double-whammy of selling at a price below the current market value and incurring higher commissions. (Fidelity charges $38 for participating in a tender offer versus $7.95 for a traditional, open market trade). Granted, tender offers are not frequently made, but they do provide a good example of why it is important to pay attention to costs.

A far more commonly incurred cost is fund fees. Within the large-cap category of our 2014 mutual fund guide, one of the cheapest funds is Vanguard Total Stock Index (VTSMX). This fund has an annual expense ratio of 0.17%. In contrast, Marsico Flexible Capital (MFCFX) ranks among the most expensive funds with an annual expense ratio of 1.44%. This 1.27% difference equates to $127 extra per year for every $10,000 invested with MFCFX instead of VTSMX. That amount adds up. On a $100,000 investment, an investor will pay Marsico $1,270 per year more than he would pay Vanguard.

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Mutual Funds Probably Should Stay Open

Posted on February 20, 2014 | Investor Update

Investor-Update

Yacktman Focused (YAFFX), a fund we recently deleted from the AAII Model Fund Portfolio, is one of a relatively small group of value-oriented mutual funds to close last year. When a mutual fund closes, it either stops accepting investment dollars from new investors or stops accepting any new investment dollars, be it from new or existing shareholders. Some funds may partially close by removing themselves from broker networks and requiring new investors to directly go through the fund. The latter is what the Sequoia Fund (SEQUX), which I own, did for a while before completing closing its doors to new investors at the end of last year.

Mutual funds, like many other investment products, earn money based on a percentage of assets managed. In concept, a mutual fund manager would want his assets under management (AUM) to be as high as possible to maximize his profits. With the average domestic large-cap fund charging nearly 1% in annual expenses, every extra billion dollars’ worth of AUM adds up to a lot of profits.

In practice, there can be a limit to what level of AUM makes sense. A fund manager with a very targeted strategy can end up with more investment dollars than good ideas. This is particularly the case if a fund invests in a country with a comparatively small securities market or follows a restrictive strategy. It can also make sense to place a cap on a fund’s AUM to prevent it from becoming so large that it is difficult to do anything but essentially mimic an index fund, albeit at a higher cost.

Funds may close, however, because a manager simply believes the prevailing market environment doesn’t offer enough attractive investment opportunities. Investors may see a preliminary sign that this is occurring by monitoring the fund’s cash balance. For example, Yacktman Focused ended 2013 with a 20.8% cash allocation, up from 16.3% a year prior.

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Finding Winners in Last Year’s Bargain Bin

Posted on February 13, 2014 | Investor Update

Investor-Update

One of the most-cited value investing studies says stocks with low price-to-book ratios outperform stocks with high price-to-book ratios. Investment firm GMO’s Ben Inker says the study’s findings still hold, but work better when a one-year lag is used.

In “The Cross-Section of Expected Stock Returns” (The Journal of Finance, June 1992), Eugene Fama and Kenneth French published data showing an inverse relationship between returns and valuations. Average monthly returns ranged from 0.30% for the decile composed of stocks with the highest price-to-book (P/B) ratios to 1.83% for the decile composed of the lowest P/B ratio stocks. Fama and French calculated average returns for the period of July 1963 through December 1990 for their study.

Inker updated the data and shared his findings in the February 2014 GMO Quarterly Letter. He concluded: “If we just look at traditional value for stock selection—good old price/book as enshrined by Fama and French—the cheapest 10% of the market has outperformed the broad market by 2.5% per year since 1965. Sounds fine, but since the original Fama/French paper was published in 1992, the group has actually underperformed by 1.6% per year. The same group lagged one year outperformed by 3.5% per year since 1965, and since 1992 has outperformed by 2% per year. You can see similar patterns in sectors as well. In most cases lagged value either works better than portfolios based on current data or works almost as well.”

What Inker is referring to is buying the stocks whose P/B ratios ranked in the bottom decile one year ago (stocks whose valuations were lower than 90% of all other stocks last year), instead of buying those stocks that now appear in the bottom decile. His rationale for doing so is based on momentum. A stock becomes very cheap because of selling pressure (downward momentum), and the selling pressure may continue for a while. By using lagged valuation data, an investor allows time for the downward momentum to end.

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Two Notable Mutual Fund Trends

Posted on February 6, 2014 | Investor Update

Yacktman Focused (YAFFX), a fund we recently deleted from the AAII Model Fund Portfolio, is one of a relatively small group of value-oriented mutual funds to close last year. When a mutual fund closes, it either stops accepting investment dollars from new investors or stops accepting any new investment dollars, be it from new or existing shareholders. Some funds may partially close by removing themselves from broker networks and requiring new investors to directly go through the fund. The latter is what the Sequoia Fund (SEQUX), which I own, did for a while before completing closing its doors to new investors at the end of last year.

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No Tradable Signal From January’s First Five Days

Posted on January 9, 2014 | Investor Update

One indicator, the “First Five Days,” suggests the S&P 500’s full-year returns can be determined by how the index performs during the first five days of the year. If the first five days are positive, January’s returns will be positive and the calendar year will end with a 12-month gain. According to the Stock Trader’s Almanac, the last 40 up First Five Days were followed by full-year gains 34 times.

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The Fed’s Shift in Policy, Plus RMDs

Posted on December 19, 2013 | Investor Update

The Federal Open Market Committee (FOMC) voted to shift its monetary policy yesterday. Monthly purchases of agency mortgage-backed securities and longer-term Treasury securities will each be reduced by $5 billion, to $35 billion and $40 billion, respectively. This tapering is significant in that it represents the beginning of the end of quantitative easing, but it is subtle in terms of the likely short-term impact on the economy.

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Risk Is Not So Easily Defined

Posted on December 13, 2013 | Investor Update

Risk seems like a word that is easily definable. Certainly, in the world of finance, explaining what risk is should be fairly straightforward. In reality, defining risk is a bit like defining obscenity—a person knows it when he sees it.

The Merriam-Webster Unabridged Dictionary lists four definitions, and several qualifiers, for risk. They include “the possibility of loss, injury, disadvantage, or destruction,” “someone or something that creates or suggests a hazard or adverse chance” and “the product of the amount that may be lost and the probability of losing it.”

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Are Quantitative Models a Better Strategy?

Posted on November 21, 2013 | Investor Update

In the middle, between passive (index) and active strategies, lie quantitative strategies. These strategies select stocks based on financial, valuation and momentum ratio analysis. Followers of quant strategies are not pure indexers, because they actively create models to identify and take advantage of market anomalies. They are not pure active managers, either, because they buy what their quantitative models tell them to buy.

One of the earliest proponents of using a quantitative approach was Benjamin Graham. Graham advocated buying stocks trading at low valuations. Though not traditionally viewed as a quant, Graham’s disciplined approach involved buying many stocks that exhibited large margins of safety.

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Taking Action on Low Yields

Posted on November 14, 2013 | Investor Update

I invited a special guest for this week’s Investor Update: PIMCO’s Tony Crescenzi. Tony will give his outlook for the U.S. and global economy and the financial markets this Saturday at our Investor Conference. Ahead of his presentation, Tony wrote the following suggestions for coping with the current low-yield environment.

I remember well the excitement of opening my first savings account and receiving a passbook as a youth in the 1970s. As a novice yet eager saver, I took pride in seeing the numbers move ever higher, both from my deposits and from the “free” money that the bank was crediting my passbook with in the smudgy blue ink they used.

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