EQUIUS Blog

The Need to be Seen as Sophisticated & Well Connected...

Mon, 7 Jun 2010 09:39:22 -0700

Steven Pearlstein wrote an article for The Washington Post recently that complements our recent Asset Class article on Oprah Winfrey. You can find the article here.
Trusting in gurus, whether they’re frauds like Madoff or just smart, hardworking stock pickers or market timers just doesn’t make sense. What’s fascinating to me is how much time and effort someone would put into evaluating commercial real estate properties, going over the finances, considering risks, checking all the disclosures (and looking for issues not disclosed) and then turn over millions to someone like Madoff with no questions asked!! It boggles the mind.
Trust in markets and people like Equius to help you fully capture their returns over the long-term. The alternative just isn’t attractive on so many levels.
JT

Giving Something Back...

Fri, 4 Jun 2010 08:36:25 -0700

One of my favorite economists, Thomas Sowell, recently wrote the following perspective on public service. It’s a refreshing alternative to the rabid anti-business rhetoric of the current political and media environment. Despite using labels such as “liberal” or “conservative” in ways that cause some people to squirm, his overall message, I think, is a good one. JT
To Grads Interested In Public Service
By THOMAS SOWELL

Every year about this time, big-government liberals stand up in front of college commencement crowds across the country and urge the graduates to do the noblest thing possible — become big-government liberals.
That isn't how they phrase it, of course. Commencement speakers express great reverence for "public service," as distinguished from narrow private "greed." There is usually not the slightest sign of embarrassment at this self-serving celebration of the kinds of careers they have chosen — over and above the careers of others who merely provide us with the food we eat, the homes we live in, the clothes we wear and the medical care that saves our health and our lives.
What I would like to see is someone with the guts to tell those students: Do you want to be of some use and service to your fellow human beings? Then let your fellow human beings tell you what they want — not with words, but by putting their money where their mouth is.
You want to see more people have better housing? Build it! Become a builder or developer — if you can stand the sneers and disdain of your classmates and professors who regard the very words as repulsive.
Would you like to see more things become more affordable to more people? Then figure out more efficient ways of producing things or more efficient ways of getting those things from the producers to the consumers at a lower cost.
That's what a man named Sam Walton did when he created Wal-Mart, a boon to people with modest incomes and a bane to the elite intelligentsia. In the process, Sam Walton became rich.
Was that the "greed" that you have heard your classmates and professors denounce so smugly? If so, it has been such "greed" that has repeatedly brought prices down and thereby brought the American standard of living up.
Back at the beginning of the 20th century, only 15% of American families had a flush toilet. Not quite one-fourth had running water. Only 3% had electricity and one percent had central heating. Only one American family in a hundred owned an automobile.
By 1970, the vast majority of those American families who were living in poverty had flush toilets, running water and electricity. By the end of the 20th century, more Americans were connected to the Internet than were connected to a water pipe or a sewage line at the beginning of the century.
More families have air-conditioning today than had electricity then. Today, more than half of all families with incomes below the official poverty line own a car or truck and have a microwave.
This didn't come about because of the politicians, bureaucrats, activists or others in "public service" that you are supposed to admire. No nation ever protested its way from poverty to prosperity or got there through rhetoric or bureaucracies.
It was Thomas Edison who brought us electricity, not the Sierra Club. It was the Wright brothers who got us off the ground, not the Federal Aviation Administration. It was Henry Ford who ended the isolation of millions of Americans by making the automobile affordable, not Ralph Nader.
Those who have helped the poor the most have not been those who have gone around loudly expressing "compassion" for the poor, but those who found ways to make industry more productive and distribution more efficient, so that the poor of today can afford things that the affluent of yesterday could only dream about.
The wonderful places where you are supposed to go to do "public service" are as sheltered from the brutal test of reality as you have been on this campus for the last four — or is it six? — years. In these little cocoons, all that matters is how well you talk the talk. People who go into the marketplace have to walk the walk.
Colleges can teach many valuable skills, but they can also nourish many dangerous illusions. If you really want to be of service to others, then let them decide what is a service by whether they choose to spend their hard-earned money for it.

Simple, Transparent, and Focused

Wed, 24 Mar 2010 10:06:07 -0700

Robert M. Maynard and The Brandes Institute have published an absolutely brilliant rebuttal to the “endowment approach” to investing that has dominated both the institutional and retail markets over the past decade or so. This effort, “Back to the Future: Conventional Investing in a Complex World,” articulates very well the principles on which the Equius Partners asset class approach is based.
It also, indirectly, indicts the whole retirement plan industry for its movement away from trustee-driven emphasis on “simple, transparent, and focused” to the free-for-all that is the 401(k) plan market of today. As long as we have the major Wall Street firms and the major fund complexes like Fidelity and T. Rowe Price controlling this market, investors in these plans will, as a whole, fail miserably in meeting their retirement goals. Complexity (far too many choices), lack of transparency (where do returns really come from?), and lack of focus (constant shifting among hot-hand managers or asset classes) are redistributing billions of dollars from 401(k) participant accounts to these Wall Street manipulators.
If more corporate executives, retirement plan trustees, investment advisors, and politicians possessed the knowledge, commitment and ethical standards of Mr. Maynard, this country would not be staring into the dire retirement abyss it is today.
JT

The More Things Change...

Wed, 10 Feb 2010 08:46:06 -0800

Whether it’s the irrational exuberance of the late 1990’s or the paralyzing fear of late-2008 and early 2009, the Wall Street wizards constantly try to convince investors that “this time is different.” They always succeed. Billions of dollars in assets move around like deck chairs on the Titanic. But as investors are left floating in the freezing waters of the North Atlantic trying desperately to survive, stockbrokers and money managers are throwing their customers out of the lifeboats to make room for their fat butts.
Harsh? Yes. True? Absolutely. (For another take on this sad reality, read Bill Bernstein’s latest and greatest book, The Investor’s Manifesto.)
Markets move up and down constantly, and some of these ups and downs are more severe than others. But the most important principles of investing are constant: the vast majority (upwards of 80% or more) of stockbrokers, individual investors, and money managers fail to beat the market; those who do cannot be known in advance (and the membership of this “elite” group changes constantly); risk and return are directly related.
I was reminded of this last fact by Eric Nelson, one of our principals at Equius, who examined the “risk premiums” of stocks for two distinct periods going back to 1928. The first period ends in 1990--the ending year for the original Fama/French “Three-Factor” research (The Cross-Section of Expected Stock Returns, The Journal of Finance, June 1992)--and the second period looks at the data from 1991-2009. Here’s what he found:
The More Things Change, The More They Stay the Same...
Two “bubbles,” the Internet, real estate, commodities, gold, hedge funds, the “endowment approach,” the re-rebirth of “tactical asset allocation,” Republicans, Democrats, tax cuts, tax increases, no deficits, high deficits, Goldman, Lehman Brothers, etc. all come and go.
Stocks beat bonds, small beats large, and value beats growth. Discipline. Patience. Things you can count on.
JT

Angels and Demons

Fri, 8 Jan 2010 14:47:12 -0800

Brokers have been doling out “advice” to their customers for years, while avoiding the standards of fiduciary responsibility and transparency (especially concerning conflicts of interest) to which registered investment advisors like Equius are held. Why is this? Bob Veres suggests in a Financial Planning magazine article that (surprise!), it’s all about money (and our politicians’ love thereof). His make-believe interview with Demons and Angels is, unfortunately, all to real. Excerpt:
“I've been talking with people who have been discussing the fiduciary issue with Washington lawmakers and staff, debating how to regulate brokerage firms that are even bigger now than when they were too big to fail, offering suggestions on the best ways to protect consumers. They tell me that a lot of people in Congress really do understand the issues involved. But there seem to be plenty who are inclined to make interesting compromises that appear to have nothing to do with protecting consumers from predatory behavior.
After one conversation, I found myself imagining what would happen if our leaders in Washington were asked to regulate the activities of the Prince of Darkness himself, and how that discussion might go.
Imagine that we've invited several of these "practical" congresspeople to a meeting with demons who were lobbying on behalf of the sulfurous netherworld, and also with angels who were hoping that Congress might tilt the playing field in their favor.”

Sloppy "Research" Misleads Investors

Wed, 6 Jan 2010 08:52:01 -0800

One of my favorite websites for financial, economic, and some political perspectives is RealClearMarkets.com (they also have a sister site, RealClearPolitics.com). These are “aggregation” sites linking to various articles on the web that the editors find most interesting and relevant. Yesterday, RealClearMarkets.com linked to an article by investment advisor OmniVest Group, LLC titled, “Understanding the Myth of the Lost Decade.” The link has since been removed (maybe for reasons apparent in a moment), but a PDF copy of the article is here.
Unfortunately, the only myth revealed in the article was their Chief Investment Officer’s grasp of past market returns. This, I believe, is a great example of starting with a premise you wish to promote and then shaping data (or ignoring it) to support your view.
In this case, it appears that the OmniVest CIO believes emerging markets is the place to invest in the future and supports his view with past data that is grossly inaccurate. This is troubling for two reasons: First, the degree of inaccuracy in the data suggests that the CIO was blinded by irrational exuberance. Second, this irrational exuberance caused him to come to an irrational conclusion, namely that ridiculously high past returns will translate into ridiculously high future returns (of course, the opposite is almost always true).
In the article, the CIO claims that for the decade previous to this past one (January 1990 to December 1999), the S&P 500 produced a total return of 432.0% while emerging markets returned a total of 2,408.6%. In fact, the S&P did gain 432%, but emerging markets (the MSCI Emerging Markets index) returned only 185% (off by a factor of 13)!
For the last decade (January 2000 to December 2009), he claims that the S&P 500 had a total return of -10% versus 102.4% for emerging markets. He was close on the S&P 500 (it actually dropped 9.1%), but this time he understated the emerging markets return, which was actually 162%.
So taking the two decades together for a total 20-year period, the OmniVest CIO concludes that the S&P 500 returned 374.4% versus an astronomical 4,977.6% for emerging markets!. This translates into an annual return for the S&P 500 of 8.1% versus 21.7% for emerging markets. In fact, emerging markets gained a total of 647.1%, for an annual return of 10.6%.
To the untrained eye, a “risk premium” of 2.5% per year over twenty years for emerging markets should look about right. A risk premium of almost 14% per year for emerging markets for such a long period should raise suspicions in even the most trusting untrained mind. As the former Merrill Lynch Chief Investment Officer for the Private Client Group, this OmniVest CIO should have known better.
Here is the table from the OmniVest article:

Here are the returns according to DFA’s Returns 2.0 software:

Looking at the inaccurate data and considering the flawed assumption that extraordinary past returns indicate extraordinary future returns, it should come as no surprise that the OmniVest CIO would conclude: “The continued growth of a large middle class in developing regions combined with the further penetration of electronic communications[*] will allow emerging markets to outpace the developed markets, once again, in the years to come.”
* My guess is that the OmniVest CIO was also a big fan of the Internet revolution of the late 90’s and got caught up in those numbers as well. But I can’t verify that.
JT
Update: After contacting the OmniVest Chief Investment Officer (Tom Sowanick) about his numbers, he clarified that the MSCI Emerging Markets and MSCI Developed returns he used are based on local currencies, not U.S. dollars. This was not stated anywhere in the article. An innocent omission? You be the judge, but it bears noting that investing in a local currency (in other words, a currency-hedged) MSCI Emerging Markets index through a mutual fund or ETF is not possible. This is an investment article with the clear intention of promoting emerging markets as an investment for U.S. investors. Therefore, the numbers he presented are inappropriate and potentially very misleading (especially without proper disclosure).

Three Decades of Subsidized Risk

Fri, 6 Nov 2009 14:15:26 -0800

“I recently sat down with legendary investor Ted Forstmann to discuss why, on the one-year anniversary of the financial meltdown, the press has largely ignored the role of government in creating the meltdown—and possibly setting the stage for another one—by allowing Wall Street to borrow cheaply and easily during the past three decades.
"I guess reporters think writing about greedy investment bankers is more interesting," Mr. Forstmann laughed.” [Excerpt from “Three Decades of Subsidized Risk,” The Wall Street Journal, November 6, 2009.]