Category Archives: mutual fund holders and financial advisors

seeking outperforming funds

October 26, 2016 By in mutual fund holders and financial advisors, Uncategorized Tags: , , , Leave a comment

Earlier this morning I ws reading a Wall Street Journal article on the Janus fund group.  What  especially caught my eye was the part on the performance of Janus bond funds.

Over the past one and three years, only 9% and 15% of Janus bond fund assets ranked in the top half of their Morningstar categories.  The corresponding figures from twelve months ago are 75% and 100%.

This home-run-or-strikeout approach to fund management is what I saw when I was competing against Janus equity products ten or twenty years ago.  The idea, which I think is never successful over long periods, is to run portfolios that are built for large deviations from their benchmark indices, in the hope of achieving eye-popping relative returns that will result in large asset inflows.

One problem with this approach is that it’s extremely hard to be very right in a big way on a consistent basis. A second is that, while the freedom to make big bets may be emotionally satisfying for portfolio managers, clients don’t necessarily want the resulting large relative ups and downs.  As one of my former bosses (often, as it turns out) put it, “The pain of underperformance lasts long after the warm glow of outperformance has disappeared.”

That is also, in a nutshell, the basic appeal of index funds:  while there are no sugar highs, there are no heart-attack lows that force the holder to periodically evaluate whether the fund manager knows what he’s doing.   Since there’s really no easy way of knowing, staying with an underperforming fund requires a leap of faith most investors are leery of making.  Better to avoid being put in this position in the first place.

 

This is probably also the gound-level reason Janus is selling itself to Henderson.  It will be interesting to see whether Janus changes its stripes under new ownership.  By the way, achieving such a cultural change is easier than one might think–just change the bonus structure to strongly emphasize batting average and defense instead of Dave Kingman-like power.

hedge funds and uncorrelated returns

August 24, 2016 By in financial planning, Getting financial advice, mutual fund holders and financial advisors, Uncategorized Tags: , , , , , , , , 1 Comment

beta     

One of the initial topics in my first investment course in graduate school was beta, a measure of the relationship ( generated from a regression analysis) between the price changes of an individual stock and those of the market.  A stock with a beta of 1.1, for example, tends to move in the same direction as the market but 10% more strongly.  One with a beta of 0.9 tends to move in the same direction as the market but 10% less strongly.  The beta of a stock portfolio is the weighted average of the betas of its constituents.

the beta of gold stocks

At the end of the class, the teacher posed a question that would be the first item for discussion the following week.  Gold stocks have a beta of 0.  What does that mean?

The mechanical, but wrong answer, is that gold stocks lower the beta, and therefore the riskiness, of the entire portfolio.  If I have two tech stocks, their combined beta may be 1.2.  For two utility stocks, the beta might be 0.8.  For all four in equal amounts, then, the beta is 1.0, the beta of the market.  Take two tech stocks and add two gold stocks and the beta for the group is 0.6. But this doesn’t mean the result is a super-defensive portfolio.

A beta of 0 doesn’t mean the stock is riskless.  It means that the stock returns are uncorrelated with those of the stock market.  So adding one of these doesn’t lower the risk of the portfolio.  Instead, it introduces a new dimension of risk, one that may be hard to assess.

a painful lesson   

Portfolio managers who embraced beta in its infancy didn’t get this. They assumed uncorrelated= riskless, learned the hard way that this isn’t true when their supposedly defensive portfolios imploded due to sharply underperforming gold issues.

uncorrelated redux      

I’ve been looking at marketing materials for financial planning firms recently.  Allocations to hedge funds are being touted with the idea that their returns are uncorrelated to those of stocks or bonds. This is substantially different from the original claims for this investment form. Over the past fifteen years or so, the hedge fund pitch has gone from being one of higher-than-market returns, to low-but-always-positive returns, to the present uncorrelated.

The reason is that in the aggregate hedge fund returns have consistently been lower than those for index funds for many years and that they do have years where their returns are negative.  What’s left?   …uncorrelated, just like zero-beta gold stocks.  I guess it has been revived because the last “uncorrelated” investment disaster is so far in the past that few remember it.

why hedge funds?

Why have hedge funds at all in a managed portfolio?  They must have some marketing appeal, sort of like tax shelter partnerships or huge fins on the back of a car, that are aimed at the ego–not the wallet–of the client.  A darker reason is that the sponsoring organization may also run the funds, and would miss the huge fees they generate for their managers.

 

 

 

 

 

 

mutual fund and ETF fund flows

July 21, 2016 By in ETFs Vs. Mutual Funds, mutual fund holders and financial advisors, Portfolio management, Uncategorized Tags: , , , , , , 2 Comments

away from active management…

There’s a long-term movement by investors of all stripes away from actively managed mutual funds into index funds and ETFs.  As Morningstar has recently reported, such switching has reached 2008-era levels in recent months.  Surges like this have been the norm during periods of uncertainty.

The mantra of index proponents has long been that investors can’t control performance, but they can control costs.  Therefore, all other things being more or less equal, investors should look for, and buy, the lowest-cost alternative in each category they’re interested in.  That’s virtually always an index fund or an ETF.

Active managers haven’t helped themselves by generally underperforming index products before their (higher) fees.

…but net stock inflows

What I find interesting and encouraging is that stock products overall are receiving net inflows–meaning that the inflows to passive products are higher than the outflows from active ones.

why today is different

Having been an active manager and having generally outperformed, neither of these negative factors for active managers bothered me particularly during my investing career.  One thing has changed in the current environment, though, to the detriment of all active management.

It’s something no one is talking about that I’m aware of.  But it’s a crucial part of the argument in favor of passive investing, in my opinion.

what is an acceptable net return?

It’s the change in investor expectations about what constitutes an acceptable net return.

If we go back to early 2000, the 10-year Treasury bond yield was about 6.5%, and a one-year CD yielded 5.5%.  US stocks had just concluded a second decade of double-digit average annual returns.  So whether your annual net return from bonds was 5.5% or 5.0%, or whether your net return from stocks was 12% or 11%, may not have made that much difference to you.  So you wouldn’t look at costs so critically.

Today, however, the epic decline in interest rates/inflation that fueled a good portion of that strong investment performance is over.  The 10-year Treasury now yields 1.6%.  Expectations for annual stock market returns probably exceed 5%, but are certainly below 10%.  The actual returns on stocks over the past two years have totalled around 12%, or 6% each year.

rising focus on cost control

In the current environment, cost control is a much bigger deal.  If I could have gotten a net return of 6% on an S&P 500 ETF in 2014 and 2015, for example, but have a 4% net from an actively managed mutual fund (half the shortfall due to fees, half to underperformance) that’s a third of my potential return gone.

It seems to me that so long as inflation remains contained–and I can see no reason to think otherwise–we’ll be in the current situation.  Unless/until active managers reduce fees substantially, switching to passive products will likely continue unabated.  And in an environment of falling fees and shrinking assets under management making needed improvements in investment performance will be that much more difficult.

 

the Supreme Court and 401k plans

May 20, 2015 By in bond market, How your broker gets paid, Industry Analysis, Investment firms, mutual fund holders and financial advisors, securities markets, stock market, Where are the customers' yachts? Tags: , , , , , , Leave a comment

On Monday, the Supreme Court made a narrow ruling on a technical point that may have far-reaching implications.

Participants in the 401k plan offered by Edison International, a California utility, sued the company claiming that it stocked the plan with “retail” versions of investment products that charge higher management fees than the lower-cost  “institutional” versions that it could have chosen instead.

The company defended itself by successfully arguing in a lower court that the statute of limitations for bringing such a lawsuit had expired.  The Supreme Court said the lower courts were mistaken.  An employer has a continuing duty to supervise its 401k offerings.  So even though years had passed since the 401k offerings were placed in the plan, the statute of limitations had not expired.

So the case goes back to the lower court, where presumably the question of whether Edison was right to offer a higher cost product than it might otherwise have.

Was this a mistake?

Why wouldn’t any company have the lowest cost share possible in the 401k plan?

The short answer is that the company receives a portion of the management fee in return for allowing the higher charges.

Typically the company argues that the fee-splitting helps cover the costs of administering the 401k plan.  In practical terms,thought, the move doesn’t eliminate the costs.  It shifts them from the company to the plan participants.

If the Wall Street Journal is correct, this is the case with Edison, which is reported as pointing out that the fee-splitting is disclosed in plan documents.

I have two thoughts:

–the sales pitch from the investment company providing the 401k services probably sounded good at the time.  The 401k would be inexpensive (free?) to Edison.  High fees would shift the cost onto employees instead–which makes sense, the seller might argue, since employees are the beneficiaries of the plan.

On the other hand, to anyone without a tin ear, this sounds bad.  The amounts of money are likely relatively small.  Edison is probably spending more on legal bills than it “saved” by choosing the plan structure it did.  And if it turns out that Edison is profiting from the arrangement rather than just covering costs, the reputational damage could be very great.

–fee-splitting arrangements on Wall Street are far more common than I think most people realize.  This case could have wide ramifications for the investment management industry if the courts ultimately decide that Edison acted improperly.

 

 

massive redemptions at PIMCO? …I don’t think so

September 30, 2014 By in bond market, Getting financial advice, How your broker gets paid, mutual fund holders and financial advisors, securities markets Tags: , , , , , Leave a comment

Late last week, bond guru Bill Gross, founder and public face of PIMCO, resigned from that firm to go to work for a much smaller rival, Janus.  This has led to speculation that the departure of Gross, who crafted the superior long-term record of the PIMCO flagship Total Return bond fund, would cause the loss of as much as 30% of the $1.8 trillion PIMCO has under management.

I don’t think the outflows will be anywhere near this bad, for a number of reasons:

1.  PIMCO deals in load funds, meaning that retail investors must pay a fee to buy them.  Two consequences:

–owners find the fact of the fee, not necessarily the size of it, a psychological barrier to sale.

–the load-fund client typically places a sell order through his broker.  The fact he can’t just go online in the middle of the night and redeem is another barrier to sale.  When called, the financial adviser can make reasoned arguments that persuade the client to hold on.  The broker may also convince the client to move to another bond fund in the PIMCO family, so that money leaves the Total Return fund but stays in the group.

What’s to stop a broker from using the Gross departure to call all his clients and tell them to take their money from PIMCO and place it with a different family of load funds–thereby generating another commission for him/her?  Generally speaking, such churning is illegal.  The transactions might even be stopped by the broker’s own firm.  Worse yet for the broker, this kind of call is pretty transparent as a fee grab.  It might also invite questions about where the broker was when the Gross performance began to deteriorate.

2.  My experience in the equity area is that while no-load funds can lose a third of their assets to redemptions in a market downturn.  Under 5% losses have been the norm with the load funds I’ve run.  Even smaller for 401k or other retirement assets.

3.  Money has already been leaving PIMCO for some time.

–Bill Gross’s performance has been bad for an extended period.

–He’s been acting like a loose cannon.

–Mohamed El-Erian’s leaving PIMCO was particularly damaging.  I think most people recognize that Mr. El-Erian is a professional marketer, not an investor.  But he was being paid a fortune to replace Gross as the public face of PIMCO.  Why leave a sweet job like that  ..unless the inside view was frighteningly bad?

At some point, however, PIMCO will have lost all the customers who are prone to quick flight.

PIMCO will try hard to get clients to stay.  It will presumably concede that it waited much too long to rein Mr. Gross.    But, it will argue, a seasoned portfolio manager at PIMCO, Dan Ivascyn, has now taken over the Total Return fund.  Supported by the firm’s broad deep research and investment staff of more than 700 professionals, Ivascyn will stabilize performance.  So the worst is now over.  In fact, Gross’s departure may have been a blessing in disguise.

4.  Arithmetic.  About $500 million of PIMCO’s assets come from its parent, Allianz.  Presumably, none of that will leave.  Third-party assets total about $1.3 trillion.  A loss of 30% of total assets would mean a loss of over 40% of third-party assets.  That would be beyond anything I’ve ever seen in the load world/

5.  Although individuals are prone to panic, institutions act at a more measured pace.  It would certainly be difficult to persuade institutional clients to add more money now, but it should be easier to persuade them to allow the assets they now have at PIMCO to remain, while keeping the firm on a short leash.

In sum, I can see that in the wake of the Gross departure, PIMCO could easily lose 10% of the third-party assets it has today.  I think, however, that the high-end figures are being put out for shock value and without much thought.