Why would you indirectly suggest owning a company oil stock over an ETF?Well this is a good comment as it brings up what really is a risk to worry about and what isn't, in terms of being realistic. Enron perpetrated a fraud, as did Worldcom. How many reasonably big companies (both of these were of course much larger than reasonably big) and larger are frauds that go to zero? We can define reasonably big as NYSE listed or NASDAQ listed. It happens so infrequently that it is statistically insignificant. There have been a few other companies that have failed for reasons other than fraud, this is also rare.
Have the memories of ENRON faded that quickly within the market?
I am purposely trying to get out of company stock and get into a commodity for a portion of my portfolio.
Further Enron was not an oil company it was a utility with a huge trading operation.
This may seem cold but worrying about statistically insignificant events, where investing is concerned, makes very little sense to me. If you have 3% of your portfolio in the next major fraud you will end up having a bad day and might set your portfolio back a couple of months. This is not a ruinous outcome.
The reader says he is seeking out a commodity product for this part of his portfolio. Over the last three months USO and OIL had standard deviations of 27.5 and 27.3 respectively. In that same time BP had a standard deviation of 18.2, XOM 19.6, Chevron 19.4, Total 17.8 and the Energy Sector SPDR (XLE), which might be the least compelling energy ETF out there, comes in at 20.5.
Individual stocks are not right for every one and trading a commodity ETF is a valid way to go for people that want to assume that kind of action but the logic of picking a very volatile commodity ETF over a stock for fear of fraud is lost on me.
An update; I disclosed buying the Currency Harvest ETF (DBV), aka the carry trade fund, back in October. I feel like it is living up to its billing of capturing most of the market with less volatility. Over the last three months SPY has a volatility of 7.07 and DBV is 6.14. In that same time SPY is up 4% while DBV is up 3%. While that is fine I think it is too early to know for sure that it is a success.
For now I have no intention of putting client money into this. I prefer the single currency ETFs, they are simpler and have provided a better return.
On a more positive note I am scheduled to do a podcast-like interview with WallStreet.net. I've done this many times before. The show is hosted by Bobby Illich and my counterpart this go around will be Jonathan Hoenig from Cashin' In. I'm looking forward to it.
22 comments:
The average investor has less than 30 holdings?? One holding being less than 3% of their portfolio is unrealistic for many small investors. (They do not have that many good ideas and they do not have that much time.)
The average investor is a lousy stock picker. Even most professionally run mutual funds (roughly 80%) are lousy stock pickers and do not beat index funds.
IMO mutual funds and ETFs are the only intelligent investment choices for the vast majority of small investors.
This is not to say stock picking is wrong for Roger or a small percentage of highly skilled investors. But be honest with yourself, your assets and your retirement are at stake, the vast majority of small investors can not pick stocks.
But, saving and investing in properly selected funds are likely to result in a portfolio worth millions for retirement.
clearly 3% stock positions don't fit in a $50,000 account.
But I have advocated many times a blend of different products to build a diversified portfolio. I do think that the typical do-it-yourselfer that makes the time for stock market blogs has the capacity to follow and own 3 or 4 individual names, at a minimum.
oh Roger, i am going to disagree with you on so many levels.
I do not care for the particulars of commodity vs. equity issue.
But the implication that the risk of ruin is statistically insignificant is a disastrous advice/comment.
Enron maybe unique, but what about the likes of Comdisco? A Company that was started with a $5000 loan and built into a $8 billion company over 35 years. After the founder passed, it took the son 2 years to send it into bankruptcy. All while the media and the management were praising its bright future. Employees were encouraged to put their 401k into the company's stock and to buy into share purchase plans and to buy in the open market.
On its way to zero, people were told to buy the dips.
You think Comdisco is unique? it isn't. A ton of companies died over short periods of time, without "fraud". at least, without criminal prosecution.
How about companies that do not go bankrupt, like AMCC, JDSU and others that lots 90%+ of their value? too risky? how about bellwethers like Yahoo and Cisco? too concentrated? how about owning the whole Nasdaq index? and watching it go down by over 60%? maybe not ruin, but certainly will destroy retirement plans! not diversified??
How about entrusting your money to the brains at the highly respected Janus funds... and watching your portfolio melt with a six figure hit?
Rather than pointing out that in a perfect portfolio, the risk of ruin is statistically insignificant, you should be teaching the readers about STOPS and Money Management.
You mention all the time that you got stopped out of positions. I think you manage your portfolios superbly. But for the sake of the people that cannot emulate your portfolio, you should stress the ideas of stop losses. You should stress ignoring the hype and watching the chart.
Most companies implode over a period of time, giving people ample chance to exit. Most people do not exit, because they do not know what to do...
sorry about not being too cordial, but this hit a nerve with me. i love your work, and i learn from it a lot.
disagreement is always welcome.
I don't remember the timing of CDO but your other examples are all from the same event, the biggest stock market bubble we are likely to see over a 100 year time period.
what made the internet stock epsisode a bubble was the extent to which it was all encompassing in terms of the number of stocks that had 1000% increases in a year or two and the number of investors who had all their money in the sector.
In the post I say the next fraud yada yada because there will be another one. Fraud is not new it will come again but it is rare. If you look at market history and the thousands of stocks that come and go the percentage of failures (not fraud) is also quite small.
There will always be work in owning individual stocks but ex-bubble the odds of owning two failures in any ten year period are minute.
I don't think it is Roger's responsibility to be teaching/talking about investing basics (stops etc.). Roger has a nice little niche with this blog. I think (could be wrong) that most of the readers have a clue on basics. You can get this stuff all over the place.
And for these big declines (Enron), bring em on. Short them into the ground.
dnf
that is a very kind comment, TY.
Gee Sami, sounds like Roger really let you down a few years ago by not seeking you out and advising you not to put all your money in technology and other high multiple growth stocks after a massive and fundamentally indefensible runup. Roger, you might also want to make sure to tell Sami and other readers not to run with scissors or bathe with toasters.
Although I haven't seen any numbers for this, my hunch is that the risk of ruin is highly correlated with ravenous greed and abandoment of common sense. Just a hunch.
Roger, I'm curious about your comparison of DBV to single currency etf's. DBV is an absolute return vehicle, while a single currency etf is a much more speculative and concentrated holding. Unless you're saying you'd rather build your own carry trade, isn't that like comparing apples to a diversified long/short orchard strategy?
One of Sami's points is valid even for more knowledgeable investors: Getting exits right. It's not too hard to buy and setting a stop is not too tough either until you realize you are consistently getting whipsawed out of them because you don't have a model for exits that is at least as sophisticated as your model for entries.
Workers who don't realize the level of risk they are accepting when they load up their 401k's with their company's stock is another story too: Assessing risk and appropriately calculating risk/reward ratios can be a challenging exercise even for more experienced investors as I know personally all too well.
Different topic, I think oil and select distillates are oversold and am starting to like TSO and VLO as we approach the rollover to summer gas mix.
Re DBV vs currency shares;
I view currency exposure as an asset class to be held in a small portion in a diversified portfolio.
From that view point I lean, for now, to the currency shares as being preferable for my clients.
I mostly agree with the reader's comment about the differences.
Sami has left a slew of insightful comments in the past. He has more than enough credibility for me to take any of his comments seriously.
thanks Roger :)... my comments were in the spirit of "academic debate", and not -- as some assumed -- in passing blame or laminating the past.
my point is that the risk of "ruin" is inherit in the market, as far back as the tulip bubble. It is not specific to Fraud, or to the recent Nasdaq bubble. O'neil's books are full of examples of past market leaders that vanished. It is also not specific to high multiple stocks, IMH went from $27 to $7 with the P/E consistently below market average. It is also not specific to stocks, LTCM and Amaranth come to mind.
In my mind, the risk of ruin is also not isolated to stocks going down to 0. Ford went from mid 30's to under 10. If my future plans were based on Ford's stocks, i would say they are "ruined". One of your recent readers lost a fortune in that biotech company that was trying to deliver the blood substiute.
On a more personal level, my portfolio just entered the 7 figure area. I cannot realistically allocate a max of 3% to individual stocks and then keep track of all of that. If i am going to do that, i may as well just buy the SPY, especially that i am already working 60 hour weeks in my small business. Thus for me, the solution is have a concentrated yet diversified portfolio. In my case, the risk of "ruin" is very real if i do not employ prudent risk management techniques. Including position sizing, entry points and exit points, with the latter being the most important in my opinion.
Roger,
I do not think you get it. I do not think you understand how bad most small investors are in choosing stocks, exit strategies, etc.
Small investors should stick to ETFs and mutual Funds or People like you.
I might disagree with you a lot on this issue, but on the bright side I think you understate the value you bring to the table. I just do not think most small investors can do this as well as someone like yourself.
KL
If you want to cherry-pick data Sami, before IMH went from 27 to 7, it went from 2 to 27. Ruin is in the eye of the beholder I guess.
LTCM and Amaranth were hedge funds restricted to Reg D investors and came with reams of disclosure paperwork regarding the very real risk of total failure. Investors in those funds were aware of the risks, if not the degree to which their investment would be mismanaged. Had they wanted to avoid those risks altogether, that capital could have very easily been invested in Treasury bills. I challenge you to cite a single investor in either of those funds that was ruined as a result of their investment.
Roger's post was referring to Enron/Worldcom type fraud, his claim that these are highly unusual examples of calamity stand unchallenged.
There are millions of people, all over the world, that invest in individual equities. Just because you & KL may not have the time nor inclination to own stocks individually doesn't mean that Roger shouldn't comment on them.
I have never bought an individual stock in my entire life. Here's why.
1) There's overwhelming evidence against long term outperformance via stock picking. If fund managers with MBAs and PHds from Wharton (with huge research staffs to boot) can't beat an index, why should I?
2) Portfolio diversification is a challenge. I know this can be argued, but Malkiel illustrates in "Random Walk..." that investors need nearly 50 stocks in their portfolio to be adequately diversified.
3) Trading costs, spreads, etc. can be a huge drag on performance when managing an active portfolio of this size.
4) Labor intensity - I would imagine bottom-up (stock) analysis is far more time consuming than top-down market analysis. You have to ask yourself what is your return on time spent.
5)I can't remember the exact figure, but according to Ned Davis Research a huge percentage of a stock's performance is a direct result of it's sector affilation. According to NDR, it's far more important to be in the right sector vs. the right stock.
Now, with all that said, I believe the way Roger uses individual stocks makes a lot of sense - to access certain themes, countries, etc. that are difficult to do through funds. This especially makes sense with large porfolios because the stocks represent small overlays (1-3% positions) on more broadly diversified portfolios. Even if one stock blows up completely , the effect on long term portfolio performance is insignificant.
And there you go. I'm not sure why some of the posters on the board have such an allergic reaction to owning individual securities in prudent position sizes. I've owned BPL for a long time (pipeline MLP). I'm not sure which etf would mimic that holding and provide the cash flow I've gotten from it over the years. Ditto ALD & ACAS - why own the private equity etf when these holdings individually have so much diversification within their own portfolios.
I love to buy small, thinly traded community & regional banks that have great numbers and no analyst coverage - can't get that exposure through a fund or etf (although STH has possibilities). Again, not everyone has the time or inclination to pursue this, but the knee-jerk reaction that all talk of individual stocks is wrong or dangerous or can't possibly work as well as passive indexing is simply a display of ignorance.
Roger, I've got to call you on this one. In invoking DBV as a possible example of an ETF that might supply a near-market return with lower volatility, you note that its SD is lower than the SPY SD. But that's really not the correct comparison. You need to know (1) the level of correlation between DBV and SPY (presumably low); and (2) the extent to which the inclusion of DBV reduces the SD of the OVERALL portfolio. DBV could be too highly correlated with SPY to meaningfully reduce that figure.
calling me on DBV; you may be coming in on the middle of something that has been going on a while. you can click here to go to the info PDF for DBV and you will see a very low correlation.
TomK makes a great comment. The trading the costs though, I might disagree with. ETFs can be traded just as frequently and some firms charge for OEF trades. As an example I have used b4, clients own JNJ. I think I can hold it forever. If something changes, so be it I can always sell if need be.
Per Paul Ormerod's "Why Most Things Fail:
Studies of Top 100 US Companies 1919-1979 and 1912-1995:
Within the 1919-1979 time period , 216 companies made the top 100 list.
Over the individual decades from 1919-29 to 1969-79, on average 22 of the US companies that start a decade as being within the top 100, will not be there by the beginning of the next decade.
Of the top 100 at the start of study 1912 by 1995:
29 went bankrupt
48 disappeared - 10 of them within the first decade.
52 Survived
19 were still in the top 20.
28 were larger at the end of the period then at the beginning. Disappearance or decline were three times more likely then growth.
To give some idea of the size of these 1912 Top 100: Largest (in 2004 $): $160 billion market cap; Smallest: $ 5 billion market cap.
----
My comment:
Top 100 companies are certainly very large and successful, but their ongoing success over long time frames is far from assured.
oh wow... what a firestorm over a tiny comment :)
this is my last reply on this particular issue, so i will try to be very clear.
1. a reader commented on Enron,
2. Roger commented that another Enron is statistically insignificant.
3. I replied that the prudent action is to use stops instead of assuming that the risk is negligible.
That's all. Everything else was an attempt to clarify the point.
If all the Anonymous readers disagree with me, then by all means, go ahead, buy away and do not use stops. May the force be with you.
I myself, i am going to follow Roger's own methods and set stops and take profits when it is prudent to do so.
As for being allergic to stocks. I have disclosed occasionally, on this blog and others, various positions i owned or traded. Including high yield bonds, all sorts of options, real state investment trusts, individual stocks, ETFs and mutual funds.
I'd also note, that in the late 90's, before the term blog was coined, i ran a website called TradeTheSpread.com that tracked the trades i placed in my actual portfolio, with focus on trading out of the money option spreads (hence the name)...
in other words, i am not allergic to anything, i am just advocating risk management.
Hi Roger,
Sorry about the double post. BTW, it's okay that we disagree - if we both agree, than one of us in necessary.
Here is the repost, since my comments and your counterpoint seemed to stimulate discussion:
Thank you for posting the "counterpoint" to your article. You have given me food for thought.
First of all, when you write "standard deviation", I am trying to figure out what you mean by that - STD from what? The price of crude oil itself, I assume? Yes, if the OIL ETF's don't track the price of oil, then that IS problematic.
I will agree to that point.
I have noticed some graphs showing more price decline than price upswing when oil moves.
My reference to ENRON was probably a bit overdramatic (leaving you puzzled) but it illustrates perhaps the risk of a portfolio being entirely in "companies/Corporate America". (or Corporate China or Corporate Europe and so on).
Quite simply, as an average investor, I can't be privvy to but am exposed to:
1. Management changes and how the market will view that.
2. Insider trading (yes, it still happens)
3. Other unethical and/or non-transparent practices that companies engage in.
I don't know how prevalent it is (you say it is infinitely statistically small and imply Corporate America as a whole are beams of ethics and righteousness) but over the years, I have decided to learn lessons from ENRON, Worldcom, Arthur Anderson and so on.
With a commodity ETF, the way I see it, I just won't have that exposure and risk.
To me, having my portfolio in Corporate America and Corporate International. . .you are just recommending I transfer my assets from one corporation to another Corporation.
How truly diversified is that in thinking (if diversification is important to you)?
Maybe more importantly, is the risk worth the reward?
(rhetorical question)
In closing, as far as the worrisome STD, I have meditated on that. I think it may just be the "price of doing business" in a commodity. From what I can tell, this discrepancy involves the cost of doing business in the "options" market as these options expire and roll over.
Could I do business in options over the long term of my investing career? I don't think so. . .I don't know what I am doing.
Indeed. . .there may be a better way to "do business" ( a higher management fee maybe? locking the oil in vaults and sellling every 90 days?) rather than have it reflect the share price but for now, I believe I need exposure to that commodity in my portfolio and less exposure to "Corporate America" and "Corporate China."
So, for now, I will choose to ignore your recommendation that I place my faith in a company and go with an ETF and just concede to the fact, it is like a mutual fund with a high management fee of 2 or 3%.
- Scanner (having blogging in problems)
BTW,
If my opinion counts for anything, I am a long term bull on oil at $50/barrel.
As far as next summer or the Feb. OPEC meeting, I haven't got the foggiest. Take your chances on that.
So, if it goes down, sign me up for some more Oil ETF's. I'll just consider it on sale.
- Scanner
Quick question on the risk of USO, the oil ETF. The description on one site says "The investment seeks to reflect the performance, less expenses, of the spot price of West Texas Intermediate (WTI) light, sweet crude oil. The fund will invest in futures contracts for WTI light, sweet crude oil, other types of crude oil, heating oil, gasoline, natural gas and other petroleum based-fuels that are traded on exchanges. It may also invest in other oil interests such as cash-settled options on oil futures contracts, forward contracts for oil, and OTC transactions that are based on the price of oil. The fund is nondiversified."
An ETF that simply buys a portfolio of companies is one thing, but ETFs like this or the "Carry Trade" ETF that was mentioned earlier seem to have plenty of operational risk. Comments please...
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