New Years Eve!

A short post as there is a lot of football work today.

I received an invite to go to an NYSE bell ringing ceremony for GlobalX for the middle of next month. While I won't be making the trip I was curious to see that on the invite they listed all of their Chinese sector ETFs including the Materials Sector ETF which will have ticker symbol CHIM.

That fund is not out yet so the invite makes it seem like it could be out by January 20, we'll see. I mention it because I think it has potential to be one of the more interesting of the bunch. Chances are that Jiangxi Copper (JIXAY) is going to be a big holding. I would also expect Shenhua Energy, which is a big coal company to be another. It will be interesting to see if the fund takes an agricultural turn, there are quite a few stocks in the industry in China so we'll see.

Along the same line I found a site, via Seeking Alpha, called Top Foreign Stocks which has a little commentary but a lot lists of ADRs from various countries, both NYSE and OTC, as a database of sorts. There were a couple of omissions I noticed but it would be very difficult to capture every single ADR. Also their lists so far are just ADRs not ordinary shares.

The latest article in the Seeking Alpha Positioning For 2010 series was out yesterday. It is a writeup from Michael Johnston from ETFDatabase. It lists 10 ETF that ETFDatabase thinks "present compelling cases for investment in the new year." I'm not sure whether the site is more about reporting news, which they do a lot of, or if there is some sort of money management tied in as well point being I am not sure what is behind the recommendations. Not a knock, I just don't know but the article is worth reading.

Did you see Idaho's last second come from behind win against Bowling Green? Wow, the blue turf is like magic.
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CNBC Today

I am scheduled to appear on CNBC 30-ish minutes after the close today to talk about five top picks for 2010.

So far I have Red Sox in 6, Celtics in 6, Bruins in 7 and the Pats to win the Super Bowl. Hopefully I come up with a fifth by the time I go on the air.
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Narrow Based ETFs

IndexUniverse has a useful post up that compares the PowerShares Aerospace & Defense Portfolio (PPA) and iShares Dow Jones U.S. Aerospace & Defense Index Fund (ITA). Obviously the two cover a lot of the same ground and perform very similarly to each other.

I have been a big believer of keeping a defense stock (or if you prefer, an ETF) in the portfolio as something that might go up in the face of certain types of external shocks. The article spells out some of the macro factors that make the space compelling as well, at least I find it compelling anyway.

This is a pretty good example to support the case to go narrower than broad based index funds. In an equity portfolio with four or five broad based equity funds there is very little chance of creating any sort of zigzag effect in the portfolio. In the case of four broad funds you really have four funds that will move in the same direction but in different magnitudes and probably with different volatility characteristics. So they represent different market segments, broadly speaking, but the actual diversification is not that effective.

In the face of certain external shocks gold and defense stocks have a pretty good chance of going up. This effect cannot be created with a combo of SPY, IWM and EFA.

For anyone interested in going narrower in their portfolio construction and including defense stocks they either need to buy one of these ETFs or buy an individual stock. We have a bigger cap defense stock instead of an ETF and at times it outperforms the ETFs and other times it lags but really there hasn't been much difference in the price movement but the stock pays a pretty good dividend, more than the trailing yields on the ETFs.

Defense stocks are obviously part of the industrial sector. In building that sector within a portfolio there are themed funds to use like PPA and ITA, there are relatively broad based funds like Industrial Sector SPDR (XLI) that will be heavy in things like General Electric (GE) and 3M and maybe a country fund can fit the bill.

I'm not sure off the top whether or not there are any country funds that are very heavy in industrial stocks but other examples could be iShares Taiwan (EWT) which is 50% tech or iShares Peru (EPU) which is 65% materials. And of course now we have sector/country funds those being the Chinese sector funds from GlobalX. To be clear there are a lot of different theme funds that are heavy in industrial stocks that could be used for exposure to that sector.

Figuring out the exposures provided is as simple as going to the website of the fund provider and looking at the sector make up. I would not take a short cut here and make assumptions because sometimes they are not as they appear. For example while EPU is a proxy for materials the GlobalX Colombia Fund is heaviest, by far, in financial stocks. Another example is the wind and solar ETFs which are primarily the industrial companies that make the equipment so not an energy proxy.

Sadly, Jason Bay is no longer on the Red Sox, he signed with the Mets. I was hoping that because Bay puts up big numbers without being a loudmouthed idiot that they would figure a way to make it work.
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What Is Average?

Last week I put up a post about active versus passive investing that included my belief that the debate is not as linear as people make it out to be. I don't believe that alpha has to be finite, I do believe people can beat the market but not all the time, there are way too many variables for this to be tied together in a tidy and congruous fashion. It is just more complicated than that.

On the Seeking Alpha version of that post a reader engaged me in an interesting discussion summing up his point by noting that for every active winner there must be an active loser and lumping them together equals the market's result. Again I do not believe it is that simple, first there is no way to lump everyone together, I mean everyone. Would you define someone who went 100% cash on January 2, 2008, an active manager or a non-participant?

I responded that I am not saying most people beat the market just that explaining this is not as simple as the academics believe. The reader responded that "even outside of academia it is impossible for the average person to be above average."

I responded again with what I thought was an interesting example that I believe shows the potential complexity of the issue or should I say the lack of congruity in explaining the issue.

First here are the results for the S&P 500 for the most recent bull market cycle and the down year of 2008 not including dividends.

2003 up 26.4%
2004 up 9.0%
2005 up 3.0%
2006 up 13.6%
2007 up 3.5%
2008 down 38.4%

If someone invested $100,000 into the S&P 500 level based on the close on December 31, 2002 they would have $102,780 or a return of 2.78% not including dividends on December 31, 2008. So now let's look someone else who had an actively managed portfolio during that time that did not do very well most of the time. Let's say that for 2003, 2004, 2005, 2006 and 2007 this person lagged the S&P 500 by 5% in each of those years meaning that in 2003 he was up 21.4%, 2004 up 4% and so on.

At the end of 2007 the first investor, the passive investor, would have had $166,851 and the lagging active manager would have had $132,356. With no other information about the second investor's circumstance the lag would have compounded into a meaningful number. Now let's say that whether by luck or skill the active investor went 100% cash on January 2nd, 2008 and missed the entire 38.4% decline. In that case the passive investor would have $102, 780 on December 31, 2008 and the active investor would have $132, 356. Again with no other information the difference is meaningful.

So is the active investor above average? Did he beat the market? I think both yes and no can be argued here. The guy lagged the market for five years in a row but came out way ahead anyway. Regardless of where you stand on active versus passive I don't think the active investor chronicled in this post is easily lumped in with the winners or the losers as framed in the reader comment mentioned above.

To repeat what I said above and last week the debate is simply not as tidy and congruous as some people believe.
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Connie Mack

Consuelo Mack articulated something interesting in the opening for this week's show. She talked about the school of thought that says the best active managers tend to outperform in flat and down markets and lag during markets that are up a lot. If I followed her correctly she attributed this to Francois Trahan of ISI group and Smart Money magazine.

It appears that this is something I am trying to emulate in how I perform the task and by extension this is what I write about here. So part of the equation comes from Ken Fisher's idea of the market only doing four thing; up a lot, up a little, down a little and down a lot. If you miss a big chunk of that last one and go a long for the ride for the other three then you should come out ahead in terms of the entire stock market cycle.

The breakdown of Consuelo's observation might be as follows; in a flattish market it is easier to add value with things like increasing the overall dividend yield, country selection, sector weightings or other things that a given manager might focus on. When the market is down a lot some sort of defense trigger like going below the 200 DMA or the 50 DMA crossing below the 200 DMA or any other similar device can be a way to add value. However when the market goes up a lot it is typically because most of the big sectors are up a lot. If an entire sector is up 50% during some short period of time then chances are most of the constituents of that sector are going to be up a lot.

Moves like we've had since March are in some part snapbacks fueled by emotion the represents the undoing of the other emotional extreme; the implosion in stocks that took them to their lows. If a group of related stocks are all up a ton chances are the move is not really about fundamentals. Moving for non fundamental reasons happens all the time. Sometimes the fundies dictate trade and sometimes not--just how it is.

Consuelo mentioned something else of interest, an argument for top down portfolio construction. She said that in 2008 95% of all US stocks were down and this year 90% of all US stocks are up. While I do not know how normal 95% is for the typical bear market (my guess is that is higher than normal), chances are that if the market is down a lot most of the stocks that comprise the market will be down a lot too. In that light it makes more sense to focus on missing the full brunt of the decline as opposed to trying find the 5% of stocks that will be up.
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Sunday Morning Coffee

Last Thursday Seeking Alpha published a post they asked me to write about some things I think will be important to the markets in 2010.

A good portion is devoted to country selection, investing at the country level, why this has been important and my opinion that it will become increasingly more important in the year to come.

My article is part of a series SA runs and they draw a lot of comments. I'm not sure what the ratio of you're a complete idiot to makes some sense comments is but there was one comment in particular that I thought could be useful to answer in some depth as I think it gets to the core of what country selection is all about.

In the article I listed most of the countries I own across the board (Australia, China, Chile, Norway, Canada, Israel, Sweden, Switzerland, Brazil and UK) and a few I would consider adding as across the board exposure in the future (Denmark, Egypt, Peru, Singapore and Vietnam) but there are more than just those that I follow in this context.

The reader went down the list of countries and itemized various things about each one (some I would agree with and some I would not) but said he had "a bit of an issue with your country selection from the asset correlation perspective." He mentioned that several of the countries are tied to going up with the risk seeking trade and going down with the risk aversion trade but he worded it differently. He then added comments on the rest of the countries. He asked why not just buy commodities instead of the the countries tied to commodities.

My thoughts here have been part of a running dialogue that has lasted for years now and is still ongoing and so for someone who has never read my stuff before there is likely to be a lot of context missing.

The reason to invest in foreign anything is for diversification. One way to think of diversification is always having a few things that are going up and a few things that are going down. More specifically as pertains for foreign is to own countries whose economies have different attributes than your home country. A service based economy has different attributes than a commodity based economy, exporters different from importers, deficit different than surplus and so on. These different attributes might then mean that the timing of the economic cycles in these respective countries are not in sync which might mean that the respective stock market cycles are not in sync.

This manifested itself in the last couple of years as the markets for quite a few of the countries mentioned above kept going up for months after the US had peaked. Some countries ended up going down a lot less and some turned up a little sooner. Chile peaked in Q2 2008 so an equity portfolio that was 50% Chile and 50% US would have still gone down plenty (assuming no defensive action was ever taken) but it would have gone down less and the ride would have been smoother.

While a 50/50 split like that is not realistic a combo of different countries is but it takes time and a willingness to go narrower than EAFE and EEM for foreign exposure. The reason I say that doing this requires going narrower than EFA is that with EFA you end up with a lopsided exposure to foreign countries whose attributes are very similar to the US. Some of that is fine of course but too much of that and the diversification becomes far less effective. You can compare EFA's results over varying periods of time to many different countries and see for yourself.

Whatever countries are selected for inclusion in the portfolio, they must be blended in some sort of proportion consistent with some expected outcome. Someone favoring commodity based economies would not want nothing but commodity based economies because any expected outcome could be wrong so owning some countries that do not, in this case, benefit from commodity production could be protection against being wrong.

In past posts I've broken countries down into different types of categories. Some countries are part of the global build up and out or modernization of the emerging world. Other countries are in their own world--these countries tend to have large populations that are going to grow no matter what, even if it is in fits and starts. And other countries still are becoming increasingly more important in the world economic order. Of course some countries are a combination of two or three those descriptions.

Obviously including a country comes after some sort of study is done to understand the economy, determine that there is some reason to buy the country (or in some cases avoid it) and then figure out the best way to add it in to the portfolio while still working with the rest of the holdings. I say it often but this is a time intensive process and understand there is certainly no guarantee of always being right. As with any form of investing, some decisions will be right and some wrong.

A few years ago I had a foreign allocation in the low 30s, percentage wise, and now that is generally in the neighborhood of 40% and will probably get closer to 50% in the next couple of years. From quarter to quarter or year to year the benefits may or may not be obvious but over longer periods of time the difference can be huge. A lot of the countries I've been writing about over the last five plus years of this blog have done much better than the US and so have contributed to the result over that time. Concluding that a country could be healthier than the US is not exceedingly difficult but again this does not guarantee success but I do believe it puts the odds in the favor of anyone able to spend the time.

The picture is from Molokai.
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Merry Christmas And Forget About Retiring

For several years now I have been talking about the idea of retirement evolving into something much different that what most people think of by necessity of circumstance. In this decade we have had two events that have cause some people to be permanently underemployed, stocks have not had a normal decade, collectively we have not saved enough, assumptions about home values have been mucked up something awful, some folks have financial burdens of adult children or aged parents (or both) and there are probably other items we could include on this list.

I enjoy exploring the topic and writing about it because I view it as a problem to be solved and think there is much to learn in how people are going about trying to solve the problem.

The catalyst for this post is an article from Yahoo Finance titled 10 Reasons You Shouldn't Retire. Some of the ten reasons were the usual suspects like staying healthier, not needing to tap you retirement funds so soon, continuing to get benefits like health insurance and having more meaning to your life (this is tie in to staying healthier).

One point I have made many times before is that when the time comes you have what you have that is your reality. It does not matter how much you made when you worked or how much you had in your portfolio ten years ago, you have what you have. A lot of the content here is aimed at giving yourself the best shot of maximizing how much you have mostly by avoiding some stupid actions and side stepping certain things but if you lived a $200,000 lifestyle when you worked but only have $1.5 million in your portfolio then something is going to have to give (taking into account the 4% rule $1.5 million would generate $60,000 per year) and social security won't make up the difference.

So how we retire needs to evolve. An easy way part of the solution can be reducing your overhead. Easy in that it is easy to say but not so easy to actually do. This other article from Yahoo Finance talks about cutting expenses by downsizing you car, cable TV package, cell phone package, dropping the health club (to go jogging instead), refinance your mortgage and eat out less.

These are fairly typical suggestions. I think the best way to cut expenses are more long term oriented which is having no mortgage, as opposed to refinancing, and have no car payments. Obviously a car needs to be bought every so often but not every five years. Toyotas often can last for 200,000 miles. One thing I disagree with vehemently is the one about the health club but that's just me. Not working out is the easiest thing in the world to do but exercising obviously provides a chance for keeping health costs down which are obviously much more than $50 or $100 spent at the gym.

In addition to keeping the overhead low some sort of job would seem to be another obvious way to relieve some of the burden from your portfolio. Some sort of job not any old job. I've made the point before about trying to figure out how to monetize your hobby. Some people can do this but I think it takes a lot of planning, time and figuring and not everyone will be able to do it. Obviously if you love your career then staying with it longer would seem like an ideal solution.

I've written about a few off the wall solutions as well. I have mentioned my 78 year old neighbor who does backhoe work countless times (how many hours at $60 per would you need to supplement the income from your portfolio?).

Another one that I just found out about via Joellyn's animal rescue work is that a rescue in Phoenix has a house that they use as a 1-5 day layover for dogs and cats (no more than four of each) in between going from animal control to their foster (or permanent) home. They need someone to live there and care for the animals. They can live there for free and can work outside the home. This would be a bad fit for the vast majority of folks but will be ideal for someone. Someone is going to get a free place to live and get to help animals.

Depending on the type of town you live in there is seasonal work at sporting events. Prescott has minor league sports so the seasons are short in terms of number of home games. The possibilities are only limited by a person's ingenuity. This is a problem to be solved with innovative thought. Often the comments on this sort of post include very inside the box thinking. Successful solutions will require creativity.
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Bespoke 2010 Roundtable

I participated in the Bespoke 2010 Roundtable. Here the link to the main page for the Roundtable and this page has my complete answers to all the questions.
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Must Lose? Really? Must?

IndexUniverse posted a series of articles asking six people, including Jack Bogle and Jeremy Siegel, whether buy and hold investing is dead or not. One of the six was Larry Swedroe who said something that I want to examine a little closer. I realize that disagreeing with someone like Swedroe draws criticism but this is worth exploring nonetheless.

Swedroe cited a paper by William Sharpe called The Arithmetic of Active Management. There was no link in the article and I have not read the paper in question. Apparently Sharpe said "that active management must lose in any environment or any asset class" and Swedroe believes in the work behind that conclusion.

Again, having not read the paper and whatever criticism that may draw out the idea seems to be academic to the point of having no real world application. This is not to say beating the market is easy because I don't think it is but you know the names of people with long term track records for beating the market, there are plenty of them. They do not make up the majority of participants but must lose, no there are plenty of successful participants.

Some very simple examples that require no real acumen just vague following of current events; For someone who benchmarks to the MSCI EAFE Index the iShares EAFE Fund (EFA) goes back on Yahoo Finance to August 2001. Since that presumed inception through yesterday's close the fund is up 32.8%. Japan, which is one of the largest component countries at 21% of the fund is up 9.8%--Japan measured by iShares Japan (EWJ). The simple act of recognizing that Japan had big problems and omitting it from the portfolio and keeping every other country would have lead to a very long term out performance and again just one simple action.

Another example; In the last five years, a little less time than when the financial sector grew to 20% of the S&P 500, the Financial Select Sector SPDR (XLF) is down 52.9% while the S&P 500 SPDR (SPY) is down 7.3%. Again the simple act of omitting one sector would have made a colossal difference. Anyone so inclined to do the math for either or both examples it would be much appreciated.

The reason I picked these two examples is because I have been writing about completely avoiding Japan from the start of this site and about underweighting (as opposed to omitting) financials since the beginning of this site. Neither idea is trade-intensive but very effective and, if I've been writing about them for a long time, not difficult to isolate. Must lose? No.

Hussman frames this in a way that is far more practical and I believe he has influenced how I do things to an extent (to an extent in that his analysis seems to have far more moving parts). There are times where risk/reward for a fully invested portfolio in equities is simply less attractive. When the risk/reward is less attractive having less exposure becomes prudent. It does not mean you will be right every time but that does not have to be the goal. Sidestepping one horrible event in a lifetime can add a lot of real value to a lifelong result. For many people this sort of context becomes a more realistic way to assess the active/passive debate for themselves.
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The Beginning Of The End?

Alexis Glick announced that she is "leaving Fox." I put that in quotes so as not to misquote. I found out via Facebook but I imagine it was announced elsewhere also.

While I may be adding one plus one and getting eleven this strikes me as the beginning of the end of Fox Business Channel. To be clear I don't know anything or anyone (picture notwithstanding) but that is my first impression from this news.

About the picture, I was on Money For Breakfast in February 2008 on the Thursday (maybe it was Friday?) before the Patriots loss to the G-men in the Superbowl.

Now that I think about the beginning of the end was when Imus was put on during the Money For Breakfast time slot.
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Wednesday Roundup

First up is a quote from Stephen Roach who said "Investment in fixed assets such as factories and the rail network accounted for more than 95 percent of China’s 7.7 percent growth in the first three quarters of 2009 and made up 45 percent of gross domestic product, which is higher than any major economy in history."

This supports the idea that I have subscribed to about where in China to invest which is in the build up of the country and certain segments of the consumer sectors. The sectors to avoid, IMO, are financials and the exporters.

Next up is an interesting thread I think I've observed on the Seeking Alpha version of my last few posts. What I think I have observed is a sort of over-reliance on the extent to which things are linear. A few days ago I mentioned that I think the SPX and EAFE will be down a little in 2010 but that the emerging markets, collectively, will be up a little. One reader laid out a well reasoned argument about emerging markets needing developed markets to do well; a sort of A causes B which causes C.

Recently Bespoke posted a table with decade-to-date returns for various global markets. The US was down about 25%, similar to the UK, a little better than France and Switzerland and a little worse than Germany and Sweden. Some countries on there had great nominal returns and others had great relative returns. Norway was up 120%, Chile up 194%, Brazil up 301% as some examples. I don't know if the reader would have made the same A causes B which causes C argument ten years ago or not but the dispersion from country to country has been huge and that is likely to happen again.

To the point of avoiding the right the things, according to the iShares website the decade to date number for the MSCI EAFE Index is +2.55% which I find shocking given the results from the UK, France and Germany (mentioned above) and Japan which was down 49% but assuming it is correct the examples of Norway, Chile and Brazil are from from obscure. China was up 136% and India was up 243%, neither of those are obscure either. Avoiding the right countries was very important. Simply put I do not believe the endeavor of investing is always and everywhere linear.

Another reader, perhaps he was heckling me, congratulated me for market beating stock picking in the article about the ETF portfolio from Hedgeables that allocated 27% to a total stock market fund. I had noted that depending on the account size 27% into equities could be enough for a fully developed portfolio. This reader said that VTI holders could swap into individual stocks but the track record for active managers is not good. The line does not have to go from VTI to individual stocks. There are plenty of country funds and sector funds that allow for constructing a portfolio targeting very narrow segments.

The other point here again is that avoiding certain things can be more important than what is included. The two most important domestic sector trades for this decade obviously would have been avoiding tech nine years ago and avoiding financials three years ago (both provided pretty good warnings of trouble even if they did not warn of the magnitude).

To repeat I do not believe the endeavor of investing is always and everywhere linear.
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BAB Correlations

Yesterday the folks at Powershares sent around an ETF report that included a lot of information on their new Build America Bond ETF (BAB). As I have mentioned before I am favorably disposed to the segment and the fund but do think that at a minimum it needs a few months of trading under its belt before I would be comfortable buying some.

In the report was the table of correlations to other asset classes and other bond market segments. A crucial element of portfolio construction is the interaction of a thing with the other things in the portfolio. Part of this understanding comes from looking under the hood (if we are talking about an ETF) but some must also come from observing actual trading. It is ok to give a fund a few months to build a little track record without you. The fund will still be there in six months.

Chances are the numbers in the table are not a shock to anyone but still instructive. It has a 0.89 correlation to ten year treasuries, it looks as though the index underlying BAB yields quite a bit more than the ten year however.

This serves as a warning of sorts. Even after a noticeable move up in rates in the last few days 3.68% is a very low number by historical standards. Additionally the current environment of debt issuance creates a visible path to higher rates.

The above does not ensure higher rates just creates visibility. If ten year treasury rates do go up then the prices will go down and based on the history of the index underlying BAB so too will build America bonds. As a rule of thumb increase in yield of 100 basis points works out to about an 8% drop in price, obviously it could be a little more or a little less with an ETF. The difference with an ETF is there is no par value to collect at maturity.

According to Yahoo Finance the ten year yielded 6% or more the vast majority of the time from 1969 to 1997. Although Yahoo Finance does not go back past 1962, yields were generally lower than 6% most of the time before that in the 20th century.

You can decide for yourself what normal is, whether rates are going higher or not and if they do go up how much but it should be clear that if rates go up BAB will feel that pain. Owning BAB means believing rates will not go up or being willing to actively follow the interest rate market and being willing to take action of some sort if rates do start to rise in a meaningful way.
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Hedge Fund Portfolio With ETFs

This week's Electronic Investor column in Barron's was mostly about a company called Hedgeables that builds ETF based portfolios that try to capture hedge fund strategies to deliver hedge fund results. The article makes it seem as though the focus is on risk adjusted returns which is always interesting to me.

I am intentionally not looking at the website nor am taking in any other info than what was in the article to just focus on what Mike Hogan (the author) reported as being a portfolio that Hedgeables had recommended at some point (I take the following to be a past tense example not how they are positioned right now, apologies if this is incorrect).

As best as I can tell at one point they allocated as follows;

Total stock market ETF27%
Total bond ETF 23%
Pacific Region stock ETF 7-10%
European stock ETF 7-10%
Gold ETF 7-10%
Yen ETF 7-10%
US oil/gas pipelines ETF 7-10%
Malaysia ETF a few percent
Peru ETF a few percent

The article is not more specific than that on the numbers which is reasonable, I took the numbers verbatim from the article. It is not clear to me if total stock market means just US stocks or is an all world fund but I find the mix to be very interesting. Apparently the above combo was "completely uncorrelated to the S&P 500 index," only had 60% of the risk of owning SPY and had "an absolute return of 19.53% annually." I do not know the time covered and not sure what to make of it in that the Peru ETF hasn't been around that long (perhaps a back test of that fund's underlying index?).

I find the mix to be be very interesting and instructive in terms of blending things together. If you read enough ETF content you will see a lot of ETF portfolios and most of them, quite candidly, are not interesting and more importantly do not convey that much value will be added but the Hedgeables portfolio does give me the impression that some real innovative thought is behind the finished product.

I've written a lot about portfolio construction and trying to capture certain effects and nuance and anyone who has been reading this site for a while probably knows I come at this differently but still I think there is something to learn from the exposures listed above.

Using ETFs to create sophisticated, on a risk adjusted return basis, portfolios is one of the second level attractions (once you get beyond the basics of low costs and transparency) but of course there is no need, IMO, to only use one type of product. The intellectual interest of the Hedgeables portfolio is the blending of asset classes. Depending on the size of the portfolio the 27% could be $300,000-$400,000 which is certainly enough for a fully developed equity portfolio and in that instance the 23% for bonds would be enough for a fully developed bond portfolio. I'm not sure at what dollar level 27% of someone's portfolio should go into just one ETF but I certainly would not buy a total stock market fund with $100,000.

I would take this as a template to learn from not a way to do less work.
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Sith Lords or Something Else?

The notion of Skeletor is much funnier than Sith Lords.

BTW there is a now a group on Facebook called Sith Lord Conspirators.
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Sunday Morning Coffee

The Pragmatic Capitalist posted an interesting chart showing the Shanghai Composite appearing to rollover. The Seeking Alpha version of the post was titled China:It Looks Like The Easy Money Has Been Made which while I think may not have been the best title, the notion of easy money being made is worth exploring and understanding.

Early on in a theme, generally speaking, is when stock selection is least important because everything goes up a lot. A few years ago I owned an oil stock for Chinese exposure for most clients and a couple of people owned iShares China 25 (FXI). I preferred the oil stock but had no qualms in owning FXI for anyone where individual stocks were not ideal. I exited China in Q2 2007 and then got back in in Q3 2008 but FXI was no longer an acceptable proxy for me because of its very large weighting in the financial sector (I have since mentioned countless times that I believe financial sector exposure in China is a very bad idea).

I would not necessarily say that Chinese financial stocks have been so bad to own compared to the broader Chinese indexes but the fundamental risk of owning them has increased dramatically. As time goes on in the life of an investment theme it makes sense to expect more and more work will need to be done to isolate attractive risk reward tradeoffs for the particular theme (in this country).

On a related emerging/frontier market note Yahoo ran an interview of Mark Mobius that yielded a couple of interesting nuggets. First of which is that he owns DP World which is the publicly traded ports business of Dubai World. I mentioned this company a couple of weeks ago. It owns ports all over the world, I mean all over. It obviously offers exposure to commerce on the ground where it has a presence and so seems like it could be a proxy for global economic activity as opposed to for just Dubai or even just in the Emirates but globally.

This is interesting and hopefully serves to get you thinking about how foreign investing might evolve in the next few years. The stock itself cannot be held at Schwab, don't know about other brokerage firms, and its price, which is well below $1, makes it unattractive as buying 10,000-30,000 shares for each client would make for huge commissions let alone the liquidity of trading it but in terms of the future, still interesting. And keep in mind that these things do evolve. We now have easy access to Vietnam and Poland which previously were very difficult.

Mobius then went on to talk about some markets that will be investment destinations in the future, or perhaps more correctly, easily accessible investment destinations. These included Pakistan and Qatar. I have mentioned Kazakhstan in this context and I believe (as do other people) that Iran will be an important investment destination at some point. The country is the 17th largest (600,000 square miles compared to about 3 million in the US) has a ton of oil and natural gas but cannot refine the oil. Assuming it stabilizes politically at some point (and maybe that takes 100 years or maybe not...) there are efficiency and lifestyle improvements that could make the country an investment bonanza.

I believe Kazakhstan has a more diverse resource base but less to overcome before being viable (corruption is huge problem for now) and there are other countries that will merit future exposure. The reason to follow them now is that it easier to be comfortable with a place you've been studying for a few years than waiting until it greenlights as a place to invest because an ETF gets issued.

The picture is from inside a seafood restaurant in Helnar, Iceland which is as close as I've ever gotten to visiting an emerging market country (of course it isn't). Oh wait, Mexico in college.
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The Big Picture For The Week of December 20, 2009

A few odds and ends this morning.

From the Generalisimo Franco is still dead file Morningstar still does not get it with ETFs. You can read Matt Hougan's takedown of an article about buying an energy related ETF on takeover speculation based on the recent XTO news. Good gravy, the only thing I would add to Matt's thoughts is that it wreaks of Ten Hottest Stocks Now!

Felix Salmon has a funny post about never investing in Art Funds. There are a couple of these floating out there along with a wine fund or two. The angle on these is always the same; the returns appear to be great and the correlations to equity indexes low. Learning about these things is always interesting (well, to me anyway), I've mentioned the Australian Meat Fund a few times before (real concept, not the correct name, Macquarie has the fund I'm talking about but it is not listed).

Owning one or two "diversifiers" in moderate weightings is fine but I prefer exchanged traded vehicles and I prefer them to be simple. Too much exposure and you end up with a portfolio of diversifiers hedged with a little bit of equity exposure.

Pimco has raised the cash level in its total return fund to 7% from a negative 7% and reduced its exposure to government related securities recently. The obvious conclusion would be concern over a back up in interest rates. I'm not positive if that is the reason but I thought it'd be worthwhile to pass this along.

Barclays has labeled ten countries as "advanced emerging markets." The ten are Brazil, Chile, Singapore, Korea, Taiwan, Israel, China, South Africa, Poland and the Czech Republic. We can worry about the idea that several of them may not be emerging anymore later. The logic here is that these countries have "a future of solid growth without the volatility and tail risk characteristic of the original emerging-market countries."

This reminds me of the N-11 concept that originated from Goldman Sachs JB Were. Those countries are Mexico, Korea, Bangladesh, Egypt, Indonesia, Iran, Nigeria, Pakistan, the Philippines, Turkey and Vietnam. As my thoughts on the importance of country selection evolves I think the delineation between developed and emerging will become less important.

Mebane Faber has a post up about asking yourself tough questions regarding tolerances for risk (I would replace the word risk with volatility). Basically the market puked down then had a massive rally in last nine months of 2009 which is a gift relative to where the market was in March. Mebane asks you to ask yourself what have you learned and what are you going to do with what you have learned?

And one closing thought. Part of the problem in 2008 was that correlations all went up causing people to doubt the merits of diversification. Um, how different has 2009 been in this regard?
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Friday Randoms

First up is that SPDR came out with a 1-3 year corporate bond ETF that has ticker symbol SCPB. The fund is brand new and so very likely not fully deployed but there is a download of the holdings available. The number of issues in the fund is about 30 versus over 500 in the index so they have a little ways to go to look more like the index.

According to the fact sheet the index, that's the index not the fund, has an average credit rating of A2/A3, the yield to worst is 2.69%, it has 46% in industrial companies, 45% in financials and 8% in utilities. One thing to point out is that if you download the holdings of the fund you will see a lot of coupons in the sixes and sevens but that will not be the yield. The 2.69% may or may not turn out to be correct but do not think the yield of the fund will be 6%, it won't be. At least not now.

That the fund has a lot in industrials is a positive, that it has a lot in financials is a negative. In the last year or so I have added similar exposure for client accounts as this fund in the industrial sector, tech sector and healthcare sector. PowerShares has filed for bond funds that go to the sector including the industrial sector. That one could be a great hold for people not looking to use individual issues for corporate bond exposure.

Ok, jerk store time but the Seeking Alpha Sector ETF panel seemed like a bit of a dud to me. Kim Arther makes active sector decision in his practice so his inclusion makes sense. Matt Hougan from IndexUniverse dissects sector funds in some of his writing and contributed in this regard to the panel so his inclusion makes sense.

Tom Lydon is more of a technical analysis guy over fundamentals. As I understand how he does things he could own a bunch of sector ETFs or none at any given moment. I am not critical of his approach in the least but it seems as though he is sector agnostic. If the chart is good then it can be a buy and if the chart is bad it can be a sell. That sounds agnostic to me so I'm not sure he was the best choice for this panel.

JD Steinhilber said he only uses broad based funds except for Market Vectors RVE Hard Assets Producers ETF (HAP). JD's approach is different than mine obviously which is fine but why invite someone who doesn't use sector funds to talk about how to choose sector funds?

I'll sneak in something here that I have mentioned a couple of times that I believe is going to be very important. As important as sector selection (avoidance) has been for the last couple of years I believe country selection (avoidance) will be just as important in the next few years.

I've participated in a couple of 2010 surveys and a couple of things that I'm leaning towards, resulting from a combo of contrarian thinking and fundamental opinion;

SPX down 10%

EAFE down a touch more (because of exposure to big Western Europe and Japan)

Emerging markets up 5%

Ten year US treasury to 4% (I have since concluded it will be higher than that)

Favored sectors telecom, healthcare, staples and utilities (selectively as rising rates are a negative for utilities)

So we'll see what happens.

After three previous visits from Qwest, including one where I had to shovel out the guy's truck so he could leave, since our big snow and wind storm on December 7 our landline is finally fixed. They sent out two workers and a manager of some sort yesterday. What needed to be done was that someone had to go through the snow a couple of hundred yards into the forest and fix the line and no one wanted to do this until yesterday.

They showed up while I was at the gym. I had to park up top walk down the driveway because there were still here when I got back, they were just finishing up. As I am walking down the manager, or whatever, was throwing snowballs at the two linemen and hitting my house with a couple of them. Taking a page from most interesting man alive, the right look sufficed. The other funny thing was that one of the crew told Joellyn that we would have DSL on the mountain in a few months. Hmm, do we really want to bet on these guys for internet reliability?

Lastly the shoes. Kevin Durant of the OKC Thunder is now sporting the Orange Creamsicle, AKA the KD2. As someone partial to orange creamsicle I told my wife I must have them. She shut that down before I could even finish the sentence. Not sure if I need to disclose Nike as a client holding when talking about orange cremsicles but it is a client holding.
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GlobalX Energy ETF

GlobalX launched its fifth out of six planned China sector funds, the most recent being the Energy Fund (CHIE). The only remaining fund from the original filing is the materials fund but it appears as though they may wait a little while for that one.

Before a look under the hood was available I had wondered how heavy it would be in the NYSE traded mega cap energy stocks, Petrochina (PTR), Sinopec (SNP) and CNOOC (CEO), and what my reaction would be.

Some of the other funds in the line limit exposure for one stock to 4.75% but the financial fund (CHIX) allows some holdings to be 10% and apparently so does the energy fund. CHIE allocates 10% each to the three mega caps listed above, though not the NYSE listings, and also China Shenhua Energy a coal company which appears to have an ADR with the designator CSUAY. For clarity the weightings of these four may actually be in the nines at the moment.

Included in the 4.75% tier are names that might be somewhat familiar like Huaneng Power (HNP) which is more of a utility company and a couple of the solar stocks like Suntech Power and Trina Solar.

Alternative energy comprises 18% of the fund. This is unusual in that solar companies tend to be equipment makers and so better thought of as industrial companies. I'm not sure if any of the alternative stocks are wind oriented or not but I know there are a few wind companies in China and I would generally find those to be a little more interesting.

My first exposure to China was through the oil majors, I've since moved elsewhere within China. The idea, which I think I first heard talked about by Puru Saxena, was that Chinese per capita use of oil was about 1.25 barrels of oil whereas in the US that number was about 24 barrels. While it is unlikely that China will get anywhere close to US per capita consumption levels a move to two and then three barrels would be enough to move the global needle and generally be a positive for the Chinese oil majors.

I believe this line of thought to be still intact and if it is then I would think CHIE would mostly capture it by virtue of its 43% weighting to oil and gas but at just 43% it probably wouldn't be a pure play. Also I am not sure if the 18% in alternatives is enough to change the volatility characteristics of the fund versus just owning PTR or the like. And to muddy the waters a little more, if the alternatives do weigh enough to increase the volatility would the 16% in "electric," which I presume to be utility stocks, neutralize that increased volatility?

From the top down I think energy is a valid way to access China. First and foremost it is not the financial sector and is it not really about exports that rely on the US consumer (yes in a way increases in manufacturing activity means more energy consumption but I don't think of it as being direct).

Tying in yesterday's comments about figuring out the best exposure to choose for country or a sector it is tough to know whether CHIE will be the best or not. The fund does not make a bad first impression but like with most new funds, it probably makes sense to see how this trades before considering any action.
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Norway

The Norway Trade

Enough from me about Norway, above is another take.
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Sector ETF Panel

On Thursday at 2pm EST Seeking Alpha is hosting a live panel about investing in ETFs at the sector level. The panelists are Kim Arthur, Matt Hougan, Tom Lydon and JD Steinhilber. The links in their names will take you to an article by each of them featuring their answers to the same five questions about sector ETFs which were like a primer for the panel.

While I am not participating I thought I would take a stab at most of the same questions.

1. What are the key factors you're looking for when choosing a particular ETF among many available to capture a given sector?

My take here is different than the panelists, although Tom Lydon does cover some of the ground I think is important. As I start from the top down (a couple of the panelists are also top down but maybe the logistics are different?) I figure out what exposures I want. By exposures I mean, sector weights, countries, volatilities, cap size, yield (sometimes) and style (also sometimes). From there it becomes about the best way to work these opinions into the portfolio.

For example sectors like energy and financials are easy places to add foreign exposure because just about every country has a bank and oil company. Materials can be a good way to add volatility as another example and so on. If energy is indeed a sector where foreign is to be added what then becomes the best way to do that? For me this means an assessment of countries and then how to add the preferred countries. Where there is choice those choices must be weighed against each other, how they might interact with other holdings in the portfolio and on their own bottoms up merits. Where there is only one choice that choice must be assessed and ruled in or out. If it is not obvious this process is time consuming.

2. Can you give an example of two sector ETFs that you considered, and why you chose one over the other?

Read the answers each of the panelists gives. I would focus more on what is under the hood. For example there are some sector funds that offer international exposure or other funds that combine domestic and foreign or just domestic. Additionally there are specialized, or theme funds that can also serve as a proxy for a given sector. With the industrial sector there are broader funds that are probably heavy in General Electric (GE) or other funds are heavy in Western European companies.

Another way to come at this sector then would be some of the infrastructure funds or maybe wind, solar or water funds. If you invest at the sector level you have very likely thought about these narrower groups even if they are not necessarily right for you but these are the choices in terms of funds and what you have to choose from. Anyone open to a blend of ETFs and stocks obviously has more to choose from.

3. Is ETF selection and portfolio construction something the individual investor can effectively do on their own, or given the complexities and the dynamic nature of this market, do you think it's best left to a professional?

As I have said repeatedly; for most people, I believe this boils down to time available to spend on the task.

5. What are your thoughts on the relatively new actively managed ETFs? If an investor is interested in purchasing an actively managed ETF, what are the important elements to look for?

The general thing with actively managed products that I don't like is that you do not know what it will own in six months making it very difficult to implement forward looking analysis. This issue is not as big of a deal with an actively managed sector fund. You know that an actively managed global utilities fund will always own utilities stocks. You wouldn't know what countries you would own six months from now but leaving that to a manager you believe can add value might not be the worst thing in the world.

I'll conclude by circling back to a couple of things. Understanding how a fund is likely to behave is crucial. Chances are a solar fund will be much more volatile than a mega cap dominated fund for example. This is neither good nor bad, it just is. If you build a portfolio at the sector and country levels you need to understand the dynamics of the sectors and countries, have a sense of the holdings in the funds and understand the volatility characteristics of the funds.

To repeat a point I make a lot, the only thing easy about ETFs (beyond SPY and IWM) is the access.
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Run From These ETFs As Fast As You Can

So maybe that title is a bit much. I read an article (link intentionally not provided) about the quirks inherent in a couple of the more notorious exchange traded products that concluded with advice that these funds, one of them was US Natural Gas (UNG), "should be avoided by all but the most sophisticated investors."

I would come at this differently. Sophisticated is not the right word IMO. Generally speaking the typical person just trying to have is money grow in a reasonably diversified portfolio may not need UNG or the like but I think how a portfolio is constructed is mostly a function of how much time is spent on the portfolio.

Chances are the typical do it yourselfer with a full time job and a family won't have the time to manage a portfolio of 40-50 stocks, but of course he might. Jim Cramer offers a rule of thumb about needing one hour a week for each stock owned in a portfolio. While that idea is way too simplistic, some weeks need more than one hour and some weeks need close to no time (this is where news feeds can come in handy, oh Motley Fool article, never mind), it makes a point that time is needed to follow each holding.

In assessing these "sophisticated" funds it doesn't take a whole lot of time to get a decent sense of what a fund will be like. For example if a fund is going to own futures then it will be subject to the normal goings on in that market. At times contango is a big issue for oil for example--to the point of creating the appearance of the fund of "not working." Owning these funds requires an understanding of contango and backwardation and I think an understanding of the dynamics influencing changes in the degree of contango or backwardation or what would cause the market to go from one to the other.

Another example is the Macro Shares Housing Up and Housing Down products. In addition to having an opinion on the Case Shiller Index you also have to have opinion on the market's perception of that index.

Personally I don't want to spend time on any of that so I don't own the funds. The energy products can also be moved a lot by things having nothing to do with supply and demand (more so than other commodities).

Don't take the above as my saying you don't need to read the prospectus but I am saying it is not the first thing you need to read. Chances are a quick read of an article at IndexUniverse or Seeking Alpha is enough to know whether you have a general interest in learning more. Prospectuses are not fun to read so reading one for a fund you will never want to own seems unnecessary.

There are reasonably some things that could be difficult to foresee like being forced by a third party to halt creations. This has happened a couple of times and while a few years ago this may have seemed like something that would never happen we now know it can. The more complex the fund it would seem the the greater probability for some sort of problem in the future. Even if you can't guess what that problem would be you probably now know more about this than you did before.

The vast majority of ETPs I have used have been plain vanilla funds tracking baskets of stocks which have a lower probability of running into problems than do ETNs or futures based funds. We do hold PowerShares Agriculture (DBA) which is futures based and SPDR Gold (GLD) which owns bullion (I am not in the camp that believes they are lying about holding the bullion in vaults) so they have more of a chance, IMO, of having a problem at some point but I do think the chance is low.

If there were one fund that has future unforeseen problem written all over it I would think it would be the new iShares Diversified Alternatives Trust (ALT). A look under the hood is a little confusing as to what the strategy is. I have not read the prospectus yet (I may write about it for thestreet.com so a little prospectus time would be warranted in that case) but as I understand the product it is an actively managed go anywhere vehicle.

I'm not saying there will be a problem but there is a greater chance for one that with a generic equity fund.
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2010 Country GDP Growth Estimates

Bespoke Investment Group: 2010 Country GDP Growth Estimates

Very useful table after you click through. Singapore, 5.5%. Wow.
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Hussman Out Early

Hussman Funds - Weekly Market Comment: Decidedly Speculative - December 14, 2009

Based on this week's post we can only infer that he had a bad weekend (a little humor in light of the dark outlook in the post).
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Sunday Morning Coffee

Ah, life on the mountain. I'm sure there are several life lessons in this and I'm sure this tale of stupidity has applications for investing but if not then hopefully it can be amusing nonetheless.

A little background; apparently the snow and wind storm we had Monday was a hurricane of sorts. The wind that took down so many trees and utility lines was north of 70 mph. Winds of this speed were prevalent in many places in the state and I guess hurricanes kick in at 74 mph? Even if not exactly right you get the idea.

Landlines have been coming and going all week but it has been out now for a long enough time that we thought it would be a good idea to call Qwest and make sure they knew. Joellyn called in and was very clear that this is a problem for a lot of people and that the roads up here are a mess. There has been an army of Qwest guys up here working the whole time and we just wanted to make sure they knew the phone was out.

The woman at the call center seemed to have no idea that there were workers up here or that there had even been a weather event. There can be no explanation for this that would instill confidence. Either she really was clueless (not her fault) or she has to act like she does not know (also not her fault).

Joellyn reiterated that no one should come down our driveway because getting out would be very difficult and that, again, this is a problem affecting many people.

Well something got lost in the translation because a guy showed up, came down our driveway and was spinning around violently coming uncomfortable close to several hazards, like our SUV and propane tank, in order to point himself forward. I went out there and he said "well at least it is pointed the right way." I explained to him what was what and that we relayed this to the call center person. He took it quite well actually and never acted like he was ticked.

He seemed content to wait for someone to come get him out but I noticed he had a shovel on his rig so I mentioned that, said I would get my shovel and we would dig him out. There was no way I was going to let him wait here for a couple of hours. I shoveled out two of his tires and presumably he shoveled out the other two but he made no meaningful progress up the driveway.

Alright more shoveling then. Now keep in mind a neighbor came by yesterday with a backhoe and plowed the part of the driveway I hadn't already shoveled so there was plenty of dirt but still spots with a couple of inches or so of slush. About 30 seconds after we started, me on one track and he on the other, he let out a whoooh, I said yeah we're up here (we live at 6900 feet).

He turned out not to be much of a shoveler. Along the way I heard that he is not in shape, takes medication and at one point he was lightheaded. Oh boy. I just plugged away, I had to pause the Montana Appalachian State football game and wanted to get back to it, and he did what he could. We made a decent runway and there was plenty of dirt up above so he should have bee all set. He made several runs and I swear it looked like he was taking the wrong line and taking down some snow from the side. He got half way up and spun out again. Dude?!?

He had all dirt on his right I don't know how he could have gotten stuck again but he did. By this point he was on the phone calling for help (at one point he said to whoever was on the other end of the line "because I'm an idiot") as I kept shoveling. I practically cleared his path of all snow and he made it out finally. Up top he got out and thanked me and said he didn't think he would get out and said something positive my remaining optimistic. I said he was definitely getting out it was just a matter of whether it would take 40 minutes or two hours (it took 40 minutes). Stubborn as I am there was no way it was going be anyone but the two of us digging him out.

The dispatcher did not relay all the information this guy needed, he did not recognize the situation for what it was, had the wrong equipment (Ford 350 dually that was two wheel drive) and he was not able to provide a reasonable portion of the work needed for the solution.

Joellyn's Facebook status from the middle of all of this; what about the driveway is slippery did Qwest not understand? looks like we now own a Qwest truck! He can comeback in the spring get it.

Oh I forgot to mention that as he was violently spinning around to point forward he broke a couple of things off of his truck.

As I think the picture shows it is very serene up here in the winter but it can also be very treacherous.
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The Big Picture For The Week of December 13, 2009

Rolfe Winkler posted about an appearance he made on public radio in Oregon. Here, for me, was the winning quote;

A caller made the good point that government stimulus for jobs is a bad use of money, once the stimulus is gone, so is the job. The caller didn’t finish the point: after the stimulus and job are gone, the debt is still there.

In the darkness of our home this week I started to read When Giants Fall by Michael Panzner, I gave up on it after the introduction for being, in my opinion, over the top pessimistic. In there in talking about empires falling he mentioned Rome. Comparing the US in the 21st century to the fall of Rome loses it for me because one of the reasons the US is at the top. Many other countries contributed to putting the US on top and they contribute still to keeping us there. This is a dynamic that did not exist when the Roman empire was conquering the world.

This does not change my opinion in the least about the US being less attractive as an investment destination and my wanting to have continually less US exposure, a path embarked upon several years ago. And course the US staying at the top may be changing.

Back to the quote from Rolfe's post. Whatever you think about the effectiveness of what has been done so far and whatever might occur in the near future in the name of stimulus; afterward the debt will still be there. There will be growth that offsets some portion of the debt, this is always the case so debating whether there will be growth to bail out some of the debt is useless because there will be some. However how much growth offset we get is up for debate and for now I lean low, meaning I don't think any growth offset will be meaningful.

The willingness to borrow and spend, despite the extent to which borrowing and spending got us into this mess (this is a line of thought Jimmy Rogers had spoke of many times), seems limitless. There is something to the idea of being willing to go into debt to try to solve the problem but of course the debt was already massive.

I have no idea if I can figure this all out ahead of time but I wouldn't bet on it and more importantly I am not betting client money that I can. This means, repeat theme, slowly adding more foreign.

This was a "time bomb" post, we are still without power. The power is back on but I hope the post is still useful.
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Passive v Active Evolves

I wanted to follow up on yesterday’s video about active versus passive investing. In the video I made the case for a third path, really I’ve been making this point for a long time, of making an attempt to sidestep when markets go down a lot.

Throughout these conferences that I go to there is very little attention paid to things like defensive strategies or managing volatility when it is these things that many people care the most about. A couple of years ago I asked a question to a panel about how they manage volatility and none of the three did anything like that.

We can debate where the line is between art and science where investing is concerned but it is an evolving discipline. The tools at our disposal evolve, the relationships between various markets evolve as do the relationships between the various asset classes. It is likely that we are living through some sort of evolution of the US’ role in the world economic order right now.

In these types of posts there are invariably comments where the reader sees no need for whatever; country selection, defensive action, sector funds whatever. OK I guess, but to the extent you feel differently there are choices that can be made and tools that can be utilized that some folks do use but most do not.

If you somehow pull off Serrapere’s 75-50 in your portfolio (trying to capture 75% of the upside but only 50% of the downside) then you are obviously getting a fantastic risk adjusted result which will become very apparent after a full stock market cycle. The quest for alpha does not have to mean being up 80% in an up 20% world. Much to my shock not enough people get this.

I believe people lose sight of the really big picture which is that hopefully they have enough money set aside when they need it. The amount of money you accumulate for whatever your goal is will come from some combination of savings, growth and avoidance of truly stupid actions. That is the really big macro. A decent risk adjusted result, and what Serrapere targets is better than “decent,” or put another way smoothing out the ride goes along way to removing the most common obstacles to the desired result. You can either be open to the various tools that give a better chance for smoothing out the ride or not but the framing of how we look at passive versus active is, IMO, evolving into an antiquated discussion.
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Thoughts on the evolution of the Active Passive Debate

We are still without power but did make it into town to catch up on the world. In roughly 48 hours I have had 117 emails, cripes.

I shot this video last night, it is about my observations of a debate about active versus passive between Gus Sauter and Laurence Seigel that occurred at the Super Bowl Of Indexing.

The video is a real video even if funny as opposed to the one from a couple of weeks ago at the basketball tourney. I have a "time bomb" post scheduled for tomorrow that is a follow up for the video. Until the power comes back, which could be quite a while, I'll head into town to catch up every other day, maybe more. I will continue to post to the blog either in real time or "time bomb" fashion.

Thanks for bearing with me on this.
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Power Is Still Out

Roger wanted me to relay that the power is still out, and going to be out for what looks like several more days. He will try to go into town tomorrow, and among other things, update a blog post. Posted by Roger's Assistant
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New China Tech ETF

GlobalX recently launched China sector funds for consumer and industrial and today Claymore launched a tech ETF with ticker CQQQ. It is heavy in the Chinese internet stocks we have all known for a long time like Baidu, Sina and Netease.

One of the things about China ETFs, sector or otherwise, is that I would rather seem them offer access to parts of the market that are not otherwise easily accessed. That does not make a fund necessarily better but it does offer an alternative to what is out there and CQQQ really does not.

You've probably heard of Huawei (pronounced wah-way) the Chinese networking company that is not publicly traded. While obviously no ETF would have this company there are other tech companies in China and seeing fund just of those stocks, that is not easily accessed in the US, would make for a more interesting fund.

Hat tip to IndexUniverse.

Just got an update on the electricity situation and it is not promising. So again, if there is not post it means the power is still out.
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Regulation

Later today I will be a panelist in a session about regulatory reform. Our "homework" assignment was to think about what, if regulated, would be a very bad thing. This could include unintended consequences or any other negative outcome.

My initial reaction is a rather boring one because of how obvious it is. The worst possible thing would be anything that disrupts or otherwise impedes investor access to plain vanilla equity index products. My idea of plain vanilla is any fund that simply owns equities either by completely tracking an index or via some sort of sampling but under the hood all that is there is stocks.

The other part of the homework was what needs regulation the most. This is tougher for me. To paraphrase someone else; guns don't kill people, people kill people (what would you expect someone from Arizona to say?). If someone is dumb enough to put too much of their money in a 3X levered fund I tend not to have a lot of sympathy. People interested in the "most dangerous" funds tend not to read what they need to read to understand this stuff, I am talking about the most complex of ETPs.

I sort of participated in a conversation last night with the cigar chomping brains behind a couple of very controversial ETPs. He said that when someone interviews him he always says "well, when you read the prospectus..." and of course the reporter did not read it. I talk a lot about ETPs creating easy access but there are no shortcuts where the due diligence is concerned. If you don't want to read the prospectus of some complex fund then don't but then you should not buy the fund either. There are plenty of products I don't write about and the reason is that I don't want to try to wade through all the nuance when I know I will never own the product. Not reading is fine, the problem is the not reading but still buying, that is where people get into trouble.

I am headed back to Prescott this morning after my session. As of last night our power was out because of the snow with no ETA of when it will come back on. If there is no blog post tomorrow morning then you can assume the power has not come back. The picture is of Pee Wee enjoying the fresh snow, Joellyn got it on Facebook before the power went out.
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No Country For Old Alpha

That is the tagline for the Super Bowl of Indexing that I am headed down to later today. Needless to say it is hysterical. That tagline can mean different things to different people of course, still I think it is brilliant, but I think it is what have been trying to explore here over the last five years minus the clever tagline.

Alpha can also mean a better risk adjusted result not just higher returns. While not all ETPs will end up being useful, chosen selectively and weighted properly they are an increasingly important part of the solution.

A big theme here has been country selection and sector weighting. I can't be certain how difficult country selection and sector weighting really are I doubt it is as difficult as many people think especially when attention is paid to not overly relying on any one outcome. Discretionary stocks tend to do better early cycle, staples tend to do better late cycle along with healthcare stocks, China was up a ton by the middle of 2007 then it went down a lot, Australia has no subprime loans, big Western Europe has a lot of the same problems that the US does.

These are all fairly casual observations that are easily made and then implemented either with purchases or avoidance of certain market segments. ETPs obviously make this much easier to access.

Today I will be moderating a panel titled "IS THERE STILL A NEED FOR AN ALLOCATION TO INTERNATIONAL DEVELOPED MARKETS AND THE IMPACT OF CROSS MARKET CORRELATION." Based on the conference call we had last week I believe one of the panelists is in the all world index camp so we may be able to mix it up some depending on what the other panelists think.

Tuesday I am a panelist in a session about regulatory reform for ETPs but we've been given free reign to go wherever we want with that one. We have a brokerage guy, a product guy and an RIA (yours truly) all moderated by a lawyer--this could be the best conference session I've ever participated in.

As I have been attending these things over the last few years I have observed a reluctance on the part of professionals to embrace new things. The move into ETFs, given the utility they offer, has been much slower than I would have thought. Yes they are used by a lot of people but that is mostly the the broadest of funds like SPY and EFA. This has not been sufficient for long term portfolio success during this cycle. I think it would be a bad idea to bet on these horses for the next cycle.
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Sunday Morning Coffee

Some interesting reading this weekend as we brace for a pretty big snow storm due to hit Monday afternoon. I've got a ton of stuff to do today before the storm and before I head down to Phoenix for the Super Bowl of Indexing on Monday.

First up is this run down of sorts of various issues tied to climate change from the New York Times ahead of the big get together in Copenhagen. It is a pretty tidy explanation of quite a few of the talking points but does not get into any real nitty gritty.

This issue really whips up a lot of passion ranging from complete hoax to immediate and imminent doom. Like most things the answer will probably be in the middle somewhere. We know that there is a natural cyclicality of some sort (the ice age) so the idea that there could be some observable movement (that is not life altering) over some 50 or 100 year period certainly seems plausible.

As far as man's contribution to speeding things up or not I am not certain but I do know that the summers in Phoenix are now hotter than when my wife was a little girl there. The number of square miles that are now paved to accommodate new houses and all that goes with them has grown exponentially. For anyone who knows Phoenix, when I first got there in 1990 the intersection of Hayden and Frank Lloyd Wright had one car dealer on one corner with nothing else near by and now that same intersection has essentially become downtown Scottsdale in terms of the commerce, highways and houses that have filled in.

One knock against the concept I have heard is that the hottest year ever was in 1997 (or maybe 1998). It would seem to me that if this is real that it would happen at a glacial pace (insert knee slap) and more ebb and flow as opposed to go in one straight line.

One thing I've read many times and agree with completely is that ultimately money will talk here. When other forms of energy become universally cheaper than fossil fuels is when we will see meaningful change.

Next up is John Mauldin getting interviewed by Damien Hoffman over at Wall Street Cheatsheet via Barry Ritholtz. John offered up a couple of economic tidbits and a couple life nuggets. On the economic front he put together an argument for needing to create 17-20 million jobs to get the unemployment rate back down near 5% which sounds impossible to me but he believes that it can happen because it has to just like it did 30 years ago.

One thing that is true is that there will be some people who if they did nothing to pull themselves up by their own bootstraps would be permanently disenfranchised. What I mean by that is there are people who have lost their homes and stand to be permanently underemployed. Of this segment some portion will pull themselves up and accomplish great things and the other portion not. Mauldin appears to be betting on the former and I hope he's right.

Barron's Trader Column had one little item that resonated in an odd way. There was mention of some strategist "making a persuasive case" for the rally to continue. My immediate thought was "we're up 60%, I wouldn't want to try to make a persuasive case." I am quite happy to be mostly going a long for the ride while remaining skeptical. We have a some cash and a dash of SDS. The combined weight of these two has been shrinking as the market has gone higher and would increase if the market went down leaving us pretty close to the market right now which, given my belief on trying to add value over the entire stock market cycle, leaves me quite happy with about four weeks to go.

Last up was an article in the Washington Post about Neel Kashkari who has been living in a cabin somewhere in the vicinity of Lake Tahoe. He need to "de-tox" from Washington after leaving his job as TARP czar and is doing so by building a shed, chopping wood, losing 20 lbs and helping Hank (Henry Paulson) edit his book.

The article seemed to portray him as being happy there in the mountains doing things with his hands but it is clear that this is temporary and that he will go back to work somewhere in the business. It is very interesting to read what motivates people. Obviously the idea of staying in the mountains and letting the industry come to him is more interesting to me as it is the path I chose but of course life, career and markets are more complicated than that.

We had a little wildfire nearby during the week and then for firetraining yesterday we went on a hike all geared up to practice sizing up a fire and then scratching out a line. All the things Kashkari appears to love doing in Tahoe are similar to what I love doing here. There is no way I would give that up. It is truly fascinating what makes people tick.

The picture is inside the hoodoos in Bryce Canyon.
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The Big Picture For The Week of December 6, 2009

Earlier in the week I mentioned the new GlobalX China Industrial Sector ETF (CHII). I am favorably disposed to the concept of investing in China at the sector level and something to do with this sector would be one of a couple of very good choices, conceptually. I may end up buying CHII but other than the PowerShares Water ETF (PHO), which I bought during it's first week, I tend to give new funds a little time to ramp up. With funds like this that make a good first impression I will watch them for a while maybe learn a little about some of the companies in the fund and finally draw a conclusion at some point down the road.

CHII leans infrastructure. You may have noticed that IndexUniverse has mentioned a filing from Claymore for an China infrastructure fund, along with a tech fund and a consumer fund. In all of IU's articles about these funds they always mention an iShares fund that targets infrastructure in China but is only traded in Hong Kong.

So after reading the fourth mention of this fund I tried to find it to take a look at what was in there and with a little help from the google I found the iShares HK site and the holdings for the fund.

Apparently it is able to own A-shares and while some A-shares are listed in multiple places several of the stocks in this fund are only on the A-share market (or maybe the A-Share market and the B-share market) like Shanghai International Port, Shanghai Municipal Raw Water Co Ltd (Yahoo finance knows it as Shanghai Chengtou but only an A-share listing) and Shanghai International Airport.

Google Finance has some decent information on these companies (the links embedded above are to the corresponding pages for those stocks. In trying to decide how to allocate to China I think you need to decide what parts of the country (parts meaning sectors or themes) makes the most sense to you and then figure how best to access the space you think makes the most sense.

This particular A-share fund is not available in the US (yet?) but it is easy to look at the holdings and realize that it is heavy in transportation (like railroads, ports, airports, toll roads), certain utilities and it has a 9% weighting in a telecom stock. It is also easy to look at the holdings of CHII, realize it covers a lot of the same ground, some of the same names, with the biggest difference being CHII has a lot of exposure to cement stocks, and so owning both funds (were both available) probably wouldn't make sense.

However something that focused on wind or water could be different enough to be owned without a lot of overlap. The FT mentioned a wind turbine IPO just yesterday and these companies, some of them anyway, are going to be part of the solution and we will very likely see more ways to invest in them.

A point made here long ago and repeated numerous times is that the ETP industry will allow for more targeted exposure to various countries and themes allowing the opportunity to create more sophisticated portfolios (I think of more sophisticated as getting a better risk adjusted return, not necessarily a better nominal return).
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Friday Randoms

S&P has created an index that tracks the S&P 500 hedged with gold. The idea is US equity exposure for US based investors that offers protection against a decline in the US dollar. The catalyst for this was a "response to the current interest surrounding gold." Over the last ten years the gold hedged SPX would have outperformed the regular SPX buy 1000 basis points annually.

No kidding.

I think the idea is innovative, very innovative actually, but an attempt to market it based on the last ten years is a woefully incomplete look. Measured over 20 year it would probably not be so compelling and over 30 years it would probably look lousy. If there is utility here, and there very well could be, it would be because in the future the dollar might really get away on the downside.

If S&P is responding to investor interest, so be it, but be wary that this is coming after a fantastic multi-year run for gold. For my money it would just be easier to own foreign equities. To be clear, for now this is just an index, there was no mention of an ETF or other trade-able product.

David Kuo a director of research at Motley Fool called ETFs the lazy man's way to invest as part of an interview with Deborah Fuhr on Asia Squawk Box on Friday. Amusingly Fuhr had no reaction to the statement; a statement that I believe belies a general lack of understanding of the product at Motley Fool.

I wrote for Motley Fool for most of 2004. Back then ETFs got nowhere near the coverage they do now and I made a genuine effort to get them interested in covering ETFs early on but they had no interest. They were very slow to recognize what was happening and I believe they, like several other big sites, don't really understand the product.

Unless we are talking about broad based funds, and since the conversation between Kuo, Fuhr and anchor Mandy Drury was about the GCC region they were not talking about broad based funds, then the only thing easy is the access. The work that that should go into investing (as opposed to trading) into a country, sector or theme should be detailed and ongoing.

Obviously no one can account for everything that might happen but the suggestion that there isn't much work needed with ETFs is simply wrongheaded.

A quirky item; The other morning I noticed a name on the screen crawl on European Closing Bell; New Britain Palm Oil. The screen indicated that it is UK listed but in doing a little research the company's plantations and facilities are in Papua New Guinea. The London ticker is NBPO and Yahoo Finance has the US five letter designator as NBPOF but pinksheet.com doesn't know the symbol. In doing a little bit of reading its growth in productive hectares along with its technology for getting trees to produce fruit sooner are interesting.

So it would appear to be an economically sensitive ag stock in a part of the world that is likely to grow much faster than the US, because it is traded in London it is easy to access and the website is in English so this would appear to be a reasonable stock to consider.

Unfortunately, and this is where the quirks come in, there seems to be quite a bit missing from the website. The first thing I noticed was a forward looking statement that by the end of 2008...oops, well maybe they just haven't gotten around the updating that page. In looking at the page for downloadable reports there was no annual report for 2008 or any quarterly reports for 2009 although I did see something about a dividend announcement. As a rule of thumb [understated font] it is a good idea to take a peek at the reports that companies file[/understated font]. It is possible that I missed the info but I did look in a lot of places on the site and I also emailed the company to see if they could email me the reports but have not replied yet.

Next Monday and Tuesday I am participating in the Super Bowl of Indexing down in Phoenix. I am moderating a panel about foreign investing and sitting as a panelist in a session about regulation of investment products but this will probably drift into alternative investment funds. Obviously I do not know who from the industry will be there but if there is anything you would want to bend someone's ear about WRT to ETFs leave a comment and I'll try to direct it to the correct person.
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