The Big Picture for the Week of May 1, 2011

Right at the open yesterday Brian Shactman made an interesting comment while reporting on Caterpillar's (client holdings) earnings. He noted that CAT was up 64% in the last year versus 16% for the Dow (I think those were the numbers he cited) and then asked rhetorically "what does that say about the indexers out there."

That he would take a shot at any group of investors like that is pretty funny but I'm not sure if I am laughing at him or with him. More seriously there are all sorts of fallacies and behavioral nuggets embedded in the comment. The result of an index will obviously be a mix of components that do better than the index and that do worse than the index. Using the existence of a stock that has ourperformed the index as a reason not to be an indexer is pretty thin.

I am obviously not a big fan of indexing for quite a few reasons but that does not make it invalid. It can work for what some people need. To me this is no different than how I think about daytrading; it would be naive to think it can't work for other people but not for me.

One of the repeat ideas I try to convey here is taking little bits of process from various sources to create your own process. Whatever you prefer; indexing, buy and hold, stock picking, some form of very active trading or some combo of any and all it would be a mistake to believe that something other than what you think is best can't work. People have success with every form of investing and people fail with every form of investing.

With regard to Caterpillar's earnings; the network and the several articles I read about the earnings report all heaped an abundance of praise and adoration on the stock (including one $200-$300 price target)--that stock that seemingly can do no wrong and for quite a while now it has done no wrong. I've owned it for clients since 2003 except for a brief hiatus from January 2008 to January 2009 as part of our defensive strategy.

The name has been one of my favorites for a reason that might not be so obvious. It is great when a stock does so well of course but the reason it is a favorite is that it does what I think (or hope) it should do over the course of the entire cycle. At some point it will stop working in this way but during the up part of the cycle it continues to outperform and during the down part of the cycle it does worse than the broad market which is why I sold it in January 2008.

True to form CAT bottomed out with a 71% decline versus a 56% drop for the S&P 500. I don't think the story underlying the company ever changed in 2008, the world is going to modernize and Caterpillar vehicles are going to move the earth needed for this to happen and this can last for many more years globally, in my opinion.

It likely that this theme for CAT will last much longer than this stock market cycle but when the next bear market starts I am quite certain that CAT will again go down more than the market and so selling it again as part of a future defensive strategy is very likely. This could be thought of as a type of pre-planning. I don't think there is any emotion here despite my labeling the stock as favorite, the history of the stock suggests it will go down more than the market in a large decline. Given the high likelihood of this repeating and my preference for taking defensive action, why wouldn't it be a sell the next time defensive action is called for?
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Uranium and Fish

Doug Casey sat for an interview with a site called The Energy Report that was rerun on Seeking Alpha. They interview covered a lot of ground and I wanted to hit a couple of the highlights as they could be thought provoking.

Based on the interview (I am not terribly familiar with Casey) the top investment themes seem to be uranium and food that wealthy people want to eat by which he meant beef and fish although with fish there was no mention of fishery companies. About fish he said "if I could buy long-term contracts on caviar and good eating fish, I'd do it." I have to believe he knows about things like the Norwegian fisheries that are publicly traded but either way, no mention. I have mentioned many times that Global X has filed for a fishing ETF but I have no idea when or if it will ever list.

He also mentioned being "quite involved in the cattle business in Argentina and I think cattle actually will go much higher for a lot of fundamental reasons." If I read this correctly he lives in Argentina.

Another point he made was the need (as he sees it) to be "geographically and politically diversified." The precise use of these words were not clear to me but based on this interview he said that people should invest outside the US and he then devoted more commentary to the need (as he sees it) to live outside the US.

There is of course something intellectually appealing about moving to another country (this is something I've blogged about before) but more practically is the idea investing more into foreign assets. There is the psychology of home bias that needs to be overcome for this to happen of course. More investors are of course learning how to do this. If you read this site regularly then you know where I am coming from on this so it can be useful to take in the idea from another source.
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FactorShares ETFs Might Actually Be Working

About a month ago FactorShares listed five spread ETFs. Each one tracks the spread between two asset classes and levers the result times two targeting a daily result.

I wrote about them for theStreet.com when they first came out with a sort of I don't know what to make of them conclusion. FactorShares is presenting them as a potential low vol, low correlation, absolute return sort of a thing. The volume on them is very low which either means that the market does not know what to do with them either or the people who actually want to trade the long crude/short SPX spread are continuing to do so in the same manner they did before the FactorShares came out.

The results of the five vary but FOL is up 20% in the month (through Tuesday) and FSU is up 13.9% versus 3.1% for the S&P 500 and I would note the other three are slightly positive. FOL is long crude/short SPX and FSU is long SPX/short USD and again both are 2X.

Strategically there are several moving parts here. There can be no certainty that the dynamics between oil and stocks that lead to FOL going up 20% will persist. In fact it is more likely that the relationship between the two will change all the time. The long stock/short treasury fund which is symbol FSE could be on the verge of doing something meaningful based on how people have couched the Fed's press conference. Likewise the long gold/short SPX fund.

Further complicating this is that no matter the correlation right now between any of these funds and straight equity exposure, next week the correlation dynamics could be complete different for any reason at all which is to say possibly no reason at all. So again, what, if anything, should be done with these. The above paragraph has guesses about two funds that could become more relevant. Certainly it would not shock anyone if we saw more volatility there, so is that what these are about? Maybe so. It is very plausible that at some point bonds will get hit hard and stocks would not need to go up for FSE to go up a lot.

I am generally favorably disposed to layering absolute strategies, in moderation, into a portfolio. Adding FSE because I think now might finally be the time that treasury bonds start to roll over is a little thin in terms of justification but this could make for a fine speculation (not my type of trade). If these interest you at all then you should also look at the Nasdaq Alpha Indexes which I wrote about a few months ago. For now these appear to only trade as index options but I would certainly suggest taking the time to learn about both if I were really interested in either. And at some point in the future I might be interested.

My wife took this picture yesterday during the Bernanke presser, for how little bite there was in questions I'd have been better off hiking with her.
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Pink Sheets Dot Com

Last night after reading this post about farmland prices in various countries I went to pinksheets.com to see if I could find any Romanian farming companies (Romania was one of the countries mentioned). While I am unlikely to buy a Romanian farming stock I am quite likely to want to learn about one.

In going to the site I found a new (to me) functionality on the site. I typed Romania in the search box which lead to a page where I could search the site by country so while there were no Romanian stocks this page showed me there was one company from Uruguay, two from Zambia and two from Papua New Guinea among many others.

Not all of these can actually be bought but many could be. This is potentially more useful than ADR.com or BNYADR.com as pinksheets.com includes ordinary shares traded on the US pinks. The picture is from the website of Deep Sea Supply (DSSPF) which is a Cypriot shipping company.

Obviously time spent doing this would be for people who are interested enough to want to spend the time learning about something like Ukrnafta (UKRNY) which is a Ukrainian oil and gas company.
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It's Not One Or The Other

Seeking Alpha republished a post from a site called Portfolioist (very clever name) about what seemed like a dichotomy between buy and hold and tactical asset allocation. Some people think buy and hold is dead and other people (namely a quote from Jason Zweig) think that tactical asset allocation is bunk or has yet to prove itself leaving the investor stuck trying to figure what is best for them.

To the extent this is how the debate is being framed it is a false dichotomy that serves almost no practical purpose.

Buy and hold is no more alive or dead than it ever was. When an investor buys a stock (so not a trader) I would think they would want to hold it forever. Being so correct about a stock pick that it never needs to be sold means no taxes and no future trading expense. Plenty of people buy stocks this way. They did this in the 1980s and even during the 2000s. When a stock is bought and the intention is to hold forever that purchase is still subject to proving out to be right or wrong no matter the decade.

I'm sure that back in early 1992 one investor might have bought Dell Computer thinking it was a hold-forever stock while on the same day someone else bought Novell with the same intention. The charts tells it all. From early 1992 until late 1999 DELL went up 12,000% and NOVL went down 24%. Perhaps with hindsight bias DELL was the obvious choice but Novell was plenty popular back then.

There were even buy and hold stocks that worked in the 2000s. An easy example (because we have owned for clients for many years) is Vale (VALE). Yahoo Finance goes back to March 2002 and from that date forward it is up 1400%. While that pales next to Dell's 12000%, VALE did make for a great hold despite a huge decline in 2008. If you are a long term investor with mediocre stock picking skills (mediocre can be good enough when combined with an adequate savings rate) then some picks will generally work out as hoped for and some will not. Regardless of what is going on in the world and the market a long term investor is unlikely to need to sell one that is working out as hoped for (more on this below) but will need to sell one that is not--again no matter what is going on in the world.

The above is sort of the building block for then layering in tactical decisions in the portfolio. Long time readers will know I've owned Statoil for clients for many years. It was clearly bought with the intention of holding forever but over the years there have been occasions where the position needed to be altered for varying reasons. There can be news events, price swings or cyclical reasons to alter a position. With Statoil the stock obviously got ahead of any reasonable valuation in April 2006 and May 2008 so partial sales made sense. The stock then got behind any sort of reasonable valuation in October 2008 so increasing the position made sense. The long term story never changed but some market dynamics were changing, requiring action in my opinion. Coming to an opinion on these sorts of things requires ongoing monitoring and understanding of what you own which is a different form of study from learning the stock the first time.

Another example of a long term hold that did not work out was Plum Creek Timber (PCL). I bought it believing in the diversification benefits of timber (I still believe in the concept) and also as a low vol, high yield name and it did serve those purposes and was a fine hold. However the supposedly low correlation started to go away, slowly as more people clued in to this potential benefit in owning the name. Where low correlation was one of the objectives and that stopped being the case in the manner I hoped for it became a sell in late 2009. In this instance I believe it was working out for quite a few years and then it just changed.

I could give countless examples on both sides of the ledger but the point is that in any environment a stock can work out as a great long term hold and in any environment a stock can not work out. The odds of a tech stock, like Novell, not working during the 1990s have to be very low yet it was the case and obviously Dell eventually became a sell too.

On an unrelated note is this article about a Russian defense company going public. The company is OAO Russian Helicopters and apparently many of the helicopters are for military use. I find this to be a fascinating world is getting flatter or circle of life type of thing. I don't know anything about the company other than the article but the story just fascinates me.
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Sectorology

Yesterday on CNBC I heard a tease for segment (I missed the actual segment) about the fact the domestic financial stocks are not doing well relative to technology. While I am not sure that tech is the best comparison there is a point here about financial stocks that I have been making for a long time that I believe will remain relevant for several more years.

First, some numbers with results of a few different sectors over several time periods;

YTD;
Financials XLF +0.88%
Technology XLK +4.75%
Energy XLE +14.97%
Staples XLP +5.12%
Discretionary XLY +6.51% (XLY is a client holding)
S&P 500 6.16%

One Year;
XLF -4.11
XLK +9.58%
XLE +26.37
XLP +9.92%
XLY +11.72%
S&P 500 +9.68%

Four Years;
XLF -56.64%
XLK +8.91%
XLE +24.35%
XLP +11.63
XLY +0.71%
S&P 500 -10.05%

The numbers say a lot about the mess that has been made in the domestic financial sector. The events in the market from 2007-2009 were obviously about the financial sector. There were many types of excesses that resulted in a monumental meltdown in the sector--monumental for the number of large companies that failed and the large number of stocks that dropped 90% and are nowhere close to where they traded before the implosion.

The nature of this sort of event is such that it will be years before domestic financials, collectively, are attractive on a fundamental basis and so I think it is likely that they will continue to struggle as stocks. This has been the case with technology from that market event. For ten years the S&P 500 is up 7.41% while XLK is down 12.02% (MSFT is down 25% for ten years and INTC is down 32% for ten years). It looks to me like outperformance of tech over the SPX may have started at the 2009 bottom which is a long time for the ground zero sector to lag and while an exact duplicate in financials is unlikely, if you then consider the fundamental outlook, I think we are a long way from health.

The above brings in two different things to consider; one being how markets tend to work which is more of a top down factor and the other being what I believe is a lack of fundamental health which is of course a bottom up factor. It seems to me that no matter any of this, that the financial sector has been a favorite of many professional market participants. Given my perceptions of the sector I think it makes sense to underweight the risk in whatever financial sector exposure you have (I believe in having exposure to all sectors as zero weight is a big bet). For us this means mostly owning foreign banks as I have discussed many times before.

Think of it this way, in speculating on parts of the financial sector where the fundamentals are not yet healthy, how much do you hope to make? Let's say you think you can double your money. I would say it makes more sense to go to a sector that is healthy on all fronts to pick a stock where you think you could double your money. I realize other people view it differently and clearly there were some great trades off the bottom in the financial sector but speculating on something with weak fundamentals is not a risk I am willing to take.

The Harley belongs to a friend whose father bought it new in 1954.
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An Entire Assortment

Barry Ritholtz posted a video that was all about being wrong which was useful to watch. As I view a big part of portfolio management as being about mitigating the consequences of the times I will be wrong it served as a confirmation of some of what I believe in.

From the standpoint that no one can be correct with every portfolio decision they will make the end result then becomes a netting out of correct and incorrect decisions. If you have the self-awareness to understand ahead of time that some decisions will be incorrect you increase the chances that mistakes will not crush you. Small setbacks are one thing, completely re-writing you financial plan every five years is another.

At one point in the video, the speaker says something along the lines that what we know is far less important than what we don't know. This is similar to Taleb talking about the most important books in your library being the ones you haven't read yet.

Next is an article posted at Seeking Alpha by Kevin Feldman who writes for the iShares corporate blog. The title was What's in the iShares Silver ETF? Silver! As you can imagine it drew a lot of comments with all sorts of reasons why the fund is a fraud. Some of the comments went into great detail. One of the lines of discussion had to do with a short position that JP Morgan has in silver. The relevance per the comments is that JP Morgan is conflicted in terms of being the custodian of the bars and being a participant in the market with this short position.

I don't know for a fact that JPM is short but I will take the commenters' word that there must be something to their being short. In among the comments was one that is along the lines of my questions about this. The short position that the bank supposedly has, how big is, when did they put it on and where are the risk controls that would have them get out? Using SLV as proxy, silver is up 50% YTD, for the trailing 12 months it is up 154% and for two years it is up 289%.

The other aspect of this I don't understand is why they would take the reputational risk implied in these accusations. SLV has $16.5 billion in AUM. I've not seen the short position quantified, is it larger than the size of the SLV fund? Given how underwater the position would have to be now, there is no winning in the trade so the implication becomes that the bank is risking everything for a trade that now cannot work--all that can happen from here is that the loss would get smaller. The tradeoff simply doesn't make sense to me.

A more plausible idea here would be some sort of incompetence or even malfeasance at the lowest levels where some small "unnoticeable" amount of bars were unaccounted for. Some dishonest employee stealing a few hundred ounces makes far more sense than fraud at the institutional level. To be clear, the "dishonest employee" scenario is completely made up.

Yesterday I had a couple of fun debates. One was in the comments of Friday's post. A reader did a good job defending the argument that alpha is finite and the zero sum nature of any form of market timing. If this debate interests you then you already know what the reader said and you already know what I said but you can glance through for a quick recap. I essentially countered his arguments with what I think were plausible yeah-buts many of which I have mentioned before.

For me it boils down to there being far too many variables in strategies, objectives, tactics and investment choices (many of which I've addressed before) along the lines of Karl Popper's it only takes one instance to disprove something. For me it simply does not stand up for being too academic to be practical, you should draw your own conclusion. That I do not believe alpha is finite does not mean I believe everyone will or can beat the market. Just as there are countless variables that (in my eyes) debunk finite alpha, there are countless variables that impede success.

The other debate was about the financial crisis that I had on Facebook. The particulars of the debate are less important than a big picture thought process that I think was relevant. In the past I've talked about staying on your own mat (a yoga term for not worrying if the person next to you in the class does the positions "better" than you do). Personally, my job is not to solve the world's problems it is to understand the world's problems as best as I can and then try to protect my clients (and my wife and I) from the world's problems if it all possible.

If you are the caretaker of someone's money (yours, other people's or both) then you are probably not going to be able to do that unless you take the time to understand (as best you can) the dynamics of the thing in question. It is very difficult to do this if you only read things that agree with your position or put differently, confirm your bias. I think we are more likely to be adversely affected by points of view we don't like that we have not taken the time to understand.

Lastly, this blog was mentioned by CNNMoney as one of the 100 best money moves. A friend mentioned this to me on LinkedIn but I didn't know what he was talking about, I thought he was referring to something from many years ago but then a blog reader mentioned it in a comment yesterday. One of the comments from the writeup was that I am not a loudmouthed tout. And just when I was considering a format change. Just kidding.
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Sunday Morning Coffee

A couple of weeks ago I had a birthday and birthdays are always a good time to reflect a little or maybe recalibrate somehow. A while back I came to a theory about "tough" or "difficult" birthdays being a function of not being happy with where you are in life (no claim of originality). The only difficult birthday I've ever had was 25--my job at the time was at Lehman Brothers cold-calling for 12 hours a day. Enduring a job you don't like during some portion of your life probably helps you develop as a person but a lifetime of this sort of thing probably means a lifetime of unhappiness.

This sort of thing plays a big role with investing. When you can figure out a few things about yourself and what actually matters to you and then figure a way to prioritize your life in accordance with what is important to you then your investing should be more aligned with those priorities. As an example and tying in a point I've made before is that finding out you had too much in equities after a 50% decline is a bad place to be. Having too much can be mitigated with self-awareness. I also think self-awareness makes for a better quality of life.

To again quote our friend Bill here in Walker; "you can figure it out now or you can figure it out later but if you can figure it out now your life will be much easier."

As a matter of personal philosophy I think life can be made much easier by living well within your means and making a commitment to fitness. I also think life can be much happier by finding something volunteer-wise that you can really get into and want to spend time doing--the possibilities are endless.
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The Big Picture for the Week of April 24, 2011

IndexUniverse published a lengthy article by Agustin Fleites titled Is Core Investing Dead. The article does a good job exploring important portfolio concepts and addressing some of the mental and emotional obstacles that get in the way of succeeding in the stock market (whatever that means to you). There are a couple of quick points that I would add.

Early on he notes the following;

Why did advocates of a core investment approach endure such pain over the past decade? Investor experience could have been substantially improved with a greater focus on three key tenets of a core investment program: realistic return expectations, sustainable asset allocations and appropriate levels of diversification.

Occasionally the stock market has a bad decade and I am not sure that realistic return expectations are going to be a big part of the solution in a large decline where diversification as most people think of it seems to not be working. Obviously I am going to say that there needs to be a willingness to be on the look out for times when the risks of a large decline are elevated (like a breach of the 200 DMA) and heed those warnings by reducing net long exposure one way or another.

Successful core investment programs set asset allocations to match long-term return objectives with projected growth in liabilities. To best capture the asset class risk premium implied in the strategic asset allocation, investors need to maintain asset class exposures over long-term horizons.

Fleites is talking 30 years. A while back I linked to an article by Niels Jensen from Absolute Return Partners that spelled out an argument that we only have 20 years to save based on when we start making a lot of money (relative to our own earnings), when children are likely grown and a couple of other factors and while I'm not sure I agree entirely with Jensen, for some folks their accumulation phase may not be very long if they hope to retire at a "normal" age.

The other point I would add to the article is about investing in foreign markets but doing so selectively. "Selectively" means avoiding broad foreign indexes and going to the country level. In talking in the article about all that went wrong during the last decade I was reminded of how many foreign markets had very good decades. Not to say they did not correct down when the US market went down a lot but it should be obvious that people who were self aware enough shed their home bias and had modest exposures to countries that went up 100-300% in the decade while the SPX was dropping 24% on a price basis probably fared pretty well.

Going forward, the fundamental, long term investment case for many other countries is simply better than that of the US. If you agree then you probably need more foreign exposure.
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Three Day Weekend!

A couple of quick holiday items;

Rick Ferri says the following in an article at IndexUniverse about passive investing;

Market timing strategies are a zero-sum game in the marketplace. The financial markets don’t earn any more or any less return just because one person is buying and another is selling. If one investor buys in at the right time it means another investor must have sold at the wrong time.

Who loses if you buy a stock at $10, you sell it at $20 and the person who bought it from you takes it to $30? What if you sell half your position at $20 and it goes to $30, who loses?

Yesterday's post about gold being in a mania was re-run at Seeking Alpha and it drew a couple of comments laying out in one form or another the case for why gold is where it is and why it is likely to keep going up. Actually the way I read the comments I think both people were saying gold cannot go down in price because of the fundamentals behind it--fundamentals being how messed up the US is right now.

Anything can go down in price at any time for no reason at all. Some sort of price correction would not necessarily mean the fundamental story had changed but as something that is traded actively in markets it can drop for no reason at all.

People used to think that real estate could not go down in price. The internet stock niche got decimated yet the actual internet exceeded expectations as far as how much it has changed our lives.

The title is a bit of a joke, my wife says my entire life is like the weekend.
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The Gold Mania

Gold, and probably silver more so, is in a mania. Perhaps this is an obvious observation at this point but yesterday as I heard what seemed like segment after segment on CNBC about the best way to buy gold it just clicked; mania.

Part of the equation is the Fed's having stimulated speculation in many asset classes. All commodities have been very popular for the last few years so it makes sense that in an environment where speculation is being rewarded that commodities would participate. Another part of this equation is some level of concern being exhibited about what inflation may do shortly (or may be doing already, depending on your thought process).

I've read several commentaries from people who are not gold perma bulls making the case for some sort of big leg up in price over a short period of time. We own gold across the board for its diversification benefits and I have often said that if gold is the best performer you own then chances are stocks are struggling. That is true the vast majority of the time but not in the last couple of years.

If prices are starting to blow off up to some level then predicting how long it lasts and to what level prices could go is well beyond what I can do but I think it makes sense to think about proportion.

If the price of gold implodes how much damage would that do to your portfolio and is whatever number you come up with acceptable? This is easy to quantify if your only exposure is something like GLD which we own for clients. Should the price cut in half you know exactly how much of a hit your portfolio would take. It would be more difficult to quantify if your exposure includes gold mining stocks or ETFs but if your total exposure is 15% of your portfolio and the price cuts in half then you're looking at maybe a 7-8% hit to the portfolio. Only you know if that is acceptable.

It makes sense to try to quantify what a large decline would do, whether you could tolerate and from there figure out what action to take. Action could include stop orders (these are not infallible), selling some now, pre-planning some sort of exit strategy (partial or otherwise) and of course you could decide to do nothing.

A few percent in the metal and a couple of more percent in a mining stock and your portfolio will not blow up should gold implode. A modest weighting like this could be enough to cause a drag but I think that goes with the territory every so often.

On an unrelated note I found an article yesterday that was about Peak Fish as in Peak Oil. Global X, are you listening?

Finally an update on Pep, the dog Joellyn and I took up to Seattle in late March to enter the search training program at Conservation Canines; apparently Pep, who is now known as Pips is a natural. The task is to help biologist track endangered and invasive species of animals through their scat. The dogs, once trained, are motivated to quickly find whatever they are looking for so they can then play fetch for the next however many hours.
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Diversification Tips From Marc Faber

Marc Faber was on Asia Squawkbox Monday morning for much of the show and as he often does he had some interesting things to say. One thing he said several times, which most people don't often think of when they think of him, is that he thinks people should be diversified. It is not surprising that he thinks this but it does not get much attention relative to the other things he talks about.

He answered several emails through the appearance including one about asset allocation. He answered that investors should diversify with real estate, farmland, equities and precious metals. In trying to find different ways to build a portfolio around his ideas I would not discount the off the cuff nature of his comments but the asset classes he mentioned are a combination of old standbys and popular "new" exposures.

If I had to buy one type of REIT (we don't own any) I would probably look at college apartment REITs. You can look at American Campus Communities (ACC) and easily find the few other names in this niche but again we have no exposure. There are also several companies considering converting to REIT status even though the underlying businesses are not real estate in the way you would typically expect. There are a slew of REIT ETFs, if I wanted to own this space I would prefer an individual issue but if you have to go the ETF route I would avoid anything with China in.

For the farmland segment it would be impractical for the typical 50 year old who is doing reasonably well and had $300,000-$500,000 in a 401k to go buy a farm (it might also be impractical for someone with millions saved) but there are some exchange traded proxies. The closest ETF is probably the new IndexIQ Global Agribusiness Small Cap Fund (CROP). The large cap ETFs in this space like PAGG, CRBA and client holding MOO don't really have exposure to farms. There are various plantation stocks from Asia (a couple of which trade in London), there a couple of companies listed in Sweden with farms in Russia, there are big chemical companies like Yara (YARIY) or Israel Chemical (ISCHY).

One new stock in the space that is easily accessed is Adecoagro (AGRO) which listed on the NYSE a few weeks ago. It has operations in Argentina, Brazil and Uruguay, it owns actual farms and it also processes food at mills. George Soros sold a bunch of shares into the IPO but he still owns a bunch of shares. In its two and half month trading, which I think is long enough that the syndicate bid would be gone, it has had a volatile ride to a 4% gain. That it did not blow up immediately tells me it is a real company and that no one is trying to pull a fast one--no one pulling a fast one is not much of an argument to buy a stock but I am willing to watch this one as I try to learn more about it (I watched Ecopetrol for months before buying it for clients).

Coincidentally I found this article about food and farming on Bloomberg. For me, the money quote was "global food output will have to climb 70 percent between 2010 and 2050 as the world population swells to 9.1 billion people and rising incomes boost meat and dairy consumption." Figuring the best way in may not be easy but this is a real theme. If New Zealand's Fonterra ever went public I'd probably be very interested.

As far as equities, this blog covers this all the time. There is no reason that in any of these portfolio concepts that the equity portion can't be a properly diversified equity portfolio. Given the doom that Faber sees coming to the US and Euroland he might suggest avoiding those parts of the world in favor of certain markets in Asia and maybe Latin America (here I am talking about what he might suggest, I am obviously a big fan of certain parts of Latin America).

Precious metals are easy in terms of choices. There are now multiple physical gold ETFs and several other metals are available too. If you believe there is any sort of malfeasance with how the metal is accounted for, as some people do, then you should avoid the funds. There are also plenty of interesting equity ETFs and individual stocks in this space as well.

You can look under the hood of the various ETFs for ideas for individual names if you are so inclined to that type of investment. While no one should forget the Mark Twain quote about showing him a gold mine and his showing you a hole in the ground with a liar standing over it there are plenty of small companies with producing mines in various parts of the world that trade in Canada and London, again for anyone inclined to do the work, and some of these stocks will do very well. There is nothing easy about selecting this type of stock but they are out there.

No mention from Faber about Thai Tap Water which is a name he was mentioning quite frequently there for a while.
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"Hard To Avoid Treasuries"

Yesterday I was asked for my reaction, in terms of portfolio construction, to the outlook change for the US' debt (this may have been an interview or just a more casual email conversation, I'm not sure). Along the way the interviewer pointed out that it is hard to avoid treasuries.

We all know what he meant of course but just because treasuries are easy to access and there are plenty of them available does not mean we have to own them (either individual issues or funds). The only US treasuries we own are legacy positions that clients may have brought with them so the yields are worth holding on to.

Long time readers will know my belief in avoiding spaces where the risks (relative to the history of the space) are elevated or the fundamentals have obvious problems. With treasuries this has meant interest rate risk for quite a while now (prices can stay high for a very long time) and with muni bonds, which we also avoid, I believe there is credit risk. Even if Meredith Whitney turns out to be wrong in terms of magnitude I prefer to not have to even think about it.

There are many tools with which to build a fixed income portfolio and still avoid obvious trouble spots or at least minimize the exposure.

For now "safe" yields are very low. We allocate quite a bit of our (relatively) safe fixed income allocation into short dated high quality corporate notes. With a 2013 maturity date if rates go up a lot a meaningful price decline is unlikely because of how soon the notes have to pay out at par. The yields in the space are low but quite a bit higher than treasuries with like maturities, 70-90 basis points is better than 20. There are obviously plenty of ETFs in this space but the downside is that there is no par value to return to. The best middle ground is probably the Guggenheim BulletShares which terminate when the last issue in the fund matures.

We do a lot with foreign sovereign debt issues. We own debt from several countries including Norway and Australia. Individual issues can be difficult to access for individual investors but the fund space is improving here. The first funds are all heavy in Japan but we are starting to see a next generation of these funds coming that avoid Japan. The first one came out recently from WisdomTree and it is Asia ex-Japan. There is also the Aberdeen Asia Pacific CEF (FAX) which has always been heavy in Australian debt (some clients own FAX), there is a Canadian preferred stock ETF that someone has in registration that could also turn out to be useful in this regard.

We do own TIP from iShares so there is some US treasury exposure but I feel far more confident here than with plain vanillas. The monthly payout has been all over the place (not unusual for an ETF) ranging from zero to pretty decent but it has generally done well.

Another space is emerging markets with the PowerShares Emerging Market Bond ETF (PCY). The paper is denominated in USD but there are times where the fund exhibits dollar sensitivity. We also own the Vanguard GNMA Fund (VFIIX). This fund has had a dividend cut a couple of years ago from four cents a month to three which is obviously noticeable but the historically low volatility of the fund makes it a good hold. We own one bank preferred stock which has a pretty good yield and I am quite certain the bank will not fail and we own one other closed end fund which is very un-volatile as CEFs go.

There a lot of funds that although they do not own bonds could be thought of as bond proxies or bond substitutes. A while back I wrote about the Collar Fund (COLLX) which owns mostly volatile stocks that it collars with options. Part of the marketing is that the fund can be a bond substitute. Based on price action this might be true but not based on payout. If the idea of bond proxies interests you then you may find some suitable candidates within the various absolute return niches.
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A Permanent Portfolio By Another Name

At the end of Alan Abelson's column there was some commentary from Michael (Dogs of Dow) O'Higgins and a portfolio he called MOAR which stands for Michael O'Higgins Absolute Return. Really this was a spin on the permanent portfolio concept. The original Permanent Portfolio was put forth by Harry Browne which called for equal weighting in equities (a broad domestic index), gold, long term bonds and cash.

The MOAR is a blend of of the Permanent Portfolio and the Dogs of the world which apparently means the worst performing developed market country funds. Per the Barron's article there would be 25% each in iShares Barclays 20 +Year Bond Fund ETF (TLT), in the iShares Barclays 7-10 Year Bond Fund ETF (IEF) and in the SPDR Gold Trust (GLD). IEF serves as a cash proxy. The other 25% goes into iShares Belgium Fund (EWK), iShares France Fund (EWQ), iShares Italy Fund (EWI), iShares Ireland Index Fund (EIRL) and iShares Spain Fund (EWP) with each getting 5%.

Although specifics were not given, the portfolio has outperformed "every major stock index, long-and-intermediate term bonds, gold, cash and inflation and done so with only a single down year."

There are a lot of these types of portfolios out there that "work" or otherwise get the job done over long periods of time but it is very difficult for me to be comfortable with this type of rules based allocation. Theses types of things involve no forward looking analysis. The Dogs of the whatever relies to a certain extent on some sort of reversion and that is placing a lot of faith in something that simply should just work.

The other issue is that longer term treasuries are expensive these days. They have been expensive for a while and there is no way to know how long they will stay expensive but if at some point they revert to normal the transition from expensive to fairly priced will be very painful for holders of ETFs where the holders are devoted to some sort of strategy that doesn't look forward.

To the extent avoidance is a key part of successful portfolio construction (I believe this to be a crucial concept) there is much to dislike, especially with all the European equity ETFs. For all I know the strategy could do very well yet again but a portfolio built on lousy fundamentals has much less margin for error. This doesn't have to be the worst thing in the world as long you you understand the fundamentals of what you're buying and the lack of financial underpinning.

Happy Patriots Day! Of course that means the Red Sox play at 11am local time as part of Boston Marathon Day.

The picture is of the "painted ladies" in San Francisco from a link that my brother sent with a bunch of pictures from back then.
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Sunday Morning Coffee

One of the mutual fund articles in Barron's had some interesting things to say this weekend about investor habits and preferences as a result of the financial crisis. The comments covered baby boomers and gen-xers.

The big take away seemed to be that people are saving more but not investing it, there is a lack of buy-on-the-dip mentality. People are sitting on relatively high cash balances despite rates being so low. There was also a comment about investors not wanting "complicated, financially engineered products" as a function of not trusting Wall Street.

In contradiction to that study, another was cited that said "72% of financial advisors have recommended that clients increase their retirement contributions, yet only 18% of boomers did so in the past 12 months."

In having a Facebook debate with a friend I was reminded of something Nassim Taleb has said several times. (Paraphrasing) everything you need to know about finance, you learned from your grandmother; don't borrow money, don't lend money and save a lot of money.

One point I've made repeatedly over the years is that finding out after a large decline in stocks that you had too much exposure is a bad place to be. I think this happened on a grand scale in 2008 and as opposed to past market events it is possible that more people remember what the pain of cutting in half felt like. I don't know if this is the case but if it is then it can be a good thing. There is nothing wrong with having less in stocks as long as the trade off of probably needing to save more money is understood.

Being wary of investment products makes sense. I have no idea to what extent this pertains to ETFs. Obviously I think there is great utility with ETFs but they are a mixed bag. Investors have lots of problems (I think mostly from incorrect expectations) with certain commodity based products where contango is involved, there are also problems with perception of levered funds and they way in which they reset daily and I don't doubt that there will be future market events that draw negative attention to the space.

The vast majority of funds are plain vanilla, tracking baskets of stocks. If there is something there you distrust then don't use ETFs. To me this differs from avoiding complex products that might be difficult to fully understand or have a lot of moving parts but either way no one should use products they are not comfortable with.

Hopefully people start to get serious about saving money, assuming the one study is correct. I don't know what the fate of entitlements will be (I have an opinion) but it seems like they are now on the table for discussion. Regardless of anyone's politics discussions look like they will happen soon. Speaking personally, having my financial fate determined by politicians making up policy as they go is simply unacceptable. I have no control over whether we get social security but we have some control, by virtue of saving aggressively, over the impact of not getting social security. If this makes sense to you then you know what you need to do.
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The Big Picture for the Week of April 17, 2011

Yesterday I read what seems like the 700th positive article on the Canadian banks. I have had clients in this space for a little over six years with Scotiabank (BNS). On a relative basis the Canadian banks are much healthier (not risk free) than the US banks.

This reminded me of an idea I had a few years ago that I think I called exchange traded baskets. These would be narrower than ETFs. Someone interested in Canada and who knew about the banks could choose the Canadian Bank Exchange Traded Basket which might only have four or five holdings.

There are countless other niches where ETBs could be created. In looking at some of the segments discussed here in the past ETBs could be created for Australian banks, Chinese toll roads, Chinese coal stocks, Norwegian fisheries, Singaporean banks, Scandinavian banks, various segments in farming and the list could be endless in terms of spaces where there might not be enough names for an ETF.

Something like this could easily be created right now by an investment bank for the right type of institutional client. Such things, if they do exist now are obviously not exchange traded and so not accessible by individual investors or many RIAs for that matter.

The idea would require plenty of work on the part of the end user in terms of research but obviously they would avoid single stock risk and also provide access. It would be very difficult to buy a Malaysian plantation stock through a US brokerage even if it does trade ordinary shares on the US pinksheets.

There are countless mutual fund-regulations that would have to be overcome and really these would need to be a different product like maybe a UIT but that could be traded on an exchange somehow or maybe this could be part of the ETN space but if individuals are allowed to take the risk of buying an individual stock then I have to think that they could be allowed to take the risk of buying a basket of five stocks.

The slight bigger concept here is that if the idea of correctly selecting narrow segments for portfolio construction will be a key element to "success" for the next ten years (compared to buying domestic index funds in the 1980s and 1990s) then I would hope the investment industry would offer as many different types of tools as possible for those willing and able to put the proper time in. In that context these can make plenty of sense and be worked in along with individual stocks, ETFs and even traditional mutual funds.

In thinking one sector at a time, it would be perfectly valid to build the energy sector with some broad ETF, an oil sands ETB with six names in it and an MLP to add a little yield.

Occasionally people on the product-creation side of the industry read this blog so perhaps today's post can create a dialogue.

If you are a baseball fan then you understand both pictures.
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ETF Alchemy and Other Evils

FT Alphaville had a couple of posts yesterday following up on a report about ETFs from the Financial Stability Board. The second post was mostly about iShares' response to the report. Among other things addressed were issues involving ETFs with swaps (and presumably other derivatives) and the extent to which securities lending plays a role in the evolution of the product.

An important macro point that pertains to all investment products, including individual issues, is that there will always be products that for one reason or another will be unsuitable for you but unsuitable for you does not mean unsuitable for someone else. Matt Hougan was on CNBC yesterday talking about inverse ETFs and to a lesser extent levered ETFs and he was asked whether these funds are better suited to professionals as opposed to individuals. He did say professionals but I would say the better answer is that these are more suitable for people able to spend a lot of time on the task at hand which does not have to be limited to professionals and certainly there would be plenty of professionals who should avoid inverse and levered funds.

As a possible rule of thumb for ETFs, the more moving parts under the hood the more time the fund requires. This does not necessarily work for ETNs as there is nothing under the hood but a promise which means understanding at some level the dynamics of the company issuing the debt.

Anyone constructing a portfolio needs to use products they can understand which should be an obvious statement however just because there is a product that you or I may not understand well enough to use doesn't make it a bad product. It could be a bad product but our lack of understanding of a product does not make it bad for someone else. The multitude of ETPs tied to the VIX index are very popular vehicles that some participants have success with. However the dynamics that make them tick are very complicated and not something I want to devote client money toward trying to understand. Unfortunately I am certain there are people trading these funds without a real good understanding of them but that will always be the case with complex funds.

The framing of these conversations is usually incorrect. The conversation should really be about the end user's ability to sort out whether a product is suitable or not and whether they understand the product. The price performance of a levered fund will depend on the pattern of up and down days in the future because of the daily reset needed to achieve the stated objective which is usually a daily result. Over the next six months some double short fund might "do what it is supposed to" or it may not but this is dependent on information that is not knowable. Simple as that. If you can live with that uncertainty then you would be better suited for one of these funds.

Going a little deeper the double short funds (and double long funds and single short funds) use derivatives to deliver the effect. Rarely, very rarely, those markets will face events like in 2008 where there are serious counter-party risks or other near term threats that impede the function of these funds and it could be difficult to be out in front of something like this. It won't happen very often, maybe never again, but if you can't have that sort of uncertainty then these funds are not for you.

Taking it to a different level, you might recall FactorShares recently came out with a suite of funds offering exposure to various spreads like SPX and gold, SPX and oil and and a couple of others all levered to 2X. For some people these might be just what the doctor ordered (although there is no real volume on these) but for anyone paying even a little bit of attention it should be easy to realize buying these requires understanding intermarket dynamics and being able to aggressively mind the store due to the leverage. I am not saying understanding the dynamics is easy but realizing that this is what these are about is. Ruling out funds like this for your portfolio shouldn't take more than a few minutes of work.

It is also important to understand the potential adversarial relationship with the ETF provider. A fund company issues a fund that it believes there is demand for. The fund company hopes to profit off of this demand. This is not necessarily bad unless you don't realize it. It is just as true that the way a fund company helps demand is by building funds that function well with as few surprises as possible. In late 2008 and during the flash crash there were a lot of ETFs that had to endure surprises of varying types. 2008 was about markets ceasing up as the world had to figure a few things out and the flash crash was a temporary malfunction. Both events might be looked at by history as being bad but people who kept their cool were not hurt (except for perhaps the Bear Stearns ETN which I think had symbol YYY). Keeping your cool was as simple as knowing the product well enough to realize that a basket of stocks with a $50 IIV at 2:15 could not be worth $0.01 at 2:40.

When a fund provider creates a very narrow fund there is often rhetorical commentary like does the world need a smart phone ETF or an aluminum ETF? It is obvious that there will be many more very narrow niche ETFs to come. It is not crazy that an investor might do some research and come up with Motorola Mobility (MMI) as a solution for the smart phone theme and come up with Alumina (AWC) to target an upturn in the economic cycle. I would think that the process for coming up with those two names would include, in some order, learning about the industry and then the individual stocks. How much time would this take? That is a different answer for each of us but obviously not every participant has the time/inclination to learn both the industry and the stock. The burden of work to learn the ETF is probably less than with an individual stock and so this is how ETFs can democratize portfolio construction.

All funds (well, there are a couple of exceptions) have their pluses and minuses and it is incumbent on the end user to really take the time to understand what they are buying, in addition to the fundamentals of what they are buying, before they buy it and with funds that simply track baskets of stocks it doesn't have to be an impossible task.
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Fun Pictures

No post today. Yesterday we had an After Action Review for our regional training drill (fire department related), an inter agency drill that I am told is a national model for cooperation. One of the participants was the Civil Air Patrol. They took a bunch of pictures, here are two. In the second picture our Walker Patrol 80 is the one red truck, the green ones are from the Forest Service. The other picture was a little meeting prep I did (I brought the doughnuts) at the Prescott Doughnut Factory.
















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There Is No Single Best Way To Succeed

A couple of days ago I wrote a post debunking (or trying to anyway) some of the concepts put forth by Larry Swedroe in an interview with Seeking Alpha. I looked back at that interview yesterday to see what might be there in the way of comments. There were over 130 when I last looked. The comments were a mix of pro-passive and anti-passive along with several replies from Swedroe.

Scanning through the comments was a great reminder that there are many different ways to construct a portfolio and have success versus whatever the objective might be. I think the objective for most people is really about having enough money when they need it, but I realize not everyone can look at it that way.

The original Swedroe article seemed to imply there is only one way to get it done which intuitively cannot be. Indexing can work but there are plenty active managers with long track records of beating the market. People trade their way to success (where success is having enough when they need it) while others buy and hold their way to success. Within trading there are countless ways to succeed like selling on strength versus selling on weakness along with countless other choices.

This is not to say that any type of investor can't get better at what they do but it is encouraging for those willing/able to put the time in to figure out their best way and devote time to improving can have success even if they are not the next Peter Lynch. A proper savings rate doesn't hurt either. The key takeaway is putting in the time necessary to figure out what is best for you and how to improve as time goes in order to give yourself the best chance for success.

On a somewhat related note Felix Salmon had a post where he reviewed Market Riders which is a sight that helps people with rebalancing their portfolios. In the post was the following quote from Felix; "One of the reasons that individual investment returns nearly always lag the market as a whole is simple laziness."

This is a provocative comment. Obviously this is true to some degree, the question is to what degree? There is no limit to the types of behaviors that inhibit portfolio success and certainly laziness is one of them. The context of lazy in the article was just taking the time to rebalance but it can also apply to many other aspects of investing including saving money. In another aspect of my life I like to say that not going to the gym is the easiest thing in the world. Not saving money might be just as easy.

While doing the requisite work may not be easy it is relatively easy to recognize when we are being lazy and it is a behavior that is easier to fix than flaws with various parts of the analytical process.
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The International

Over the weekend I saw the movie The International which was essentially about burnt out Interpol dude and laughably hot NY DA chick taking down big, evil, arms dealing bank in Luxembourg. I'm not sure if I liked the movie or not although there was a shoot-out scene that took place in the Guggenheim Museum which seemed to go on for 90 minutes that was pretty cool.

There has been a sinister element to banking and a general distrust of bankers throughout much of history. I was struck by this quote from a character in the movie named Umberto Calvini who right before he was shot and killed told burnt out Interpol dude and laughably hot NY DA chick that;

...This is the very essence of the banking industry; to make us all, whether we be nations or individuals; slaves to debt.

While I am not sure that banks are as evil as implied in that quote or in the movie (although the bank in the movie was based to some extent on a real bank that shut down in 1991) I found the quote to be thought provoking and made the movie worthwhile. Well that and the 90 minute shoot out in the Guggenheim.

Anyone reading this site for a while knows I am a big fan of getting debt paid off and generally avoiding credit card use (except for cash back and where the balance is paid off every month) and while I'm not sure I would liken it to slavery it certainly is liberating to be out from under.
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Sunday Morning Coffee

From the cover story in Barron's about American Funds comes the following quote from Jim Rothenberg who is the Chairman of the Executive Committee;

"Do you want to own a bond with less than a 3% coupon for 10 years, or do you want to own a good-quality company with a 3.5% yield and a growing dividend? To me, it's something of a no-brainer,"

I believe this to be a false dichotomy. A particular asset class may generally be a better value at any given moment than some other asset class in the generic way that Rothenberg notes but that does not make the one that is a better value a proxy for the other one. If 3% for a ten year debt issue is unattractive to you but you want fixed income exposure then logically you would look for segments in the fixed income market that are attractive, not equities. A high yielding equity should not be expected to have the same volatility characteristics as debt.


Also from Barrons in the Trader Column "...cash earning no interest at the bank keeps up the pressure to invest." Hopefully you don't believe this. It might be very frustrating to take in such a paltry yield but the part of your allocation that should not take risk should not take risk. If the yield in that part of the investment world is ten basis points , ok, but we all have certain money that should not take risk and that should not be forgotten.

Last night the University of Minnesota-Deluth won the NCAA mens hockey championship in overtime on a goal by Kyle Schmidt. To recirculate a joke I made before, that kid will never have to buy a meal or a drink in Minnesota for the rest of his life.

The picture is from Mount Pilatus in Switzerland. Kind of looks like Dr. Evil's secret volcano lair, doesn't it?
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The Big Picture for the Week of April 10, 2011

Larry Swedroe was interviewed at Seeking Alpha and as always had some interesting things to say. I generally disagree with him on most things but he is usually interesting. Swedroe is an index investor who favors DFA funds (in many instances anyway) and does not think that any real value can be added with analysis in the context of making active decisions.

There are several points made in the interview that while they can be correct do not have to be universally correct which calls for a little more detail for people to decide what is better for them based on both sides of these issues.

In pointing out the potential folly in economic forecasting he notes that a year or so ago, the chief economist from Goldman Sachs said the biggest risk to the economy was deflation while the chief economist from Morgan Stanley was more worried about inflation. Swedroe noted that both are smart but that one would have to be wrong. Actually it could be argued that both were wrong as over the ensuing 12 months neither proved ruinous.

In what I think is a related example, when asked about commodity exposure Swedroe said he prefers the actual commodity with the thinking being that gold could go up but the mining stock you buy could have its assets seized for some reason or have some other calamity where the price goes to zero. In an interview this week at IndexUniverse, noted indexer William Bernstein said he prefers the stock instead of the metal because the stock will pay a dividend. Both are smart guys, can they both be right?

Another point that is a little more concrete is about sectors. Swedroe says "there's no reason to think any sector-specific information you have is value relevant. If you know it, so does Goldman and Morgan Stanley and it's likely already baked into the price." Um, not necessarily. The notion of healthcare, staples, ma bell telecoms and utilities doing better in a declining market and lagging during large rallies has been repeating for decades. Sectors growing to more than 20% of the SPX as a warning for trouble is pretty reliable too--although this happens rarely. There are also reliable sectors and industries early in the cycle.

The way I read this part he seemed to be saying that a sector can't be picked to forever be the best performer but of course that is simply not how it works. If this is how he is framing this part of the discussion (my interpretation could be wrong) then either he is missing the point or he is spinning the point. The fundamentals of sectors ebb and flow, as mentioned above there are cyclical issues and so not addressing this aspect of sector analysis makes the conversation incomplete.

Elsewhere in the article Swedroe makes the argument for there only being a finite amount alpha;

There's no indication active managers outperform in even the most inefficient of these areas and there's no way they can. If a market returns 10%, that means that both active and passive investors on aggregate receive 10%. So since active management is more costly, by definition active investors take home less than passive investors.

IMO this line of thinking only exists on a theoretical island. When he says if a market returns 10%, which market does he mean? He might be referring to a domestic market or some global index. Whatever benchmark is selected there are stocks that are outside that benchmark that can be bought. The iShares MSCI World Index Fund (ACWI) is certainly a broad fund. It has 977 holdings allocated over 44 countries (I manually counted the countries so I may be off by one or two). One country not included is Vietnam. Another one not included is Argentina. Someone comfortable with country selection could put 90% into ACWI and put the other 10% into some combo, long or short, of the Vietnam ETF and the Argentina ETF to generate alpha. This example is not put forth as a plausible strategy but to point out that in practical sense, alpha does not have to be finite.

ACWI allocates 0.09% to Colombia. I'm not sure what Colombian stocks are in there but I know one that isn't; Cementos Argos (CMTOY). Someone who understand the Colombian cement industry could put 95% into ACWI and the rest into CMTOY at the right time and generate alpha. And again this example is not put forth as a plausible strategy but to point out that in practical sense, alpha does not have to be finite.

What if you bought a foreign stock and you were literally the only one in the United States to trade that stock and that stock went up more than the market in the time you held it, would that be alpha? This example is real, I bought a small foreign stock and based on reported volume on Google Finance (so it could be flawed) I am literally the only person who has traded it in weeks; incidentally it took Schwab less than one minute to execute it. The stock is up about 10% since I bought it versus 5% for the SPX. While I am not willing to take this type of liquidity risk for clients, is this not alpha? (Please note, that this example could be more about luck is not lost on me).

You might have read the three preceding paragraphs and said to yourself "he is ignoring the risk taken with those examples." Well, in the interview above and other ones I've read, so does Swedroe. What I mean is risk adjusted return. Depending on how it is structured, an equity portfolio that achieves a market equaling result with 10% in cash has achieved a pretty good risk adjusted result. An other example could be 75% of the market's return with only 50% of the market's risk. What about the approach Hussman takes (which I emulate up to a point) in targeting a result over the course of the entire market cycle? Another example similar to Hussman is John Serapere's 75-50 (targeting 75% of the upside with only 50% of the downside).

Swedroe's interviews strike me as being very limited conceptually. Active management means many things. And while it may not be right for many people the conversation is simply not cut and dried in the manner Swedroe frames it.

Manny? What the hell dude?
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Innovation

Yesterday I stumbled across this article at SmartMoney about an idea I mentioned a few times several years ago; buying a two family house, living on one side and renting out the other. Hopefully it is widely accepted that financial success over the next 20 years will require more ingenuity than it has over the past 20 years. This has been a (relatively) popular topic here over the years with a wide range of topics in this regard addressed.

The linked article was surprisingly thin but I think the idea has merit in certain circumstances. The strategy can be simple and obvious. While there is a mortgage, the rent from the one unit can offset some portion of the monthly payment and after the mortgage is paid off some portion can go toward your living expenses (there would be at least minimal expense in maintaining the rental unit).

The article linked above seemed to focus more on shorter term profit which would be nice but I'm not sure attempting to profit in the next couple of years is the right goal. Prices are low in many places but I don't think it would shock anyone if they went lower and I don't think it would be a shock if prices did not go meaningfully higher for a long time. That does not mean that there are not affordable situations that could be paid off in 15 years and then generate a decent cash flow as part of a retirement plan.

Strategically I would target less house than I could afford to avoid desperation when the unit is empty. The other big thing that comes immediately to mind is being handy. Among other things it would be helpful to know how to pull a toilet, know a little about plumbing that you can see (under sinks for example) and some basic electrical, surely there are a couple of other basics not coming to mind at the moment.

This is clearly not for everyone and really not even for most people but for some folks this would work very well. We all know someone who is not wealthy but ok and who is very handy. Someone like that would seem to have the best shot of succeeding with this idea. I would also note that some people are quite comfortable managing a bunch of properties which is fine for them of course the context here is relative simplicity.

The bigger idea here is innovative (even if not original) solutions that work with your lifestyle, temperament and interests. That and not buying new Shelby Super Snake Mustangs that will cost "less than $100,000." That picture is awesome though.
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One Working Dog's Dream: Pep's Story

Pep's story as published at the Best Friend's website. Pep is the dog we took up to Seattle last week....

Pep faced hardship after hardship in finding his forever home. But through the determined perseverance of a dedicated rescue volunteer, this working dog found his dream job in the most unique of places.

Pep's Story Begins

Pep's journey with United Animal Friends began in November 2010, after the energetic, intelligent Cattle Dog–Heeler mix was picked up as a stray by Animal Control of Prescott, Arizona. A striking dog, Pep lived in the shelter for two full months and was adopted out of the shelter three times – only to be returned for a slew of different reasons: dog aggression, hyperactivity, and a sudden inability of the new owner to care for him. Understandably, Pep became quite a bit frustrated by all this change. Being locked up in small, confined space just didn't suit his nature, and his frustration soon morphed into aggression towards other dogs. That's just how Pep ended up on the euthanasia list.

As a coordinator for United Animal Friends, I regularly visited the shelter and had met Pep a few times. Make no mistake; Pep was ball-obsessed and very active, but beneath all that energy was a sincere love for people. I saw him in his kennel and knew he could be a good dog; it would just take the right owner – someone who had the energy to keep up with him. So, I got Pep out of the shelter and into the UAF system. Pep went into boarding as no foster homes without existing dogs or cats (another unpleasant aspect of life for Pep) were available. Pep did relatively well in boarding and would behave for a little while at adoption events. But eventually, he would become bored and frustrated, and he'd start acting out.

Months passed, and finally, we had an interested couple fill out an application for Pep. It all looked very promising and I optimistically thought we had made a match. It was hard to advise the new couple on how Pep would behave in their home; he had never been in a foster home, so the best we could do was tell the couple about Pep's energy level and his penchant for balls. The couple seemed to take it in stride, perhaps assuming (as we did) that Pep had been in a kennel and it would just take time. Well, not much time passed before word got back to us: Pep was just too much for them to handle. His ball obsession was more than they could take – he simply never let up. Pep was returned yet again and it was back to into boarding he went.

Bonding Despite Setbacks

Throughout these troublesome times, I really bonded with Pep. I would take him on long hikes in the mountains and over time, I realized that I really loved him. But at the same time, I knew I couldn't adopt him. I consulted with another rescue person and we talked about getting him into a Search-and-Rescue program. Pep seemed to have a great amount of focus and drive, so the idea seemed like a natural one. After getting into contact with some Search-and-Rescue folks, I had them come out and evaluate him; they loved him. The problem was that they currently had other dogs in their homes so he could not be adopted by them.

A Bright Idea: The Journey Begins

Despite yet another failure, Pep and I ventured on. I brainstormed again with my rescue friend and this time, she told me about "conservation dogs." She explained that "Working Dogs for Conservation" is a program that utilizes the natural instinct of dogs to detect scat – all in the effort of identifying animals that are either endangered or invasive. It sounded great to me! I researched the organization and eventually got in touch with someone named Alice. Alice said she couldn't take Pep because she had dogs in her home already, but she suggested I contact a man named Heath with the University of Washington. I emailed Heath, who helped run the "Conservation Dogs" Program at the University of Washington's Center for Conservation Biology, and luckily, he responded to my inquiry. He sent me a couple of tests to run Pep through to see if he would be a good candidate; Pep passed all the tests with flying colors. Heath then said he was willing to try him out in their program.

The next stage of the journey for Pep meant travelling to Washington. In late March of 2011, my husband Roger and I decided to take the opportunity to learn more about the program, so we flew him up ourselves. Heath was very excited to meet Pep (Heath loves cattle dogs) and even offered up his guest bedroom for us. The Conservation Dogs facility is a brand new facility and I was impressed to see how nice and well-kept the kennels were. The setting was gorgeous with a pond just a short walk away. The Conservation Dogs program folks use the pond to exercise the dogs because it is more forgiving on their joints.

The dogs are all very loving, but just like Pep – ball-obsessed! I took this as a good sign. Most of the dogs that have come to this program were labeled (as Pep was) as dog aggressive and after being in the program and getting training all of the dogs have been able to get along and are no longer considered aggressive. Heath and his crew train the dogs with positive training methods and work the dogs 7 to 8 hours a day, which is precisely what these dogs need. They hike and bike with them in the forest and hide samples of scat for them to find. And of course, there is a LOT of ball play! Pep played ball for two hours the second day he was there and went on a hike with another dog and they got along fine.

Pep's Second Chance

So, my trip was a great success! Of course, Pep is not fully accepted into the program yet. He'll undergo more testing and training to see if he'll fit into the program. In a month or so, we will find out if he made the cut. All the program's working dogs are either adopted by their handlers, placed up for general adoption or given back to their original owners when their working years pass. By this time, the dogs are older and calmer, as they've have been able to thoroughly channel all that energy, so they're much more suited for normal dog life.

A quick update from Pep (now Pip's) new handler Heath explains that Pep is off to a great start!

Just wanted to give you a quick update on Pips first day. First off I'm pretty sure he's earned the name Pipsqueak, now we're just trying to decide if we'll shorten it to Pips, Squeaks, or Squeaker. I imagine it'll be a little of all of them. We played ball for about 2 hours after I got back this morning. He never let up. We even progressed to deep brush and covering his eyes to make him look for it. Just after playing fetch we took him on a hike with Sampson. They did great together! We then played fetch for another hour this evening.

We'll be slowly introducing him to the rest of the pack this week and see how things go. I'm delighted with how well this has turned out and to have Pips in our program. We've still got the hurdle of introducing him to odors but we'll cross that one when we get to it, for now we're just going to focus on getting him situated and having fun, not that smelling poop isn't fun. ;)

Pep's story taught me an important lesson. Working in animal rescue means you need to think outside the box. Dogs – like people – are all different; some are easy to adopt and some, like Pep, need alternative placement. The key is that we don't give up. As rescue volunteers, we are the only hope for many of these animals. And they depend on our ability to keep an open mind and persevere.

Click here for more information about United Animal Friends of Prescott, AZ.

Click here for more information about the Conservation Dogs of the University of Washington's Center for Conservation Biology.

Click here for more information about Working Dogs for Conservation.

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TFSMX

TFSMX is the symbol for the TFS Market Neutral Fund that I first mentioned in the summer of 2008 after hearing the manager interviewed on CNBC. There have been four blog posts on this fund here, here, here and here. The reason to bring it up now is that someone affiliated with the fund left a comment over the weekend on one of the posts asking if I wanted to revisit the once over I gave the fund back then.

In re-reading all four posts it is not clear why I am being asked to review the previous analysis. As I read the old posts I note the results were good but the nature of the fund appeared to be very complex and that I generally prefer simple where possible. Back then the fund had over 1300 holdings and the manager in the CNBC interview said there is a lot of turnover.

The chart is from Morningstar which I believe is the best way to chart a mutual fund because it accounts for the payouts. It captures TFSMX in dark blue against the Rydex Managed Futures Fund (RYMFX) in green (which has been my preferred choice in the space and we which we still own), the SPDR S&P 500 ETF (SPY) in yellow and the market neutral category in orange.

If you've ever used a market neutral fund, why did you use it? What were you hoping for? Did it do what you wanted when you wanted? There is no single answer for any of those questions but I think they are relevant as there are many funds in this space and they can behave differently during different market conditions.

The context that I've written about these funds is to have something that zigs when the market zags. When I wrote about RYMFX for the first time at the Street.com in March 2007 the editors actually included the words zig and zag in the title. When the market is doing poorly I hope this exposure will help avoid the full brunt of the decline and when the market is doing well then I expect nothing out of the fund. Some readers will see it the same way and some will view the role of these funds differently.

I believe the chart shows some of what I mean. The start date is the day that I first wrote about the fund. In one of the subsequent posts I noted the drop in TFSMX in the second half of 2008 and said that the decline would have been a disappointment for certain expectations including mine. As the market headed lower in 2008 RYMFX went up and TFSMX went down with the market; less than the market but at the same time as the market. Per the Morningstar chart $10,000 invested in TFSMX on the day of the post July 9, 2008 would have shrunk to $8381.01 by November 30, 2008 versus $9703.22 for the market neutral category and $10, 582.19 for RYMFX. For the effect I am seeking that would have been a very disappointing result had I owned TFSMX.

Over the longer term, like since July 9, 2008 through to today the fund has had about the same return as SPY but with a much smoother ride and over that same almost three-year period it has done much better than RYMFX. Someone looking for more of an equity-like result over a few year period but with a smoother ride would probably be pretty happy with TFSMX.

I think I've been clear since I started writing about this type of fund that I prefer a low correlation-zigzag effect not a muted equity proxy. Clearly TFSMX is a better muted equity proxy but for my money RYMFX is the better tool as part of a defensive strategy.

The picture, totally unrelated to this post, is from nearby. We have an actual road to nowhere here in Prescott (it is supposed to connect to another road eventually).
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